Denmark: Staff Report for the 2018 Article IV Consultation

2018 Article IV Consultation-Press Release and Staff Report


2018 Article IV Consultation-Press Release and Staff Report

Recent Developments

The Danish economy continues to enjoy solid growth and job creation. Inflation remains subdued and wage growth is aligned with productivity growth. The fiscal position continues to improve. House prices are still trending upward, with emerging signs of overvaluation in urban areas. Credit growth is modest, yet the level of household leverage and the current account surplus remain elevated.

1. The Danish economy is on an upswing and the output gap has closed for the first time in a decade. GDP growth in 2017 was 2.2 percent, higher than the average 1.3 percent rate recorded over 2010–15. Growth is broad-based, driven by private consumption and investment, supported by easy financial conditions, appreciating household assets (led by housing) and employment gains. The contribution from net exports was also positive, sustained by the rebound in global activity and the improved outlook of trading partners. Nevertheless, the external demand picture is slightly distorted by a one-off overseas payment for the use of a Danish-owned patent, which accounts for the bulk of the contribution from net exports. The output gap is estimated to have closed in 2017.


Contributions to Real Growth and Output Gap

(Percentage points, yoy percent change)

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Sources: Statistics Denmark and Fund staff calculations.

2. The labor market has recovered in line with the upswing and shortages have appeared in some sectors. Employment and participation rates continue to rise reflecting past pension and labor market reforms and the gradual integration of migrants (Figure 2). The employment rate has risen from its 2014 lows to close to 75 percent, while the unemployment rate has declined to its lowest post-crisis level (around 5 percent). The labor force expanded to 80 percent of the working-age population, with gains since 2013 roughly evenly split among people 60+ years old, foreigners employed in high-skilled jobs, and refugees and migrants (see survey). Labor shortages are rising and are being increasingly reported as a limitation to production, particularly in services and cyclical sectors, such as construction. Job vacancies have continued their upward trend and wage growth is aligned with productivity growth, albeit subdued.


Labor Force Shortages

(End of previous month, percent of respondents, 3-month moving average)

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Source: Statistics Denmark (Business Tendency Survey).

3. Inflation remains subdued despite the economic rebound. In 2017, average inflation edged to 1.1 percent after hovering near zero for much of 2016. In March 2018, harmonized headline inflation (HICP) declined to 0.5 percent, accentuated by base effects, some of which are temporary (for instance the decline of energy-related inflation rates). This pattern of weak inflation over the past year reflects limited domestic pressures in an environment of declining (but still available) spare capacity and low inflation globally. Subdued inflation rates span across the major HICP components, with few exceptions. Notably, services inflation has been the highest running major subcomponent of the HICP basket, having averaged over 2 percent in the last six months. However, goods inflation remained stuck in negative territory (-0.7 percent yoy) and imported inflation is currently negative, partly because of krone appreciation over the last year (by about 3 percent on an effective basis). Past labor market and pension reforms are resulting in an expansion of labor supply, alleviating wage and inflation pressures.


Harmonized Inflation Rate

(Percent, yoy, sa)

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

4. The fiscal position continues improving and public debt remains sustainable. The headline fiscal balance is estimated to have increased to 1.0 percent of GDP in 2017, driven by stronger than expected cyclical revenues and buoyant pension yield tax. Lower than expected public consumption also contributed to the improved balance. The structural balance is projected to decrease from 0.2 to 0.1 percent of potential GDP between 2017–18. The projected fiscal deficit is driven by a one-off payment of early retirement contributions as part of the June 2017 agreement on more years in the labor market and rebound in public spending relative to 2017.1 The public debt stock is estimated at 35.5 percent of GDP in 2017—well below the Stability and Growth Pact (SGP) benchmark.


General Government Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Sources: IMF World Economic Outlook and Fund staff calculations.

5. Property prices continue rising with emerging signs of overvaluation in urban areas. Property prices have been rising steadily across Denmark, averaging 4.6 percent in the first three quarters of 2017, and continuing to run well above inflation. Recent analysis suggests that house valuations for Denmark as a whole are consistent with fundamental factors including, supply conditions, demographics, disposable incomes, and mortgage interest rates.2 However, prices for flats and houses in large urban areas, where households with total debt above four times their income tend to be more common, have risen considerably faster than the national average. Notably, average property prices in Copenhagen have risen by almost 11 percent in the first three quarters of 2017, and property prices in cities tend to be either close to (Aarhus) or even exceed (Copenhagen) their pre-crisis peaks (Figure 4). As a result, valuations in major urban areas appear to be more stretched, particularly in segments where demand is especially strong (e.g., apartments).

6. Credit growth is subdued, yet household debt is high. Nominal private sector credit grew by 2 percent in 2017, marginally higher than in the previous two years. Credit to households grew by 3 percent on the year to rise to 136 percent of GDP, and nonfinancial corporate credit rose by 1 percent in 2017 to 104 percent of GDP. The ratio of household debt to disposable income at 272 percent has fallen from its 2010 peak, but it remains the highest in the OECD.


Private Sector Credit

(DKK, billion; and percent on right axis)

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Source: Danmarks Nationalbank.Note: Includes credit from banks and mortgage credit institutions, accounts payable and securities other than shares.

7. The current account surplus remains large. Denmark’s external sector surplus (7.6 percent of GDP) is driven by strong net exports and a robust primary income. Denmark’s recent high surpluses have been impacted by exports of goods produced abroad and investment income reflecting Danish firms’ increasing overseas activities and integration in global value chains. The surplus also mirrors growing private sector savings and slowdown of domestic investment since the global crisis. Staff assess the external position to be stronger than implied by medium-term fundamentals (see Annex I). Nevertheless, this assessment is subject to important uncertainties.


External Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Source: Statistics Denmark.

Outlook and Risks

8. The baseline outlook remains strong and the current account surplus should gradually decline. Growth is projected to hover around 2 percent in 2018–19, before gradually decelerating to its estimated potential rate in the medium-term. As the economy is projected to grow at above potential rates in the near term and unemployment to remain low, inflation and wages are set to gradually rise further. Activity is expected to be supported by a balanced demand composition. Private consumption is projected to remain strong in the near term, on the back of employment gains from earlier labor market and pension reforms, business confidence due to easy financial conditions, a strong housing market and a temporary fiscal relaxation.3 Investment is projected to rebound from relatively low levels, supported by favorable interest rates and the need to offset pressing domestic capacity constraints. Exports are projected to remain robust on the back of stronger external demand due to the improving outlook of Denmark’s main trading partners, but the contribution of net exports to growth is expected to stay neutral, as stronger consumption is expected to boost imports. Together with a gradual decline of household savings due to aging, these factors should put the current account surplus on a downward path. A debt sustainability analysis points to a gradually declining public debt ratio over the medium term (Annex III).

9. Risks around the outlook are broadly balanced. Upside pressures on aggregate demand could stem from consumption that has lagged the upswing but might overshoot in the presence of buoyant financial conditions and increasing asset prices. Stronger than expected global growth could underpin demand for Danish goods, possibly aggravating demand pressures. Widespread labor shortages and capacity constraints could intensify wage pressures, potentially weakening competitiveness and hindering medium-term growth prospects. Conversely, uncertainty surrounding developments in Denmark’s main trading partners—including Brexit and global trade disruptions and protectionist tendencies-could weigh on the outlook. Also, faster than anticipated normalization of monetary policy by major central banks could excessively tighten financial conditions, with possible adverse effects on aggregate demand and property prices.

10. Continued increases in high house prices combined with high gross household debt could raise macro-financial vulnerabilities over time. Highly-levered households may restrain consumption further—from the historically low current levels—in the event of house price and interest rate shocks. This includes some low-income households that are already overburdened by large mortgage payments. Given the high integration of the Nordic financial system, shocks originating in Nordic countries could impact Denmark through exposures of Danish intermediaries in the region and through constrained financing in Denmark from regional entities.

Authorities’ Views

11. The authorities broadly concurred with staff’s assessment of the outlook and risks. They expect the economic expansion to continue and agreed that the output gap has seemingly closed. The authorities observed that capacity constraints are becoming more binding, weighing on growth. The authorities viewed the risks to the outlook to be broadly balanced, with downside risks from sudden increases in interest rates and international trade tensions, but also upside risks from more buoyant household and corporate spending behavior. They broadly shared staff’s concerns about household vulnerabilities due to rising house prices and elevated leverage. The authorities agreed the current account surplus remains high, but considered it as temporary and did not see major imbalances in the economy or distortions from policies.

Policies for Sustained Growth

Policies need to boost growth and enhance macro-financial stability, while remaining vigilant against signs of demand pressures. The economic upswing and considerable fiscal space create favorable conditions to move forward with capacity-enhancing reforms. These include targeted initiatives to boost productivity, investment, and labor supply. Macro-financial vulnerabilities should be tackled through tightening macroprudential tools, combined with tax and housing supply policies.

A. Macroeconomic Policies

Fiscal Policy

12. Fiscal consolidation is set to continue despite temporary disbursements to accommodate reforms. With the 2017 headline surplus at 1.0 percent of GDP, the authorities have made faster than envisaged progress with consolidation, reflecting stronger than expected revenues and under-spending at the state level. Government spending is projected to accelerate in 2018 driven by low base effects. The 2018–2020 fiscal deficits will be pushed up to accommodate reform costs, such as tax-free withdrawal of early retirement contributions and payback of property taxes during transition to the new real estate valuation system. Additional reforms envisaging cuts in personal income taxes with the intention of boosting labor supply were diluted during the 2018 budget discussions. In the near term, the structural deficit is projected to comply with SGP rules and stay within limits of Denmark’s own budget law (½ percent of GDP). The authorities plan on continuing gradual fiscal consolidation with the objective of reaching a balanced budget in the medium-term.

Key Indicators for the General Government

article image
Source: IMF Staff calculations.

Percent of potential GDP.

13. Staff advised using the fiscal space to pursue growth-friendly policies. Boosting potential output requires further progress on structural reforms “while the sun is shining,” which may require fiscal accommodation. Therefore, while fiscal policy should remain anchored on the medium-term objective, the existing fiscal space available due to the low level of debt and prudent policies should be used to facilitate structural reforms. Increasing growth-enhancing public spending to upgrade infrastructure, improve broadband access in rural areas, and strengthen digital skills to reap the benefits from advances in artificial intelligence and automation, would support medium-term growth and contribute to the reduction of the current account surplus. On the revenue side, reduction of distortionary labor taxation would help boost labor supply and changes in corporate taxation could foster private investment (see IMF report). At the same time, the government should be prepared to arrest excessive demand pressures if needed. Built-in automatic stabilizers and gradual improvements in the underlying fiscal position driven by past labor market and pension reforms should be the first line of defense.


Tax Wedge: Denmark and OECD, 2017

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Source: OECD.

Gross Fixed Capital Formation, 2017

(Percent of general government total spending)

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Monetary Policy

14. Monetary conditions remain accommodative. The krone has been broadly stable against the euro, edging above central parity in recent months, but continuing to oscillate within a narrow range, and requiring no significant FX markets intervention since 2016:Q2. This lack of intervention is in contrast with previous years, when the central bank intervened more frequently to stabilize the currency, and reflects the absence of currency pressures.


FX interventions and the Exchange Rate


Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Sources: Haver Analytics and Fund staff calculations.

15. The central bank should remain ready to defend the peg and continue to normalize rates as conditions allow. The leading spread between Danmarks Nationalbank (DN) and ECB’s policy rate has remained unchanged at -0.25 percent since March 2016, while the negative differential between money market interest rates in Denmark and the euro area has widened slightly. US interest rates are expected to rise further vis-à-vis euro rates, which could weigh against the euro and the krone in the short-term. A gradual reduction of Danish monetary policy spreads relative to the ECB should continue as market conditions permit.

Authorities’ Views

16. The authorities highlighted complications with the use of fiscal instruments to smooth output fluctuations and argued that structural reforms would not warrant short-term fiscal easing. Legislative and implementation lags constrain the effectiveness of discretionary fiscal policy as a demand management tool, if needed on top of the already strong automatic stabilizers in the economy. Expenditure rules cover large part of the budget, with discretionary expenditure limited to capital spending and active labor market policies. The conservative expenditure growth embedded in the medium-term budget plan should help dampen demand pressures in coming years, but further fiscal tightening or other measures could be needed, if overheating risks materialize. The authorities viewed that using fiscal space through a temporary fiscal expansion to incentivize structural reforms and investment would be procyclical at the current juncture. They also found that structural reforms do not require fiscal easing and some reforms could be implemented through changes in regulation. Nevertheless, many reforms were already enacted and the sustainable fiscal position and strong employment performance seemingly reduce the appetite for major reforms. The authorities reiterated that the exclusive objective of monetary policy is to maintain the peg.

B. Financial Sector and Macro-Financial Policies

Financial Sector Policies

17. The financial system is robust and signs of increased risk-taking have emerged. Despite slow credit growth and low interest margins, credit institutions maintained strong profitability, including via greater fee income (see Table 7 and Figure 3).4 Systemwide nonperforming loans are low, although arrears for medium-sized banks are considerably higher than for Systemically Important Financial Institutions (SIFIs). Liquidity requirements, such as the liquidity coverage ratio, are comfortably met, with a proposal for treating mortgage credit institutions’ (MCIs) covered bonds as stable funding for purposes of the Net Stable Funding Ratio (NSFR) under negotiation.5 Lending surveys suggest rising appetite from medium-sized banks to relax credit standards (Figure 4). If this easing bias were to persist, it may encourage excessive risk-taking at a time of elevated financial and real asset prices. Banks are adequately capitalized, but in early 2018 the Danish Financial Supervisory Authority (DFSA) issued a public warning against excessively low IRB risk weights for mortgages in high growth areas. Recent stress tests by the central bank reveal the potential for a capital shortfall for some SIFIs (DN, 2017).6 The pension and insurance firms have adjusted their business models to the low interest rates by promoting more market-based products over guaranteed-return products.

18. Additional capital and resolution buffer requirements are set to take effect in the next few years. The government approved the activation of the countercyclical capital buffer to ½ percent of risk-weighted assets from March 2019. While this capital surcharge is not currently binding given banks’ high capital levels, it signals an intention to guard against financial vulnerabilities.7 Implementation of the Basel III minimum risk weights is estimated to increase capital requirements for Danish SIFIs by DKK 78 bn (almost 5 percent of total risk-weighted assets) or 34 percent higher than the previously-planned fully-loaded capital (expert report by the Ministry of Industry, Business and Financial Affairs). The DFSA completed the final stage of the Banking Recovery and Resolution Directive (BRRD), by setting minimum requirements for own funds and eligible liabilities (MREL) and the resolution strategy for all financial institutions from July 1, 2019. Single-point of entry resolution for SIFI groups was granted, but MCIs continue to be exempt from the bail-in central resolution tool and MREL. Instead, SIFIs are subject to a debt buffer requirement in line with the Single Resolution Board’s recommendation for a minimum 8 percent of Total Liabilities and Own Funds (TLOF).8 An outstanding item is to finalize the debt buffer requirement and resolution strategies for Nykredit, the largest mortgage lender, and DLR Kredit.9 Following an FSAP recommendation, the DFSA is establishing an independent audit function. A new Memorandum of Understanding with Nordic counterparts was signed in February 2018 to lay out coordination and cooperation principles for the exchange of information on resolution issues.

19. Staff recommended further policies to strengthen the financial system. The treatment of mortgage covered bonds for the definition of the NSFR should be consistent with long-term funding stability, irrespective of market access. The authorities should continue the dialogue regarding the debt buffer for MCIs to ensure the credibility and feasibility of resolution plans. In line with earlier FSAP advice on strengthening the independence of the DFSA, the regulator’s budget should not be subject to central government cuts. Adequate budget should be available to ensure the DFSA’s continued effectiveness. Similarly, lengthening the term of its board members can help maintain policy continuity. Staff supports the Systemic Risk Council’s broad information approach to assess systemic risk and set the countercyclical capital buffer. If risks continue to build up, additional increases of the countercyclical capital buffer would be important to enhance financial resilience. Staff recommended to continue developing key indicators to assess systemic risk, possibly including macroprudential stress tests to quantify losses due to systemic risk amplification owing to cross-sectoral and/or regional contagion.

Authorities’ Views

20. The authorities deem the financial system profitable and resilient to shocks. They expect credit institutions to meet capital requirements under Basel III rules and maintain adequate funding. The government agreed on the importance of maintaining strong bank supervision but did not see the need for lengthening the term of DFSA board membership. The authorities conducted a review of the MOUs with Nordic-Baltic counterparts, which they believe should promote effective oversight of systemic banking groups in the region.

Macro-financial Policies

21. The adverse feedback loops between housing and the real economy in Denmark are important. The centrality of housing in the Danish economy reflects at least three aspects. First, housing is a major asset of Danish households, together with pensions. Second, MCIs issue covered bonds to fund the mortgages provided to households, transferring part of mortgage risks to investors, mainly financial institutions, including pension funds and insurance companies (Figure 4). Third, because of the high real estate valuations and low interest rates, house purchases typically need to be funded via large mortgage multiples relative to disposable income. These factors help to explain why Danish households’ debt to income ratios are among the highest among advanced economies, and why consumption is sensitive to house price developments.

22. High household leverage combined with high and rising house prices could raise macro-financial vulnerabilities. There is a risk that high and still rising house prices (particularly in urban areas), the relaxation of credit standards (Figure 4), and mortgage rates near all time-lows, may increase the perception of affordability across a broad spectrum of income levels. In this environment, two types of Danish households are particularly vulnerable to shocks. First, low-income households who spend more than 40 percent of their disposable income on housing (Figure 4). Second, households who have purchased in highly appreciating and potentially overvalued urban areas such as Copenhagen (Selected Issues), where LTI ratios and credit growth are noticeably higher than in the rest of the country. These vulnerabilities are compounded by the large proportion of variable-rate and interest-only mortgages in the system.


Housing Cost Overburden by Income Group, 2016 1/


Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

1/ 2017 data for BGR, DNK, LVA, HUN, and ROU; 2015 data for TUR.Source: Eurostat.

Apartments and Houses 1/


Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

1/ Weighted average for Copenhagen and Aarhus, simple average for all. Yellow dots denote Capital region.Sources: Danmarks Nationalbank, Finans Danmark and Fund staff calculations.

23. In recent years, authorities have implemented an extensive package of policies to address rising vulnerabilities. These include diverse macroprudential policies,10 various supervisory guidance for MCIs and banks, and a reform of property taxation (Denmark 2017 Article IV report). The authorities continued building their macroprudential toolbox. Following the March 2017 Systemic Risk Council’s recommendation to limit lending via interest-only and floating-rate mortgages to high DTI households in areas with rapid housing prices growth, authorities introduced LTV restrictions. Effective from 2018, changes to consumer protection rules limit lending via interest-only and floating-rate mortgages to highly indebted households. Specifically, there are lending restrictions for households with DTI greater than 4 times and LTV greater than 60 percent: (i) the interest-rate fixation of floating-rate mortgages needs to be at least 5 years, and (ii) deferred amortization is only applicable on 30-year fixed-rate loans.

24. Coordinated policies are needed to tackle macro-financial vulnerabilities, including those stemming from excessive household leverage combined with rising house prices and affordability. Staff recognized authorities’ efforts and advocated continuing with the deployment of policies as follows.

  • Macroprudential instruments. The existing macroprudential measures should be tightened further. Staff analysis suggests that the LTV limit should be lowered from 95 to 90 percent to better protect households from house price declines. This decrease would lower aggregate consumption by about 1.5 percentage points one year after introduction, but increase it by 0.2 percentage points in a new steady-state because of lower debt-servicing costs (Denmark 2016 Article IV, Selected Issues). Thus, tightening the LTV limit would have a positive spillover by alleviating demand pressures in the near-term. DTI restrictions should be strengthened for all loans irrespective of LTV considerations. Tighter DTI limits for interest-only and adjustable-rate mortgages should also be considered to contain leverage, increase resilience, and limit the drag on consumption. Highly-leveraged households—with debt-to-income above 400 percent—should be subject to mandatory amortization.11 To encourage further reduction of interest-rate sensitivity, the DTI limit could be calibrated to account for lower risk if financing is via fixed–rate mortgages.

  • Tax policy. Mortgage interest deductibility (MID) should be reduced further than currently planned, as MID distorts investment incentives and incentivizes leverage (Gruber, 2017). During the transition period to a lower mortgage deductibility regime, the current low rate environment would mitigate the adverse impact on homeowners. Also, fiscal savings from this measure could be used to reduce labor tax burden.

  • Housing supply. Restrictions on the size of new apartments should be relaxed in urban areas where demand-supply imbalances appear to have been a factor pushing valuations higher. Simpler and more streamlined zoning and planning processes would allow housing supply to respond to increases in demand without steep price increases. Rent controls are among the highest in the EU and should be reduced to incentivize the rental market and alleviate demand for housing. Below-market rents limit the incentive to supply rental units, and incentivize the purchase of housing, adding upward pressure to property prices. Upgrading public and transport infrastructure—especially around inner-city areas experiencing strong house price growth—would help mitigate house prices pressures.

Authorities’ Views

25. The interaction between high household leverage and rising house prices poses macro-financial risks. Authorities indicated that household resilience to interest rate increases likely improved as more homeowners had shifted towards fixed rate mortgages and longer fixing periods. But if risks continue to build up, the DN sees scope for tighter LTV limit, higher countercyclical capital buffer, amortization requirements and reduction of variable-rate loans. The government argued that additional measures would require further analysis of the effects on the housing market and the overall economy. The government considers unlikely that mortgage interest deductibility will be reduced beyond the planned gradual decline ending next year, and noted that mortgage interest deductibility should take into account balances towards other capital taxation rates.

C. Structural Policies

Labor Market

26. The labor market continues to improve and wage flexibility facilitates labor allocation. Supported by strong economic activity and recent reforms, employment and labor force participation rates have increased, while unemployment dropped (Figure 2). The wage formation is responsive to domestic and external conditions, and wage growth is in line with long- and short-term determinants (Annex II).12 Denmark’s flexible sectoral wage setting provides greater efficiency gains in labor allocation compared to other economies.


Danish Nominal Wage Growth and Model Fits 1/

(Percent; y/y; SA)

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Sources: Statistics Denmark; Eurostat; IMF WEO; and Fund staff calculations.1/ Total economy wages and salaries. See Appendix I for details.

Sectoral Wage Differentiation 1/

(Percent; 1995–2017)

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Sources: Eurostat; and Fund staff calculations.1/ Standard deviation of the sectoral average wage in share of the national average wage across sectors.

27. Labor market initiatives are ongoing, but there are a few untapped labor resources. Increasing labor supply and reducing the propensity for transfers are critical for long-term sustainability of the Danish system. Earlier reforms include Phase I of JobReform, a job-premium program for the long-term unemployed, basic education, training, skill-upgrading and other active labor market policies. A more recent reform to lower taxes on labor income and increase deductions for pension contributions was introduced in February 2018, and will be fully in effect by 2020. All these have sought to increase youth labor participation, keep people in employment longer by incentivizing later retirement, incentivize benefits recipients to work and avoid inactivity traps, help more people obtain the skills to enter the workforce, and improve migrant integration. Given the already large and planned increase in the employment rate of older workers following the 2011 pension reform, there are few remaining pools for gains which involve young and migrants. The increase in youth inactivity since the crisis, demonstrates the difficulty of entering the labor market without high-level qualifications. Efforts to integrate existing migrants already in the country seem to be yielding favorable outcomes (such as the basic integration education (IGU) program), but unemployment rates for foreign-born people are 2 to 3 times higher than for native-born people (Figure 2). The high level of qualification needed to enter the Danish labor market and the relatively high minimum wage eliminate the option of “working poor” and limit the supply of low-skilled jobs thereby restraining migrants’ chances to integrate (Andersen, 2017).


Employment Rate by Age Bracket

(Percent of respective group’s working age population)

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Sources: Statstics Denmark; Fund staff calculations.

Youth Not in Employment, Education or Training

(Percent of 15–29 year olds labor force; period average)

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Sources: OECD; and Fund staff calculations.Note: For Finland the earlier period is 2003–07.

28. Participation rates of the young and migrants can be increased further. Reducing taxes on labor by increasing the ceiling for the tax brackets of low- (up to around DKK 50,000/year) and middle-income (up to around DKK 520,000/year) groups can help reduce the inactivity trap by incentivizing greater labor participation. Greater vocational and education training (VET) opportunities (such as under the recent tripartite agreement) can support the reduction in youth inactivity and give young people better chances of entering the workforce. The 2 percent annual reduction of the VET budget could be reconsidered to intensify education efforts. Denmark’s commitment to digitalization should include improved access to digital skills. Staff welcomed the launch of the Technology Pact. This should bring educational institutions and private sector together to ensure that education will reflect future demand of technical and digital needs. Programs focusing on skills upgrading would help the labor force to benefit from technological advances. More efficient use of transfers to incentivize earlier and higher youth participation in the labor market should continue to be deployed, for instance by reducing the duration of student grants and graduates’ access to unemployment insurance. Education and accreditation of foreign degrees are crucial in raising the likelihood of migrants being employed. Staff recommend to renew the IGU program which is set to lapse in 2019 upon review. Removing restrictions on employment rules for asylum seekers and allowing them to participate into activation programs as early as possible would support faster integration. Efforts to improve integration of female refugees should intensify to mitigate the gender gap.13 The government’s labor participation incentive plan for refugees is welcome. This would allow them to transition from the integration benefit to social assistance by completing 2½ years of employment in the last 10 years. Greater flexibility is needed to attract new migrants to Denmark and overcome labor supply constraints, for instance by lowering the minimum remuneration requirement (DKK417,794/year) or granting more exceptions to the pay limit scheme for residency permits under the positive list scheme.

Authorities’ Views

29. Raising labor supply further remains a priority for the authorities. The government continues to see scope for incentivizing later retirement. Ongoing work aims at underpinning the labor participation of young people and deterring the formation of long-term unemployed. Programs for refugee integration are providing encouraging signals, but lagging employment of female refugees behind their male counterparts remains a concern. The government considers policies to shrink the gender gap important.

Reforms to Boost Investment and Productivity

30. Productivity growth is subdued and investment remains below its pre-crisis level. The decline in labor productivity has mimicked developments in other advanced economies (see McKinsey report). Weak investment following the crisis contributed to the decline in capital-to-labor ratio, suppressing labor productivity growth.14 Sectoral breakdown points at weaknesses in productivity growth rates of domestically-oriented service industries and the utility sector, which together comprise about 30 percent of gross value added in the economy. Weak investment also contributed to the recent widening of the current account surplus (Annex I).

31. The authorities put in place several initiatives to boost productivity and foster investment. The Planning Act has been amended to relax retail trade regulations, removing size caps for non-grocery stores and raising them for grocery stores. Changes in the Taxi Act removed several restrictions and geographical constraints and took effect in 2018. The government established a Management Commission in 2017, which will provide recommendations on improving the quality of public management, and proposed reallocating funding to higher education institutions with the purpose of targeting degrees with relatively better employment prospects. Progress has also been made on incentivizing cooperation between businesses and universities, with the purpose of stimulating knowledge transfer and investment in R&D. A new R&D super-deduction is also being phased in. The Strategy for Denmark’s Digital Growth launched beginning of 2018 includes important public-private initiatives to improve digitalization, such as the Technology Pact, SME Digital, and Digital Hub. The Strategy also calls for agile regulatory framework aimed at supporting dynamic developments in this promising area and unleashing synergies across different partners.


Labor Productivity Growth

(Hours worked, HP-filtered)

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Sources: OECD and IMF staff calculations.

Total Investment

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Note: EU peers areAUT, BEL, FIN, FRA, DEU, LUX, NLD and SWE.Sources: Eurostat and Fund staff calculations.

Labor Productivity Growth and Contribution from Capital-to-Labor Ratio


Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Sources: Eurostat and Fund staff calculations.

Average Real Productivity Growth in Private Industries, 2006 – 2015


Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Note: Productivity is measured as gross value added (GVA) in real terms per working hour. The figure in parenthesis indicates the sector’s share in total GVA for the entire economy.Sources: Ministry of Industry, Business and Financial Affairts.

32. These reforms are starting to yield results, but additional reforms will be needed to meet the authorities’ ambitious medium-term plan. In its inaugural report on improving productivity, the Danish National Council identified areas for further reforms, drawing on recommendations of the Council, the Productivity Commission (2012–14) and other independent organizations. Competition in the services sector could be improved further by enhancing the powers of the Competition Council in relation to companies breaching regulations and exploiting their dominant market position. The Planning and Taxi Acts could be relaxed further to allow construction of hypermarkets, easing size restrictions on retail shops located in cities and towns, and reducing barriers to utilizing digital technologies (e.g., ride hailing services). Removing ownership restrictions in some parts of the healthcare sector and legal industry and making it easier to make fixed-term commercial lease agreements is also expected to be conducive to greater productivity. While Denmark scores well in European rankings of digital progress, there is scope for improvement. The Strategy for Denmark’s Digital Growth can be an important driver of productivity growth, by allowing companies to make more effective use of capital stock, improving procedures, and reducing operating costs (EC).


Digital Economy and Society Index, 2017

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Source: European Commision.

33. Improving competition and reforming corporate taxation could increase investment.

  • Competition. Further liberalization of planning restrictions in the retail sector and building regulations in the construction sector would encourage more investment in these sectors, and could also alleviate housing pressures. Further steps in enhancing collaboration between public research institutions and businesses would expand utilization of university research and encourage investment in R&D. There is also scope for further deregulation of the utilities sector (Denmark 2016 Article IV, Selected Issues, Chapter 4).

  • Taxation. Investment by startups and high-technology firms could be supported by (i) reducing the taxation of dividends,15 (ii) relaxing the restrictions on the use of losses carried forward, and (iii) making the R&D super-deduction refundable. Investment by established firms could be supported by reducing restrictions on the deductibility of business expansion costs. Corporate income tax reforms, such as the introduction of an incremental Allowance for Corporate Equity (ACE), would increase incentives to invest and reduce the debt bias (Box 1). In implementing these measures, safeguards should be taken to reduce the risks of revenue leakages.

Authorities’ Views

34. The authorities believe the level of investment is in line with the cyclical position, but concurred on the merits of boosting productivity. The post-crisis investment slowdown is by and large explained by cyclical factors. Moreover, it reflects the reduction of real estate activities from the unsustainably high pre-crisis levels and the increased share of less investment-intensive sectors in the economy, such as services. The improved macroeconomic environment and emerging capacity constraints will provide impetus to private investment going forward. There were diverging views on the use of tax policy to stimulate investment. The authorities took note of recommendations on tax reforms that would benefit small and high-technology firms, but raised concerns about effects and implementation risks, such as the need to prevent tax avoidance by owner-run businesses. They also agreed on the potential advantages of introducing an incremental ACE to reduce debt-bias and support investment, but noted the need for detailed analysis before implementing an ACE and the already intense demands on the tax administration. The authorities concur that the ongoing transformation in the global economy calls for innovative strategies to foster efficiency gains provided by digitalization.

Staff Appraisal

35. The economy is performing well but potential growth remains weak. The output gap has seemingly closed and there are emerging signs of capacity constraints. Labor shortages and rising house prices coupled with elevated debt level are important domestic risks. External environment is favorable, but also involves risks. Benign macroeconomic environment provides conditions for renewing efforts aimed at raising potential growth and bolstering financial resilience.

36. Fiscal policy should draw on existing fiscal space to support growth-enhancing reforms, while remaining anchored on the medium-term objective. Fiscal space should be used to incentivize private investment through corporate tax reforms. Increasing growth-enhancing public spending to improve broadband access in rural areas, strengthen digital skills, and upgrade public and transport infrastructure—especially around inner-city areas experiencing strong house price growth—would help boost productivity and mitigate house prices pressures. Incentives to switch from social benefits to employment would support labor supply. However, a tighter fiscal stance may be called for in case of excessive demand pressures.

37. Monetary policy should focus on maintaining the peg. Lack of foreign exchange interventions is in contrast with past years and reflects the absence of currency pressures. A gradual reduction of Danish monetary policy spreads relative to the ECB would be desirable if market conditions permit.

38. House price pressures in urban areas coupled with elevated household debt call for coordinated policy action. Tightening of existing macroprudential measures would better protect families from house price declines and higher interest rates. Taking advantage of the current low interest rates, a further than envisaged reduction of mortgage interest rate deductibility should be considered. Reduction of rent controls and relaxation of zoning restrictions would encourage more housing supply and alleviate demand for housing.

39. Banks are well-capitalized and progress was made with upgrading the regulatory framework. Banks remain profitable notwithstanding low interest rates and modest aggregate credit growth. Additional increases of the countercyclical capital buffer may be warranted if risks continue building up. The operational independence of the DFSA should be strengthened and adequate resources should be ensured for continued effectiveness.

40. Employment rates continue rising on the back of past reforms, but there are untapped resources involving mainly young and migrants. Higher youth participation in the labor market could be achieved by reducing the duration of student grants and graduates’ access to unemployment insurance. The integration of migrants could be facilitated by improving the accreditation of foreign degrees, relaxing restrictions on employment rules for asylum seekers, lowering the minimum remuneration requirement, and granting more exceptions to the pay limit scheme for residency permits.

41. Incentivizing private investment to boost productivity is a key challenge. The investment slowdown since the crisis suppressed capital accumulation, weighing on labor productivity growth. Product market deregulation efforts in retail, taxi, and utility sectors would boost competition and encourage more investment. The ongoing digitalization initiatives are also important. Capital income tax reforms in the areas of dividend taxation, losses carried forward, R&D deductions, and business asset taxation would support investment by startups and high-technology firms. An allowance for corporate equity would more generally reduce disincentives to invest and reduce the debt bias.

43. The external position is stronger than implied by fundamentals. However, this assessment is subject to large uncertainties. In recent years the surplus is increasingly driven by offshore trading activities and investment income. While the EBA model does not identify policy gaps that explain most of the excess current account surplus, structural policies that raise investment would help reduce the surplus.

44. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Tax Reform Options1

Boosting investment in startups and high-tech firms

Various measures could be taken to decrease disincentives for investment by small and high-technology companies. Most importantly:

  • The tax rate on dividends could be reduced, as the high taxation of dividends discourages equity investments in startups. Listed firms are less affected, as their marginal shareholders are likely to be pension funds or foreign investors. For small investors with little collateral, there is no alternative to equity funding, which implies a very high cost of capital for them. Lower dividend tax rates would also increase the attractiveness of profit distributions and could thereby lower corporate savings.

  • The limitations on the use of losses carried forward could be relaxed. The limitation poses a challenge for cash-constraint startups who tend to be initially loss making.

  • The treatment of the R&D deduction could be made more generous, as currently only part of it is refundable.

Improving the neutrality toward investment and the debt-equity choice

As in most countries, the current Danish corporate income tax system entails a tax preference for debt over equity, because interest on debt is deductible. The introduction of an Allowance for Corporate Equity, which allows a similar deduction on equity finance, would improve efficiency, by greatly reducing the debt bias and by reducing the cost of capital so that the corporate income tax does not discourage investment. In other words, the required pre-tax rate of return would be lowered. Such a reform would be very promising, but a careful study of administrative data to assess the long-term revenue implications is needed, as later abolition should be avoided in the interest of tax certainty.

Protecting tax bases and preventing profit shifting

As Danish anti-avoidance legislation is already very strong, only minor technical changes will be needed in response to recent international initiatives aimed at reducing profit shifting. Specifically, one of the Danish interest deduction limitation rules will need to be changed from EBIT to EBITDA to be aligned with the requirements. The practical implication is likely to be limited, as for most firms the more binding limitation is the restriction in terms of assets, which is not affected. In general, there is little need for further tightening of anti-avoidance rules, which are already stronger than in most countries. However, as new avoidance strategies keep being developed, vigilance in this area is always warranted. Digitalization poses another major challenge that may ultimately require fundamental reform, but should not lead to rushed measures or a ring-fenced approach. Moreover, international tax developments, including reforms at the European Union level could affect Denmark, and their implications should be carefully studied.

1 See Selected Issues Chapter “Capital Income Tax Reform Options in Denmark” for details.
Figure 1.
Figure 1.

Denmark: Recent Developments

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Figure 2.
Figure 2.

Denmark: Labor Market Developments

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Figure 3.
Figure 3.

Denmark: Recent Development in the Financial Sector

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Figure 4.
Figure 4.

Denmark: Recent Development in the Housing Sector

Citation: IMF Staff Country Reports 2018, 177; 10.5089/9781484362433.002.A001

Table 1.

Denmark: Selected Economic and Social Indicators, 2015–23

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Sources: Danmarks Nationalbank, Eurostat, IMF World Economic Outlook, Statistics Denmark, and Fund staff calculations.

Contribution to GDP growth.

Based on Eurostat definition.

General government.

Overall balance net of interest.

Cyclically-adjusted balance net of temporary fluctuations in some revenues (e.g., North Sea revenue, pension yield tax revenue) and one-offs.

Table 2.

Denmark: Balance of Payments, 2015–23

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Sources: National Bank of Denmark, Statistics Denmark, and Fund staff calculations.
Table 3.

Denmark: International Investment Position, 2010–17

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Sources: Haver Analytics, Statistics Denmark and Fund staff calculations.
Table 4.

Denmark: GFSM 2001 Statement of General Government Operations, 2015–23

(Billons of DKK)

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Sources: Statistics Denmark and Fund staff calculations.
Table 5.

Denmark: GFSM 2001 Statement of General Government Operations, 2015–23

(Percent of GDP)

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Sources: Statistics Denmark and Fund staff calculations.

Overall balance net of interest.

In percent of potential GDP.

One-off items relate to vehicle registration tax, pension yield tax, North Sea oil and gas revenue, net interest payments, and other special items.