Denmark: 2019 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Denmark

The solid performance of the economy continues to be supported by domestic demand and labor market pressures are gradually building.

Abstract

The solid performance of the economy continues to be supported by domestic demand and labor market pressures are gradually building.

Context

1. Denmark enjoys one of the world’s highest standards of living. Strong institutions combined with sound economic and social policies have delivered robust economic performance and high levels of social inclusion. The business climate ranks among the best in the world and education levels are high. A flexible labor market model alongside extensive active labor market policies have fostered high employment and income levels, along with low levels of income inequality. Measures of well-being suggest Danes are among the happiest people in the world (Figure 1).

Figure 1.
Figure 1.

Denmark: Context

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

2. Notwithstanding robust fundamentals, Denmark’s recent economic performance trails peers in the region. The economy was slow to recover from the Global Financial Crisis. The global recession also coincided with the puncture of a local housing bubble, which kept consumption and investment subdued for some time after the onset of the crisis. Thereafter, GDP recovered more slowly than neighboring countries, in part attributable to low productivity growth and weak investment rates. However, a steady upswing started in full in 2014.

Recent Developments

The upswing of the Danish economy continues. With GDP above potential, growth is driven by domestic demand, supported by a strong labor market. Inflation remains subdued and the fiscal position is broadly balanced. House prices seem to be softening, yet the level of household debt remains high. The current account surplus is decreasing amid higher investment.

3. Denmark’s solid performance continues, with the economy operating above potential for a third year in a row.1 Real GDP grew by 1.4 percent in 2018. The composition has shifted to domestic drivers, with robust consumption and investment supported by accommodative financing conditions and strong employment gains (Figure 2). Domestic demand grew by 2.5 percent in 2018, while net export growth was negative, partly from a base effect due to a large one-off transaction in 2017.2 The output gap is estimated to have reached 0.9 percent in 2018.

Figure 2.
Figure 2.

Denmark: Recent Developments

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

uA01fig01

Contributions to Real Growth and Output Ga

(Percent)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources; Statistics Denmark; and IMF staff calculations.

4. The labor market is strong, with pressures gradually building. Employment has increased continuously since 2013, while the harmonized unemployment rate reached 5 percent in 2018, a ten-year low and below the estimated natural rate (Figure 3). Recent reforms and the gradual integration of migrants have boosted labor supply, but capacity constraints are starting to bind, with growing reports of labor shortages. However, overall wage growth was contained at 2.2 percent, broadly in line with productivity, contributing to stable competitiveness.

Figure 3.
Figure 3.

Denmark: Labor Market Developments

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

uA01fig02

Labor Force Shortages

(Percent of respondents, 3-month moving average)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Source: Business Tendency Survey, Statistics Denmark.

5. Inflation remains moderate despite a positive output gap.3 HICP headline inflation was 0.7 percent in 2018, from 1.1 percent in 2017. Services inflation came down to 1.6 percent from a 2.9 percent peak in mid-2017, amid weak price momentum for non-tradables.4 Goods inflation recovered after several months of negative growth in 2017, as the exchange rate stabilized in effective terms in the second half of 2018. Danish inflation has been trailing that of the euro area since mid-2016, mainly reflecting lower food price inflation.

6. The fiscal stance is neutral and public debt remains sustainable. The structural balance was 0.1 percent of potential GDP in 2018, largely unchanged from 2017. While the overall balance declined, strong employment and consumption supported revenues, and lower unemployment benefits reduced expenditures. Gross public debt stood at 34 percent of GDP—among the lowest in OECD countries.

uA01fig03

General Government Balances

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: IMF World Economic Outlook; and IMF staff calculations.

7. House price growth has started to soften, but household debt is high. Property prices grew on average 3.5 percent in 2018. While prices in urban areas have outpaced the national average in recent years, they appear to be softening. Prices for owner-occupied flats in Copenhagen grew by 5.5 percent in 2018, down from 11.4 percent in 2017. The active implementation of macroprudential policies, supply increases, as well as the property tax reform, seem to be contributing to the moderation (Figure 2).5 Private sector credit growth more than doubled in 2018, rising to 3.5 percent from 1.5 percent in 2017, and above nominal GDP growth. The stock of private sector credit as a share of GDP is broadly at the level that preceded the GFC in early 2007. Aggregate credit growth masks large differences across geographies and industries. Areas with high house appreciation have experienced significant growth in mortgage lending (Figure 4). Lending to the corporate sector has been concentrated in cyclical industries. Importantly, household debt is the highest among OECD countries at 270 percent of disposable income (Figure 5).

Figure 4.
Figure 4.

Denmark: Recent Development in the Financial Sector

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Figure 5.
Figure 5.
Figure 5.

Denmark: Recent Development in the Housing Sector

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

uA01fig04

Real Property Prices 1/

(Index, 2005Q1 = 100)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: Association of Danish Mortgage Banks; Statistics Denmark; and IMF staff calculations.1/ Prices are deflated by CPI National average and Copenhagen are the weighted averages of owner-occupried flats and one-family houses nationally and in Copenhagen, respectively
uA01fig05

Private Sector Credit

(Percent of GDP; percent on right axis)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources; Danmarks Nationalbank and Haver Analytics.Notes: ncludesfinancial institutions” lending to households and non-financial corporations.

8. Denmark’s current account surplus is declining. The current account decreased from 8 percent of GDP in 2017 to 5.8 percent of GDP in 2018. The surplus continues to be driven by export of goods, including merchanting and processing, a consequence of Denmark’s integration in global supply chains. The decline also reflects a decrease in savings from 29.6 percent of GDP in 2017 to 28.5 percent in 2018 and a rise in investment from 21.6 percent to 22.7 percent. Staff assesses the external position to be moderately stronger than implied by medium-term fundamentals. While the External Balance Assessment model does not identify policies that explain most of the excess surplus, structural polices aimed at raising investment, including through a gradual improvement in capital markets, would help reduce the surplus (Annex IV). Nevertheless, this assessment is subject to important uncertainties.

uA01fig06

Current Account

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: Statistics Denmark; and IMF staff calculations.

Outlook and Risks

9. The outlook is for continued solid growth, supported by domestic demand. Private consumption and investment are expected to be the key drivers of growth, supported by healthy consumer confidence, accommodative monetary and financial conditions, and a broadly neutral fiscal stance. Wealth effects from the strong housing market will further contribute to robust consumption growth. High capacity utilization rates, as well as elevated house prices in large cities, will also promote investment. Employment gains from recently approved labor market and pension reforms are expected to continue boosting labor supply in the next few years, alleviating to some extent constraints in the labor market. With the economy above potential and low unemployment in the near term, inflation and wages are expected to gradually rise. Net export growth is projected to remain subdued, in line with a weak external environment. As a result of structural reforms, potential output growth is projected to increase from 1.4 percent in 2016 to around 1.8 percent over the medium term, with labor productivity growth picking up after years of slow progress and as capital intensity increases. This will help narrow the output gap in the medium term. A debt sustainability analysis points to a gradually declining net public debt ratio over the medium term (Annex VI).

10. Risks around the outlook are clearly tilted to the downside. A sharper than expected slowdown in Denmark’s main trading partners and/or a flareup in trade tensions could further slow export growth, especially in the shipping sector and for firms participating in global value chains. A steeper than anticipated softening of the global cycle, notably in Germany and China, could be a source of weaker external demand. A disorderly Brexit could weigh on activity in Denmark through a number of channels, including through lower trade from increased tariff and non-tariff barriers, disruptions in supply chains, and tightening of financial conditions due to confidence effects. Several U.K.-exposed sectors, including food products, chemicals, machinery, and trade and transport would be negatively affected.6 A disregard for the common fiscal rules and rising sovereign yields for high-debt countries of the euro area could spread to other European countries through confidence and trade channels.

11. High household leverage amid high house valuations is a key source of macro-financial vulnerability. While overall house prices seem to be softening and households continue to switch to loans with higher amortization and lower interest rate risk, more than a decade of high price increases has left some households highly indebted, particularly in urban areas. These are especially vulnerable to housing price and interest rate shocks. The deep integration of the Nordic financial system leaves Denmark exposed to shocks originating in other Nordic countries. The ongoing money laundering case involving Denmark’s largest bank could further impact confidence in the financial sector and undermine financial stability.

Authorities’ Views

12. The authorities broadly concur with staff’s assessment of the outlook and risks. They expect the strong economic expansion to continue and the output gap to remain positive over the medium term as domestic demand remains healthy. They view external risks, due to Brexit and trade tensions, tilted to the downside, but note that the Danish economy has sufficient buffers. Domestic risks are on the upside with buoyant consumption and investment. They recognize staff’s concerns about macro-financial vulnerability due to elevated household debt.

Policies for Sustained Growth

Policies need to boost potential growth and enhance macro-financial stability. The continued solid economic performance calls for a neutral fiscal stance, while supporting capacity-enhancing policies tailored to boost labor supply, productivity and investment. Macro-financial vulnerabilities should be addressed through enhancing the macroprudential toolbox, combined with tax and housing supply policies. Efforts to strengthen cross-border anti-money laundering supervision should continue.

A. Macroeconomic Policies

Fiscal Policy

13. Fiscal policy is envisaged to remain broadly neutral over the medium term. The structural position is projected to remain close to balance, above the fiscal framework deficit limit of ½ percent of GDP. A relaxation of the overall budget balance is planned—consistent with a prudent use of existing fiscal space—amid accommodation of ongoing structural reforms. The fiscal balance is expected to turn into a small deficit of -0.1 percent of GDP by 2021, from 1.4 percent in 2017. Higher deductions for pension contributions will compensate for the increase in retirement ages and a partial refund of property taxes will support the transition to a new real estate valuation system. General government revenues and expenditures will be reduced in structural terms. Staff welcomes the planned increase in public investment to 3.5 percent of GDP, higher than the 3.0 percent average since 2000. Gross debt and gross financing needs will increase to around 40 percent and 7 percent of GDP respectively in the medium term as the central government takes a more active role in the financing of social housing (Annex VI).7 Net debt however will continue to decline as a share of GDP, as higher assets will match the increase in liabilities.8 Staff assesses that Denmark has substantial fiscal space over the medium term, but long-run sustainability hinges on continued implementation of pension reform.

uA01fig07

Fiscal Balances

(Percent of potential GDP)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: IMF World Economic Outlook; and IMF staff calculations.
uA01fig08

General Governement Expenditures

(Percent of potential GDP)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: Haver Analytics; and IMF staff calculations.

14. The fiscal stance should remain neutral, while letting automatic stabilizers operate fully in case of shocks to aggregate demand. With the economy operating above potential, a neutral fiscal stance would allow to comfortably support ongoing reforms—as envisaged in the latest medium term projections, while helping to protect buffers in the short term in case adverse shocks were to materialize given substantial downside risks to the outlook. In the long term, the ageing population is projected to increase healthcare costs quite substantially, also calling for fiscal prudence. 9 Additionally, the significant decline in the current account surplus and projected increases in investment and consumption undermine the case for fiscal loosening. In case of shocks to aggregate demand, Denmark’s strong automatic stabilizers should operate fully. In the event of a severe downturn, additional temporary loosening should be considered, while remaining anchored to the medium-term objective.

uA01fig09

Automatic Stabilizers, 2014

(Government balance response to 1 percent increase output gap)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Source: Mourre, Astarita and Princen (2014).

15. Efficiency-improving reforms that cover both revenues and expenditures should continue. These could be implemented in a fiscally-neutral way or calibrated to provide stimulus if loosening is warranted. Recent cost estimates provided by the OECD suggest these reforms appear feasible (Table).

  • On the revenue side, reducing high marginal and participation tax rates could promote labor supply (Section C). Tax incentives for pension savings could be rationalized while the Mortgage Interest Deductibility (MID) could be further reduced. This could help slow households’ large balance sheet expansion and reduce maturity mismatches from high pension savings and large mortgage debt (Section B). The introduction of an incremental Allowance for Corporate Equity (ACE) would increase incentives for firms to invest and reduce the debt bias (Section C).

  • On the spending side, increasing public investment to upgrade infrastructure and broadening R&D support to more firms could also be considered (Section C).

  • Staff welcomes the ongoing review of the budget law. This offers an opportunity to ensure adequate flexibility in setting the structural deficit limit, while maintaining the medium-term objective of budget balance. The use of performance budgeting could be expanded and improved.10 Ensuring public sector compensation is better linked to performance could help improve resource allocation and boost productivity growth (Danish Productivity Commission 2013).

uA01fig10

Marginal Effective Tax Rates by Earnings Level

(Percent, 2018)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: OECD Taxing Wages and IMF staff calculations.Notes: Averages by income level taken over family types. Calculations exclude social security contributions.

Illustrative Costing of Proposed Structural Fiscal Reforms

article image
Source: OECD 2019; IMF staff calculations.Notes: The table reports estimated impacts of selected recommendations. The effects of the proposed ACE and MID are estimated over a five to ten year horizon. The MID would be reduced to a uniform rate of 25 percent from about 33 percent for expenses below DKK 50,000. The proposed increase in public investment would bring the projected level in 2019 to the highest level of public investment recorded in the last ten years.

Monetary Policy

16. Monetary conditions have remained accommodative so far. The Danish krone recently weakened against the euro, after a period of broad stability since early 2017. This likely reflected, around the time of exchange pressures, expectations of a relative tightening of monetary policy in the euro area versus Denmark, as indicated by future swap rates. Despite remaining within the Exchange Rate Mechanism (ERM) band, these pressures prompted two successive interventions in December 2018 and January 2019 that strengthened the krone. The deferral of policy normalization announced by the ECB in early March 2019 has not resulted in appreciation pressures on the krone so far. The policy spread between Danmarks Nationalbank and the ECB has remained unchanged at -0.25 percent since March 2016, while negative differentials in money market rates have widened slightly.

uA01fig11

FX Interventions and the Exchange Rate

(LHS: Bln. DKK;RHS: percent)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: Haver Analytics; and IMF staff calculations.
uA01fig12

Policy Rate Differential with the European Central Bank

(Percent)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: Danmarks National bank and ECB.

17. The fixed exchange rate policy has served Denmark well; thus, the objective of monetary policy should remain to preserve the peg. The policy provides a framework for low and stable inflation in Denmark. Thus, the central bank should stand ready to defend the peg when faced with currency pressures using foreign exchange interventions and changes in the policy rate as deemed necessary. Such situations could include possible appreciation pressures from monetary accommodation by the ECB—in the event of a no-deal Brexit or due to ECB’s deferral of policy normalization—or depreciation pressures—in the event of a large confidence shock originating from the ongoing money laundering case.

Authorities’ Views

18. The authorities consider that fiscal policy should remain broadly neutral. They concur with staff that Denmark’s strong automatic stabilizers would help dampen shocks to aggregate demand. However, they see limited scope for discretionary fiscal loosening to respond to shocks. The authorities did not have a view on whether the ongoing review of the budget law would result in major changes to the structural deficit limit. The authorities reiterate that the exclusive objective of monetary policy is to maintain the peg. The fixed-exchange-rate policy provides a framework for low inflation in Denmark.

B. Financial Sector and Macro-Financial Policies

Financial Sector Policies

19. The banking system remains profitable, liquid, and solvent. While profitability has decreased, it remains solid despite slow credit growth, low interest margins, and the introduction of IFRS 9.11 System-wide non-performing loans (NPLs) remain low but vary across medium-sized banks and systemically important institutions (SIFIs). Danish banks’ liquidity coverage ratio is comfortably above the current minimum requirement of 100 percent (Figure 4). Banks have ample capital buffers as confirmed by the 2018 European Banking Authority (EBA) and the Danish central bank stress tests (ST).12

20. However, pockets of vulnerabilities remain. Lending surveys suggest that some banks are relaxing credit standards for corporate loans. The ongoing money laundering case could undermine financial stability. Higher expenditures for anti-money laundering (AML) controls and increased cost of funding—due to increased risk perception—have already impacted Danske Bank’s profitability, stock price and default probability.13 Additional negative developments related to money laundering could potentially raise competitiveness concerns and further affect confidence in the broader financial system. Close interlinkages across the Nordic financial system expose banks to regional spillovers as the temporary (end-2018) increase in systemic risk measures, such as joint default probabilities of banks in the region, suggest.

uA01fig13

EBA Stress Test Results: Capital Ratios In Adverse Scenario

(End 2020, in percent)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Source: European Banking Association.
uA01fig14

Systemic Risk Indicator for Nordic Banks 1/

(Percent)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: Bloomberg; and IMF staff calculations.Note: 1/ Sample includes Danske Bank Nordea, SEB, Swedbank DNB and Handelsbanken. 2/ JPoD reflects the probability of all banks in the sample becoming distressed.
uA01fig15

Danske Bank: Marginal Contribution to Systemic Risk

(Percent, Ratio)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: Bloomberg; and IMF staff calculations.1/ Measures the expected shortfall which represent the extreme loss to the system that occurs with a probability of one percent (or less). 2/ Measures Danske’s assets relative to sum of assets of banks in the sample. 3/Ratio above one indicates that contribution to systemic risk is higher than banks relative assets.

21. Denmark’s financial regulatory framework has been strengthened and additional capital buffers are being built. The Danish Financial Supervisory Authority (DFSA) completed the final stage of the Banking Recovery and Resolution Directive (BRRD).14 Banks are now subject to MREL requirements, while Mortgage Credit Institutions (MCI) are exempted (DN 2018) but must hold a debt buffer.15 The Systemic Risk Council (SRC) recommended raising the countercyclical capital buffer (CCyB) from zero to 1½ percent by June 2020, amid risk build-up related to the low interest rate environment.16

22. Additional policies can support the resilience of the financial system. If risks continue to build up, a combination of micro and macroprudential tools should be used to increase buffers, including revisions to risk weights, Pillar 2 requirements, the SIFI and capital conservation buffers, in addition to the CCyB. To improve the calibration of tools and support financial stability surveillance, staff recommends further refining frameworks to assess systemic risk. These should include macroprudential stress test to quantify losses due to contagion across MCIs, the pension and household sectors. Extensions to estimate losses due to contagion across banks in the region should also be considered.

23. The Danske Bank case has attracted international scrutiny of Denmark’s cross-border AML/CFT supervisory regime. The possible laundering of approximately €200 billion in transfers through Danske Bank’s branch in Estonia has affected confidence in the Danish financial sector and attracted international scrutiny of the country’s cross-border AML/CFT supervision.17

24. The authorities should build upon their recent efforts to strengthen cross-border AML/CFT supervision. Financial groups are now required to implement group-wide programs to counter money laundering and terrorist financing (ML/TF). Additional resources have been allocated to the DFSA, and it now has the power to revoke a financial institution’s license in response to gross violations of AML/CFT requirements. The priority next steps are to: (i) develop a comprehensive institutional risk assessment model; (ii) increase the depth of the DFSA’s AML/CFT on-site inspections; (iii) further expand its sanctioning powers, including to issue administrative fine notices; and (iv) strengthen regional and international cooperation.

25. A decision on banking union participation should carefully assess costs and benefits given Denmark’s unique characteristics. A 2015 report concluded that participation was in Denmark’s interest but some areas required further clarification and review of experience before a final decision could be made. A committee was established in July 2017 to follow up with a final report expected by fall 2019. The decision involves assessing how participation would change bank supervision and resolution and whether the overall effects are beneficial for Denmark. For example, ultimate bank oversight would be transferred to the ECB and the Single Resolution Board; home-host issues vis-à-vis banking union members would be reduced; supervisory and resolution resources from the Single Supervisory and Resolution Mechanisms would be available. The treatment of Danish specificities, such as MCIs, the practice of resolution for small-to-medium banks and banks in Greenland and the Faroe Islands (part of the Kingdom of Denmark but outside the EU), may need to be clarified. The current structure of the banking union and its prospects for change must also be considered. Banking union participation will ultimately be a political decision, reflecting the Danish authorities’ judgement on its consequences for Denmark, including its financial stability and position within the EU (Annex II).

Authorities’ Views

26. The authorities assess the financial system to be sound and resilient to economic downturns but are closely monitoring the build-up of risk. Authorities agree that credit standards for corporate lending are deteriorating. Should risk continue to build up they expect that the Systemic Risk Council will recommend further increases in the CCyB. In such a risk scenario, the Danmarks Nationalbank (DN) agrees with the need to increase buffers, including through a combination of micro- and macroprudential tools. Authorities agree that the ultimate decision on banking union participation will require a political judgment. The authorities underlined that several initiatives have been taken to strengthen the AML/CFT framework. They welcome the forward-looking perspective of Staff’s assessment and reaffirmed the broad consensus to continue aiming for Denmark’s AML/CFT supervisory regime to be among the best in Europe.

Housing Market

27. The housing market plays a vital role in Denmark, reinforcing macro-financial linkages. High mandatory pension contributions and household savings have created a pension system that has facilitated the development of the world’s largest covered bond market in percent of GDP. Insurance companies, pension funds, and foreign investors are among the largest holders of covered bonds, which are issued by MCIs to fund household mortgages (Figure 5).18 Thus, housing asset exposures interlink MCIs, pension funds, insurance, foreign investors, and the household sector. Hence, shocks to real estate may impact negatively households’ financial and non-financial assets, hindering consumption; thus, reinforcing macro-financial linkages (SIP 2018).19

28. High household leverage amid high house valuations remains a key source of macro-financial vulnerability. High house prices, a favorable tax treatment, and easy access to low-cost borrowing incentivize the funding of housing with large mortgages. These factors explain why Danish households’ debt-to-income ratios are among the highest in advanced economies. Large liabilities are counterbalanced by large assets (housing and pension). However, high gross debt, combined with illiquid assets (concentrated in real estate) expose households to price and interest rate shocks that can impact asymmetrically their balance sheet. Two types of households appear particularly vulnerable. Households who have purchased in potentially overvalued urban areas (SIP 2018), where loan-to-income (LTI) ratios and credit growth are higher than anywhere else. And low-income households who spend a significant share of their income on housing. These vulnerabilities are compounded by the large proportion of variable-rate and interest-only mortgages in the system (Figure 5).20

29. Recent developments are encouraging but further action is needed. Staff welcomes the comprehensive suite of policies that have been implemented in recent years. These include policies targeting households and financial intermediaries in the form of macroprudential policies (SIP 2018), supervisory guidance for MCIs and banks, and a reform of property taxation (IMF 2017). While overall house prices are softening and households are switching to loans with higher amortization and lower interest rate risk, staff advocates further deployment of coordinated policies to address remaining vulnerabilities.

30. Macroprudential instruments. In an economy with elevated house prices, rules targeting loan-to-value (LTVs) become less binding. Thus, increased focus on income-based measures, including debt-to-income (DTI), loan-to-income (LTI) and debt-service-to-income (DSTI) might prove more effective in addressing high leverage and encourage faster amortization. Staff welcomes rules implemented in 2018 to limit lending via interest-only and floating-rate mortgages to highly-indebted households.21 However, authorities could strengthen DTI restrictions for all loans, irrespective of their loan-to-value ratios. Tighter limits on income-based measures for interest-only and adjustable-rate mortgages should also be considered, while calibrating limits to these measures for lower risk groups—first-time home buyers and low-levered households—and where financing is via fixed–rate mortgages.22 Highly-leveraged households—with debt-to-income above 400 percent—should be subject to mandatory amortization, irrespective of amortization periods (SIP 2018).

31. Macroprudential framework. A review of the efficacy of policy implementation is encouraged, including a review of institutional arrangements (Annex V). The process followed by the SRC to arrive at a recommendation can take too long, potentially hindering implementation. Given that the decision-making power lies with the government, there is a risk that political considerations could delay the consensus process that tends to form the basis of such recommendations (FSAP 2014). Experience from other countries indicates that improvements in timeliness can be achieved by assigning independent authorities a macroprudential mandate which includes legal powers to implement macroprudential policy with corresponding transparency and accountability requirements.

32. Tax policy. Tax treatment of owner-occupied housing is very favorable compared to other savings vehicles and most OECD countries.23 MID should be reduced further, taking advantage of the current low rate environment. To incentivize homeowners to swap risky mortgages, MID could be made conditional on amortizing and/or fixed rate mortgages. Balancing tax incentives for pension contributions could release resources for larger down-payments; thereby reducing household leverage.

uA01fig16

Marginal Effective Tax Rates Across Asset Types, 2016

(Percent)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Source: OECD.

33. Housing supply. Rent controls in Denmark, among the highest in advanced economies, should be reduced to stimulate the rental market, while protecting the interest of the most vulnerable. Restrictions on the size of new apartments should be relaxed in urban areas to improve demand-supply mismatches. Upgrading of public transportation could relieve house price pressures around fast-growing urban centers. Streamlined zoning and planning procedures across municipalities could increase supply, thereby alleviating price pressures.

uA01fig17

Rent Control 1/

(Scale 0–6, increasing in degree of control)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: Geng (2018); OECD; Cuerpo et. al. (2014)1/ The indicator is a composite indicator of the extent of controls of rents, how increases in rents are determined and the permitted cost pass-through onto rents in each country.
Authorities’ Views

34. Authorities agree that macro-financial risks stemming from the interaction between high household leverage and high house valuations should be followed closely. Authorities indicate that household resilience to interest rate increases likely improved as more homeowners continue shifting towards fixed rate mortgages and longer fixing periods. They also welcome the recent softening in apartment prices. The authorities argue that additional measures would require further analysis of the effects on the housing market and the overall economy. Authorities see the macroprudential framework as well functioning including the timeframe for the CCyB implementation and SRC’s independence. The DN notes that the long-term success of the framework depends on policy-makers’ continued implementation of the SRC’s recommendations.

C. Structural Policies

Labor Market

35. The labor market continues to improve owing to the success of past policies. Supported by reforms and strong economic activity, employment and labor force participation rates have increased, while unemployment has dropped below the structural rate. Overall, wage growth remains moderate and in line with productivity, although there seem to be misalignments in some sectors.

uA01fig18

Unemployment Rate

(Percent of labor force)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: Statistics Denmark; OECD; and IMF staff calculations.
uA01fig19

Wage and Productivity 1/

(Y/Y percent change, 3-mma, 2018)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: Haver analytics; and IMF staff calculations.1/ Both wage and labor productivity growth are nominal. Labor productivity growth equals growth in real labor productivity plus growth in the sector’s deflator.

36. Increasing labor supply is critical for the long-term sustainability of the Danish system. Policies have been designed to keep people in employment longer, incentivize labor participation, avoid inactivity traps, upgrade skills, and improve migrant integration. Earlier reforms include the 2011 pension reform, which has increased the employment rate of older workers by linking the statutory retirement age to life expectancy. More recent initiatives include the 2018 tax reform that increased deductions for pension contributions. To incentivize labor participation, JobReform imposed tighter work requirements for social assistance, while the 2018 tax reform lowered taxes on labor income. The government recently agreed on initiatives to increase enrollment and completion rates of vocational education and training (VET) programs (Denmark’s National Reform Programme 2019). Measures (e.g. 2017 tripartite agreement) were introduced to ensure that skills demanded by businesses are supplied as the labor market evolves. To promote labor market participation of refugees, a basic integration education (IGU) program was launched in 2016.

uA01fig20

Denmark: Employment Rate by Age Groups

(Percent)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Source: Haver Analytics.

37. While these initiatives are bearing fruit—participation rates have increased, and the long-term unemployment rate has declined—challenges remain. Denmark has one of the lowest average work hours among European countries. While this reflects to some extent social preferences, Denmark also has high labor tax rates, which can weaken incentives to work. Youth inactivity has increased since the crisis due to the high bar of entering the Danish labor market. Skill shortages are increasing and access to skilled foreign labor remains cumbersome. While programs for labor market integration of refugees (e.g. IGU program) seem to be yielding favorable outcomes, lagging unemployment of female refugees remains a concern. Overall, gender gaps have narrowed but significant challenges remain, for instance the share of women in management positions is one of the lowest among the OECD countries (Kleven, Landais, and Søgaard 2018; OECD 2019). Public childcare provision services tend to be limited outside regular working hours. Women tend to bear a larger burden of primary childcare, including maternity leaves (OECD 2019).

uA01fig21

Participation Tax Rate, Average Wage

(Share of earnings lost to higher taxes and lower benefits, 2018)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: OECD Tax-Benefit model; and IMF staff calculations.
uA01fig22

Annual Hours Worked Per Worker

(Units, 2017)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Source: OECD.
uA01fig23

Youth Not in Employment, Education or Training

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

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources; OECD and IMF staff calculations.

38. A comprehensive tax and benefit reform could increase labor supply. Increasing reliance on in-work benefits and improving targeting to lower-income workers would help alleviate inactivity traps and improve youth employment. Reducing marginal tax rates for average income earners would increase hours worked. Staff analysis suggests that a reform of this type, even when implemented in a revenue-neutral way, could have a significant positive impact on employment rates, hours worked, and the level of output (Annex I).

39. Policies to improve employment in knowledge-intensive sectors, better integrate migrants, and reduce the gender gap should be considered. There is a clear scope to increase employment in knowledge-intensive sectors (KIS). However, labor market institutions should adapt to cope with transformation to KIS and to counter inequality growth (Annex III). Policies should continue to encourage education in fields of high demand, including technical and digital skills (Technology Pact), which would ensure that the right skills are in place and help workers face the future of work (Disruption Council). Staff welcomes the continued budgetary support for VET as it would support the effort to align skills to future labor demands as well as facilitate youth employment. Staff recommends streamlining the accreditation of foreign degrees to raise the likelihood of migrants being employed. Lowering minimum remuneration requirements for residency permits via the pay limit scheme and clarifying conditions for continued residency for occupations on the “positive list” should help attract skilled foreign labor.24 Staff welcomes the renewal of the IGU program. Efforts to improve integration of female refugees remains a priority. To close the gender gap, flexibility in the provision of childcare services should be increased and incentives for a more equal split of parental leave could be considered.

Authorities’ Views

40. Raising labor supply further remains a priority for the authorities. There is recognition that labor supply could be further increased through tax reforms, notably by using targeted in-work benefits and reducing marginal tax rates. They consider that policies to encourage education in fields of high demand are important, especially in the face of automation. Authorities agree with the need to better integrate migrants and attract foreign labor. They generally consider policies to shrink the gender gap important, including for female refugees, but some pointed out the importance of political consensus to introduce additional measures.

Reforms to Boost Investment and Productivity

41. Productivity growth remains weak. As in many advanced economies, Denmark’s overall labor productivity growth has been weak in recent years. This is in part due to weak investment after the crisis (SIP 2018); although recent revisions of national accounts lifted investment-to-GDP by 0.7 percentage point in 2017. Productivity growth was weak in less knowledge-intensive service industries such as trade, transport, food and accommodation, but stronger in knowledge-intensive services (Annex III).

uA01fig24

Denmark: Gross Fixed Capital Formation

(Percent of GDP, current prices)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Sources: European Commission; Eurostat; and IMF staff calculations.
uA01fig25

Labor Productivity Growth, 2000–2015

(Percent)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Source: OECD.

42. Denmark has taken important steps to increase productivity growth and foster investment. The government’s business-oriented policy focuses on six areas including digitalization, qualified labor, venture capital, cost of doing business, competitiveness, and good conditions for investment (Ministry of Industry, Business and Financial Affairs 2018). The digital growth reform package, introduced in early 2018, provides legislative support for digitalization. The launch of the Digital Hub Denmark, the Technology Pact, the Danish National Strategy for Artificial Intelligence, and expansion of public-private partnerships provide incentives for adopting new technologies, particularly in SMEs. Measures were also implemented to foster cyber security. Equity savings accounts to ease investments in stock markets as well as a tax deduction for households investing in unlisted SMEs were introduced. Additionally, the tax deduction for R&D expenditures will be gradually increased from 100 percent to 110 percent in 2026. The Danish Growth Fund was set up as a one-stop shop for access to finance entrepreneurs, while the Innovation Fund facilitates subsidies for innovation and R&D.

uA01fig26

Denmark’s Business-Oriented Growth Policy

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Source: Danish Government “Report on Growth and Competitiveness 2013”.

43. But further measures can be taken.

  • Support broad-based innovation. Aggregate R&D spending is high but concentrated among a few large firms. Thus, R&D deductions could be tailored to incentivize a larger spectrum of firms, especially SMEs. The R&D super-deduction could be made more generous as currently only part of it is refundable. Collaboration between universities and businesses could be promoted further.25

  • Improve the institutional framework for competition. Denmark’s competition framework is generally in line with international best practice, but the structure for enforcement and determination is more complex than in other EU countries (OECD 2015).26 While authorities are working on implementing the European Competition Network directive (ECN+)27, they should aim for a simple and efficient framework that gives them greater power to use administrative instruments. 28 Staff welcomes the agreement entered by the government in April 2018 designed to ensure fairer and more equal competition between public and private bodies.

  • Foster the environment for high productivity sectors to expand. KIS exhibit high productivity growth; thus, expanding these sectors is important to raise productivity (Annex III). Policies to increase ICT investment and ensure that labor adapts to the future of work (Labor section) are needed so that high productivity-growth sectors continue expanding while mitigating potentially disruptive effects on workers.

44. Improving access to finance and rebalancing taxation will increase investment:

  • Upgrade capital markets. While capital markets appear well developed, they are dominated by few large firms. The equity market for SMEs and the number of initial public offerings is relatively small in Denmark (Copenhagen Economics 2018). Better access to equity finance would improve funding options for new and smaller firms that might be subject to credit constraints due to lack of collateral. Reviewing regulation for pension funds to provide further incentives for investments in domestic equity markets while ensuring adequate risk practices should be considered. Ensure that adequate resources are available for vehicles like the Danish Growth Capital Funds, by which pension sector and public resources are invested in entrepreneurs and SMEs. Staff welcomes the introduction of the Growth Plan for Creative Business.29

  • Taxation. Investment by startups and high-technology firms would benefit from relaxing the cap on the use of carry-forward losses, as this limitation poses a challenge for cash-constrained startups which tend to be initially loss making. Reducing the taxation of dividends, while ensuring regulations are in place to minimize avoidance, would encourage equity investment. The introduction of an incremental ACE would reduce the debts bias and cost of capital. However, an assessment of implementation risks is needed (SIP 2018).

uA01fig27

Corporate Bond Market, 2017

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Source: OECD.
uA01fig28

Top Marginal Tax Rates

(Percent, 2017)

Citation: IMF Staff Country Reports 2019, 178; 10.5089/9781498321129.002.A001

Source: OECD Tax database.Notes: The overall rate on dividend income includes the personal and corporate income taxes on distributed profits.
Authorities’ Views

45. The authorities agree on the importance of boosting productivity. They see the potential advantages of introducing an incremental ACE to reduce debt-bias but note the significant challenges associated with transitional arrangements and potential revenue losses in the long term. The authorities took note of recommendations to introduce further tax measures to promote R&D investment and benefit small and high-technology firms; but they indicated that welfare-enhancing effects of further subsidization remain unclear. They broadly agree that upgrading capital markets could improve access to equity finance for SMEs and that growth of knowledge-intensive services is an important contributor to continued productivity growth. Authorities agree with recommendations to streamline and strengthen the framework for competition, but raised the point that initiatives shall take into consideration other social objectives and legal constraints.

Staff Appraisal

46. Growth remained solid in 2018, supported by domestic demand, with the economy operating above potential. The external position was moderately stronger than the level consistent with medium-term fundamentals in 2018. The outlook is for continued strong growth but with downside risks. A sharper than expected slowdown in Denmark’s main trading partners could slow export growth. High household debt amid elevated house valuations remains a key vulnerability. The ongoing money laundering case could further affect confidence in the financial sector and undermine financial stability. Policies should enhance macro-financial resilience and target higher potential growth.

47. Denmark’s public finances are sound with substantial fiscal space in the medium term. The fiscal stance should remain neutral, while letting automatic stabilizers operate fully in case of shocks to aggregate demand. In the event of a severe downturn, additional temporary loosening should be considered, while remaining anchored to the medium-term objective. Efficiency-improving reforms that cover both revenues and expenditures could be implemented in a fiscally-neutral way or designed to provide stimulus if loosening is warranted.

48. The fixed exchange rate policy has served Denmark well. The policy provides a framework for low and stable inflation in Denmark.

49. The banking system is profitable, liquid and solvent, but pockets of vulnerabilities remain. Lending surveys suggest that some banks are relaxing credit standards for corporate loans. To strengthen financial resilience, a combination of micro- and macroprudential tools should be considered to increase capital buffers, in addition to the CCyB, if risks continue to build up. The decision on banking union participation should carefully assess costs and benefits.

50. The authorities should build upon their recent efforts to strengthen cross-border AML/CFT supervision. The priority next steps are to: (i) develop a comprehensive institutional risk assessment model; (ii) increase the depth of the DFSA’s AML/CFT on-site inspections; (iii) further expand its sanctioning powers, including to issue administrative fine notices; and (iv) strengthen regional and international cooperation.

51. High household leverage amid elevated house valuations call for coordinated policy action. Increased focus on income-based macroprudential instruments might prove more effective at reducing macro-financial vulnerabilities than current instruments that rely more on loan-to-value ratios. The authorities should seek to improve the efficacy of policy implementation, including through a review of the SRC’s institutional arrangements. Mortgage interest deductibility should be reduced further than currently planned. Policies to promote housing supply should be considered.

52. The labor market is strong, with pressures gradually building in some sectors of the economy. Increasing benefits to low-income workers would help alleviate inactivity traps and promote youth employment. Reducing marginal tax rates for average income earners could increase hours worked. The authorities could also further incentivize upgrading of technical and digital skills, integrate migrants, and attract skilled foreign labor.

53. Productivity growth remains weak, as in many advanced economies, partly because of lower investment rates following the crisis. The authorities should support broad-based innovation, improve the institutional framework for competition and foster the environment for high-productivity sectors to expand. Addressing the debt bias and improving access to equity finance for SMEs would also promote investment and help reduce the current account surplus.

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

Table 1.

Denmark: Selected Economic and Social Indicators, 2016–24

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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, 2016–24

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

Denmark: International Investment Position, 2011–18

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

Denmark: GFSM 2001 Statement of General Government Operations, 2016–24

(Billons of DKK)

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Sources: Statistics Denmark and Fund staff calculations.