Abstract
The Swedish authorities would like to thank the mission teams for the reports as well as for the open and constructive policy discussions during the FSAP mission and Article IV consultation with Sweden. The authorities broadly agree with the conclusions and recommendations of the staff reports.
The Swedish authorities would like to thank the mission teams for the reports as well as for the open and constructive policy discussions during the FSAP mission and Article IV consultation with Sweden. The authorities broadly agree with the conclusions and recommendations of the staff reports.
Recent macroeconomic development and outlook
The Swedish economy developed strongly at the beginning of 2022, which also meant that the labour market strengthened. The employment rate reached new record levels and many companies found it difficult to recruit people with the competence they needed. High external price pressures resulted in rapidly rising electricity and food prices during 2022. Together with the rapid upturn in demand and supply restrictions, this led to a rise in inflation. Russia’s full-scale invasion of Ukraine aggravated the situation, and to counteract the upturn in inflation monetary policy was tightened rapidly. Large price increases and rising interest expenditure had a significantly adverse effect on households’ purchasing power and meant that demand slowed down in the fourth quarter of 2022.
The manufacturing industry still has large order stocks, but has seen a rapid decline in orders. As demand in Sweden and abroad is falling, industrial production and Swedish exports are expected to be significantly weaker going forward. Households’ purchasing power is deteriorating due to high inflation and tighter monetary policy and households are expected to continue to reduce their consumption. The fact that households are in a tough situation at present is visible in consumer confidence and in the retail trade sales, which have fallen since spring 2022. The situation in both the retail trade and the service sector is now said to be very weak, according to the Economic Tendency Survey.
The high inflation and tighter monetary policy are also evident in the housing market, where both prices and construction have declined, and are expected to continue to decline in 2023. During the pandemic, however, housing prices rose fairly substantially and the fall means that they are back at the level prevailing prior to the pandemic. Compared with the peak in 2021, around 50 per cent fewer homes are expected to be built in 2024 and housing investment will thus weigh on growth in total gross investment in both 2023 and 2024.
After being very high during 2022, the demand for labour is expected to decline this year as a result of the expected fall in GDP. Indicators point to a weaker labour market ahead and during the current year, employment is expected to fall gradually and unemployment will rise. The Government will compensate households and companies retroactively for the high electricity prices which will contribute positively to household income and thus contribute to dampening the downturn in consumption. In the Riksbank’s forecast, households’ real disposable incomes will improve and both consumption and the housing market will recover during 2024 and 2025. This is expected to, together with rising demand abroad, lead to GDP growth increasing from the middle of 2024. As economic activity strengthens, the demand for labour will rise. Unemployment is assessed to peak at the end of 2024, and then begin to fall back.
Financial stability and macroprudential policy
The authorities broadly agreed with the IMF team’s assessments and recommendations related to financial stability issues. They have found it helpful that the team has provided guidance with regards to timing and priority to the key recommendations. Moreover, they welcomed the IMF’s positive endorsement of Sweden’s continued progress in strengthening regulation, supervision, and crisis management since the last FSAP in 2016. They agreed that their determined efforts to bolster financial sector oversight and crisis preparedness, not least through large capital and liquidity buffers in the financial sector, as well as the public support measures implemented helped Sweden to weather the global COVID-19 crisis well. Looking ahead, the authorities acknowledged the importance of ensuring that the regulatory framework and supervisory capacity keep pace with the evolving landscape.
The authorities agreed with the IMF team’s risk assessment and that highly leveraged commercial real estate companies constitute a key risk. They underlined that several measures have been taken to address the risks, not least the introduction of risk weight floors on CRE and residential real estate exposures as well as the reciprocation of measures by Norway and Denmark. The FSAP bank solvency stress tests indicate that the banking system appears resilient against potential shocks emanating from the CRE sector. While high profitability offsets some of the effects, the higher impact on banks that are heavily exposed to the CRE sector warrants monitoring. In this respect, the authorities concurred that macroprudential policies can help attenuate cyclical and structural risks. The authorities also agree with the IMF team’s risk assessment of the households given their high level of indebtedness. However, they did not see a need to strengthen the amortization requirement.
The authorities find that data collections such as the mortgage survey, the consumer loan survey, commercial real estate loan survey as well as KRITA covering all loans to non-financial firms are examples of high-quality micro data. However, they agree that there are still data gaps, particularly for indebted households’ assets and debts. The lack of such statistics in Sweden imposes constraints on the analysis of important questions linked to financial stability and monetary policy.
The authorities agreed with the need to be vigilant of risks related to the growing financial technology sector in Sweden, including increased cyber risks. The authorities noted the need for a framework for comprehensive operational and cyber resilience. Strengthening the legal framework for FMIs in order to enforce compliance with the PFMI and other guidelines as well as managing outsourcing risks in the payments area will be part of the agenda in the period ahead. The authorities took note of the insights and recommendations related to the ongoing work on a CBDC and shares the views regarding the importance of risk mitigation to deal with the risks that are addressed in the FSAP in a proper manner. The analysis and recommendations on CBDC are coherent with the authorities’ views.
Prudential Supervision
The authorities welcome the IMF’s acknowledgement of Sweden’s continued progress in strengthening banking regulation and supervision since the last FSAP in 2016, and recognize the importance of ensuring that regulatory framework and supervisory capacity is continually enhanced to keep pace with the evolving financial landscape.
The authorities broadly agree with the FSAP assessment and recommendations on how to address the identified gaps including, amongst others, the need to further optimize existing supervisory processes and tools. The authorities take note of the IMF’s assessment regarding the need to further increase the intrusiveness in the supervision and can confirm that through the risk-based approached used, Finansinspektionen (FI) can continuously aim at achieving intrusive outcomes regardless of which type of supervisory activity used. The authorities would also like to mention that measures have already been taken to reduce gaps identified, for example within IRB model supervision.
The continued strengthening of the supervisory regime for AML/CFT is another of the areas of key focus. FI has as from 1 March, 2023, established a new operational section (along-side the operational sections Bank, Insurance and Market) in which the AML/CFT supervision has been elevated to a stand-alone department to ensure an increased and continuous focus on its market-wide supervisory responsibility.
Crisis readiness, management and resolution
The cooperation between the relevant authorities in Sweden regarding crisis preparedness and crisis management has historically functioned well. The authorities share the view that progress has been made since 2016, but that further efforts are needed to get the new crisis management framework fully operational. This includes further development of the published “open bank” bail-in mechanic and further work on a policy for funding in resolution.
Monetary policy
The Riksbank agreed with the IMF team’s opinion that monetary policy should remain flexible and be set against the risks surrounding inflation. The very rapid upturn in inflation last year has meant that CPIF inflation is now over 9 per cent and thus far above the inflation target. The Riksbank underestimated the inflationary impulse in the wake of the pandemic and factors that were difficult to predict, such as Russia’s invasion of Ukraine and the ensuing disruptions on the European energy markets, aggravated the situation further. To bring down the high inflation, the Riksbank has raised its policy rate at every meeting since April 2022, in total from zero per cent to 3.0 per cent in February 2023. The increase has been rapid in relation to earlier phases of interest rate hikes and the effects on demand in the Swedish economy can now be seen. As it takes time before monetary policy affects inflation, those effects will only become clear this year.
A high rate of inflation creates problems in the economy. It is therefore important that inflation shows a clear downturn this year and that it is not merely due to lower energy prices. There are many indications that this will happen. But it is uncertain whether inflation will fall sufficiently quickly and far enough. There is a risk that the recent rapid price rises will develop into a changed pricing behaviour and that inflation will then, even if it slows down somewhat, become entrenched at a level that is too high.
The risks of tightening monetary policy too little in the near term are assessed to be greater than the risks of tightening too much. The Riksbank’s tolerance for a continued high rate of inflation is thus low, not least in the light of unexpected unfavourable developments in inflation last year. A tighter monetary policy does mean that economic activity will weaken further, but attaining a low and stable rate of inflation within a reasonable period of time is a necessary condition for good development in the Swedish economy in the long run. If inflation is high for a long time, the negative consequences for Swedish growth and the labour market will be much greater.
In addition to a higher policy rate, the Riksbank’s monetary policy motivated asset holdings have declined since the first quarter of 2022. The total maturities have been greater than the purchases, and the Riksbank ceased purchasing assets entirely at the end of 2022. In February, the Executive Board decided to reduce the Riksbank’s holdings of government bonds through sales. This measure is a step towards normalisation of the Riksbank’s balance sheet, now that support measures during the coronavirus pandemic have been phased out and monetary policy is being tightened by means of a higher policy rate. As always, the Riksbank is carefully monitoring developments and will evaluate the effects of the sales regularly. This is something that the IMF team also highlighted. The Riksbank may alter the volumes and terms if market conditions are unfavourable.
The Riksbank’s forecast is that the policy rate will probably need to be raised somewhat further going forward. This is considered necessary to get inflation to fall back towards the target. But the uncertainty regarding monetary policy is still considerable. One factor is the higher sensitivity to interest rates in the Swedish economy, as a result of households’ increased indebtedness and the short interest-rate fixation periods on their mortgages. Even in an international perspective, it appears that sensitivity to interest rates is higher in Sweden than in many other economies.
Fiscal policy
The government agrees with Staff’s assessment that fiscal policy stance should support monetary policy in reducing inflation. Bringing inflation back to target is a key priority, and it is important that fiscal measures do not augment inflation by increasing aggregated demand. At the same time, vulnerable households and companies, which are hit the hardest by price increases, need to be protected. The government has accommodated for this in the 2023 budget bill, meaning a broadly neutral fiscal stance for 2023 overall.
Regarding energy support measures, a swift delivery of support measures to households and businesses has been a key priority for the government. Meanwhile, given the wide impact of the shock, the energy support package was designed to offer the greatest relief to those who saw the greatest increase in their electricity bills.
In the short term, it is important the fiscal policy balances the need to bring down the high inflation rate and the capacity to manage the downturn in the economy. However, as inflation returns to target, there will be scope for further reforms and the government has an ambitious reform agenda outlined in the Tidö agreement for both the medium and long term, containing areas such as employment, energy, climate, healthcare, and the schooling system. Moreover, reforms will be aimed at increasing employment and productivity in the long term. In this regard, the government will consider lowering the wage tax wedge during its term of office; however, there is no political support for higher property taxes.
Overall, the government’s fiscal policy will be carefully calibrated to strike the right economic balance both in the short- and long term.
Structural issues
Labour market policy
Structural reforms that result in higher employment and productivity in the long term are key priorities for the government. Sweden has comparatively high unemployment, partly due to high labour force participation. The unemployment rate is likely to rise in the short run as a result of weaker demand in the Swedish economy. The situation is particularly difficult for foreign born– mainly those who are newly-arrived, those who have little or no education, and women with a non-European background – as many are outside of the labour force. The government plans to look at both increasing incentives to work through well-targeted tax cuts, reforms to the benefit system, as well as strengthening the possibilities for individuals to transition into the labour force. In that respect, the government shares Staff’s views on the importance of supporting the youth and foreign born through improving the effectiveness of the education and training programs to facilitate their entry into the labour force. Meanwhile, the government is confident that the October 2022 reform to the employment protection framework will be implemented in a way that will be beneficial for the labour market. The changes implies that the labour laws have been adapted to today’s labour market and the increased need for flexibility and security.
Housing policy
The linkage between household indebtedness and the functioning of the housing market remains a key issue to the authorities. To fundamentally address this linkage, a broad range of policy measures would need to be assessed.
On housing, the government shares Staff’s assessment that improving the functionality of the housing market is a challenge. The government intends to implement reforms that increase incentives for construction, not least to make housing more available to groups of the population that have difficulties entering the housing market. It also aims to simplify the rules for building permits, as well as implement reforms that will increase access to buildable land. The government also notes that the process for building permits in Sweden is 7.5 weeks shorter than the EU average, according to the World Bank report1. The same report states that Swedish building rules are accessible and transparent. Regarding changes to the tax system, it is of particular importance to maintain stable and predictable rules in the housing market. Any measure in this area must be seen in a long-term perspective. Changes must be handled with great care, due to the potential effects a change may have on household’s financial position, household demand and economic growth.
Subnational Investment Climate Assessment 2022: Sweden, The World Bank, November 2022.