Date: 2009-11-23 | Ministry of Finance
INTERNATIONAL MONETARY FUND
Norway – 2009 Article IV Consultation
Concluding Statement of the Mission
November 23, 2009
1. The Norwegian economy has weathered the global financial crisis remarkably well. Growth has already resumed after a comparatively mild recession, and unemployment has remained at low levels. Norway’s resilience has been underpinned by a substantial easing of macroeconomic policies, continued strong investment activity in the oil and gas sector, high public-sector employment, limited dependence on the hardest-hit segments of global manufacturing, and the relative stability of the domestic financial sector. The authorities responded forcefully to the global crisis, reducing interest rates to historic lows and adopting a strongly expansionary fiscal stance. In addition, a number of timely measures were put in place to mitigate the effect of the crisis on Norway’s financial markets and institutions.
2. Looking ahead, the economic recovery is expected to continue. After declining by more than 1 percent in 2009, mainland real GDP is projected to grow at around 2 percent in 2010, with private domestic demand progressively replacing public spending as the main driver of growth. Private consumption should strengthen further as households continue to benefit from low interest rates, steady employment, and higher asset prices. A turn in the inventory cycle and buoyant offshore investment should also support activity, even though mainland investment may remain subdued and the growth contribution from net exports is likely to decline. Unemployment is set to rise somewhat, but remain relatively low. In the near term, inflationary pressures should be kept in check by slower wage growth and a stronger krone, although tighter cyclical conditions may reemerge sooner than in many other advanced economies given the relatively limited spare capacity in the economy.
3. The uncertainty around this central forecast is, however, significant. Mainland growth could pick up faster if the recent improvement in consumer confidence and the renewed rise in house prices translate into a stronger-than-expected increase of private consumption. A more rapid global recovery could provide a greater boost to exports. On the downside, a relapse in global growth could weaken export-oriented activity, trigger a tightening of credit conditions, and undermine consumer confidence.
4. The key challenge in the period ahead will be to preserve Norway’s strong macroeconomic performance under potentially more difficult conditions. Over the past decade, Norway has enjoyed rapid economic growth, combined with high employment and low inflation. A sound policy framework has contributed to this success, but the economy has also benefited from significant terms-of-trade improvements, rising asset prices, benign demographic developments, and low global macroeconomic volatility. Going forward, these favorable trends cannot be taken for granted. To maintain the economy’s flexibility and resilience, policymakers and social partners should ensure that competitiveness remains strong, fiscal space is regained to deal with future shocks and long-term aging-related spending pressures, and the financial sector stays healthy.
5. The large fiscal stimulus implemented in 2009 has been effective in softening the economic downturn. The stimulus package was well designed, with an emphasis on timely and, for the most part, temporary spending measures. The 2010 budget envisages a small additional stimulus, motivated by remaining uncertainty about the strength of the domestic recovery and the global growth outlook. It is unfortunate; however, that many of the temporary spending measures introduced in 2009 have been replaced by more permanent expenditure increases. The expected rise in social security spending is particularly large.
6. The significant spending increases in 2009-10 have pushed the structural nonoil deficit well above 4 percent of the Government Pension Fund-Global capital, bringing forward the entire fiscal expansion planned for the next decade under Norway’s fiscal guidelines. Given the relatively limited slack in the economy, there should be strict expenditure control in the 2010 budget implementation, and any upside surprises to revenue or growth should be used to reduce the deficit. This will also help ensure a consistent fiscal-monetary policy mix. Indeed, continued fiscal stimulus would require commensurately tighter monetary policy, which could lead to further strengthening of the exchange rate.
7. In the medium term, a steady withdrawal of fiscal stimulus will be appropriate as the economic recovery takes hold. To reaffirm commitment to the fiscal guidelines and regain flexibility for discretionary action in response to adverse shocks, future budget plans should aim to reduce the structural nonoil deficit to the 4-percent target, preferably within the current term of Parliament. The discretionary tightening could be more ambitious if growth turns out stronger than expected, while downside shocks to growth should be addressed predominantly through monetary policy. The credibility of fiscal plans will be enhanced by early identification of concrete measures to achieve the desired consolidation. A focus on expenditure-side measures, as implied by the government’s commitment not to raise the real level of taxes, appears warranted.
8. Once deficits have been brought in line with the 4-percent target, the flexibility to deviate temporarily from the fiscal guidelines for stabilization purposes should be used symmetrically. In particular, it would be important to avoid procyclical fiscal policy during periods of robust economic growth. Excessive public spending can push up already-high cost levels further, with adverse consequences for competitiveness of the broader economy.
9. The key challenge to long-term fiscal sustainability is the rapid rise of aging-related expenditure. The authorities’ pension reform appropriately aims to encourage longer working lives and contain the rise of pension outlays by tying benefits to demographic developments. For the reform to be successful in achieving these goals, however, it will need to be supplemented by concrete steps to curb the very high inflows into sickness and disability benefit schemes. It is crucial to build broad public consensus on the need for effective reform in this area. Measures should be geared toward improving the incentives of employees and employers, in both the private and the public sector, and could include greater use of cost-sharing and increased reliance on specialized social insurance physicians in assessing and verifying eligibility for benefits.
10. Norges Bank responded forcefully to the downturn last year by cutting the policy rate to a historic low and providing liquidity in greater amounts, at longer maturities, and against a wider range of collateral. The expansionary stance has had a considerable stabilizing effect on the economy by easing the debt servicing burden of the private sector. At the same time, medium-term inflation expectations have remained well-anchored, underscoring the credibility of Norway’s monetary policy framework.
11. Given the relatively favorable cyclical position of Norway’s economy, Norges Bank appropriately has been one of the first central banks to start raising policy rates again. The strengthening outlook, a relatively tight labor market, and the macroeconomic risks implied by strong house price appreciation all point to the need for a continuing withdrawal of the extraordinary monetary stimulus in the period ahead, as envisaged in the latest monetary policy report. Nonetheless, the tightening should proceed at a gradual pace to avoid undermining the economic recovery.
Preserving the strength of the financial system
12. Norway’s financial institutions have benefited from a robust domestic economy, a sound prudential framework, low exposure to toxic assets, and stepped-up liquidity support by the authorities during the global crisis. Nonperforming loans have increased only modestly through the third quarter of 2009, and profitability has generally remained strong. However, some financial institutions have significant exposure to sectors facing a weak cyclical outlook, notably shipping and ship-building. In addition, the high indebtedness of households and the rich valuation of real estate markets represent vulnerabilities that could amplify negative economic shocks, with adverse effects on banks’ credit portfolios and income. In that context, it is particularly worrisome that a significant share of new mortgage loans is extended at very high loan-to-value ratios.
13. Against this backdrop, recent efforts to increase capital buffers in the banking system are welcome. A number of banks have announced plans to raise capital from private sources and through the Government Finance Fund. Looking ahead, the supervisory and regulatory authorities should continue to assess carefully the risks facing both individual financial institutions and the financial system, and take prompt corrective actions. To contain the macroprudential risks associated with high and still-rising mortgage debt, targeted prudential measures should be considered. The distortion that arises from large existing tax incentives for housing investment should also be addressed directly, for example through an increase of property taxes offset by tax reductions elsewhere.
14. Efforts to strengthen further the prudential framework should be based on international practices as promulgated by the Basel Committee and embodied in amended European Union Directives. Given the regional character of the Nordic financial market, close coordination with Norway’s neighbors should be used to ensure higher common standards as appropriate. In this context, particular priority should be placed on strengthening the management of liquidity risks. In addition, there could be merit in supplementing existing capital adequacy rules with a maximum gross leverage ratio that would act as a backstop against excessive balance sheet growth.
15. The crisis has highlighted the need for close cross-country cooperation in the supervision, regulation, and resolution of internationally active banks. The recent MoUs on cross-border financial stability and the existing agreements between the national authorities of the Nordic-Baltic countries and between Norway and the European Union should provide a good foundation for close collaboration. It would be especially important for supervisors and regulators across countries to join forces to identify emerging problems early and take coordinated preventive action.
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We are grateful for the warm welcome extended by everybody we have met during our discussions.