31 May 2013

IMF: Sweden — 2013 Article IV Consultation: Concluding Statement of the Mission

The IMF concludes that growth will remain modest this year - at about 1.1 per cent - but it should gather speed by 2014, reaching 2.3 per cent for the year, with exports and private expenditure picking up as the uncertainty associated with the euro area crisis slowly recedes.

The economy will be faced with downside risks from both external and domestic sources. A re-intensification of the euro area crisis could hurt growth through negative shocks to trade and domestic demand. Importantly, it could also adversely affect Sweden’s banking sector, which at more than four times GDP is very large and relies heavily on wholesale funding. Financial fragilities are also a key risk at home. With household debt rising to more than 1.7 times of disposable income, a sudden and sizeable fall in house prices could have a flow-on effect to consumption and banks, raising unemployment and lowering inflation further, and pushing up non-performing loans and bank funding costs. Given the strong cross-Nordic activities of Swedish banks, such a scenario would also have spillovers across the Nordic region. Conversely, a sudden deterioration of household financial health elsewhere in the region poses risks for Sweden, with possible adverse feedback loops.

Securing financial stability is the main challenge ahead. Notwithstanding the recent progress on financial regulation, household debt is still very high and increasing, and the large banking system remains a vulnerability to the economy. Strengthening the financial sector will help reduce the need for fiscal buffers, limit the requirement for stockpiling foreign liquidity at the Riksbank, and reduce excessive institutional reliance outside the Riksbank on monetary policy to address financial stability concerns.

Improving coordination of macro-prudential policy is another key aspect of the financial reform agenda. Recent proposals rightly stress the importance of information exchange between all relevant parties. But it will be just as crucial to ensure that all macro-prudential policy tools are deployed in a timely and well-coordinated manner both in normal and crisis times. The first option would be putting all instruments at the disposal of the Riksbank, which is well-placed to oversee the macro-economic and financial issues that may threaten stability. Alternatively, the FSA could be put in charge. In both cases, close consultation with others would be required. A third option would be to explore the possibility of delegating the final approval of decisions taken by individual authorities to a Council, with a composition similar to the one suggested by the Financial Crisis Committee, and with clear voting rules. Allocating different responsibilities and instruments to different decision makers would instead likely complicate rather than strengthen necessary macro-prudential coordination.

The need for a fiscal buffer could be made more explicit. The existing framework has been serving Sweden well, helping to bring general government debt to very low levels after the crisis of the early 1990s—a rare feat among advanced economies. The framework could be improved further by introducing an explicit long-term anchor that would ensure that the government’s fiscal buffer—that is, maintaining adequate room to borrow—is preserved. Explicitly providing for such a fiscal buffer could contribute to, for example, keeping actual debt ratios in a range well below the 60 per cent debt-to-GDP ratio defined in the Maastricht treaty. The debt target range would have to be carefully selected. It would need to account for the changing needs to provide for cyclical budget swings, ageing costs, and to retain a prudent borrowing capacity adequate for countries with large financial sectors such as Sweden. In this context, the authorities could explore the introduction of such a debt target range with a well-calibrated structural balance rule that also provides for higher public savings in case of larger-than-budgeted debt accumulation.

Structural reforms to strengthen the labour market and relieve housing bottlenecks will add to the resilience of the economy. Recent reforms have increased labour market participation, and eventually will reduce unemployment and further increase employment from current levels. To strengthen the impact on jobs and growth, it will be important to improve the matching process between workers and available vacancies and facilitate transition, especially from school to work. This is particularly important for vulnerable groups such as those young and foreign-born facing risk of long-term unemployment. This can be achieved, both by stimulating demand for these groups in a targeted way and by continuing to help them improve their job skills through training and education in the spirit of recent reforms. Further steps to make the supply of housing more responsive to demand would also be helpful, particularly to improve housing access in urban areas. This would involve several well-coordinated steps to increase land supply and to raise the incentives to invest in residential construction—for example through additional reforms of the rental market, simplifying building regulations, and increasing competition in the construction sector.

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