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Denmark is well-positioned to address its macro-economic policy challenges. The current account surplus is about 6 per cent of GDP; gross public debt is under 50 per cent of GDP and partially offset by a substantial government deposit at Danmarks Nationalbank, and its triple-A credit rating supports market access on favourable terms.
Fiscal Policy
Medium-term consolidation is appropriate, but the authorities should stand ready to take additional action to support the economy and consider a less rapid adjustment if growth falls significantly below current projections. There is a risk that the consolidation could undercut the still weak economy, particularly if it is compounded by a repeat of underspending by sub-national governments or slower-than expected implementation of investment projects. As in the past, automatic stabilisers should be allowed to operate fully. Should additional fiscal support for the economy be needed, tax measures should be considered, in particular those that further reduce the tax wedge on labour income or increase incentives for work. On the other hand, further tax preferences for housing would be less desirable given the existing tax preferences for housing already in place. Further acceleration of public investment seems less promising given that public investment projects are slow to implement and the pool of good candidates for investment has been depleted by the earlier stimulus. However, the authorities should at a minimum be prepared to take actions within the space under current EU limits if conditions dictate.
The authorities’ medium- and long-term fiscal plans set out a prudent and strong fiscal path through 2020. However, the projections would benefit from additional sensitivity analysis that could take into account a divergence between growth in real wages, spending and productivity. In particular, the assumption of an above-trend productivity growth rate might be revisited or contingency measures considered in the event that the assumed increase in productivity growth does not materialise in the 2012-2020 period. The mission understands the authorities’ view that specific measures to be implemented beyond 2020 would best be developed in subsequent plans; however, more sensitivity analysis in the government’s very long-term scenarios could better inform those future decisions.
Financial Sector Policy
Progress has been made in strengthening the banking sector and reducing banks’ dependency on state guarantees. Three-year loans to banks are helping to replace expiring state guarantees, prudential regulations have been strengthened through the “supervisory diamond” indicators, and the activation of the new resolution procedures applying haircuts to senior bank debt has reduced the perception of an implicit government guarantee on banks. However, stress in the system has increased over the past year, in part reflecting European developments, and this requires a continued robust policy response.
The plan to improve the institutional framework through the creation of an interagency committee charged with making recommendations on macro-prudential policy is welcome. The planned Systemic Risk Council and the entities responsible for implementing its recommendations (e.g. the economic ministries and the Financial Supervisory Authority) should have clear roles and responsibilities, consistent with their institutional mandates, and information-sharing and coordination arrangements.
The creation of an inter-agency committee to develop prudential arrangements for systemically important financial institutions (SIFIs) is a positive step. This could keep Denmark at the forefront of bank resolution regimes in the EU. The potential inclusion of a bail-in framework would be appropriate, but reducing the risk posed by large institutions will take time, and the pace of implementation of higher capital requirements will need to take into account the possible contractionary impact of deleveraging.
Banks should continue to build robust capital and liquidity buffers. The flexibility embedded in EU regulations should be used to design strong macro-prudential and micro-prudential policies, treating Basel III and the CRD IV regulations as floors. Banks have made progress in shoring up regulatory capital ratios, but they should continue to retain earnings, raise new equity, and improve capital ratios through an orderly deleveraging. Large banks might also be required to report capital and risk-weighted assets on the Basel III definitions in addition to the current regulatory definitions to demonstrate their ability to meet more stringent future requirements.