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Public Information Notice (PIN) No. 03/95
August 5, 2003
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2003 Article IV Consultation with Sweden

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2003 Article IV consultation with Sweden is also available.

On July 25, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Sweden.1

Background

The Swedish economy recovered in 2002, assisted by a sizeable fiscal stimulus. While continued weakness in the telecom sector and persisting excess capacity held back business investment, household consumption strengthened as tax cuts and government transfers boosted disposable income. After an early upturn in 2002, external demand weakened rapidly with the worsening global outlook, contributing to the deceleration of economic activity in the second half of the year. Driven by net exports and consumption, GDP growth picked up in the first quarter of 2003.

Inflationary pressures are receding rapidly after a temporary surge. Due to high demand―reflecting the unusually cold winter—and exceptionally low reservoir levels in Nordic hydroelectric power plants, energy prices rose sharply, pushing headline inflation up to 3.4 percent in February 2003. However, ample spare capacity and wage moderation are keeping underlying inflation―excluding energy― well under 2 percent. As energy prices began to decline, headline inflation fell back below the 2 percent target and inflation expectations remain well anchored around that level.

Wage increases have been restrained by persistent weakness in the labor market. With the manufacturing sector continuing to shed labor, employment stagnated despite increased demand from the construction and the public sectors, and the rate of unemployment remained virtually unchanged in 2002. However, rising sickness absenteeism and a cyclical contraction of overtime led to a fall in the number of hours worked. Nominal wages rose somewhat less rapidly than a year earlier, but strong productivity gains offset their impact on costs.

Despite the appreciation of the krona, competitiveness remains strong, reflected in the persistence of large current account surpluses. Helped by improved relative growth prospects, rising interest rate differentials, and a slowdown in portfolio outflows, the krona appreciated by more than 5 percent in effective terms and the unit labor cost-based real exchange rate by almost 6½ percent in 2002, gradually reversing some of the sharp decline of the previous two years. However, the current account surplus rose further to 4.2 percent of GDP as the lagged effects of the 2001-02 depreciation boosted exports—mainly in the first part of the year—and imports fell. Markets expect the krona to appreciate by another 5 percent vis-à-vis the euro in 2003.

Monetary policy has been quick to react to signs of weakness in the economy and heightened risks to the global outlook. After tightening in early 2002 on the back of accelerating inflation, the Riksbank reversed course toward year-end, when disappointing growth prospects in the euro area and increasing geopolitical uncertainties led to a reassessment of the inflation outlook. Judging the spike in inflation fueled by energy prices as temporary, the Riksbank cut rates twice in November and December. With the rapidly worsening external outlook, these cuts were followed by another 25 basis point easing in March 2003. As the international recovery appeared to be delayed and inflation prospects improved further, the Riksbank eased policy by a further 50 basis points in early June.

The rising trend of spending has eroded the exceptional strength of the public finances. The overall balance this year is expected to be 3 percentage points lower than in 2000, half of which is due to expenditure increases, mostly discretionary. In fact, with the structural balance projected to be 2¾ percentage points of GDP weaker over this same period, only part of this deterioration can be accounted for by cyclical conditions. The first three steps of a four-step program of tax cuts were accompanied by the ratcheting up of expenditure, particularly by local governments, and tax increases at the local level.

Fiscal policy remains anchored to the medium-term framework, centered on the target of a surplus of 2 percent of GDP over the cycle. The fiscal stance in 2003 is expected to be moderately contractionary. Despite the expected slowdown in economic activity and further discretionary spending increases, the structural surplus is projected to rise to almost 1½ percent of GDP. Faced with budgetary pressures, the authorities have postponed further income tax reductions indefinitely. In line with the fiscal rule specifying a 2 percent surplus over the cycle, the structural surplus is now projected to return to this level by 2005, as the output gap narrows.

Sweden faces subdued economic growth and rising unemployment in the near term. As weak external demand holds back exports, and imports recover from recent unusually depressed levels, the external sector is expected to contribute little, if anything, to growth in 2003. Public consumption is projected to slow sharply, and the continued weakness of the telecom sector will hamper an upturn in business investment. With high house prices and low interest burden providing ample support to household financial positions despite losses in stock market wealth, and the sharp rise in household saving rate over the past two years, private consumption is likely to hold up well, barring any unexpected shocks to confidence. All in all, economic growth is likely to remain significantly below potential, with continued unutilized resources. Inflation is expected to remain well below target over the next year.

Executive Board Assessment

Directors commended the authorities for the continued successful implementation of their well-designed fiscal and monetary frameworks, which have underpinned Sweden's strong macroeconomic performance of recent years. Despite some slowdown in growth, the economy has remained resilient in 2002 in the face of the global slowdown, with low unemployment and inflation and a large external current account surplus.

Directors concurred that short term economic growth is expected to be subdued, and that—with weak external demand holding back exports, and business investment hampered by spare capacity and uncertain prospects—demand appears increasingly dependent on the resilience of private consumption. While healthy household finances and low interest rates should continue to support consumer spending, increasing unemployment could, however, weaken confidence in the short term. Looking ahead, Directors considered that the Swedish economy is well placed to benefit from the projected global recovery, provided timely action is taken to further strengthen the economy's supply response by correcting rigidities in product and labor markets and the erosion of effective labor supply.

Directors commended the Riksbank for its skillful and proactive management of monetary policy and for its transparent communications strategy, which has enhanced the credibility of the inflation-targeting regime and provides a strong anchor to wage formation. They considered the recent substantial easing of monetary policy appropriate, in the light of an inflation forecast below target and the hesitant global recovery. The recent acceleration in headline inflation due to electricity prices is already reversing, and, with inflation expectations well anchored to the two-percent target and upside risks to inflation well contained, Directors saw room for some additional monetary easing if needed. They further noted that in view of Sweden's strong competitive position and provided wage moderation continues, a moderate appreciation of the krona would be sustainable over the medium-term.

Directors considered that in the event of a decision to join the European Monetary Union , Sweden's sound macroeconomic fundamentals position the country well for a smooth transition. Despite some recent deterioration, public finances remain strong and the available fiscal instruments appear adequate to protect the economy from asymmetric shocks in the absence of an independent monetary policy.

Directors agreed that Sweden's fiscal framework has generally worked well so far and remains fundamentally sound. At the same time, however, they cautioned that the strength of the public finances has begun to erode and that the framework has recently experienced strains, calling for appropriate policy responses in the period ahead. While the recent erosion is partly due to the cyclical slowdown, it also reflects a continued and—in the view of Directors—worrisome ratcheting up of discretionary public spending, in response to growing demand for higher public services, especially at the local government level. They therefore welcomed the authorities' firm commitment to preserve the credibility of the fiscal framework, and encouraged them to give careful consideration to proposals for further strengthening the framework with a view to reducing the pro-cyclicality in government finances, in particular at the local level.

Directors noted that the expenditure ceilings have so far been successful in restraining public spending growth at the central government level. They underscored, however, that preserving the credibility of the ceilings in the period ahead will require decisive action to curtail rising expenditure, particularly on sick leave expenses. They welcomed, in this context, the measures in the Spring 2003 budget to curb sickness leave costs, but many Directors felt that stronger efforts to affect incentives may well be needed. Some Directors regretted the authorities' decision to postpone setting an expenditure ceiling for 2005 until the autumn budget. Directors also encouraged the authorities to consider improvements in the fiscal framework to ensure that the margins under the ceilings are used only as a cyclical buffer and to link expenditure ceilings more explicitly to the surplus target.

Directors observed that the increase in public spending has stalled further progress on lowering the high tax burden, and that taxes might even rise further to meet pressures on local spending. They noted that prospects for a reduction in the tax burden may well recede as demographic pressures on public spending are expected to intensify in the coming years. Directors recognized that Sweden's welfare state continues to enjoy widespread support and that further tax rate cuts would be envisaged only if they can be afforded without jeopardizing the overall fiscal targets and the quality of public services. In view of the challenges arising from population aging, Directors, however, also considered that additional efforts to contain expenditure, particularly on social transfers, will be needed to preserve the welfare state and a strong fiscal position in the long run, while creating room for a desirable further reduction in the tax burden.

Directors underscored, in this context, that streamlining some of the generous social insurance provisions with a view to reducing disincentives to work would substantially improve long-term growth prospects. They considered that the high taxation of labor income and the high replacement ratios for social benefits, along with the generosity of the sickness and early retirement schemes, discourage labor force participation and work effort. Directors, therefore, encouraged the authorities to make a concerted effort to mobilize support for addressing these issues.

Directors also saw a need for a new impetus to structural reforms aimed at strengthening competition. Despite the progress made since participation in the European Union internal market, barriers to competition appear to remain in a number of sectors, as evidenced by the persistence of high price levels, which, Directors agreed, call for further measures to improve the functioning of markets. In this regard, they welcomed the recent strengthening of the Competition Authority.

Directors noted that Sweden's financial system is fundamentally sound and stable. While the decline in property values and rising unemployment are posing risks, bank profitability and capital adequacy remain at sound levels and non-performing loans low. Continued vigilance is, nevertheless, warranted, and Directors welcomed, in this context, the steps which the authorities are taking to further strengthen the financial system, following up on last year's Financial Sector Assessment Program recommendations.

Directors commended the authorities for their exemplary efforts to promote open trade policies and for the high level of official development assistance, which, at 0.74 percent of GNP, remains among the highest in the world.

It is expected that the next Article IV consultation with Sweden will take place on the standard 12-month cycle.


Selected Economic Indicators


 

1998

1999

2000

2001

2002

2003 1/

2004 1/


 

 

 

 

 

 

 

 

Real economy (in percent change)

             

Real GDP

3.6

4.6

4.4

1.1

1.9

1.3

2.4

Domestic Demand

4.3

3.3

3.8

0.1

0.7

1.2

2.3

CPI

1.0

0.6

1.3

2.7

2.0

2.0

1.9

Open unemployment rate (in percent)

6.5

5.6

4.7

4.0

4.5

4.2

4.0

Participation in labor market programs (in percent)

4.1

3.3

2.6

2.5

2.6

2.5

2.4

Gross national saving (percent of GDP)

21.1

21.7

22.4

22.0

21.4

21.1

21.5

Gross domestic investment (percent of GDP)

17.2

17.5

18.5

18.1

17.2

17.5

17.9

               

Public finance (in percent of GDP)

             

General government balance

2.3

1.3

3.4

4.6

1.1

0.4

1.0

Structural balance 2/

4.4

2.3

4.1

2.8

0.8

1.5

1.7

General government debt

69.3

62.6

52.9

54.4

52.4

51.0

50.0

               

Money and credit (12-month, percent change)

             

M0

5.1

11.9

2.0

8.8

-0.9

3.3 3/

...

M3

2.1

9.9

2.8

6.7

4.5

5.0 3/

...

Credit to non-bank public

6.8

5.6

9.1

8.9

6.5

-5.5 3/

...

               

Interest rates (year average)

             

Three-month interbank rate

4.2

3.1

4.0

4.3

3.8

2.8 3/

...

Ten-year government bond yield

5.0

5.0

5.4

5.4

5.1

4.1 3/

...

               

Balance of payments (in percent of GDP)

         

Trade balance

6.2

6.1

5.6

5.7

6.1

6.5

6.5

Current account

3.9

4.2

3.9

3.9

4.2

4.5

4.6

Reserves (gold valued at SDR 35 per ounce

14.3

15.3

15.1

14.2

17.4

19.1 4/

...

end of period, in billions of SDRs)

             

Reserve cover (months of imports of goods and services)

2.7

2.7

2.5

2.5

2.7

2.8 5/

...

               

Exchange rate (period average, unless otherwise stated)

             

Exchange rate regime

Floating exchange rate

Present rate (July 29, 2003)

US$ 1 = SKr 8.035

Nominal effective rate (1995=100)

104.7

102.3

101.6

93.5

95.3

102.2 3/

...

Real effective rate (1995=100) 6/

107.9

104.5

103.7

94.0

96.0

102.6 4/

...

       

Source: Statistics Sweden; Riksbank; IMF, International Financial Statistics; INS; and IMF staff estimates.

1/ Staff projections.

             

2/ In percent of potential GDP, also adjusted for timing of tax revenues.

3/ As of June 2003.

             

4/ As of May 2003.

             

5/ As of April 2003.

             

6/ Based on relative normalized unit labor cost in manufacturing.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.




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