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Public Information Notice (PIN) No. 04/86
August 9, 2004
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2004 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 2004 Article IV consultation with Sweden is also available.

On August 4, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Sweden.1

Background

The downturn experienced by the Swedish economy in 2002-03 was relatively mild, with growth remaining well above the EU average. Expansionary fiscal policy in 2002 underpinned private consumption. Private investment, however, remained weak and activity decelerated when the impact of public sector stimulus waned in the first half of 2003. With external demand picking up in the second half, activity resumed its strength. The steady upturn, driven by exports and household demand sustained by low interest rates, has continued in early 2004.

Growth has been sustained by a strong rise in productivity, which, while partly cyclical, suggests significant efficiency gains from the diffusion of new technologies. Coupled with economic slack, productivity growth dampened inflation pressures, widening the room for monetary easing. Inflation fell rapidly back toward the 2 percent target and continued to decline in early 2004 on account of base-year effects, falling import prices and strong productivity growth. Inflation expectations have remained low, contributing to wage moderation.

The recovery, however, has yet to turn around the decline in employment and average hours worked. Unemployment rose sharply in the year to early 2004, reflecting continued labor shedding by the business sector and financially constrained local governments. The average duration of unemployment increased as did youth unemployment. In recent years, the high rate of sickness absence has been primarily responsible for the fall in average hours worked. Although sickness absence leveled off in 2003, the adverse impact of overall ill health on labor supply continued to rise as many on long-term sick leave shift to disability pension.

The competitive position remained strong, reflected in the large surplus on the external current account. The krona was broadly unchanged vis-à-vis the euro, but appreciated by over 6 percent in effective terms in the year to March 2004, reflecting the weaker U.S. dollar, and by 3 percent in real effective terms, measured by relative unit labor costs. Nevertheless, with the krona remaining undervalued and with no further worsening of the terms of trade, the current account surplus rose from 5.4 percent of GDP in 2002 to a record-high of 6.4 percent of GDP in 2003. Financial markets took in stride the rejection of the euro in the September 2003 referendum.

With inflation falling faster than expected and forecast to remain below target, the Riksbank eased policy aggressively in early 2004.The policy rate was cut by 25 basis points in February 2004 and by another 50 basis points in early April to 2 percent, its lowest level for more than 50 years. The Swedish policy rate is now at the same level as in the euro area. Signaling the end of an easing cycle, the Riksbank left the rate unchanged in May and June.

The budget for 2004 is broadly neutral and only a marginal rise in the structural surplus of the general government is expected. The fiscal framework is built around a structural surplus target of 2 percent of GDP, complemented by expenditure ceilings for the central government and a balanced budget rule for the local authorities. However, with new spending initiatives in the Spring 2004 Budget, the surplus target is not expected to be met at least until 2007. The margins under the expenditure ceilings are once again too narrow to provide any leeway in the event of unexpected shocks.

Economic activity is expected to pick up steadily in 2004-05 as the global recovery gathers pace. Adjusted for calendar effects, output is expected to rise by around 2 percent in 2004, rather than the unadjusted forecast of 2½ percent. The supportive monetary and fiscal policy stance and rising household confidence should stimulate private consumption, and improved demand prospects and profit position of manufacturing should assist a revival in business investment. Barring a sustained spike in oil prices, strong productivity gains and moderate wage increases would be expected to keep inflation below the target of 2 percent. The external demand stimulus could be larger than expected, especially if the krona continued to remain undervalued. However, the recovery over the coming year is unlikely to be accompanied by substantial gains in employment, which could hold back consumer spending, and persistent excess capacity in manufacturing could again postpone the projected pick up in business investment.

Executive Board Assessment

Executive Directors praised Sweden's strong economic performance in recent years, grounded in well-designed fiscal and monetary policy frameworks, and strong productivity gains that have succeeded in making the downturn in 2002-03 more moderate than the average in the European Union. Directors noted that such strong performance had been thus far consistent with the generous welfare state. They saw a need, however, to revitalize the agenda of structural reform in order to address the challenges of demographic transition and global economic integration.

Directors considered that economic activity should gather strength in the near-term, as the global recovery picks up pace and monetary and fiscal policies remain supportive. Directors noted, however, that in spite of the recovery, employment and average hours worked are still declining, with uncertain prospects for a reversal in this trend.

Directors concurred that, with inflation projected to be below target over the next two years, a policy of keeping interest rates on hold for the near term would be appropriate. They considered that, as the recovery gathers speed, monetary policy will need to be tightened, particularly if the fiscal stance is not adequately restrictive. Directors commended the Riksbank's success in achieving the inflation target that has earned it high credibility. Nevertheless, they saw some room for refining its communications strategy, by making explicit the role of judgment in inflation assessments and extending the forecast horizon beyond two years.

Directors noted that Sweden's fiscal framework has a good track record and its fiscal position remains favorable in a comparative EU context. Nevertheless, noting that efforts to attain the fiscal surplus target have slackened in the recent past, Directors emphasized that safeguarding the target is central to maintain confidence in Sweden's medium-term fiscal framework. Most Directors encouraged the authorities to consider a more ambitious fiscal adjustment in 2005-06 to demonstrate their continued commitment to the surplus target.

Directors observed that there are no margins left for error in the expenditure ceilings and that pressures on public spending are unlikely to ease significantly as spending on sickness and disability benefits may not decrease as much as expected. In Directors' view, strict adherence to expenditure ceilings remains a key instrument for restraining the growth of spending, maintaining credibility of the fiscal framework, and allowing for a reduction in the high tax burden to ease constraints on growth. Some Directors cautioned against continued use of ad hoc measures to meet fiscal targets, as they could undermine transparency and credibility of the fiscal framework.

Directors noted that the rising tensions in public finances are also evident at the level of local governments. Local authorities have raised income tax rates in order to meet the balanced budget requirement in a context of increasing demands for public services related to health care and elderly care. Noting that the rising tax burden also reflects insufficient policy coordination between central and local governments, Directors encouraged the authorities to consider improving fiscal coordination and the use of balancing grants from the central government. Directors also underlined the importance of efforts to review the complex capital tax system in view of the intensifying international competition over tax bases.

Directors underscored the need to reform the tax-benefit regime to improve work incentives and achieve the increase in labor supply needed to meet the authorities' ambitious employment and social policy objectives. In this context, Directors highlighted the importance of more effective steps to reduce sickness absence, better integration of immigrants into the labor force, and efforts to reverse the declining trend in youth participation. A number of Directors urged the authorities to make a concerted effort to mobilize public support to address the incentive aspects of sickness absence as a key requirement to make any significant progress in this area.

Directors viewed a strengthening of competition in product markets as a necessary component of the agenda for faster growth. Directors welcomed the authorities' efforts to promote greater competition between public and private sectors in the provision of public services.

They observed, however, that barriers to competition still remain significant in some sectors. Against this background, Directors recommended a faster pace of structural reforms, particularly in light of the challenges stemming from an ageing population, EU enlargement, and globalization.

Directors concurred that Sweden's financial system remains sound. They noted that bank profitability has improved and capital adequacy and loan loss provisions remain at satisfactory levels. Although household debt has continued to rise, low interest expenses and higher home values mitigate its burden. Considering overall credit risks well-contained, Directors encouraged continued careful monitoring of risks associated with potential fluctuations in property values or a rise in interest rates.

Directors praised the authorities' positive role in revitalizing the Doha Development Agenda and Sweden's high level of official development assistance, which, at 0.7 percent of GNP, remains one of the highest in the world.



Sweden: Selected Economic Indicators


 

1998

1999

2000

2001

2002

2003

2004 1/

2005 1/

                 

Real economy (in percent change)

               

Real GDP

3.6

4.6

4.3

0.9

2.1

1.6

2.5

2.6

Domestic Demand

4.4

3.5

3.9

-0.2

0.9

1.0

1.6

3.0

CPI 2/

1.0

0.6

1.3

2.7

2.0

2.3

0.7

2.0

Open unemployment rate (in percent)

6.5

5.6

4.7

4.0

4.0

4.9

5.5

5.2

Participation in labor market programs (in percent)

4.1

3.3

2.6

2.5

2.6

2.1

2.3

2.0

Gross national saving (percent of GDP)

21.1

21.8

22.6

22.2

22.1

22.1

21.6

21.4

Gross domestic investment (percent of GDP)

17.2

17.5

18.5

17.7

16.8

15.8

15.2

15.8

                 

Public finance (in percent of GDP)

               

General government balance

1.9

2.3

5.1

2.9

-0.3

0.5

0.3

0.6

Structural balance 3/

-0.9

0.5

3.8

3.0

-0.2

1.1

1.2

1.3

General government debt

69.4

62.7

52.8

54.4

52.6

51.9

52.1

51.5

                 

Money and credit (12-month, percent change)

               

M0

5.1

11.9

2.0

8.8

-0.9

2.7

...

...

M3

2.5

9.7

2.8

6.7

4.5

3.1

...

...

Credit to non-bank public

6.9

5.6

9.1

8.8

4.2

2.7

...

...

                 

Interest rates (year average)

               

Three-month interbank rate

4.9

3.6

3.6

4.1

3.9

3.9

...

...

Ten-year government bond yield

5.9

4.3

5.6

4.8

5.2

4.6

...

...

                 

Balance of payments (in percent of GDP)

               

Trade balance

6.2

6.2

5.7

6.2

6.9

7.0

7.5

7.2

Current account

3.9

4.3

4.1

4.4

5.4

6.4

6.4

5.6

International reserves (in billions of US dollars)

16.9

18.0

16.3

14.8

19.3

22.4

...

...

Reserve cover (months of imports of goods and services)

2.3

2.4

2.0

2.1

2.6

2.4

...

...

                 
                 

Exchange rate (period average, unless otherwise stated)

           

Exchange rate regime

Floating exchange rate

 

Present rate (May 31, 2004)

US$ 1=Skr 7.4515

 

Nominal effective rate (1995=100)

101.1

99.7

100.0

91.6

93.1

97.5

...

...

Real effective rate (1995=100) 4/

103.8

100.6

100.0

90.8

93.0

98.3

...

...


Sources: Statistics Sweden; Riksbank; Ministry of Finance; Datastream; INS; and IMF staff estimates.

1/ Staff projections.
2/ Harmonized index of consumer prices. 4/ 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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