IMF Executive Board Concludes 2006 Article IV Consultation with Sweden

Public Information Notice (PIN) No. 07/15
February 7, 2007

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2006 Article IV Consultation with Sweden is also available.

On January 26, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Sweden.1

Background

A new center-right coalition government has launched an ambitious program of economic reform, aimed at addressing widespread exclusion from the labor market. The government's first budget is centered on proposals to cut taxation for low and average income earners, reduce generous unemployment and sickness benefits, and redefine the scope of labor market policies.

A broad-based economic upturn is under way, spurred by strong global growth and supportive fiscal and monetary policies. Private consumption has served as the engine of expansion, supported by a resurgence in investment and buoyant exports. The momentum of the current recovery is expected to continue, although easing back in 2007-08 in the face of capacity constraints and fading policy stimulus.

Wage inflation remained moderate during 2005-06 and, coupled with strong productivity gains, has helped contain labor costs. However, cost pressures have begun to emerge in recent months, reflecting the pass-through of higher energy prices and incipient wage pressures. With capacity utilization at an all-time high and a sizeable positive output gap projected to open, measures of expected inflation have been rising toward the inflation target.

The Riksbank has begun to gradually withdraw the strong monetary stimulus in place for the past two years. In response to rising underlying inflation and higher expected inflation over the policy horizon, the key policy rate was raised in steps from a historic low of 1.5 percent in January 2006 to 3 percent in December.

The structural surplus is estimated to fall below the 2-percent target in 2006, as buoyant tax revenues are offset by pre-election spending on job-creation programs. The tax cuts in the budget for 2007, including those in income, wealth and property taxes, amount to around 2 percent of GDP. They would be financed partially by lowering welfare benefits, raising unemployment insurance contributions, and reducing spending on labor market programs. The staff projects a further fall in the structural surplus in 2007.

The krona has remained broadly unchanged against the euro in recent years; however, it has appreciated 5 percent in effective terms over the past year. Large actual and projected current account surpluses are expected to continue in the medium-term.

Growth is expected to ease back in 2007-08. As the stimulative effects of monetary and fiscal policy fade, domestic demand is expected to slow and the positive output gap will start to close. The risks are broadly balanced, with a possible slowdown in world growth offset by the likelihood of stronger-than-projected domestic demand.

Executive Board Assessment

Directors commended the Swedish economy's strong performance in recent years, marked by rapid growth and a robust competitive position. Directors, however, noted that strong growth has yet to translate into a durable revival in employment, and that a large section of the workforce continues to be excluded from the labor market. They therefore welcomed the new government's program of reform, centered on restructuring the tax-benefit system to increase incentives to work. Directors considered that the thrust of the government's program is consistent with the aim of restructuring the extensive tax and benefit system to address the challenges of demographic change and globalization.

Directors noted that the economy is on course for another year of strong growth in 2007, following very buoyant growth last year, with both monetary and fiscal policies set to remain supportive. As the incipient recovery in employment strengthens, the complementary initiatives of tax cuts, cutbacks in welfare benefits, and the revamping of labor market programs should begin to steer more people into gainful employment.

Directors took note of the significant divergence in views between the staff and the authorities on the cyclical position, and consequently on the fiscal stance. A number suggested caution in assessing policies given the uncertainty surrounding estimates of the cyclical position, especially in times of major reforms.

Looking to 2008 and beyond, Directors underlined the need to achieve the surplus target of 2 percent of GDP over the cycle. The authorities' strong political commitment to adhere to the framework reinforces the credibility of their economic program with the markets and the public. Going forward, Directors viewed expenditure restraint as critical to the creation of room for additional tax cuts over the medium term.

Directors encouraged the authorities to refine further their fiscal framework to improve its transparency and accountability. The fiscal surplus target lends itself to different interpretations, compromising the effectiveness of the framework. The government's intention to refine and clarify the framework is therefore welcome, as are the decisions to restore the three-year horizon of spending ceilings and reduce reliance on tax expenditures. Addressing the value of establishing an independent economic agency to help strengthen confidence in the fiscal framework, a number of Directors agreed with the authorities that such an institution should provide ex post evaluations of adherence to fiscal targets.

Directors agreed that the Riksbank will need to tighten monetary policy further in the coming year. With inflation rising toward the target, and given the fiscal stimulus in 2006-07, Directors saw scope for continued tightening, broadly in line with current market expectations.

Directors viewed the recent changes to the inflation targeting framework as improving the clarity and transparency of monetary policy communication. Further modifications to the framework, such as the use of the Riksbank's own forecasts of interest rates consistent with achieving the inflation target, would keep the approach at the forefront of international best practice. Directors welcomed the recent decision by the Riksbank to make the framework evolve in this direction.

Directors considered the financial system sound and stable. They welcomed the authorities' plans to improve the legislative framework for bank resolution in light of the recent difficulties in closing a small deposit institution in a timely manner. Asset prices, especially those for real estate, need to be monitored closely.

Directors noted that the pay-off from labor market reforms could be enhanced by initiatives to promote competition, especially in sectors such as construction, and encouraging entrepreneurship. In this context, they welcomed the government's plans to sell some of its holdings in the large state-owned enterprise sector.

Directors praised Sweden's high level of official development assistance.


Sweden: Selected Economic Indicators
  2001 2002 2003 2004 2005 2006 1/ Average
2007-09 1/

Real Economy (in percent change)

             

Real GDP

1.1 2.0 1.7 4.1 2.9 4.8 2.3

Domestic Demand

-0.2 0.7 1.7 2.1 2.7 4.3 2.1

CPI Inflation

2.7 1.9 2.3 1.0 0.8 1.6 1.9

Open Unemployment Rate (in percent)

4.0 4.0 4.9 5.5 5.8 5.5 5.2

Participation in labor market programs (in percent)

2.5 2.6 2.1 2.4 2.7 3.1 2.0

Gross national saving (percent of GDP)

21.9 21.7 23.7 23.1 24.2 24.2 25.3

Gross domestic investment (percent of GDP)

17.5 16.6 16.4 16.3 17.1 18.3 18.8
               

Public finance (in percent of GDP)

             

General government balance

2.6 -0.5 -0.2 1.6 2.8 2.8 2.7

Structural balance 2/

2.1 -0.4 0.9 1.8 3.0 1.7 1.5

General government debt

53.8 52.0 51.8 50.7 50.4 46.3 37.9
               

Money and credit (12-month, percent change)

             

MO

8.8 -0.9 2.7 0.2 2.2 ... ...

M3

-0.3 8.3 3.4 4.0 12.9 ... ...

Credit to non-bank public

8.8 5.4 4.8 6.3 10.7 ... ...

Interest rates (year average)

Three-month treasury bill rate

3.7 3.7 2.7 2.0 1.7 ... ...

Ten-Year government bond yield

5.2 4.9 4.9 3.9 3.4 ... ...
 

Balance of payments (in percent of GDP)

Trade balance

6.3 6.9 6.8 8.3 7.6 7.2 6.8

Current account

4.4 5.1 7.3 6.8 7.1 6.0 6.5
International reserves (in billions of US dollars) 15.3 17.4 20.0 22.4 26.5 ... ...
Reserve cover (months of imports of goods and services) 2.1 2.3 2.1 2.0 2.1 ... ...
               

Exchange Rate (period average, unless otherwise stated)

             

Exchange rate regime

   

Floating exchange rate

       

Skr per U.S. dollar (Dec. 5, 2006)

    6.7975        

Nominal effective rate (2000=100)

91.8 93.7 99.0 100.8 98.7 ... ...

Real effective rate (2000=100) 3/

96.9 92.6 95.2 99.2 97.9 ... ...

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

1/ Staff projections.

2/ In percent of potential GDP, also adjusted for one-off effects.

3/ 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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