IMF Executive Board Concludes 2009 Article IV Consultation with SwedenPublic Information Notice (PIN) No. 09/102
August 7, 2009
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 2009 Article IV Consultation with Sweden is also available.
On July 22, 2009 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Sweden.1
Sweden has been hit hard by the global financial crisis. Two of its banks built up large exposures in the Baltics that significantly increased loan losses beyond normal recessionary levels. Liquidity crunched in the wake of dysfunctional wholesale funding markets on which these banks increasingly relied, and extensive public guarantees only partly mitigated market unease about their capital adequacy. Sweden was particularly vulnerable to the global recession that followed the crisis given the dominance of its output bundle by investment goods and consumer durables. Exports turned sharply negative in the fourth quarter after weakening throughout 2008, and with investment following them down, this led to large reductions in economic activity and inflation. Driven in part by increased risk perception, the Swedish krona depreciated substantially, albeit, to the extent that the composition of global demand that favored Swedish exports during the recent boom was temporary, this depreciation has probably resulted in only a modest undervaluation.
In response to the crisis, the authorities have taken wide-ranging measures to stabilize the financial system and support demand. The measures included expansion of Riksbank’s lending facilities, often at lengthened maturities at fixed interest rates and via extension of the eligible collateral; expanded deposit and credit guarantees; and a new bank recapitalization scheme. Considerable policy stimulus has also been injected into the real economy. A decisive relaxation of the monetary policy stance led by a reduction in the policy rate to ¼ percent has recently been complemented by the imposition of a penalty on banks’ excess reserves at the Riksbank’s deposit facility. On the fiscal side, full operation of large automatic stabilizers and a discretionary budget loosening for 2009 is underway taking the budget from a surplus of 2½ percent in 2008 to a deficit of 4 percent in 2009.
These steps have supported the economy and helped address downside tail risks, but prospects for recovery are very much dependent on developments abroad. If global demand for Sweden’s output bundle recovers slowly relative to other components, Sweden could have a late exit out of the current recession. Staff projects the economy to contract by 6 percent in 2009, with a modest recovery beginning in the middle of 2010.
Executive Board Assessment
Executive Directors noted that the Swedish economy has been relatively harder hit by the global crisis, owing to its export composition and the regional role of Swedish banks. Directors welcomed the authorities’ prompt and appropriate policy responses, which have allayed immediate concerns with financial sector stability, and helped cushion domestic demand. Immediate prospects for recovery are, however, highly dependent upon developments abroad, and downside risks remain. Accordingly, Directors encouraged the authorities to adapt their integrated policy response as necessary to this testing environment.
Directors considered securing confidence in financial sector stability to be a key immediate task, given the impact of recession on asset quality and Swedish banks’ exposure to Baltic economies. While recent stress tests indicated that regulatory capital requirements would continue to be met by all major institutions, market doubts persist. Thus, steps to strengthen banks further—including raising private capital where necessary—should be undertaken as soon as possible. Where private capital proves insufficient, public investment—at prices ensuring protection of taxpayer interests—alongside implementation of a bad-bank model, could be considered. Directors encouraged the authorities to review the current toolkit of supervisory intervention as part of contingency planning, with increases in the Financial Supervisory Agency’s capacity. It would also be important to continue efforts to strengthen coordinated cross-border financial oversight and crisis resolution mechanisms.
Directors welcomed the authorities’ aggressive monetary easing, noting that inflation expectations remain well anchored in low, but positive, territory. Further immediate steps into quantitative easing should remain under review, ready for use should risk of sustained deflation rise.
Directors noted the staff assessment that the krona is probably modestly undervalued. Recent steps to raise international reserves, combined with swap arrangements with other central banks, will boost the Riksbank’s capacity to respond to financial sector liquidity stresses.
Directors endorsed the significant fiscal stimulus provided by the 2009 budget, notably via full play of the large fiscal stabilizers and the planned discretionary measures—which has been made possible by Sweden’s strong fiscal performance in recent years. The composition of the discretionary component would assist supply-side efficiencies. Directors considered that further fiscal stimulus should be weighed carefully reflecting the importance of maintaining fiscal sustainability and recognizing the uncertainties about the public debt burden resulting from financial sector fragilities. Most Directors did not see a need for additional discretionary fiscal action at present. In this context, Directors suggested that the current fiscal rules should be retained, and many Directors considered that the nominal spending ceilings could be supported by a new commitment allowing for adjustments to the spending ceilings that offset the revenue impact of any further discretionary tax reforms.