IMF Executive Board Concludes 2010 Article IV Consultation with DenmarkPublic Information Notice (PIN) No. 10/160
December 16, 2010
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 2010 Article IV Consultation with Denmark is also available.
On December 13, 2010 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Denmark.1
Denmark is recovering from a deep recession. Output contracted sharply—by about 7 percent from peak to trough—led by a 20 percent correction in house prices which gave way to a domestic banking crisis in mid-2008. Danish banks, highly dependent on interbank funding, faced additional pressures in the fall of 2008 as international wholesale markets froze.
A strong and swift policy response to the global financial crisis softened its impact on the Danish economy and stabilized the banking system. The recovery in the global economy and normalization of financial markets have boosted exports and confidence. This, together with fiscal stimulus and easing monetary conditions, has supported output and halted a rapid rise in unemployment from low pre-crisis levels. Domestic demand was buttressed by large automatic stabilizers, discretionary fiscal easing of almost 4 percentage points of GDP, and major interest rate cuts in line with reductions in the ECB policy rate. Extended active labor market policies helped contain employment losses, while relatively generous unemployment benefits lessened the social impact. The banking system was fortified by a wide range of measures, including a blanket government guarantee for depositors and creditors; liquidity support; capital injections; and a temporary bank resolution scheme. In this context, output began to rise in the second half of 2009 and staff project real GDP to grow at about 2½ percent this year and 2 percent in 2011.
Nonetheless, the crisis and policy response have weakened the fiscal position, moving it away from the planned pre-crisis path. The general government balance swung from a surplus of 3.4 percent of GDP in 2008 to a deficit of 2¾ percent of GDP in 2009, and the deficit is projected to further widen in 2010, to around 5 percent of GDP—around 2 percent of GDP when excluding cyclical and temporary components. Even with a return by 2015 to the pre-crisis targets for the budget balance, gross general government debt as a share of GDP will still be some 30 percentages points higher that year than envisaged before the crisis. Accordingly, the planned pre-funding of ageing-related spending pressures will only partially materialize. Moreover, the expected tightening in monetary conditions raises vulnerabilities for households and corporate given their highly leveraged balance sheets and the prevalence of variable interest rate loans, with possible knock on effects to banks and the real economy.
Executive Board Assessment
Directors noted that the Danish economy had been hit hard by dual shocks—a domestic housing market correction and the global recession. A strong policy response—led by a large discretionary fiscal stimulus building on Denmark’s strong macroeconomic framework—has stabilized output and the banking system, and has prevented an increase in structural unemployment. The economy has begun to recover.
Directors broadly concurred that economic policies should be geared at managing two key risks: a possible worsening of growth prospects; and a tightening in monetary conditions, which could expose household and corporate vulnerabilities arising from highly leveraged balance sheets and variable interest rate loans.
Directors welcomed the authorities’ three-year fiscal consolidation package as an important step towards strengthening Denmark’s fiscal position and reaching structural balance in 2015. Achieving this medium-term objective would be key to safeguard the credibility of the peg to the euro, prepare for ageing-related pressures, and ensure fiscal sustainability. The lagged effects of the large fiscal easing in 2009-10 would continue to support the recovery in 2011, and some Directors saw room for slowing the pace of consolidation should recovery be at risk.
Directors considered the consolidation strategy, including its frontloaded element, to be well designed. At the same time, they supported stronger efforts to rein in public consumption growth in order to meet the deficit targets. While welcoming recent expenditure control reforms, they saw scope for further strengthening public expenditure management, particularly at the municipal level. Containing expenditure growth would also reduce the need for tax increases, given that Denmark’s tax burden continues to be high, even after the recent tax reform.
Directors supported the strengthening of financial sector supervision. They commended the establishment of benchmark thresholds for various bank ratios, the recently signed Nordic cooperation agreement on cross-border financial stability, crisis management and resolution, and the strengthened cooperation between the financial supervisory agency and the National Bank with increased focus on macro-prudential risks. Directors encouraged further efforts to address remaining vulnerabilities in some medium-size banks, and risks that could arise from a resurgence of domestic real estate problems or international financial pressures. They also noted the challenges arising from implementation of Basel III rules.
Directors noted that flexicurity had helped avoid an increase in structural unemployment. Given sluggish labor productivity growth and to boost longer run growth, Directors recommended steps to increase returns on education, in particular at higher skill levels, and to step up competition in the services sector to help reallocate resources to more productive uses. Directors noted that in view of looming labor supply shortages, reforms of early retirement schemes and of sickness and disability leave benefits are also a priority.