## cr18279

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### GDP and Activity Indicators
- Norway leveraged oil and gas discoveries to achieve high GDP per capita with principles: wide sharing of oil rents, saving most rents abroad and spending only the real return, and wage bargaining to share terms-of-trade windfalls.
- Petroleum production currently constitutes about ⅛ of output; a large new field will come onstream around 2020 with a projected peak in the mid-2020s, then production set to decrease.
- Recent developments:
  - Mainland GDP growth: 1.9 percent (2017); 2.6 percent (2018:Q1).
  - Drivers: stronger private consumption, business investment and exports; housing investment growth slowed from its 2016 peak.
  - Cumulative fiscal impulse since 2014: about 2.5 percent of mainland potential GDP.
  - Labor Force Survey unemployment rate: around 5 percent (mid-2016 peak) to 3.9 percent in March 2018.
  - Wage growth: 2.3 percent in 2017; recent agreements suggest acceleration to just below 3 percent in 2018.
  - Headline inflation: slightly above the 2 percent revised target; core inflation: around 1¼ percent.
  - Current account (mainland GDP basis): fell from 13 to 4½ percent between 2014 and 2016; recovered to 6½ percent in 2017.
  - Oil services industry accounts for close to one third of mainland Norway’s exports.
- Key projections and selected statistics:
  - Mainland GDP growth: 1.9 percent (2017); 2.5 percent (2018 projection); 2.4 percent (2019 projection).
  - Real GDP: 1.9 percent (2017); 2.1 percent (2018 projection); 2.1 percent (2019 projection).
  - Domestic demand: 2.5 percent (2017); 2.3 percent (2018 projection); 2.2 percent (2019 projection).
  - Mainland exports: 2.1 percent (2017); 3.5 percent (2018 projection); 4.0 percent (2019 projection).
  - Unemployment rate (LFS): 4.2 percent (2017); 3.8 percent (2018 projection); 3.7 percent (2019 projection).
  - Output gap: -0.6 percent (2017); -0.2 percent (2018 projection); 0.2 percent (2019 projection).
  - CPI inflation (average): 1.9 percent (2017); 1.9 percent (2018 projection); 2.0 percent (2019 projection).

### Fiscal Sustainability and Policy
- Fiscal position and risks:
  - Sovereign wealth fund value: 303 percent of mainland GDP as of end-2017.
  - Staff static public sector net worth: 340 percent of mainland GDP.
  - Non-oil fiscal deficits: close to 8 percent of mainland GDP when spending the fiscal rule’s projected 3 percent real return; non-oil deficits were less than 2 percent of mainland GDP in the early 2000s.
  - Health care and pension expenditures expected to grow by about 1 percent of mainland GDP every decade.
  - Without adjustment, intertemporal financial net worth (IFNW) would be minus 240 percent of mainland GDP.
  - Ensuring intertemporal solvency requires a permanent, cumulative fiscal adjustment of about 4–5 percent of mainland GDP in the future; delaying adjustment raises the final cost.
- Fiscal rule and guidance:
  - Government should use fiscal rule flexibility to stay below the 3 percent line for the foreseeable future and start structural consolidation during the up-cycle.
  - Structural non-oil deficit remains below the long-term guideline of 3 percent of the sovereign wealth fund despite expansionary policy in recent years.
- Recent policy actions:
  - 2018 budget broadly neutral; supplementary 2018 budget saves some 1¼ percent of GDP in additional oil revenues relative to the original budget.
  - Projected deficit under the supplementary budget: represents 2.7 percent of the GPFG’s value (slightly below 3 percent guideline).
- Fiscal recommendations (staff appraisal):
  - Gradually reverse the trend increase in non-oil fiscal deficits.
  - Continue using fiscal rule flexibility to keep non-oil deficits below 3 percent of sovereign wealth fund assets.
  - Next year’s budget should target a modest structural consolidation of ¼–½ percent of mainland GDP.
  - Permanent 4–5 percent of GDP consolidation needed over the long term, with scope to extend adjustment to minimize impact.
  - Scale up public spending efficiency efforts and largely save resulting gains to pre-finance age-related spending needs.

### Monetary Policy and Financial Sector
- Monetary policy framework and outlook:
  - New framework (March 2018) formalizes flexible inflation targeting; inflation target lowered from 2.5 to 2 percent.
  - Norges Bank forward guidance: policy rate at 0.5 percent; projects hikes to 2¼ by end 2021 subject to gradual phasing in as slack diminishes.
- Banking sector strengths:
  - Banks’ average CET1 capital ratio: 16.8 percent of risk-weighted assets at end-2017.
  - Banks’ average leverage ratio: 8 percent at end-2017 (all institutions exceed 5 percent requirement).
  - Liquid reserves exceed LCR and prospective NSFR requirements by ample margins.
- Financial vulnerabilities:
  - Household debt: 224 percent of disposable income and rising.
  - Debt service-to-income ratio close to pre-crisis peak of late 1980s.
  - More than 90 percent of mortgages variable rate.
  - Norges Bank studies: private consumption could fall by 0.4 percent for every 1 percentage point increase in mortgage rates.
  - CRE prices increase ~10 percent annually in real terms; CRE exposures amount to 15 percent of total bank assets.
  - About half of banks’ funding comes from the market; >50 percent of market funding from foreign sources.
  - Large cross-holdings of covered bonds within the domestic system pose contagion risks.
- Prudential measures and recommendations:
  - Measures in force/introduced: mortgage regulations (DTI limit of 5; tightened amortization; LTV limit for secondary homes in Oslo 60 percent; speed limit 8 percent for Oslo and 10 percent outside), countercyclical buffer 2 percent (1.5 percent before), Pillar II add-ons (4–5.5 percent for consumer-credit-specialized banks), provisioning rules phased in, BRRD-equivalent legislation effective January 2019, licensing process for credit registries underway.
  - Staff recommends: be ready to tighten prudential policies further; make mortgage regulations permanent with parameters adjustable to the financial cycle; consider regional differentiation; reduce tax preferences for housing and relax constraints on new construction.

### Competitiveness, Wages, and Productivity
- Wage and productivity trends:
  - Over last two decades, wage growth exceeded productivity growth in most sectors and outpaced trading partners; manufacturing nominal wages rose 160 percent since 1995 versus <100 percent in other Nordics and <80 percent in Germany.
  - Manufacturing labor productivity in Norway grew 50 percent while other Nordic peers more than doubled.
  - Large aggregate unit labor cost increases, pronounced 2005–13.
- Sectoral outcomes:
  - Tradable sectors not benefiting from terms-of-trade shocks have declined in value added share; manufactured exports did not respond to the 20 percent real exchange rate depreciation of 2014–16.
  - Non-oil tradable competitiveness is a key challenge as oil contribution wanes.
- Labor market and social-scheme reform priorities:
  - Labor participation high by OECD standards but falling since 2008, especially prime-age men.
  - Sickness and disability: as of January 2018, Work Assessment Allowance duration shortened and extension requirements tightened; 80 percent of disabled receive full 100 percent disability grade.
  - Recommendations: tighten eligibility and grading of disability benefits; reform sick leave benefit sharing to incentivize return to work; expand working hours among women (e.g., more flexible child care); consider higher labor market flexibility with tradeoffs to social model.
  - Authorities are implementing Productivity Commission proposals: improve R&D tax incentives, boost vocational and higher education quality.
- Wage policy recommendations:
  - Shift expectations for wage growth downward; continue wage moderation by social partners to aid transition out of oil and build resilience.
  - Social partners delivered wage moderation during 2014–17 and should carry it forward.

### Housing, Household Debt, and Regional Dynamics
- Housing developments and vulnerabilities:
  - National nominal house prices down ~5 percent in H2 2017; Oslo rebounded by 7.5 percent seasonally-adjusted in Jan–May 2018.
  - Nominal house prices: Oslo and nationwide stand 85 and 55 percent above 2010 levels respectively; Oslo fell 10.5 percent in 2017 then rose 7.5 percent Jan–May following year.
  - Supply now increasing in Oslo after lagging population growth.
- Household balance and risks:
  - Household debt high: 224 percent of disposable income; households aged 30–59 with high incomes (8–10 decile) account for close to 40 percent of household debt.
  - Young households have limited financial assets.
  - New mortgage regulations (Jan 2017): DTI limit of 5 binding especially in Oslo; led to lower LTVs for new mortgages.
  - Virtually all mortgages variable rate; households cut consumption more strongly in response to shocks.
- Regional overvaluation and mobility:
  - Staff estimated regional overvaluation: Oslo 10–20 percent overvalued; non-oil non-Oslo about 0–10 percent; oil regions in equilibrium or slightly undervalued.
  - A 25 percent increase in regional house prices relative to national average estimated to reduce internal net flows to that region by about 10 percent.
- Policy recommendations on housing:
  - Make mortgage regulations permanent and adjustable by region as needed.
  - Further reduce tax preferences for housing and relax local construction regulations to address supply constraints.

### External Position, Reserves, and Risks
- External and reserve positions:
  - NIIP end-2017: 260 percent of mainland GDP; general government net external assets: 287 percent of mainland GDP; GPFG assets: 303 percent of mainland GDP.
  - Norges Bank reserves: 19 percent of mainland GDP (636 percent of imports of goods and services).
- Current account and REER assessment:
  - Current account surplus: 4½ percent (2016) bottomed from 13 percent (2014), recovered to 6½ percent (2017); staff expects gradual convergence to 8 percent of GDP medium term.
  - Staff assesses cyclically-adjusted 2017 CA at 6.1 percent of GDP; EBA norm 12 percent of GDP; staff sees CA 3–4 percent weaker than implied by fundamentals.
  - Staff overall assessment: real exchange rate overvalued by about 10–15 percent relative to fundamentals and desired policies.
- Financial account and vulnerabilities:
  - 2017 capital and financial account: FDI ~1/3; portfolio flows ~2/3.
  - Wholesale funding ~50 percent of banks’ funding; 60 percent of wholesale funding foreign.
  - Private sector short-term external debt 14 percent of mainland GDP (financial sector 9 percent; nonfinancial 5 percent).
- Risk Assessment Matrix (selected):
  - High-likelihood downside: Sharp tightening of global financial conditions → response: relax countercyclical buffer; deploy countercyclical monetary and fiscal policy.
  - Medium/high-likelihood downside: Sizeable energy price fall → response: allow automatic stabilizers, delay monetary normalization, relax fiscal policy if needed, and progress structural reforms.
  - Medium-likelihood downside: Large house price reduction → response: reduce countercyclical buffer, ease monetary policy, use automatic fiscal stabilizers.
  - Medium-likelihood upside: Stronger recovery → response: bring forward fiscal tightening and interest rate hikes if overheating.

### Institutional and Structural Reforms
- Institutions managing oil revenues:
  - GPFG established 1990; since 1996 all oil revenues transferred to GPFG; GPFG invests overseas; fiscal rule (2001) restricts spending to expected real return (set at 4 percent until 2017, revised to 3 percent).
  - Fiscal rule allows average fiscal non-oil deficit of 8 percent of mainland GDP when measured that way.
- Pension reforms:
  - 2011 reform: flexible retirement 62–75, actuarially-fair adjustment, linked to earnings and life expectancy.
  - 2018 public sector occupational pension reform aligns public with private occupational scheme; expected to foster labor mobility and support labor participation among older employees.
- FSAP and macroprudential institutional progress:
  - Mortgage regulations, LCR, preparation for NSFR, BRRD-equivalent legislation, enhanced liquidity stress testing and improvements to FMI operational risk management implemented or underway.
  - FSA powers on AML/CFT strengthened; new AML/CFT Act adopted May 2018.
  - Resolution framework aligned with BRRD and FSB Key Attributes; FSA designated resolution authority; BRRD-equivalent effective January 2019.

### Staff Appraisal — Summary Recommendations
- Short-term: Mainland economy expected to grow by 2½ percent this year and next; core inflation converging to 2 percent.
- Fiscal: Use fiscal rule flexibility to keep non-oil deficits below 3 percent of sovereign wealth assets; implement modest structural consolidation of ¼–½ percent of mainland GDP next year; plan for 4–5 percent of GDP permanent consolidation over the long term.
- Competitiveness and labor market: Continue wage moderation; advance Productivity Commission reforms; further reform sickness and disability schemes; boost labor participation (including among women and vulnerable groups).
- Financial stability: Maintain stringent capital, leverage, and liquidity requirements; make mortgage regulations permanent and regionally adjustable; address housing supply constraints and reduce tax incentives for home ownership to durably mitigate housing risks.

*Source: IMF Staff Report — Norway country report excerpts (cr18279).*

### 1. GDP and Activity Indicators ____________________________________________________________________ 22

### 1. GDP and Activity Indicators

### Context: managing oil wealth and competitiveness
- Norway leveraged oil and gas discoveries (1960s onward) to achieve high GDP per capita and strong income, wealth, and gender equality, based on three broad principles:
  - Oil rents should be widely shared; most oil revenue flows back to the State.
  - Much of the oil rent should be saved for future generations by only spending the real return on accumulated oil savings and keeping most savings abroad to contain Dutch Disease effects.
  - The wage bargaining system should ensure terms of trade windfalls are shared across sectors.

- Oil outlook and role in the economy:
  - Petroleum production currently constitutes about ⅛ of output.
  - Oil production has outperformed expectations over the last 15 years due to technology improvements and profitability of previously marginal fields.
  - A large new field will come onstream around 2020, producing a further projected peak in the mid-2020s; thereafter petroleum production is set to decrease.

- Fiscal and competitiveness trade-offs from oil wealth:
  - Sovereign wealth fund value: 303 percent of mainland GDP as of end-2017.
  - Spending the fiscal rule’s projected 3 percent real return amounts to a non-oil fiscal deficit of close to 8 percent of mainland GDP.
  - Non-oil deficits amounted to less than 2 percent of mainland GDP in the early 2000s.
  - Staff analysis: without adjustment for aging pressures, these deficits will gradually erode and eventually deplete public savings.
- Key policy challenges identified:
  - Competitiveness of non-oil tradable sectors (wages have grown faster than productivity and faster than peers).
  - High non-oil fiscal deficits and aging.
  - Financial stability risks: sizable household debt and high real estate valuations.

### Recent political and institutional context
- Center-right coalition of Prime Minister Solberg reelected September 2017; now in minority status in parliament, potentially limiting scope for difficult reforms.
- Traction of Fund advice: most recommendations from 2017 and earlier Article IV consultations and the 2015 FSSA have been implemented (pension reform, incapacity benefits reform, extended mortgage regulations, liquidity coverage ratios for banks’ foreign currency exposures).

### Recent macroeconomic developments
- Growth and demand:
  - Mainland GDP: annual growth reached 1.9 percent in 2017 and 2.6 percent in 2018:Q1.
  - Drivers: stronger private consumption, business investment and exports; housing investment growth slowed from its 2016 peak.
  - Cumulative fiscal impulse since 2014: about 2.5 percent of mainland potential GDP.
- Labor market:
  - Labor Force Survey unemployment rate: trended down from mid-2016 peak of around 5 percent to 3.9 percent in March 2018.
  - Wage growth: 2.3 percent in 2017; recent wage agreements suggest acceleration to just below 3 percent in 2018.
- Inflation:
  - Headline inflation: risen since November 2017 and now slightly above the 2 percent revised inflation target.
  - Core inflation: around 1¼ percent.
  - Drivers of headline increase: higher energy prices and changes in indirect taxes (reduced VAT rate increased from 10 to 12 percent effective January 2018).
- External sector:
  - Current account surplus (mainland GDP basis): fell from 13 to 4½ percent between 2014 and 2016; recovered to 6½ percent in 2017.
  - Non-oil exports: remained stagnant despite large real depreciation; oil services industry accounts for close to one third of mainland Norway’s exports.
- Housing:
  - National house prices fell by about 5 percent in nominal terms in the second half of 2017.
  - In Oslo, prices rebounded by 7.5 percent on a seasonally-adjusted basis during the first five months of 2018.

### Key statistics (selected)
- Mainland GDP growth: 1.9 percent (2017); 2.5 percent (2018 projection); 2.4 percent (2019 projection).
- Real GDP: 1.9 percent (2017); 2.1 percent (2018 projection); 2.1 percent (2019 projection).
- Domestic demand: 2.5 percent (2017); 2.3 percent (2018 projection); 2.2 percent (2019 projection).
- Mainland exports: 2.1 percent (2017); 3.5 percent (2018 projection); 4.0 percent (2019 projection).
- Unemployment rate (LFS): 4.2 percent (2017); 3.8 percent (2018 projection); 3.7 percent (2019 projection).
- Output gap: -0.6 percent (2017); -0.2 percent (2018 projection); 0.2 percent (2019 projection).
- CPI inflation (average): 1.9 percent (2017); 1.9 percent (2018 projection); 2.0 percent (2019 projection).

### Authorities’ views
- Authorities share staff views on outlook and risks.
- Authorities forecast mainland growth to pick up to about 2½ percent this year and next and see the output gap closing in late 2018 or the first half of 2019.
- Authorities view risks as broadly balanced; high household debt seen as key vulnerability.
- Authorities’ assessment of medium-term potential growth: around 2 percent (mainland economy).

### Recent policy actions referenced
- 2018 budget: broadly neutral stance, focused on boosting long-term growth potential through tax shifts (direct to indirect taxes), improving public sector efficiency, enhancing infrastructure, and promoting innovation.
- Supplementary 2018 budget: saves some 1¼ percent of GDP in additional oil revenues relative to the original budget to preserve the neutral stance.
- Projected deficit under the supplementary budget: represents 2.7 percent of the GPFG’s value, slightly below the long-term fiscal guideline of 3 percent.

### Traction of prior Fund recommendations
- Implemented reforms since last Article IV include: public-sector pension reform, incapacity benefits reform, extension of mortgage regulations, and introduction of liquidity coverage ratios for banks’ foreign currency exposures.

*Source: IMF Staff Report — Norway: 1. GDP and Activity Indicators*

### 18.      In addition, high non-oil deficits would—in the absence of adjustment—eventually

### cr18279 - 18.      In addition, high non-oil deficits would—in the absence of adjustment—eventually

### Fiscal sustainability: current position and risks
- Staff analysis of an intertemporal public sector balance sheet for Norway shows the public sector has a static net worth of 340 percent of mainland GDP.
- Current high non-oil deficits, gradually declining oil revenues, and increasing aging pressures will weigh on public finances.
- Health care and pension expenditures are expected to grow by about 1 percent of mainland GDP every decade.
- In the absence of adjustment to contain the resulting increase in deficits, Norway’s intertemporal financial net worth (IFNW) would be minus 240 percent of mainland GDP.
- Ensuring intertemporal solvency would require a permanent, cumulative fiscal adjustment of about 4–5 percent of mainland GDP in the future.
- Delaying adjustment would raise the final cost by running larger deficits for a longer period.

### Fiscal rule and policy guidance
- The government should use the flexibility embedded in the fiscal rule to stay below the 3 percent line for the foreseeable future.
- The ongoing up-cycle provides an ideal setting to start structural consolidation.
- Allowing the deficit to drift toward the “allowed” 3 percent line would:
  - stimulate the economy when it is not needed;
  - increase the long-term adjustment need; and
  - reduce space to respond to negative asset price shocks that could affect the sovereign wealth fund and increase pressure on the real exchange rate and competitiveness.
- The structural non-oil deficit is still below the long-term guideline of 3 percent of the sovereign wealth fund despite several years of expansionary fiscal policy.

### Pension reform and long-term fiscal measures
- Recent agreement on public sector occupational pension reform, agreed in the first half of 2018 and to be phased in by 2020, aligns the public with the private occupational pension scheme.
- The reform is expected to foster labor mobility between private and public sectors and support labor participation among older public sector employees—an effect already observed among private employees after the 2011 reform.

### Public spending efficiency
- There appears to be potential in various public spending areas for authorities to extract more value for money.
- Authorities are in the initial stages of designing systematic public expenditure reviews; first spending reviews in the last two years have been modest in scale.
- Going forward it is important to widen the scope of reviews and to forge political agreement to realize and bank identified savings, rather than reallocating them.

### Authorities’ views on fiscal strategy
- Authorities agreed on the amount of fiscal savings required in the long term, but noted difficulties in budget consolidation at this point in the cycle.
- They consider the economy no longer in need of fiscal stimulus and have adjusted fiscal policy towards a neutral stance in latest budgets.
- Further consolidation will be made in light of developments in the output gap.
- Authorities aim to stay below the 3 percent benchmark to provide a buffer against potential asset price fluctuations given the size of the GPFG.
- They expect to minimize needed consolidation and improve growth by expanding labor participation and improving value for money through more systematic expenditure reviews.

### Monetary policy framework and outlook
- A new monetary policy framework adopted in March formalizes Norges Bank’s practice of flexible inflation targeting, adding mandates to contribute to high and stable employment and output and to counteract financial imbalances.
- The inflation target was lowered from 2.5 to 2 percent.
- Norges Bank’s forward guidance projects a hike in the policy rate from its current level of 0.5 percent by late this year, and further increases to 2¼ by end 2021.
- The inflation outlook warrants a gradual phasing in of tighter monetary policy as slack diminishes and wage negotiations point to accelerating income growth.

### Financial sector: strengths
- Banks’ balance sheets are strong: profits have been solid, loan losses are low, and banks comfortably meet higher capital requirements effective from 2018.
- Banks’ average CET1 capital ratio was 16.8 percent of risk-weighted assets at end-2017.
- Banks’ average leverage ratio stood at 8 percent at end-2017, with all institutions exceeding the 5 percent requirement.
- Liquid reserves exceed LCR and prospective NSFR requirements by ample margins.

### Financial sector: vulnerabilities and risks
- Household sector:
  - House prices remain overvalued, particularly in the Oslo region.
  - Household debt is 224 percent of disposable income and is still gradually rising.
  - Debt service-to-income ratio is close to its pre-crisis peak of the late 1980s.
  - More than 90 percent of mortgages in Norway are variable rate.
  - Norges Bank studies suggest private consumption could fall by 0.4 percent for every 1 percentage point increase in mortgage rates.
- Commercial real estate (CRE):
  - CRE prices increase rapidly, rising by about 10 percent annually in real terms.
  - CRE exposures amount to 15 percent of total bank assets, with branches of foreign banks more exposed.
  - Average initial lease duration is seven years; a sizable part of CRE relates to property management companies.
- Funding and contagion:
  - About half of banks’ funding comes from the market, and more than half of that from foreign sources.
  - Reliance on wholesale funding has slightly decreased while maturities have lengthened; covered bond issuance has increased.
  - Large cross-holdings of covered bonds within the domestic banking system pose contagion risks.

### Prudential measures and recommendations
- Recent and planned measures:
  - Mortgage regulations extended until end-2019 (initially effective from beginning of 2017): DTI limit of five times gross annual income; tightened conditions for amortization requirement; lowered LTV limit for secondary homes in Oslo to 60 percent; permitted “speed limit” share of mortgages violating criteria is 8 percent for Oslo and 10 percent outside Oslo.
  - Higher countercyclical buffer requirement of 2 percent (1.5 percent before) effective start of 2018.
  - Pillar II requirements set in the 4 and 5.5 percent range for banks specialized in consumer credit (versus 1.5–2 percent for other banks).
  - New rules requiring provisioning for prospective loan losses are being phased in.
  - Legislation corresponding to the EU’s BRRD adopted and will become effective in January 2019; FSA designated as resolution authority.
  - Licensing process to establish credit registries underway.
- Staff recommendations:
  - Stand ready to tighten prudential policies further if risks intensify, including mortgage regulation parameters and Pillar II add-ons for CRE.
  - Make mortgage regulations a permanent part of the prudential toolkit and adjust parameters with the financial cycle.
  - Consider expanding regional differentiation of measures if house price overvaluation diverges further across regions.
  - Reduce still-generous tax preferences for housing and further relax constraints on new property construction to address housing risks more durably.

### Authorities’ views on financial stability measures
- Authorities agreed with staff on financial stability risks but cautioned against overreach with prudential regulations.
- They judged mortgage regulations effective in reducing risky mortgages but emphasized regular reassessment of usefulness and design.
- Authorities emphasized balancing prudential measures against banks’ ability to assess credit risks and cautioned about micromanaging the market with regional differentiation.
- There are presently no plans to further reduce tax deductibility of mortgage interest; its effective value has shrunk with lowering of the ordinary income tax rate and other tax changes (net wealth tax changes in 2014–18 and more municipalities collecting property taxes).

_International Monetary Fund — Norway country report excerpts._

### 30.       The wage growth seen in the last 15 years

### 30.       The wage growth seen in the last 15 years

### Wage growth and competitiveness
- Over the last two decades, Norway experienced wage growth that exceeded productivity growth in most sectors, and outpaced wage rises in trading partners.
- Terms of trade gains (in energy, fisheries, and metals) allowed this without a disproportionate loss of competitiveness up to 2014.
- Tradable sectors that did not benefit from positive terms of trade shocks have struggled to adjust, shown by declining shares of value added; these tradable sectors will gain in importance as the role of oil diminishes.
- High prevailing wages have contributed to the emergence of a dual labor market in non-tradeable sectors, with an increasing share of workers not covered by collective agreements.
- Going forward, rapid wage growth as in the past will only be possible if Norway again experiences favorable terms of trade; otherwise society may need to downwardly adjust expectations of future wage increases.
- The government, nominally a follower in the wage bargaining system, will have a key role to play in moderating society’s expectations.
- Social partners delivered wage moderation during the recent downturn (notably in 2014–17) and should carry this forward to build resilience and facilitate transition out of oil.

### Productivity and reform priorities
- Productivity growth has fallen considerably since the mid-2000s, especially among non-oil sectors less exposed to international trade and competition.
- Authorities are implementing reform proposals from the Productivity Commission report to promote innovation, improve labor skills, and expand product market reforms.
- Reforms already underway include improving the effectiveness of tax incentives for R&D and innovation and boosting the quality of vocational and higher education.
- Continued prioritization and implementation of proposed reforms is recommended to generate further productivity gains.

### Labor participation and social-scheme reform
- Norway’s labor participation rate remains among the highest in the OECD but has been falling since 2008, especially among prime-age cohorts and men.
- Sickness and disability:
  - Effective January 2018, the maximum duration of extended sickness leave (“Work Assessment Allowance”) was shortened and requirements for its extension tightened.
  - Sickness and disability schemes require further and substantial reforms.
  - Roughly 80 percent of all disabled receive a full 100 percent disability grade, which disqualifies them for undertaking any work.
  - Tightening benefits eligibility criteria and increasing the grading scale of disability could create more incentives to work for the disabled.
  - Reforming sick leave benefits to incentivize employers to bring employees back to work earlier—e.g., through more equal sharing of long-term sick leave costs with the state—should be considered.
- Female participation:
  - More could be done to expand working hours among women, for example by making child care even more flexible.
- Labor market flexibility:
  - Higher flexibility in temporary work contracts and wages might be needed to prevent some people from being permanently excluded from the labor market, though tradeoffs with Norway’s social model must be considered.
- Upcoming policy windows:
  - The upcoming expiration of an agreement on working conditions between government and social partners, last reviewed in the early 2000s, is an opportunity.
  - The Employment Committee has been tasked with examining the impact of current social security schemes on employment rates.

### Housing, regional mobility, and urban planning
- Job-to-job flows are high by international standards, but there is evidence of growing net outflows of prime-age cohorts from big cities where housing affordability has deteriorated.
- Rising house prices can be a barrier to interregional migration of low-skilled workers and to regional income and productivity convergence.
- Construction and urban planning regulations are perceived as quite strict, especially in the Oslo area.
- Authorities have taken measures to lower construction costs and time; supply of new housing in Oslo is now increasing after lagging population growth for several years.
- Recommendations:
  - Consider more active use of region-specific housing policies, including relaxing excessively stringent local regulations.
  - Consider further lowering preferential tax treatment of housing.

### Agricultural protection
- Parliamentary vote to phase out export subsidies for agricultural products by 2020 and to free up price setting.
- Action is still needed to reduce high agricultural domestic subsidies and tariffs.
- Reducing agricultural protection would increase efficiency and benefit low-income groups through lower food prices.

### Stakeholders’ views
- Authorities:
  - Agreed competitiveness should be reinforced further.
  - Emphasized that wage growth consequences should not be overstated given terms of trade gains leading up to 2014.
  - Noted the floating exchange rate helped adjust relative prices and improve competitiveness after the oil price drop in 2014.
  - Agreed high cost levels leave Norway vulnerable to a reversal in the terms of trade and that wage moderation might be necessary going forward.
  - Plan to continue implementing Productivity Commission proposals to enhance work incentives.
  - Noted efficiency measures since 2015 reduced growth in construction costs.
- Labor unions:
  - Emphasized threats posed by the dual labor market to Norway’s social model.
  - Concerned about rising shares of workers not covered by collective agreements and receiving considerably lower wages, especially in services, industry, and construction exposed through labor migration.
  - Called for increased focus on vocational training and lifelong learning.
- Confederation of Norwegian Enterprises:
  - Agreed on need for wage moderation going forward.
  - Noted past rapid income growth was made possible by strong terms of trade gains that are unlikely to be repeated.
  - Expressed confidence social partners can deliver restraint when needed.
  - Viewed changes to wage formation introduced in 2014, which give greater prominence to wage developments abroad, as positive.

### Staff appraisal: growth, fiscal, and financial stability assessments
- Short-term outlook:
  - Mainland economy expected to grow by 2½ percent this year and next.
  - Core inflation expected to converge to 2 percent.
  - Recent positive trends in oil prices and a strengthening labor market could cause growth to exceed expectations.
- Vulnerabilities and downside risks:
  - High and rising household debt, much of which is in the form of variable-rate mortgages, exposes households to abrupt tightening in financing conditions.
  - Housing prices already overvalued in some regions; a continued housing price rebound could increase vulnerabilities.
  - Rising global trade tensions are a concern for a small, highly open economy.
- Structural challenges:
  - With the contribution from the oil sector projected to wane, Norway must transition to new growth sectors.
  - Non-oil fiscal deficits have risen steadily to high levels over the last 15 years, despite limited aging impact to date.
- Competitiveness policy recommendations:
  - Wage moderation by social partners should be continued to facilitate the transition away from oil and build resilience to adverse international price developments.
  - Continue reforms to support innovation and productivity growth.
  - Sustain high labor participation; the agreement on public sector occupational pension reform is an important advance by lengthening working lives and fostering labor mobility.
  - Further progress needed on work incentives, including more substantial reform of sickness and disability benefit schemes and better integration of vulnerable groups into the labor market.
- Fiscal policy recommendations:
  - Gradually reverse the trend increase in non-oil fiscal deficits seen over the last 15 years to help alleviate pressures on the real exchange rate and pre-finance aging-related consolidation needs.
  - Continue using flexibility in the fiscal rule to keep non-oil deficits below the rule’s long-run benchmark level of 3 percent of sovereign wealth fund assets.
  - Next year’s budget should target a modest structural consolidation of ¼–½ percent of mainland GDP, given that output is likely to exceed potential in 2019.
  - To address longer-term fiscal sustainability, a permanent 4–5 percent of GDP consolidation will be needed, though adjustment can be extended over a long period to minimize impact.
  - Scale up efforts to realize efficiency gains in public services provision and largely save resulting gains to pre-finance age-related spending needs.
- Financial stability recommendations:
  - Significant action has been taken; banks meet stringent capital, leverage, and liquidity requirements.
  - Recent extension of mortgage regulations (effective at limiting issuance of high-risk mortgages) is welcome; envisaged gradual normalization of monetary policy is appropriate.
  - Mortgage regulations should be made a permanent part of the prudential toolkit, with parameters adjustable as needed.
  - If house price valuations and financial stability concerns continue to diverge across regions, consider more regionally differentiated mortgage regulations.
  - To more durably address housing risks, further address supply constraints and reduce tax incentives for home ownership, which remain generous by international standards despite reductions.

*Source: cr18279 - 30.       The wage growth seen in the last 15 years*

### 44.      It is proposed the next Article IV consultation with Norway be held on the standard

### It is proposed the next Article IV consultation with Norway be held on the standard 12-month cycle.

### Economic rebound and activity indicators
- The economic rebound is gathering steam, driven by stronger private consumption, business investment and, most lately, exports.
- Recovery of exports is largely led by oil products and services, while non-oil exports are still lagging.
- Business and oil investment strengthened throughout 2017, but housing investments softened somewhat.
- The PMI continues to trend up; businesses and consumers are gaining confidence.
- Growth decomposition (contribution to real GDP growth, y/y, in percent) series for 2013Q1–2017Q4 show private consumption, public consumption, gross fixed capital formation, total exports, change in inventory, total imports, and total real GDP contributions (figure summary).

### Labor market developments
- Increasing demand for labor has been filled to a considerable extent through more working hours; growing number of vacancies should translate into higher employment going forward.
- Participation and employment rates of the prime age cohorts continue to decline; the disability rate is high in international comparison.
- The gap between male and female participation rates is narrowing, mostly due to declines among males.
- Integration of immigrants into the labor market remains a challenge (unemployment rate by immigration status shows a persistent gap).
- Unemployment and disability, 2013: comparative panel lists NOR DNK FIN SWE USA GBR CAN DEU FRA AUS NZL JPN (percent).
- Labor force participation for 25–39 years: series for males and females, 2009–2017.
- Labor force, employment, and total hours worked indexed to 2010=100 (4-quarter moving average) show employment and hours trends 2010–2018.
- New vacancies index (2010=100; 4-quarter average) increased 2010–2018.

### Price developments and inflation
- Headline inflation has reached the revised target, but core inflation remains subdued.
- Subdued core inflation reflects incomplete exchange rate passthrough to import prices, weakening producer prices, and subdued wage growth.
- Capacity utilization is slowly rising; inflation expectations remain well anchored (survey-based 5-year inflation expectations series).
- Annual inflation series (Headline inflation, Core CPI, Inflation target) for 2014–2018.
- Exchange rate and imported price dynamics: nominal effective exchange rate (import-weighted) and imported consumer goods inflation (percent change, yoy).
- Producer Price Index (consumer goods) shows total and domestic PPI y/y percent change for 2014–2018.
- Wage growth (y/y percent change) versus unemployment rate series for 2007–2017.

### External sector developments
- Norway’s current account improved marginally in 2017 driven by an improvement in the oil trade balance.
- Oil prices edged up; volume of petroleum production has been stable.
- Non-oil exports have declined slightly despite the Krone depreciation in 2015.
- Norway has been losing ground in competitiveness during the last 15 years (real exchange rate indices and unit labor costs comparisons).
- Petroleum production projections and historical series (Million cubic meter oil equivalents) shown through 2022.
- Oil and gas prices: Crude Oil Brent, Oil future, Natural gas Russian natural gas border price in Germany (U.S. dollars).
- Nonoil exports composition (Aquaculture and other foodstuffs; Chemicals; Machinery and transport equip.; Other manufactures; Other nonoil services; Tourism services) in million U.S. dollars.
- Current account and oil balance reported as percent of mainland GDP, series through 2017.
- Real exchange rate indices (EREER ULC based; EREER CPI based; NEER) with price of oil (RHS), Jan-1995=100.

### Fiscal position, expenditure composition, and aging
- Norway’s fiscal expenditure ratio is about 2 percentage points of GDP lower than that of Nordic peers when measured in percent of total GDP (including oil production). 1/
- Norway’s expenditure on general services is in line with other Nordics, although transport and defense spending is higher.
- Dependency ratio has not increased yet but is about to; pension spending is lower for now than in peers, but sickness and disability spending is significantly costlier.
- Health spending is higher than most peers despite fewer old-age people, partly due to higher domestic wages and preferences for decentralized provision of services.
- As aging progresses, age-related expenditures are forecast to rise significantly more than in Nordic peers.
- Projections of old age dependency (ratio of population aged 75+ to those aged 15–74) for 1990–2060 for Norway, Finland, Denmark, Sweden, Germany.
- Increases in age-related expenditures (Norway in percent of mainland GDP versus 2017; Finland in percent of GDP versus 2015) show Pensions, Health Care, Long-term care, Total across projection years 2020–2060.
- Expenditure on general public services, 2016 (percent of GDP) by category and country; Nordic average: 21.2 percent of GDP.
- General government primary expenditure, 2016: Nordic average: 52 percent of GDP.
- Social expenditure, 2016: Nordic average: 23.2 percent of GDP; Public health care expenditure by category, 2016: Nordic avg.: 7.6 percent of GDP.
- Note 1/: Normalized by total rather than mainland GDP for cross-country comparison. If expressed as percent of mainland GDP, Norway’s primary expenditure would be 7½ percentage points higher than Nordic peers’.

### Credit developments
- Real interest rates remain low for now, but the Norges Bank has suggested that tightening may start before year end.
- Nominal credit growth has remained stable around 5–6 percent.
- Banks’ portfolios are heavy on real estate exposures; consumer credit still makes up a small share but has been growing rapidly.
- Corporate credit is being driven by property management, services, and, most recently, the recovering oil sector. Corporate credit standards have stopped tightening as the economic recovery strengthens.
- Real interest rates (percent, adjusted for Norway's one-year ahead inflation) series include key policy rate, 3-month effective interbank rate, lending rates to NFCs and households (2007–2018).
- Growth in domestic credit (y/y percent change, seasonally adjusted) shows Total, Households, NFCs, NFCs - foreign and domestic loans, Municipalities (2012–2018).
- Banks' loan portfolio, 2017Q3 (percent): Residential mortgages 56.3; Consumer loans 3.0; Other personal market 3.5; Property management 11.5; Construction 3.4; Other corporate market 16.5; Other loans 5.8.
- Bank and mortgage company lending to NFCs (percent, 12-month change in stock) by sector: Commercial property, Manufacturing, Services, Construction, Other industries, Total (2013–2017).
- Corporate loans: demand and credit standards survey responses (percent).
- Growth in consumer lending and household debt (y/y percent change) series 2008–2017.

### Banking sector developments
- Banks have continued to strengthen their capital ratios on the back of higher equity from retained earnings.
- Profits are underpinned by low operating expenses but dependent on interest revenues.
- Nonperforming loans and associated losses remain low.
- Banks have strengthened liquidity positions in response to phasing-in of liquidity requirements; however, banks remain vulnerable to global financial turmoil as half their funding comes from wholesale sources.
- Select bank ratios: net interest revenues as share of operating revenues; operating expenses relative to operating revenues; profit relative to total assets (NORSWEDENFINDEU).
- Loan losses (percent of total lending) show very low levels historically; 20-year average highlighted.
- Liquidity Coverage Ratio and Net Stable Funding Ratio (weighted average, percent, 2017Q3) display Total and by bank size; specific LCR components by currency/instrument shown.
- Market funding composition by source and maturity: foreign vs Norway, covered bonds (OMF), senior bonds, ST market funding & interbank (percent).
- CET1 capital ratio series (with and without transitional rule) and CET1 capital/total assets (percent) trend 1996–2017.
- Changes in CET1 capital ratio (percentage points) decomposed into contributions from change in risk-weighted assets and CET1 capital across 2008–2017.

### Housing developments
- After outpacing incomes for most of the post-crisis period, house prices slowed since early 2017, driven largely by declines in the Oslo market.
- Supply has started to catch up and tighter mortgage regulations introduced in 2017 and recently extended had an effect.
- House prices remain high.
- Evolution of house prices (percent, 12-month change) for Bergen, Oslo, Stavanger, Trondheim, 2012–2018.
- Changes in number of households and housing starts (thousands) 2005–2017 show housing starts and household formation dynamics.
- House prices against disposable income per capita (index, 1980 = 100) comparison: Norway, Euro area, OECD (1980–2016).
- Real house price growth vs real disposable income growth (y/y percent change) series for 2002–2017.

### Household debt, mortgage regulations, and vulnerabilities
- Household debt is high in international comparison.
- Households aged 30–59 with high incomes (8–10 decile) account for close to 40 percent of household debt.
- Young households have limited financial assets.
- Mortgage regulations introduced in early 2017 were associated with tighter credit standards for households; the debt-to-income limit of five has been binding, especially in Oslo, and led to lower LTV ratios for newly-granted mortgage loans.
- Distribution of debt by household income, 2015: average debt by income decile (thousands of NOK) and number of households with debt burden larger than 500 percent of income by decile (RHS).
- Balance sheet by age of main income earner, 2015 (thousands of NOK): debt, dwellings, other real capital, bank deposits, other financial assets, net wealth.
- Household loans: demand and credit standards survey (percent responses) shows tightening after 2017Q1 (tighter mortgage regulations).
- Non-compliant mortgages by cause, 2017: debt-servicing capacity, debt-income ratio, LTV ratio, inadequate instalment payments; distinction secured on property in Oslo vs outside Oslo.
- New mortgage loans with high LTV (LTV>85% as share of total): shares by age group Below 30 yrs, 30–60 yrs, Above 60 yrs for 2015–2017.
- Virtually all mortgages are variable rate, including those made in 2017; Norwegian households tend to cut consumption more strongly in response to shocks (Fagereng and Halvorsen 2016).
- Effect of a 1 percentage point increase in lending and deposit rates: net effect on disposable income (percent) series 1981–2017.
- Change in net interest expenses following a 1 percentage point interest rate increase by age cohort (percent of disposable income, 2015).
- Number of households by debt burden, 2015: categories shown with shares (e.g., Debt burden 0, or negative income after tax 15%; 0 <-<100 28%; 100 -< 200 15%; 200 -< 300 14%; 300 -< 400 11%; 400 -< 500 7%; 500+ 10%).
- Estimates of change in household consumption, 2007–09 (in percent of 2007 household income) plotted by debt-to-income ratio for Norway, Denmark, UK.

### Commercial real estate (CRE) developments
- Commercial property prices doubled in real terms over the past 15 years; increases were higher in prime locations.
- Available data suggest real CRE prices rose by another 10 percent or so in 2017 amid high transaction volume.
- Office prices in Norway have trended toward the upper end of the range spanned by peers but are not an outlier; higher prices may be justified given yields remain solid relative to peers in prominent CRE segments.
- Real prices of commercial property (index: 2003 = 100; per square meter) for All property types, Offices - national average, Oslo Prime Offices (2003–2017).
- Annual percentage change in real prices of commercial property by segment for 2004–2016.
- Nominal price of office space (NOK per square meter; national averages) compared across countries 2000–2016.
- Transactions in commercial property (billions of NOK) and transaction volume series 2003–2017.
- CRE net operating yields by property category, 2017 (percent) compared across countries.

### Corporate sector developments
- Corporates’ financial positions have strengthened further; corporate debt remained constant.
- The real estate sector has increasingly sought market funding in recent past but remains a large exposure for banks.
- Market funding composition by industry (percent of total funding): Leasing and management of property, Project-related property, Other industries excl. oil and gas (2006–2017).
- Credit to non-financial corporations (percent of mainland GDP) shows foreign debt and domestic debt series 1984–2017.
- Nonfinancial corporation financial position (percent of mainland GDP): gross liabilities, net financial assets (RHS), and debt servicing capacity of listed companies (RHS) series 2002–2017.
- Norwegian firms' funding structure, 2017: bank debt (millions of NOK), other debt (millions of NOK), percent that is bank debt (RHS).

### Key indicators, projections, and selected statistics (2013–2023)
- Population (2017): 5.3 million
- Per capita GDP (2017): US$ 75,389
- Quota (3754.7 mil. SDR/0.78 percent of total)
- Main products and exports: Oil, natural gas, fish (primarily salmon)
- Literacy: 100 percent

Selected historical and projected macro aggregates (annual/change percent unless otherwise noted) from Table 1 and Table 2:
- Real GDP: 2013 1/ 2014 2.0 2015 2.0 2016 1.1 2017 1.9 2018 2.1 2019 2.1
- Real mainland GDP: 2.3 2.2 1.4 1.0 1.9 2.5 2.4 (2013–2019)
- Domestic demand: 3.5 1.6 0.7 2.7 2.5 2.3 2.2 (2013–2019)
- Unemployment rate (percent of labor force): 3.8 3.6 4.5 4.7 4.2 3.8 3.7 (2013–2019)
- Output gap (mainland economy): 0.5 0.6 0.0 -0.9 -0.6 -0.2 0.2 (2013–2019)
- CPI (average): 2.1 2.0 2.1 3.6 1.8 1.9 2.0 (2013–2019)
- Gross national saving (percent of GDP): 38.1 38.6 35.5 33.1 34.3 36.1 36.4 (2013–2019)
- Central government overall balance (percent of mainland GDP) 2/: 9.4 6.0 1.3 -3.1 -2.0 -0.7 -0.7 (2013–2019)
- Nonoil balance (percent of mainland GDP) 3/: -4.8 -6.3 -7.1 -7.7 -8.0 -8.4 -8.5 (2013–2019)
- Structural non-oil balance (percent of mainland trend GDP) 4/: -5.2 -5.9 -6.6 -7.3 -7.5 -7.6 -7.6 (2013–2019)
- Fiscal impulse: 0.4 0.7 0.6 0.7 0.2 0.1 0.0 (2013–2019)
- Pension Fund Global capital ratios (in percent of GPF-G capital): -3.3 -3.0 -2.7 -2.7 -2.8 -2.7 -2.8 (2013–2019)
- Broad money, M2 (end of period, 12-month percent change): 7.3 6.4 0.6 5.1 6.0 (2013–2017; later years not listed)
- Three-month interbank rate (year average, percent): 1.8 1.7 1.3 1.1 0.9 1.1 1.4 (2013–2019)
- Ten-year government bond yield (year average, percent): 2.6 2.5 1.6 1.3 1.6 1.9 2.1 (2013–2019)
- Current account balance (percent of mainland GDP): 13.0 13.0 9.4 4.4 6.5 9.5 9.4 (2013–2019)
- Exports of goods and services (volume change, percent): -1.7 3.1 4.7 -1.8 1.1 2.0 2.4 (2013–2019)
- Imports of goods and services (volume change, percent): 5.0 2.4 1.6 2.3 2.8 1.9 2.9 (2013–2019)
- Terms of trade (change, percent): 0.0 -6.3 -11.7 -9.9 4.9 1.1 0.8 (2013–2019)
- International reserves (end of period, in billions of US dollars): 57.9 66.9 58.5 60.9 65.1 73.3 78.7 (2013–2019)
- Exchange rate regime: Floating
- Bilateral rate (NOK/USD), end-of-period: 5.9 6.3 8.1 8.4 8.3 ...
- Real effective rate (2010=100): 99.0 94.2 86.5 86.6 87.4 ...

Medium-term projections (selected):
- Real GDP projections 2020–2023: 1.9 1.9 1.8 1.8 (Table 2)
- Current account balance (percent of mainland GDP) projections 2018–2023: 9.5 9.4 9.1 8.8 8.5 8.3 (Table 2)

Notes and definitions drawn from source:
- 1/ Based on market prices which include "taxes on products, including VAT, less subsidies on products".
- 2/ Projections based on authorities' 2018 budget.
- 3/ Projections based on authorities' 2018 budget removes both petroleum revenues and expenditures.
- 4/ Authorities' key fiscal policy variable; excludes oil-related revenue and expenditure, GPFG income, as well as cyclical effects.
- 5/ Over-the-cycle deficit target: 3 percent of Pension Fund Global Capital.

*Source: IMF staff compilation of Norway country chapter (figures, tables, and notes) from the provided content unit.*

### Annex I. Norway’s Competitiveness Challenges

### Annex I. Norway’s Competitiveness Challenges

### Wage and productivity trends (1995–2017)
- Since 1995, nominal manufacturing wages in Norway rose by 160 percent, compared to less than 100 percent in other Nordics and less than 80 percent in Germany.
- Manufacturing labor productivity in Norway grew by 50 percent while that of other Nordic peers more than doubled.
- Similar but smaller divergences exist in services (see Selected Issues Paper).
- Large increase in aggregate unit labor costs, particularly pronounced during 2005–13 when global commodity prices spiked.

### Terms of trade and sectoral composition
- Export prices rose considerably for key exports: oil, aluminum, and fisheries.
- Oil-related industries and the oil service industry benefitted; the oil service industry makes up 1/3 of mainland exports.
- Composition of Mainland Norway's Exports, 2017 (shares):
  - Energy: 6%
  - Industrial Commodities (incl. Aluminum): 17%
  - Seafood: 12%
  - Oil service industry: 32%
  - Other goods: 12%
  - Tourism: 7%
  - Other services: 14%

### Labor share and collective bargaining
- Wages have remained constant as a share of GDP during a period when several other advanced countries saw falling labor shares.
- Collective agreements cover 70 percent of employees in Norway.
- Collective wage agreements: decentralized, two-tiered system — sector-level negotiations each year; other benefits negotiated every two years; supplemental company-level agreements possible under a peace clause.

### Pattern bargaining and the machinery sector’s role
- The machinery sector (supplier to oil extraction worldwide) traditionally led wage negotiations via “pattern bargaining.”
- Machinery sector blue-collar wages (up to 2014) set a starting point for manufacturing wage agreements; manufacturing wage norm served as a target for average wage rises in the rest of the economy, including the public sector.
- Machinery sector’s exposure to oil price shocks increased its pricing power and wage outcomes.

### Spillovers and sectoral pass-through of wage increases (2001–2013)
- Manufacturing sector wage increases were above 4 percent during 2001–13 and permeated to follower sectors due to strong adherence to central agreements and an objective to contain wage dispersion.
- Nominal wage growth by sector, 2001–2013: manufacturing-led increases transmitted to many sectors (chart summary in source).

### Competitiveness outcomes and structural implications
- Non-oil related manufactures’ share in mainland GDP declined by about 5 percentage points since the late 1990s.
- Manufactured exports did not respond to the 20 percent real exchange rate depreciation of the 2014–16 oil downturn.
- Unit labor costs in services increased considerably more than in trade partners.
- Many services and nontradables (such as construction) experienced labor inward migration; migrants often accept lower wages and tend not to be covered by collective agreements, contributing to rapid decreases in union coverage in certain sectors (Staff Report ¶30).
- Potential long-term consequence: reallocation to oil-related sectors may make diversification away from oil more difficult.

### Policy implications and recommendations
- Norway should shift expectations for wage growth downward going forward.
- Wage moderation would:
  - Build resilience against less favorable international price trends.
  - Facilitate the needed transition out of oil.
- Since 2014, social partners have delivered wage moderation:
  - Manufacturing sector wage growth averaged less than 2 percent during 2014–17.
  - Other sectors reduced average wage growth from above 4 to 2.3 percent during 2014–17.
- Changes in bargaining since 2014: social partners now heed wage developments in trade partners more closely and the broader manufacturing sector — instead of machinery — leads wage negotiations.

---

### Annex II. Regional House Price Overvaluation in Norway

#### Recent house price dynamics
- Nominal house prices in Oslo and nationwide now stand 85 and 55 percent, respectively, above their 2010 levels.
- House prices fell in 2017 particularly in Oslo, with nominal house price declines of 10.5 percent during 2017.
- Correction was short-lived: house prices rose by 7.5 percent during January–May of the following year on a seasonally-adjusted basis.
- National house price to income ratio remains historically and internationally high.

#### Regional divergence since 2013
- Since 2013:
  - Prices declined in oil regions (largely due to the oil downturn).
  - Prices grew modestly in non-oil, non-Oslo regions.
  - Prices increased very rapidly in Oslo.
- Supply kept up with population growth outside Oslo but lagged behind in Oslo.

#### Mortgage regulations and binding constraints
- New mortgage regulations entered into force in January 2017. Additions included:
  - (i) a debt-to-income (DTI) limit of 5;
  - (ii) tightened conditions for applying an amortization requirement;
  - (iii) a lower limit for the maximum percentage of new mortgage lending in Oslo allowed to deviate from one or more regulatory requirements (the “speed limit”).
- Evidence suggests the regulations—especially the DTI limit—have been binding, particularly in Oslo where many mortgages hit the DTI limit.

#### Estimated regional overvaluation and financial stability focus
- Estimated regional overvaluation (staff analysis):
  - Oslo: some 10–20 percent overvalued.
  - Non-oil, non-Oslo: about 0–10 percent overvalued.
  - Oil regions: in equilibrium or slightly undervalued.
- Implication: greater potential for a price correction in Oslo; Oslo is where financial stability concerns and macroprudential focus should be concentrated.

#### Effects on internal labor mobility
- Rising dispersion of house prices is starting to limit internal labor mobility.
- Staff estimate: a 25 percent increase in house prices in a given region relative to the national average is estimated to reduce internal net flows to this region by about 10 percent.
- Region-to-region flows remain small contributors to net population changes but have an equilibrating role when shocks are asymmetric.

---

### Annex III. Norway’s Institutions to Manage Oil Revenues

- 1990: Government Pension Fund Global (GPFG) established to administer oil revenues.
- Since 1996, all oil revenues have been transferred to the GPFG.
- GPFG invests overseas to limit Dutch Disease concerns.
- 2001 fiscal rule: on average over the cycle only the expected real return of the GPFG can be spent; additional flexibility allowed to safeguard exposed sectors from Dutch Disease symptoms.
- Expected real return: set at 4 percent until 2017, when revised to 3 percent.
- GPFG assets currently amount to about 300 percent of mainland GDP.
- The fiscal rule allows for an average fiscal non-oil deficit of 8 percent of mainland GDP.

---

### Annex IV. Pension Reforms in Norway

#### Pension system structure
- Three pillars:
  - (i) basic pension provided by the National Insurance System;
  - (ii) occupational pension schemes (separate schemes for private workers and public employees);
  - (iii) additional and voluntary private pension savings.

#### 2011 reform and labor supply incentives
- 2011 reform of the National Insurance System and the private occupational pension scheme:
  - Encouraged lengthening working lives as life expectancy increases.
  - Introduced flexible retirement between age 62 and 75 (previous retirement age was 67).
  - Replacement rates adjusted actuarially-fairly for earlier or later retirement.
  - Linked pensions to earnings in each year worked and adjust pensions by life expectancy.
- Reform incentivizes pensioners to work after beginning to receive pensions; safeguarding the actuarially-fair nature of the system is important.

#### 2018 public scheme reform
- 2018 agreement between authorities and unions to reform the public sector occupational scheme (which was not included in the 2011 reform).
- The reform aligns the public scheme with the private occupational scheme and addresses key pending issues of the 2011 reform.
- Expected fiscal and labor effects:
  - Pension expenditures will increase moderately (as reform provides incentives to stay longer at work in exchange for higher pensions afterwards).
  - Overall reform is expected to increase fiscal revenues through higher income tax collections as workers stay longer at work—consistent with private sector experience after the 2011 reform.

*Source: cr18279 - Annex I. Norway’s Competitiveness Challenges (IMF).*

### 4.      Despite this important progress, reform efforts should continue. The authorities are

### 4.      Despite this important progress, reform efforts should continue. The authorities are

### Public-sector pension and related reforms
- Authorities plan a special scheme applicable to ⅓ of public employees allowing for earlier retirement; the scheme covers police, military, firefighters, prison guards, and health workers.
- Integration of the old-age pension scheme for public employees on disability into the current framework is still pending.
- Important reform to public-sector pensions was agreed in June 2018:
  - Design contains strong incentives for employees to lengthen their working lives.
  - Reform aligns the public pension scheme with its private counterpart (reformed in 2011), ensuring portability of benefits.

### Foreign asset and liability position and trajectory — Background and assessment
- NIIP at end 2017: 260 percent of mainland GDP (increase of 100 percent of GDP in the last 5 years; ¾ explained by transactions and ¼ by valuation effects).
- General government net external assets: 287 percent of mainland GDP, driven by the Government Pension Fund Global (GPFG) with assets of 303 percent of mainland GDP.
- Financial sector net external liabilities: 58 percent of mainland GDP.
- International reserves: 19 percent of mainland GDP.
- Assessment:
  - NIIP expected to remain stable due to sound management of the GPFG.
  - Negative revaluation risks mitigated by GPFG asset diversification and solid capital position of Norwegian banks.
  - Overall external position in 2017 assessed as weaker than implied by medium-term fundamentals (confirmed by current account, REER index, and external sustainability approaches).
  - As of July 2018, developments do not point to a clear change in the external position.
- Policy response recommendation:
  - Fiscal and structural policies should aim to foster productivity growth and wage growth more in line with productivity developments across tradable sectors.
  - Enhance non-oil sector competitiveness as contribution from oil and gas to GDP starts tapering.

### Current account — Background and assessment
- Current account surplus bottomed out at 4½ percent of GDP in 2016 after declining from 13 percent of mainland GDP in 2014.
- Non-oil exports have remained flat despite krone depreciation during 2013-15.
- 2017: current account recovered marginally as oil prices edged up; expected to gradually converge to 8 percent of GDP over the medium term.
- Cyclically-adjusted 2017 CA: 6.1 percent of GDP.
- EBA regression-estimated norm: 12 percent of GDP.
- Staff assessment: cyclically-adjusted current account presently assessed to be 3–4 percent weaker than implied by medium-term fundamentals and desirable policies.
- Contributing factors to current account gap:
  - Looser than desirable fiscal policy, above-optimal health spending and credit levels together contribute 0.8 percentage points to the current account gap.
  - Note: latest upward revision of the 2017 current account surplus by 0.4 percentage points of GDP due to higher oil exports was not reflected; it would likely only slightly reduce the current account gap because the current account norm would also be expected to increase.

### Real exchange rate — Background and assessment
- REER appreciation in 2017: 0.7 percent.
- Krone depreciation during 2013–15: 12.6 percent.
- REERs (both ULC and CPI) are about 2 percent stronger as of March 2018 relative to June 2017 data.
- Assessment using different approaches:
  - EBA elasticities: a 3–4 percent of GDP current account gap would imply a real exchange rate overvaluation of 8½–11½ percent.
  - Real exchange rate index approach: real exchange rate is 5 percent stronger than its norm in 2017.
  - Alternative real exchange level approach: points to an undervaluation of 20 percent (but historically a poor fit for Norway).
  - Staff overall assessment: real exchange rate overvalued relative to fundamentals and desired policies by about 10–15 percent.
- Note: stickiness of current account response to krone depreciation suggests EBA elasticity may be overstated.

### Capital and financial accounts: flows and vulnerabilities
- 2017 composition of capital and financial account balance:
  - FDI: about 1/3.
  - Portfolio flows: about 2/3.
- Flows mainly to other Nordic and EU countries.
- Banks’ funding structure:
  - Wholesale funding accounts for about half of total banks’ funding.
  - 60 percent of wholesale funding from foreign sources.
- Assessment:
  - Financial account vulnerability is low overall, but banking sector’s reliance on external wholesale funding is a source of vulnerability.
- Private sector short-term external debt in 2017: 14 percent of mainland GDP (financial sector: 9 percent; nonfinancial: 5 percent).

### FX intervention and reserves
- Exchange rate regime: the krone floats freely and independently.
- Norges Bank has not intervened since 1999 but could intervene if exchange rates deviate substantially from fundamentals.
- At end 2017:
  - Norges Bank reserves: 19 percent of mainland GDP (636 percent of imports of goods and services).
  - GPFG reached 303 percent of mainland GDP.
- Assessment: reserves are comfortable even considering banks’ exposure to wholesale funding and risks of regional contagion.

### Risk Assessment Matrix — Key downside and upside risks and policy responses
- High-likelihood downside: Sharp tightening of global financial conditions (triggered by a sharper-than-expected increase in U.S. interest rates or other risks).
  - Expected impact: increasing costs of borrowing and debt servicing; lower spending by highly-leveraged households; hindered corporate investment; potential liquidity stress for banks given high dependence on wholesale funding.
  - Policy response: Relax the countercyclical capital buffer; deploy countercyclical monetary and fiscal policy if needed.
- Medium/High-likelihood downside: Sizeable downside deviations from baseline energy prices.
  - Expected impact: weaker demand for oil-related mainland goods and services; weigh on economic recovery as in 2014–16.
  - Policy response: Allow automatic stabilizers to operate fully; delay monetary policy normalization and relax fiscal policy in event of larger slowdown; progress on labor market and productivity-enhancing reforms; target temporary expenditure measures to boost long-term growth potential.
- Medium-likelihood downside: Widespread and large reduction in house prices followed by household deleveraging.
  - Expected impact: dampened private consumption; negative spillovers to banks’ balance sheets.
  - Policy response: Reduce the countercyclical buffer and ease monetary policy; call upon automatic fiscal stabilizers and, if needed, discretionary fiscal policy.
- Low/Medium-likelihood downside: Rising protectionism and retreat from multilateralism.
  - Expected impact: lower demand for exports and weaker investment leading to lower domestic growth.
  - Policy response: Re-double efforts to reach new economic cooperation and trade agreements; make further progress on labor market and productivity-enhancing reforms; target temporary expenditure measures to boost long-term growth potential.
- Medium-likelihood upside: Stronger-than-expected recovery of the Norwegian economy amid improving domestic confidence and oil prices.
  - Policy response: Bring forward fiscal policy tightening and interest rate hikes if signs of overheating emerge.

### Debt Sustainability and fiscal scenario assumptions (selected figures)
- Baseline scenario real GDP growth projections: 2018: 2.1; 2019: 2.1; 2020: 1.9; 2021: 1.9; 2022: 1.8; 2023: 1.8.
- Baseline scenario inflation projections: 2018: 5.7; 2019: 2.3; 2020: 2.0; 2021: 2.0; 2022: 2.0; 2023: 2.0.
- Baseline scenario primary balance projections: 2018: 3.1; 2019: 3.1; 2020: 2.7; 2021: 2.4; 2022: 2.2; 2023: 2.1.
- Baseline effective interest rate projections: 2018: 2.2; 2019: 0.9; 2020: 1.0; 2021: 0.7; 2022: 0.8; 2023: 1.0.
- Constant Primary Balance scenario primary balance: 3.1 for each year 2018–2023.
- Historical scenario primary balance: 2018: 3.1; 2019–2023: 7.8 each year.

### Authorities’ response to 2017 Fund recommendations (selected actions)
- Fiscal policy:
  - 2018 budget: moderate stimulus of +0.1 percent of GDP.
  - Reduced corporate and personal income taxes; increased wealth tax valuation discount for shares and operating assets to 20 from 10 percent; amendments to broaden the tax base.
- Macroprudential policy:
  - Mortgage regulations extended until end-2019 in virtually unchanged form (originally effective January 1, 2017); regulation implemented an LTI limit and tightened condition for amortization requirement.
  - Countercyclical capital buffer increased to 2 percent from December 31, 2017.
  - Liquidity coverage ratio requirements in significant currencies introduced effective September 30, 2017 and set at 100 percent effective December 31, 2017.
  - Enhanced stress tests to better account for funding risks.
- Structural reforms and labor market:
  - Nominal wage growth for 2018 agreed at 2.8 percent; expected medium-term growth is 3 percent.
  - Programs to address youth unemployment extended; reforms to the “youth guarantee” and Qualification Program being rolled out; nationwide program to promote inclusion of youth into employment expected to launch in summer 2018 with public sector committing to increase share of youth and disabled in public workforce to 5 percent.
  - Reforms to the work assessment allowance passed in June 2017 and effective January 2018.
  - Employment Committee established to examine impact of social security schemes on employment; first report expected by end of 2018.

*Source: IMF staff, Annexes V–VIII (Norway).*

### Annex IX. Status of FSAP Recommendations

### Annex IX. Status of FSAP Recommendations

### Macroprudential Policies and Framework
- Recommendation: Consider additional measures to contain systemic risks arising from the growth of house prices and household indebtedness (e.g., stricter loan-to-value (LTV) ratios, and loan-to-income or debt service ratio to supplement the affordability test).
  - Priority: S
  - Time: Mostly done.
  - Status details:
    - In June 2015, the Ministry of Finance adopted a regulation on requirements for residential mortgage loans, which converted FSA guidelines into explicit requirements, effective from 1 July 2015 to end-2016.
    - The requirements were retained in a new regulation from 1 January 2017, which also introduced a debt-to-income limit, tighter down-payment requirements, and a lower “speed limit” for Oslo (the percentage of new mortgages that can deviate from mortgage requirements).
    - The Ministry of Finance extended in June 2018 these regulations until end-2019.

- Recommendation: Consider measures to contain risks related to banks’ wholesale funding (e.g. limits could be placed on the mismatch between the maturity of currency swaps (and other hedging techniques) and the maturity of the underlying exposures).
  - Priority: S
  - Time: Partly done.
  - Status details:
    - LCR regulation introduced in Norway in 2015, phase-in completed by the end of 2017.
    - Regulation imposes LCR requirements for all currencies in total (of 100 percent).
    - LCR requirements for significant currencies introduced: banks and mortgage companies with EUR or USD as significant currencies must have LCR in NOK of at least 50 percent.
    - A NSFR requirement is expected to be introduced after final EU rules are adopted.

- Recommendation: Improve the existing institutional structure for macroprudential policies. This should include more standardized and transparent procedures for giving advice to the MOF; a transparent “comply or explain” approach by decision-makers; and, in due course, greater delegation of decision-making powers over macroprudential instruments to NB or the FSA.
  - Priority: M
  - Time: Under consideration.
  - Status details:
    - The Central Bank Law Commission’s proposal includes establishing a committee for monetary policy and financial stability at Norges Bank.
    - Proposal assigns responsibility for use of monetary policy instruments and efforts to promote financial stability, to be chaired by the Governor of Norges Bank.
    - Proposal includes more independence (e.g., raising the threshold for when government instructions can be issued to Norges Bank).
    - Proposal publicly heard and now under consideration in the Ministry of Finance.

### Stress Tests
- Recommendation: Improve liquidity monitoring by performing liquidity stress tests using the structure of cash flows at various maturities; or applying customized versions of the LCR along the maturity ladder. Consider options to discourage cross-ownership of covered bonds.
  - Priority: M
  - Time: Partly done.
  - Status details:
    - FSA and Norges Bank set up a joint working group on liquidity stress testing using cash flow structures at different maturities; funding gaps calculated under three different stress scenarios.
    - Work is in its final stages.
    - Since September 2016, credit institutions have reported Additional Liquidity Monitoring Metrics (ALMM, CRD IV).
    - The maturity ladder in the ALMM framework was implemented in March 2018.

- Recommendation: Enhance the stress test framework for the insurance sector. Allocate more resources to the FSA to assess the liability side risks and validate models and assumptions used in the bottom-up stress tests by insurance companies.
  - Priority: M
  - Time: Ongoing.
  - Status details:
    - Solvency II legislation entered into force on 1 January 2016.
    - Norwegian undertakings participated in the European Insurance and Occupational Pensions Authority (EIOPA) stress-test in 2016.
    - FSA conducted thematic on-site inspections at the three largest life insurance undertakings during autumn 2016, and three medium sized undertakings during March to May 2017; focus on calculation and validation of technical provisions and solvency capital requirement, governance, documentation, validation, and methods, assumptions and data.
    - In 2018, the FSA is conducting a survey including all life insurance companies to compare and challenge calculated levels of the best estimate of technical provisions.

- Recommendation: Achieve recapitalization of weakly capitalized insurance companies in the current environment. Continue to restrict dividend payouts by the companies with weak capital adequacy.
  - Priority: S
  - Time: Ongoing.
  - Status details:
    - January 2017 letter from the FSA to all life insurance undertakings stated life insurance undertakings should not pay dividends as long as surplus on insurance policies are used to strengthen reserves according to new requirements (new mortality tables).
    - Where transitional rule for technical provisions is used, FSA assumes boards make proper reviews of need for capital accumulation short and long term.
    - Current capitalization of life insurance companies is more satisfactory overall, partly due to higher interest rate levels; FSA continues to challenge certain companies’ target levels for when dividends can be paid.

### Micro-supervision
- Recommendation: Enhance the FSA’s de jure operational independence, powers (particularly in regard to corrective actions and sanctions), and supervisory resources. Strengthen the FSA’s supervision of small banks through conducting comprehensive assessments more frequently.
  - Priority: M
  - Time: Unaddressed.

- Recommendation: Upgrade substantially the FSA’s supervisory approach towards the AML/CFT issues, including by increasing supervisory activities and providing guidance on the topic.
  - Priority: S
  - Time: Ongoing.
  - Status details:
    - The FSA assesses the ML/TF risk in supervised institutions on a yearly basis; the 2017 risk assessment formed the basis for prioritization in 2017 and 2018.
    - The FSA has conducted AML/CFT on-site inspections in several institutions, including banks, insurance and insurance intermediaries, investment firms, real estate agents, auditors and external accountants; AML/CFT is part of all ordinary on-site inspections.
    - In 2016, the FSA updated the AML/CFT guidance paper from 2009 and published a new guidance paper regarding AML/CFT targeting real estate agents.
    - In 2017, the FSA published guidance papers regarding AML/CFT targeting auditors and external accountants.
    - Private sector provided input to guidance papers; guidance papers to be updated regularly, including when the new act on ML/TF is set into force.
    - The FSA, in cooperation with the Ministry of Foreign Affairs, the Ministry of Justice and Public Security, the Norwegian Police Security Service, The Norwegian National Authority for Investigation and Prosecution of Economic and Environmental Crime and the private sector, published a guidance paper regarding terrorist financing and proliferation financing with an appendix of Q&As; latest update was in April 2018.
    - The government published a new national risk assessment in September 2017; updating process underway.
    - The Ministry of Finance sent a draft proposal for a new AML/CFT Act to Parliament in February 2018, which was adopted by Parliament in May 2018.
    - The Act contains new powers for the FSA to react to breaches of key provisions, including powers to impose administrative fines and to ban individuals from holding certain positions in AML/CFT obligated entities.

### Financial Market Infrastructure
- Recommendation: Strengthen operational risk management related to outsourcing in systemically important payment systems.
  - Priority: S
  - Time: Done.
  - Status details:
    - Risk management framework for the NICS (clearing) system improved and is now fully compliant with the CPMI/IOSCO principles for financial market infrastructures.
    - Organizational changes and plans for increased resources for the NICS system ownership function have been implemented.
    - A new operational set-up for the NICS system is under preparation.
    - An enhanced contingency solution for the NBO (RTGS) system was implemented in November 2015.

### Safety Nets
- Recommendation: The MOF should initiate resolution planning for the largest banks, including assessing impediments to resolvability, and delegate specific responsibilities to the FSA, and define expectations for the Norway-specific elements of the recovery and resolution plans of foreign bank subsidiaries and branches.
  - Priority: S, M
  - Time: Ongoing.
  - Status details:
    - In March 2018, the Storting adopted a new legal framework corresponding to the EU’s BRRD framework, including rules on resolution planning.
    - Preparations for new requirements on planning etc., which enter into force on 1 January 2019, are well underway.
    - The FSA is designated as the resolution authority in Norway.

- Recommendation: Enhance the legal framework for resolution to comply with the FSB Key Attributes, in particular with regard to the resolution toolkit, operational independence, legal protection for the resolution authorities and administration boards, establishing earlier triggers for resolution, cross-border resolutions, and the distinction between going concern and gone concern resolution.
  - Priority: S
  - Time: Done.
  - Status details:
    - All essential elements of the BRRD have been implemented; the Norwegian legal framework will comply with the FSB Key Attributes.

- Recommendation: The BGF should adopt policies specifying under what conditions board members must recuse themselves, considering actual and prospective conflicts of interest.
  - Priority: S
  - Time: Done.
  - Status details:
    - BGF adopted policies specifying recusal circumstances:
      1) When there is a possibility that a company the board member has an interest in would bid on a problem bank or part of its assets;
      2) When there is a possibility that the whole bank in which the board member has an interest, or parts of its assets or its deposit portfolio, may be sold.
    - Board members must consider whether to recuse themselves based on these criteria before meetings where support from the BGF will be discussed; after the problem situation is over, the board shall review how the recusal was handled.
    - Policies are available on the BGF’s website (in Norwegian only).
    - At the time of entry into force of legislation corresponding to the BRRD, the board of the BGF will be appointed by the MoF rather than elected by the member banks.

### Fund Relations (As of May 31, 2018)
- Membership Status:
  - Joined: December 27, 1945; Article VIII
- General Resources Account:
  - Quota: 3,754.70 SDR Millions (100.00 Percent)
  - Fund holdings of currency: 3,510.19 SDR Millions (93.49 Percent)
  - Reserves tranche position: 244.53 SDR Millions (6.51 Percent)
- Lending to the Fund:
  - New Arrangements to Borrow: 208.44 SDR Millions
- SDR Department:
  - Net cumulative allocations: 1,563.07 SDR Millions (100.00 Percent)
  - Holdings: 1,493.33 SDR Millions (95.54 Percent)
- Outstanding Purchases and Loans: None
- Latest Financial Arrangements: None
- Projected Payments to the Fund (SDR Million; based on existing use of resources and present holdings of SDRs)
  - Charges/Interest forthcoming:
    - 2018: 0.33
    - 2019: 0.68
    - 2020: 0.68
    - 2021: 0.68
    - 2022: 0.68
  - Total forthcoming:
    - 2018: 0.33
    - 2019: 0.68
    - 2020: 0.68
    - 2021: 0.68
    - 2022: 0.68
- Implementation of HIPC Initiative: Not applicable
- Implementation of Multilateral Debt Relief Initiative: Not applicable
- Implementation of Catastrophe Containment and Relief (CCR): Not applicable
- Exchange Arrangements:
  - The de jure and de facto exchange rate arrangements in Norway are classified as freely floating.
  - The exchange system is free of restrictions on the making of payments and transfers for current international transactions other than restrictions notified to the Fund in accordance with Decision No. 144–(52/51).
- Article IV Consultation: Norway is on the 12-month consultation cycle.
- FSAP Participation: A review under the Financial Sector Assessment Program (FSAP) was completed in 2015.
- Technical Assistance: None
- Resident Representative: None

### Statistical Issues (As of June 30, 2018)
- Assessment of Data Adequacy for Surveillance:
  - General: Data provision is adequate for surveillance.
  - National Accounts: Breakdowns for oil-related parts of the mainland economy and other traditional sectors would be useful, given the need to better understand the impact of oil and gas activity on the mainland economy.
  - Ability to monitor the economy would be enhanced by better data on commercial real estate markets, including as banks’ exposures in this area are considerable.
  - The authorities are continuing to make progress in these areas.
- Data Standards and Quality:
  - Subscriber to the Fund’s Special Data Dissemination Standard (SDDS) since

*Source: Annex IX. Status of FSAP Recommendations (cr18279).*

### 1996. Uses SDDS flexibility options on the timeliness of the general

### Norway: Statement by Kimmo Tapani Virolainen and Tove Katrine Sand (September 12, 2018)

### Economic outlook and labor market
- The Norwegian economy has recovered from the 2014 oil-price-induced downturn and "is now characterized by optimism and solid growth."
- The labor market "continues to improve." Unemployment is declining and the employment rate "is now rising and is expected to continue trending upwards over the next couple of years."
- The government forecasts growth in the mainland economy (excl. oil, gas and shipping) to outpace trend this year and increase further next year.
- Drivers of growth identified:
  - Higher purchasing power supporting consumption growth.
  - Solid growth abroad and improved cost-competitiveness supporting business investment and export recovery.
  - Petroleum investment is "likely to increase over the next couple of years" after a sharp decline following the oil price fall; higher oil prices and cost-reducing measures have enabled this increase.
- Medium-term challenge: "managing a smooth transition to a less oil-dependent growth model" as petroleum production and related activities will eventually decrease.

### Housing market and financial stability
- House prices fell in 2017 after several years of rapid growth; in the first half of 2018 house prices "have risen again" and are "now slightly above the peak level from last year."
- Price dynamics are uneven: particularly strong growth in Oslo; more moderate growth in other cities.
- Household vulnerability:
  - "On average, Norwegian households hold a debt that is more than twice the size of their disposable yearly income."
  - High household debt increases vulnerability to changes in income, interest rates and house prices and poses risks to financial stability and economic growth.
- Policy responses:
  - The government revised its housing market strategy emphasizing supply-side efficiency, consumer protection, and sustainable household debt development.
  - The Ministry of Finance extended mortgage regulations in June (retaining caps on loan-to-value and total debt); the regulation is set to expire after 18 months and includes Oslo-specific requirements.
  - Authorities stand ready to amend the regulation and other macroprudential measures if risks intensify or change character.
  - Authorities agree with staff that the mortgage regulations have been effective, leading to tighter lending practices and lower issuance of high-risk mortgages.
- Financial sector assessment:
  - Norwegian banks’ balance sheets are strong, profits are solid, and loan losses are low.
  - Banks comfortably meet strict capital, leverage, and liquidity requirements; shock absorption capacity is high and has improved significantly.

### Monetary policy and interest-rate outlook
- New regulation on monetary policy (laid down March 2, 2018):
  - Operational target: "an annual consumer price inflation of close to 2 percent over time."
  - Regulation states inflation targeting shall be forward-looking, contribute to high and stable output and employment, and counteract build-up of financial imbalances; it underpins a flexible approach to inflation targeting.
  - "The new inflation target will not result in significant changes in Norges Bank’s conduct of monetary policy."
- Policy rate history and outlook:
  - Following the 2014 oil-price fall, Norges Bank cut the key policy rate to historically low levels.
  - "For more than two years, the key policy rate has remained unchanged at 0.5 percent."
  - Underlying inflation is below target but is expected to rise given driving forces.
  - "According to Norges Bank’s assessment of the outlook in June, the policy rate will most likely be raised in September 2018."
  - Given household vulnerability to higher rates, increases "will therefore be conducted gradually" and policymakers should "proceed with great caution."

### Fiscal policy, petroleum revenues, and fiscal rule
- Fiscal stance:
  - After supporting the economy since 2014, fiscal policy is now "broadly neutral" as growth strengthens and unemployment is low.
  - Spending of petroleum revenues corresponds to "2.7 percent of the Government Pension Fund Global (GPFG)," which is "well in line with our fiscal rule of spending 3 percent of the Fund over time."
- Fiscal framework and objectives:
  - All petroleum revenues are transferred into the GPFG; spending guided by the estimated real return of the Fund.
  - Framework provides flexibility to handle temporary setbacks and ensures sustainable management of resource revenues.
  - With solid non-oil growth and low unemployment, fiscal policy should "ease off" to: (1) avoid overheating and hampering recovery, and (2) be better prepared for future shocks and long-run aging-related costs.

### Tax policy and innovation incentives
- 2016 tax reform:
  - Corporate income tax rate reduced "from 27 to 23 percent."
  - Measures included to curb base erosion and profit shifting.
  - Overall marginal personal income tax rate reduced to make work more attractive.
- R&D incentives:
  - Staff recommended enhancing R&D tax incentives.
  - The Norwegian R&D tax subsidy scheme "Skattefunn" has recently been made more generous.
  - An independent evaluation shows Skattefunn "significantly stimulates private R&D investment" and suggests adjustments to better target subsidies and avoid misuse; the government is assessing the report.

### Ensuring sustainable public finances: labor participation, pensions, and public sector efficiency
- Long-run fiscal pressures:
  - Petroleum income will not shelter Norway from future fiscal challenges; age-related expenditures projected to increase significantly while transfers from the Fund will "stabilize over the next decades and, measured against the economy, decline over the long run."
- Two main government strategies to secure welfare spending without raising taxes:
  - Expanding labor participation.
  - Improving value for money in the public sector.
- Expanding labor participation measures and observations:
  - Potential to increase labor supply among part-time workers and mobilize groups outside the labor market.
  - Immigrants from low-income countries and groups with reduced employability often struggle to enter the labor market.
  - High shares receiving sick leave and disability benefits indicate potential to increase labor supply.
  - "A lower share of the working age population is employed now than ten years ago," posing a concern for welfare sustainability.
  - A public commission is due to present its first report next year with proposals to increase labor participation.
- Pension reform and work incentives:
  - Expanding labor participation has been a core goal of the 2011 pension reform.
  - In spring (2018), government reached agreement with social partners on a public-sector pension reform aligning work incentives with the private sector to lengthen working lives.
  - Ongoing work includes abolishing or reforming early-retirement schemes for specific public-sector groups (police, ambulance, military, fire service) and making the collectively bargained private-sector pension scheme ("AFP") more financially solid.
  - Authorities are pursuing regulatory processes to ensure efficient management of pension assets and safeguarding future pensions.
- Public sector efficiency initiatives:
  - Deregulation and Efficiency Reform (introduced 2015) is now a permanent part of the annual budget process and applies an "efficiency dividend of 0.5 percent on all governmental institutions’ current spending in the annual fiscal budget."
  - Government has adopted more systematic public expenditure reviews to modernize organizations and identify obsolete spending; acknowledges budget consolidation will involve difficult choices.

### External environment and trade risks
- Norway is highly reliant on open and well-functioning international markets; access to foreign markets, imports, and export demand have historically raised income and living standards.
- Rising protectionism poses medium-term headwinds:
  - "Tendencies towards rising protectionism around the world may cause considerable headwinds over the medium term."
  - Rising trade tensions would weigh on global growth and threaten the global rules-based order.
  - The authorities see "no economic rationale for raising national trade barriers" and caution against adding pressure on the multilateral trading system.

*Source: Statement by Kimmo Tapani Virolainen, Alternate Executive Director for Norway and Tove Katrine Sand, Senior Advisor to Executive Director, September 12, 2018.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18279.pdf_