## 1dnkea2021001 ## Source details **Canonical URL:** [1dnkea2021001](https://www.imf.org/-/media/files/publications/cr/2021/english/1dnkea2021001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2021/english/1dnkea2021001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2021/english/1dnkea2021001.pdf.json) --- ### Context and overview - Denmark entered the COVID-19 crisis on a strong economic footing with robust institutions and sound economic and social policies; a steady upswing since 2014 delivered substantial buffers used decisively to respond to the COVID crisis. - Real GDP declined by 2.7 percent in 2020. - Growth in real public consumption in 2020 was flat (around -0.1 percent), while in nominal terms public consumption grew by about 4 percent. - Potential growth is estimated to have declined modestly in 2020, with the output gap estimated at some -1.7 percent of potential GDP. - HICP headline inflation was 0.3 percent in 2020; HICP core inflation remained around 0.9 percent in 2020. - Current account surplus was 7.8 percent of GDP in 2020, down from 8.9 percent in 2019. ### Pandemic containment, health measures, and vaccination - Initial containment measures in March 2020: border closure, social distancing, development of extensive testing; gradual lifting began April 2020; second wave in winter prompted new measures. - Denmark undertook one of the fastest vaccination rollouts in the European Union; Danish Health Authority announced to have all eligible population vaccinated by the summer 2021. - Corona pass planned to be widely used to allow people vaccinated, recovered, or tested negative to access public spaces and support reopening. ### Fiscal policy response and public finances - Automatic stabilizers contributed about half of overall fiscal stabilization. - Announced measures as of May 2021 were about 33 percent of 2020 GDP. - Discretionary above-the-line fiscal support (announced as of May 2021): some DKK 80 billion or around 3½ percent of GDP. - Budget balance shifted from a surplus of 3.8 percent of GDP in 2019 to a deficit of 1.1 percent in 2020. - Gross public debt increased to around 42 percent of GDP in 2020 from about 33 percent in 2019. - Uptake was lower than announced amounts for several measures. Key announced vs uptake figures (Announced and uptake information as of May 2021): - Grants to businesses: Announced DKK 35.8; Uptake DKK 22.6; Announced % GDP 1.5; Uptake % GDP 1.0 - Employment support & unemployment benefits: Announced DKK 30.8; Uptake DKK 20.9; Announced % GDP 1.3; Uptake % GDP 0.9 - Boosting business activity: Announced DKK 9.6; Uptake DKK 6.5; Announced % GDP 0.4; Uptake % GDP 0.3 - Consumption support to Households: Announced DKK 2.2; Uptake DKK 2.2; Announced % GDP 0.1; Uptake % GDP 0.1 - Upskilling & Education: Announced DKK 1.1; Uptake DKK 1.1; Announced % GDP 0.0; Uptake % GDP 0.0 - Total above the line: Announced DKK 79.5; Uptake DKK 53.3; Announced % GDP 3.4; Uptake % GDP 2.3 - Below the line measures: - Tax deferrals (2020 & 2021): Announced DKK 318.8; Uptake DKK 206.0; Announced % GDP 13.7; Uptake % GDP 8.9 - Guarantees (inc. trade credit insurance): Announced DKK 82.2; Uptake DKK 36.5; Announced % GDP 3.5; Uptake % GDP 1.6 - Loans (2020 & 2021): Announced DKK 264.0; Uptake DKK 40.8; Announced % GDP 11.4; Uptake % GDP 1.8 - Equity injections: Announced DKK 18.0; Uptake DKK 1.2; Announced % GDP 0.8; Uptake % GDP 0.1 - Total below the line: Announced DKK 683.0; Uptake DKK 284.6; Announced % GDP 29.4; Uptake % GDP 12.2 - Other significant measure not affecting the fiscal budget: Announced DKK 88.0; Announced % GDP 3.8 ### Labor market developments and measures - Employment and hours dropped sharply initially but recovered quickly due to wage compensation, workshare arrangements, and other measures with employer contributions of 10–25 percent to wage compensation schemes. - Unemployment increased to 5.6 percent in 2020 from 5 percent in 2019. - Private sector wage growth moderated to about 1.9 percent from about 2 percent in 2019. - Job retention schemes included a Wage Compensation Scheme and a New Work-Sharing scheme; compensation levels and eligibility conditions are specified in the report. ### Financial sector measures and stability - Danmarks Nationalbank (DN) introduced an extraordinary lending facility and activated swap lines with the US Fed and the ECB; USD10 billion in FX interventions cited during the crisis. - Release of the countercyclical capital buffer (CCyB) provided additional lending and loss-absorbing capacity; credit growth rebounded. - FSAP and DN stress tests indicate credit institutions are broadly resilient to solvency and liquidity risks. ### Inflation and external assessment - HICP headline inflation 0.3 percent in 2020 (down from 0.7 percent in 2019). - Current account surplus 7.8 percent of GDP in 2020 (down from 8.9 percent in 2019). - Staff assess the external position to be stronger than implied by medium-term fundamentals and desirable policies, subject to uncertainties. ### Climate policy ambition - June 2020 climate law: reduce greenhouse gas emissions by 70 percent below 1990 levels by 2030; net zero emissions targeted for 2050. - Denmark’s target is more ambitious than the EU's 55 percent by 2030 target. --- ### Near-term outlook, projections, and baseline assumptions - Baseline premised on continued rollout and increased availability of vaccines by the second half of this year, rapid normalization of private consumption and continuation into 2022. - Net exports expected to rebound during 2021–22; investment momentum to gain strength in 2022 supported by green and digital initiatives. - Sectoral rebound uneven: robust activity in industry (especially construction); services to remain relatively subdued. - Labor markets expected to continue improving; inflation expected to inch up as the negative output gap gradually closes. - Potential growth expected to pick up in the medium term due to initiatives to raise investment and labor supply. Key macroeconomic projections (Selected Economic and Social Indicators, 2018–26): - Real GDP growth: 2018 2.2; 2019 2.9; 2020 -2.7; 2021 2.6; 2022 3.3; 2023 1.9; 2024 1.8; 2025 1.8; 2026 1.8 - Private consumption growth (percent): 2018 2.7; 2019 1.4; 2020 -1.9; 2021 2.8; 2022 3.6; 2023 2.3; 2024 2.2; 2025 2.2; 2026 2.2 - Output gap (percent of potential output): 2018 1.7; 2019 2.8; 2020 -1.7; 2021 -1.0; 2022 0.0; 2023 0.0; 2024 0.0; 2025 0.0; 2026 0.0 - CPI (year average): 2018 0.7; 2019 0.7; 2020 0.3; 2021 1.1; 2022 1.5; 2023 1.8; 2024 2.0; 2025 2.0; 2026 2.0 - General government gross debt (percent of GDP): 2018 33.8; 2019 33.0; 2020 42.2; 2021 40.7; 2022 41.2; 2023 41.6; 2024 41.8; 2025 41.9; 2026 41.9 Fiscal plan and DSA notes: - Denmark expected to receive about 11½ DKK billion during 2021-25 from the proposed Danish Recovery and Resilience Plan (3¾ DKK billion in 2021); around 60 and 25 percent of these funds planned for the green and digital transitions, respectively. - Public investment as share of GDP planned to increase during 2021–25 and peak at around 3.7 percent of GDP in 2023. - Public gross debt and financing needs expected to stabilize at around 42 percent and 7 percent of GDP respectively. Staff macroeconomic policy guidance: - Fiscal stance appropriate for baseline; remain flexible given uncertainty. - If recovery falters, deploy substantial fiscal space and consider discretionary loosening. - Once recovery entrenched, return to medium-term objective appropriate. - Staff welcome Budget Law review; recommend more flexibility than current rule (annual structural deficits must not exceed ½ percent of potential GDP). - Use available fiscal space to raise public investment efficiently and on time/budget. Monetary and FX policy actions and recommendations: - DN interventions and policy adjustments included raising the policy rate to -0.6 percent and narrowing the spread to the ECB policy rate by 15 basis points; specific March 2021 actions: - Raising CD rate 10 basis points to -0.5 percent. - Decreasing current account rate by 50 basis points to -0.5 percent and removing account limits. - Reducing the lending rate to -0.35 percent from 0.05 percent. - Staff-calculated effective reserve rates declined 4 basis points to -0.5 percent. - Recommendations: continue FX interventions for short-term pressures and interest rate adjustments for sustained pressures; harmonize reserve rates and narrow rate corridor to reduce money market volatility. --- ### Macrofinancial vulnerabilities, housing, and household balance sheets - Household leverage increased during the pandemic; housing prices rose sharply. - Household credit-to-GDP ratio increased by 3 percentage points from 2019 to 112.3 percent by 2020:Q3. - Household credit to GDP increased with 3.1 percent y-o-y credit growth in 2020. - Residential property price growth: single-family homes 8.5 percent; flats 9.0 percent. - Mortgage characteristics increase vulnerability: large proportion of variable-rate and interest-only mortgages. - Pre-pandemic lending to contact-intensive sectors (trade, hotel and restaurant, manufacturing) comprised 5.5 percent of bank exposures; lending to these segments decreased 8.8 percent y-o-y in 2020. - Concentration: exposures to households that received wage compensation comprised about 10 percent and 6 percent of households’ debt to banks and MCIs, respectively. Macroprudential and supervisory recommendations: - CCyB: increase CCyB unless risk buildup subsides markedly or a new negative shock occurs, with an appropriate phase-in. - Monitoring and risk-sensitive capital: enhance monitoring of credit cycles; consider differentiated sectoral risk weights if credit fuels overheating-prone sectors. - Capital preservation: maintain guidance on dividend payouts and share buybacks as needed. - MREL: DFSA’s adjustment of phase-in for MREL subordination requirements deemed appropriate. - Institutional process: review SRC decision process; staff recommend chair be given legal power to make proposals without consensus to avoid delays. - Use newly implemented credit registry to develop a fully risk-based prudential framework; combine with macroprudential stress tests to quantify contagion across MCIs, pension, and household sectors and to calibrate tools. Housing and tax policy recommendations: - Shift macroprudential focus to income-based measures: tighten DTI, LTI, and debt-service-to-income caps; tighten DTI restrictions for all loans irrespective of LTV. - Differentiate DTI caps by borrower riskiness; mandatory amortization for highly-leveraged households. - Consider tighter limits on income-based measures for interest-only and floating-rate mortgages or higher minimum down-payment requirements. - Reduce Mortgage Interest Deductibility (MID) which is currently roughly 33 and 25 percent of mortgage interest payments under and above DKK 50,000 respectively can be deducted. - Prioritize reforms to better link property taxes to current market valuations; rationalize tax deductions for pension contributions. CRE sector vulnerabilities and recommendations: - CRE companies had relatively higher leverage pre-pandemic; FSAP stress tests showed CRE firms experienced the largest increase in riskiness under an adverse scenario. - Authorities’ tools: CRE exposure and lending growth limits, floors on debt-service capacity; consider CRE sectoral capital requirements if risks intensify. - Authorities note MCIs face a loan-to-value limit of 60 percent on commercial property. Nonbank and pensions: - 2020 FSAP stress tests: non-life insurance and pension funds appear broadly resilient but staff recommend strengthening on-site and cross-border supervision, improving macroprudential stress-tests, and intensifying data-quality checks. AML/CFT and supervisory actions: - Denmark rated “compliant” or “largely compliant” on 38 out of 40 FATF recommendations; DFSA’s institutional risk assessment model operational by June 2021. - Recommendations: intensify AML/CFT on-site inspections of higher-risk institutions; MIBFA to consider regional consolidation options; explore DFSA’s Project AML/TEK technology proposals. --- ### Labor market, flexicurity, and activation policies - Denmark’s flexicurity model rests on: (i) flexible hiring and firing; (ii) generous social safety net; (iii) extensive activation policies. - Job retention schemes shifted adjustment to the intensive margin (hours worked) rather than extensive margin (number of workers). - New temporary measures: Wage Compensation Scheme (compensation 75% for salaried and 90% for non-salaried, cap DKK 30,000 per month), New Work-Sharing scheme (work hours can be reduced by up to 80% with minimum 20% reduction). - Activation and upskilling: expanded incentives for vocational education (VET); unemployment benefits increased to 110 percent if unemployed begin vocational education of in-demand skills in 2020–2021; IGU program expanded to migrants present up to 10 years. - Disparate impacts: unemployment among young, low-skilled, and foreign-born rose more in 2020. - Policy guidance: shift from exceptional support to measures embedded in flexicurity as recovery gains momentum; focus on matching and reallocation through upskilling; consider making the “positive list” more forward looking; improve after-hours public childcare; simplify certification of foreign degrees; increase labor supply via pension reform linking retirement age to life-expectancy and consider tax reforms with targeted in-work benefits. Retirement and pension reform timelines: - Retirement age planned to increase from 65½ years in 2019 to 67 years in 2022. - Voluntary early retirement pension age to be 64 years in 2023. --- ### Investment, productivity, and green transition - Recovery offers opportunity to boost productivity and investment, including green and ICT sectors. - Public investment planned to peak at about 3.7 percent of GDP in 2023. - Staff analysis: investment needs for climate adaptation could be as high as 1.7 percent of GDP annually during 2020–2030. - Unofficial estimate for guarding against climate risks: DKK 50–75 billion (2.1–3.1 percent of GDP). - Estimated public and private investment needs by sector (2018-2030) DKK 100-180 billion distributed: Households 20%; Industry 10%; Electricity 60%; Gas and District Heating 10%. - Policy recommendations: use fiscal space to raise public investment efficiently; define tax framework for green investment including level and base of carbon taxation to provide clarity for private investment. - Measures to boost productivity: nurture high-productivity sectors (KIS), ensure human capital supply, strengthen competition institutions (ECN+), improve access to equity finance for SMEs, consider relaxing cap on carry-forward losses, consider reducing taxation of dividends with anti-avoidance safeguards, assess implementation of an incremental Allowance for Corporate Equity (ACE). --- ### Carbon pricing and climate policy (IMF working paper excerpt) - Carbon pricing recommended as centerpiece of mitigation strategy with reinforced sectoral measures and protections for households and firms. - Mechanisms proposed: - Apply domestic carbon surcharge to power and industry emissions. - Automatically ramp up domestic carbon tax on transportation and building emissions. - Impose border carbon adjustment to address competitiveness and leakage concerns. - Complement carbon pricing with sectoral instruments such as “feebates”. - Feebates illustrative example in vehicle sector: - Feebate price: $1,000 per ton of CO2. - A full electric Tesla Long Range AWD Model 3 would receive a subsidy of $14,000. - A gasoline Audi A5 would incur a tax of $6,000. - Staff household impact and revenue analysis: - Carbon price scenario: $100 per ton of CO2 in 2030. - Estimated average burden on households: 1.8 percent of consumption. - Estimated carbon tax revenue: around 1.6 percent of total consumption. - Recycling carbon revenues plus an additional fiscal adjustment of 0.2 percent can alleviate household burden at minimal fiscal cost; alternative use is to lower Denmark’s high marginal tax rates to incentivize labor supply. - Agriculture-specific constraints: - Agriculture accounts for approximately 20 percent of total GHG emissions and occupies more than 60 percent of the surface area. - CAP subsidies limit price-based policies; non-price policies and subsidies (e.g., biogas investments, Multifunctional Land Redistribution Fund) recommended. - Climate adaptation planning: - Investment needs for adaptation could be as high as 1.7 percent of GDP annually 2020–2030. - National climate adaptation strategy expected to be finalized by end-2022. --- ### Reallocation shocks, ALMPs, and scarring scenarios - Reallocation shock measured using a stock return dispersion index; local projections show reallocation shocks adversely affect unemployment, peaking around 2 years. - Calibrated shock of GFC/pandemic size increases unemployment by about ½ percentage point in the near term. - Conditional on ALMPs, adverse impact is smaller; Denmark’s high ALMP means reallocation shocks would raise unemployment by about one-third to one-fifth of the impact in an average country in the sample. - Annex Box VII.1 scenarios for potential growth and scarring: - Baseline: potential growth about 1.8 percent medium term; medium-term output loss about 1.1 percent relative to pre-COVID projections. - Adverse scenario: output loss about 1.6 percent. - Favorable scenario: output loss about 0.3 percent. - Policy implication: maintain labor supply via reallocation policies and pension reform; increase investment to limit scarring. --- ### Staff appraisal and priorities - Denmark’s public finances are sound with substantial fiscal space to support recovery and facilitate green and digital transformations. - Fixed exchange rate policy has served Denmark well and provides a framework for low and stable inflation. - As recovery solidifies, targeted prudential tools should be deployed to maintain financial stability. - Policies should support recovery, safeguard vulnerable groups, enhance macrofinancial resilience, and facilitate green and digital transitions. *Source: IMF staff report excerpts compiled from 1dnkea2021001.* ### 1. Context __________________________________________________________________________________________ 34 ### 1. Context ### Overview - Denmark entered the COVID-19 crisis on a strong economic footing with robust institutions and sound economic and social policies. - A steady upswing since 2014 delivered substantial buffers that were used decisively to respond to the COVID crisis. - Real GDP declined by 2.7 percent in 2020. - Growth in real public consumption in 2020 was flat (around -0.1 percent), while in nominal terms public consumption grew by about 4 percent. - Potential growth is estimated to have declined modestly in 2020, with the output gap estimated at some -1.7 percent of potential GDP. ### Pandemic containment and health measures - Initial containment measures implemented in March 2020 included border closure, social distancing, and development of extensive testing. - A careful and gradual lifting of some containment measures began in April 2020; a second wave in winter prompted new containment measures. - Denmark undertook one of the fastest vaccination rollouts in the European Union and is implementing the use of a corona pass. - The Danish Health Authority had announced to have all eligible population vaccinated by the summer 2021. - The corona pass is planned to be widely used to allow people—who have been vaccinated, recovered from or tested negative for COVID-19—access to public spaces and support a safe reopening of the economy. ### Economic structure and sectoral impact - Sectors such as hospitality and travel were hit severely but are relatively small in Denmark, limiting overall impact. - The overall contraction in 2020 was mainly driven by private consumption and net exports; residential investment remained strong and mitigated the impact on overall investment. - Contributions to the decline in output: private consumption and net exports mainly contributed to the decline in output; residential investment mitigated overall investment declines. ### Fiscal policy response and public finances - Denmark’s strong automatic stabilizers provided sizable countercyclical support; the contribution of automatic stabilizers is estimated to be around half of the overall fiscal stabilization. - Announced measures as of May 2021 were about 33 percent of 2020 GDP, among the largest in Europe. - Discretionary above-the-line fiscal support (announced as of May 2021) amounted to some DKK 80 billion or around 3½ percent of GDP. - The budget balance shifted from a surplus of 3.8 percent of GDP in 2019 to a deficit of 1.1 percent in 2020. - Gross public debt increased to around 42 percent of GDP in 2020 from about 33 percent in 2019—below the 60 percent EU threshold. - Some announced measures had low take-up, contributing to a more limited deficit than the size of the announced package might suggest. - Text Table 1. Denmark: Policies in Response to COVID-19 (2020 and 2021) (Announced and uptake information is as of May 2021) - Grants to businesses: Announced DKK 35.8; Uptake DKK 22.6; Announced % GDP 1.5; Uptake % GDP 1.0 - Employment support & unemployment benefits: Announced DKK 30.8; Uptake DKK 20.9; Announced % GDP 1.3; Uptake % GDP 0.9 - Boosting business activity: Announced DKK 9.6; Uptake DKK 6.5; Announced % GDP 0.4; Uptake % GDP 0.3 - Consumption support to Households: Announced DKK 2.2; Uptake DKK 2.2; Announced % GDP 0.1; Uptake % GDP 0.1 - Upskilling & Education: Announced DKK 1.1; Uptake DKK 1.1; Announced % GDP 0.0; Uptake % GDP 0.0 - Total above the line: Announced DKK 79.5; Uptake DKK 53.3; Announced % GDP 3.4; Uptake % GDP 2.3 - Below the line measures: - Liquidity measures: Tax deferrals (2020 & 2021): Announced DKK 318.8; Uptake DKK 206.0; Announced % GDP 13.7; Uptake % GDP 8.9 - Guarantees (inc. trade credit insurance): Announced DKK 82.2; Uptake DKK 36.5; Announced % GDP 3.5; Uptake % GDP 1.6 - Other below the line: Loans (2020 & 2021): Announced DKK 264.0; Uptake DKK 40.8; Announced % GDP 11.4; Uptake % GDP 1.8 - Equity injections: Announced DKK 18.0; Uptake DKK 1.2; Announced % GDP 0.8; Uptake % GDP 0.1 - Total below the line: Announced DKK 683.0; Uptake DKK 284.6; Announced % GDP 29.4; Uptake % GDP 12.2 - Other significant measure not affecting the fiscal budget: Announced DKK 88.0; Announced % GDP 3.8 ### Labor market developments and measures - Employment and hours dropped sharply during the initial phase but recovered quickly due to wage compensation, workshare arrangements, and other measures with ‘skin-in-the-game’ features. - Employers in wage compensation schemes were required to contribute a share of wage compensation (10–25 percent) to disincentivize prolonged usage by non-viable firms. - Unemployment increased to 5.6 percent in 2020 from 5 percent in 2019. - Private sector wage growth moderated to about 1.9 percent from about 2 percent in 2019. - The hit to the Danish labor market remained milder than in peers. ### Financial sector and stability measures - A comprehensive policy package supported financial stability: support for households and corporates mitigated liquidity and credit risks. - Danmarks Nationalbank (DN) introduced an extraordinary lending facility and activated swap lines with the US Fed and the ECB. - The release of the countercyclical capital buffer (CCyB) provided additional lending and loss-absorbing capacity for banks; credit growth rebounded. - High corporate cash buffers and tax deferral schemes supported liquidity; credit quality deteriorated for some corporates, leading to higher impairment charges. - The 2020 FSAP and DN stress test results suggest credit institutions are broadly resilient to solvency and liquidity risks. ### Inflation and external sector - HICP headline inflation was 0.3 percent in 2020, down from 0.7 percent in 2019; driven by a drop in energy prices and prices of travel-related services. - HICP core inflation remained around 0.9 percent in 2020. - The current account surplus was 7.8 percent of GDP in 2020, down from 8.9 percent in 2019; decline mainly due to deteriorating services exports and, to a lesser extent, merchanting goods. - Staff assess the external position to be stronger than implied by medium-term fundamentals and desirable policies, subject to important uncertainties. ### Climate policy ambition - In June 2020, Denmark’s parliament passed a climate law aiming to reduce greenhouse gas emissions by 70 percent below 1990 levels by 2030, with net zero emissions targeted for 2050. - Denmark’s targets are more ambitious than the EU's target to cut emissions by 55 percent by 2030. - Denmark aims to stimulate innovation and the transformation to a green economy, facilitating reallocation of labor and capital towards viable sectors and strengthening social safety nets. *Source: 1. Context (Denmark), IMF staff report (extracted from 1dnkea2021001 - 1. Context).* ### 10. The near-term outlook is for a rebound in activity. The baseline outlook is predicated on ### 10. The near-term outlook is for a rebound in activity. The baseline outlook is predicated on ### Near-term outlook and growth drivers - Baseline premised on the continued rollout and increased availability of vaccines by the second half of this year, resulting in a rapid normalization of private consumption and continuation into 2022. - Net exports expected to rebound during 2021–22 as economic prospects improve in major economies and trading partners, such as China, Germany, and the United States. - Investment momentum expected to gain strength in 2022, supported by initiatives incentivizing green investment and digitalization; this is expected to bring down the current account. - Sectoral rebound envisaged to be uneven: - Robust activity in industry, especially construction. - Services to remain relatively subdued. - Labor markets expected to continue improving, supporting wages and consumption. - Inflation expected to inch up as the negative output gap gradually closes. - Potential growth expected to pick up in the medium term due to initiatives to raise investment and labor supply, helping limit pandemic-induced scarring. ### Near-term risks - Risks dominated by pandemic developments and remain high: - Downside: further waves of infections, new virus variants, slower-than-expected vaccine rollout (domestically and abroad). - Upside: faster-than-expected global vaccine distribution boosting confidence and activity. - Near-to-medium term downside risk: a disorderly reallocation toward a different post-pandemic economic landscape. - Overall risk tilt: amid high uncertainty, risks remain tilted to the downside. ### Macrofinancial vulnerabilities and housing sector - Household leverage increased during the pandemic; housing prices rose sharply. - Household credit-to-GDP ratio increased by 3 percentage points from 2019 to 112.3 percent by 2020:Q3. - A domestic or regional house price correction, or tighter global financial conditions, could ignite adverse feedback loops and weigh on consumption growth. - High interconnectedness of mortgage credit institutions (MCIs), pension funds, and insurance companies—given their dependence on the housing sector—could exacerbate stress. - Commercial real estate (CRE) activity declined sharply; while bank exposures to CRE are manageable, exposures through investment and pension funds warrant monitoring. - Other downside risks: larger-than-expected increase in NPLs due to a protracted recession or faster-than-warranted winding down of support measures; bank spillovers from foreign exposures/funding constraints including through covered bond markets. ### Authorities’ views on outlook and vulnerabilities - Authorities broadly concur with staff’s assessment: expect a strong rebound in the second half of this year continuing into 2022 as the pandemic wanes. - Authorities see both downside and upside risks (slower rollout/new variants vs. faster rollout/stronger private consumption). - Authorities expect limited scarring from the pandemic. - Authorities attribute the high current account surplus to structural features (including high pension savings), not policy imbalances. - Authorities agree that macrofinancial vulnerabilities largely stem from accelerating house prices amid high and increasing household leverage. ### Policies for a balanced recovery — overview - Objectives: support a sustainable and inclusive recovery while preserving macrofinancial stability. - Fiscal policy should remain flexible amid the uncertain outlook and provide a bridge to the economy of the future by facilitating green and digital transitions. - Current developments warrant tightening macroprudential tools while deploying tax and housing supply policies. - Continue efforts to strengthen cross-border anti-money laundering supervision. ### A. Macroeconomic policies — Fiscal policy: current stance and plans - Fiscal deficit in 2021 expected to deteriorate due to continued COVID crisis support measures (compensation schemes for businesses and capital transfers to corporations) and facilitating the green and digital transformation. - Fiscal framework in 2021 includes targeted measures—support for the hospitality sector, and upskilling and special training for the worst-hit areas. - According to the proposed Danish Recovery and Resilience Plan (April 2021), Denmark is expected to receive about 11½ DKK billion during 2021-25 (3¾ DKK billion in 2021). Around 60 and 25 percent of these funds are planned for the green and digital transitions, respectively. - Medium term: fiscal stance (in terms of the structural balance) envisaged to remain broadly neutral in line with the authorities’ medium-term objective of zero structural balance in 2025. - Fiscal plan entails a gradually declining path of public consumption as share of GDP, while accommodating a planned increase in public investment. - During 2021–25, public investment as share of GDP is planned to increase to levels higher than during pre-COVID, peaking at around 3.7 percent of GDP in 2023. - Public gross debt and financing needs expected to stabilize in the medium term at around 42 percent and 7 percent of GDP respectively. - Staff assessment: Denmark has substantial fiscal space over the medium term (DSA); long-term sustainability hinges on continued implementation of the pension reform that links retirement age to life expectancy. Key fiscal guidance and recommendations: - Fiscal stance appropriate for the baseline growth projection; framework should remain flexible given uncertainty. - If recovery falters, deploy substantial fiscal space to allow automatic stabilizers to operate fully and consider discretionary loosening as needed. - Once recovery is entrenched, plan to return to the medium-term objective remains appropriate. - Staff welcome ongoing review of the Budget Law. Current Budget Law: annual structural deficits must not exceed ½ percent of potential GDP; staff recommend more flexibility to deal with cyclical challenges and long-term needs. - Staff recommend using available fiscal space to raise public investment as much as efficiently possible—keeping implementation on time, budget, and with the intended impact—while remaining compliant with the Budget Law and the medium-term objective. - Planned increase in energy taxes (Phase 1 of the Green Tax Reform) is envisaged to have a small impact on emissions; staff call for concrete and credible plans specifying the level and base of carbon taxation and creating further incentives for private green investment. - Staff recommend a comprehensive strategy to support emission targets: - Enhanced carbon pricing, reinforced by fiscal incentives across sectors. - Use revenues from carbon pricing to cut labor taxes to boost the economy in a balanced manner. - Spread measures across sectors to avoid excessive carbon prices. - Implement “feebates” (fees on high-emission products plus rebates on low-emission products) for high-emission sectors such as transportation and agriculture to deliver a fair low-carbon transition while preserving profitability and jobs. ### A. Macroeconomic policies — Monetary and FX policy - Danmarks Nationalbank (DN) successfully maintained the peg against depreciation pressures at the onset of the pandemic through interventions and narrowing the policy rate spread vis-à-vis the ECB in March 2020. - DN launched an extraordinary lending facility and activated swap lines with other central banks. - DN intervened in recent months to ease appreciation pressures and reconfigured policy rates in March 2021 to reduce money market rate volatility. - Specific actions cited: USD10 billion in FX interventions during the crisis; raising the policy rate to -0.6 percent, narrowing the spread to the ECB policy rate by 15 basis points. - DN measures in March 2021 included: - Raising the certificates of deposit (CD) rate 10 basis points to -0.5 percent. - Decreasing the rate on the current account by 50 basis points to -0.5 percent and removing account limits. - Reducing the lending rate to -0.35 percent from 0.05 percent. - Effective reserve rates calculated by staff to have declined 4 basis points to -0.5 percent. - The exchange rate peg continues to serve Denmark well; authorities should stand ready to defend it. - Policy recommendations: - Continue using FX interventions for short-term pressures and interest rate adjustments for sustained pressures (e.g., asymmetric recovery relative to the rest of Europe). - Staff welcome harmonization of reserve rates and narrowing of the rate corridor to reduce money market volatility. ### B. Macrofinancial policies to address financial imbalances — Financial sector health and risks - Banks remain profitable, liquid, and highly capitalized, though operating in a challenging environment. - Profitability: despite pressures on net interest margins, profits remained solid due to higher administration margins, net fee income, and low impairment charges; in 2020 higher impairment charges reduced profitability. - Liquidity: banks’ liquidity coverage ratios remain comfortably above the 100 percent minimum requirement. - Capitalization: before the pandemic, capital buffers had been strengthened. - Systemic Risk Council (SRC) recommendations and pandemic response: - SRC had recommended increasing the CCyB from 1 percent to 1½ and 2 percent by June and December 2020 respectively; as the pandemic struck, the CCyB was fully released and planned increases were cancelled. - Capital was preserved via suspension of dividend payments and share buybacks, consistent with ESRB and EBA guidelines, and EU regulatory relief. - Stress test results and resilience: - FSAP and DN stress tests show banks and MCIs appear resilient to solvency and liquidity stress. - Analyses suggest banks can withstand failure of large exposures and introduction of Basel III output floors. - All banks survived severe and extended funding withdrawals without external support. - December 2020 DN stress test shows all systemic banks meet risk-based minimum requirements; under a “most severe scenario,” some systemic banks fall short of their capital buffer requirements. - Ongoing monitoring needs: - Monitor exposures through investment and pension funds to CRE risk. - Watch for potential NPL increases if recession is protracted or support measures are wound down too fast. - Monitor bank spillovers from foreign exposures/funding constraints including covered bond markets. *Source: 1dnkea2021001 - 10. The near-term outlook is for a rebound in activity. The baseline outlook is predicated on* ### 24. Structural features of the system together with policies to support households and ### 24. Structural features of the system together with policies to support households and corporates during the pandemic reinforced banking sector strength. ### Banking sector strength and immediate pandemic effects - Banks had limited exposure to contact-intensive sectors hardest hit by the pandemic: - Trade, hotel and restaurant, and manufacturing industries comprised 5.5 percent of bank exposures prior to the pandemic. - Lending to these segments decreased 8.8 percent y-o-y in 2020. - Exposures to households that received support through the wage compensation scheme comprised about 10 percent and 6 percent of households’ debt to banks and MCIs, respectively. - Corporate sector entered the pandemic with low leverage and high liquidity. - Business fixed cost support and tax deferral programs cushioned corporate liquidity. - Staff analysis: the Danish liquidity gap—the sum of negative cash flows across illiquid firms in Denmark—would have been roughly 3 percent of GDP higher absent policy support. ### Emerging vulnerabilities in the financial sector - Current outlook risks: very loose financial conditions, increasing asset prices, rapid and significant growth in residential real estate prices, and prospects for a rapid recovery provide ground for risk buildup. - The financial system is large and highly interconnected; close regional interlinkages expose banks to potential regional spillovers. - Pre-pandemic lending surveys indicated some banks were relaxing credit standards; following the crisis banks assessed credit quality to have deteriorated, leading to higher impairment charges in 2020 which are likely to increase further once corporate support policies are unwound. - Credit quality deterioration concentrated particularly for corporates that received government support: FSR (2020) notes that 10 percent of lending to customers that received compensation support from the government had one-year default probabilities greater than 20 percent at the end of the third quarter of 2020. ### Macroprudential and supervisory recommendations - Countercyclical capital buffer (CCyB): - Unless the risk buildup subsides markedly or there is a new negative shock, the CCyB should be increased with an appropriate phase-in period. - Monitoring and risk-sensitive capital: - Enhanced monitoring of credit cycles in different sectors is appropriate. - If credit fuels overheating-prone sectors, consider differentiated sectoral risk weights to ensure capital buffers reflect higher risks. - Capital preservation measures: - Guidance on dividend payouts and share buybacks should remain in place as needed to protect capital buffers. - MREL implementation: - The DFSA’s adjustment of the phase-in period for MREL subordination requirements was appropriate given funding market conditions. - Institutional process for macroprudential decisions: - Review SRC decision process; staff recommend the SRC chair be given legal power to make proposals for a recommendation after due consultation with SRC members without the need to strive for consensus to avoid delays in tightening tools. ### Credit registry, stress testing, and risk-based prudential framework - The newly implemented credit registry offers the opportunity to develop a fully risk-based prudential framework allowing timely monitoring of risk dynamics for individual exposures. - Recommended actions: - Combine the proposed risk-based framework with macroprudential stress tests to quantify losses due to contagion across MCIs, the pension and household sectors to improve calibration of macroprudential tools and support financial stability surveillance. - Use registry data to estimate PDs and LGDs at the individual debtor level, enabling estimates of provisioning and capital requirements at individual exposure level and to check robustness of IRB model estimates. ### Non-life insurance and pension funds - 2020 FSAP stress tests: non-life insurance and pension funds appear broadly resilient and largely able to withstand severe asset and housing price shocks. - Key recommendations: - Strengthen on-site and cross-border business supervision. - Improve macroprudential stress-tests. - Intensify data-quality checks and enforce high-quality supervision reporting. ### AML/CFT reforms - Improvements should continue; Denmark’s technical compliance ratings by FATF upgraded for the third year in a row: - On technical compliance, Denmark is rated “compliant” or “largely compliant” on 38 out of 40 recommendations. - DFSA’s new institutional risk assessment model will be operational by June 2021. - Recommended actions: - Continue intensifying AML/CFT on-site inspections of higher-risk financial institutions. - MIBFA should consider, select, and pursue next-stage options for regional consolidation of AML/CFT supervision. - Innovative technology proposals (DFSA’s Project AML/TEK) could enhance effectiveness. ### Authorities’ views - Authorities consider the financial system sound, resilient to pandemic-related stress, and well equipped to face withdrawal of COVID policy support, citing: - Large buffers in credit institutions. - Relatively limited exposure to vulnerable sectors. - Positive impact of fiscal support measures on asset quality. - Authorities expect the SRC will in June 2021 recommend borrower-based measures and increasing the CCyB. - Authorities agree with expanding use of the credit register to enhance risk surveillance and prioritize strengthening AML/CFT supervision. ### Real estate markets and household vulnerabilities - Credit and house price developments: - Household credit to GDP increased with 3.1 percent y-o-y credit growth in 2020. - Residential property price growth hit 8.5 and 9.0 percent for single-family homes and flats, respectively. - Pre-pandemic household leverage was high; Danish households’ debt-to-income ratios are among the highest in advanced economies. - Concentration and spillovers: - High household debt concentrated in real estate and pension assets exposes households to price and interest rate shocks that can impact balance sheets asymmetrically and spillover to aggregate demand. - MCIs and pension and insurance companies are highly interconnected and dependent on the health of the housing sector. - Mortgage characteristics increasing vulnerability: - Large proportion of variable-rate and interest-only mortgages in the system. - Distributional vulnerability: - Continued strong house price growth increases the likelihood of a revaluation that could harm highly-leveraged households, particularly those who purchased in overvalued urban areas and low-income households. - Low-income households are particularly vulnerable to price shocks; housing cost overburden by income group data indicate elevated vulnerability among lower-income groups. ### Policy recommendations for housing and household risk - Macroprudential policy: - Shift focus toward income-based measures: tighten debt-to-income (DTI), loan-to-income (LTI), and debt-service-to-income caps to address high leverage and encourage faster amortization. - Tighten DTI restrictions for all loans, irrespective of LTV ratios. - Differentiate DTI caps based on borrower riskiness. - Highly-leveraged households should be subject to mandatory amortization, regardless of maturity- and rate-type. - Tighter limits on income-based measures for interest-only and floating-rate mortgages or higher minimum down-payment requirements should be considered. - Combine proposed risk-based prudential framework with macroprudential setup to facilitate calibration, especially for lower risk groups (e.g., first-time home buyers). - Tax policy: - Mortgage Interest Deductibility (MID) is relatively high: currently, roughly 33 and 25 percent of mortgage interest payments under and above DKK 50,000 respectively can be deducted from taxable income. - Taking advantage of the low rate environment, MID should be reduced in a manner consistent with the overall tax framework. - Prioritize reforms to better link property taxes to current market valuations. - Rationalize tax deductions for pension contributions to help slow households’ large balance sheet expansion and reduce maturity mismatches. - Housing supply and rental market: - Reduce rent controls (currently high relative to peers) to stimulate the rental market while protecting the most vulnerable. - Continue review of urban area restrictions on the size of new apartments. - Streamline zoning and planning procedures across municipalities to increase supply and alleviate price pressures. ### Vulnerability evidence and calibration notes - Nonperforming loans (NPLs) increase nonlinearly for loans with LTVs above 85 and for loans with LTIs above 500. - Past policy measures implemented prior to the pandemic helped contain vulnerabilities, including household- and intermediary-targeted macroprudential policies, supervisory guidance for MCIs and banks, and property taxation reform. *Source: IMF staff analysis as presented in chapter 24 of the referenced Denmark report.* ### 35. CRE companies had relatively higher ### 35. CRE companies had relatively higher ### CRE sector vulnerabilities and financial stability risks - CRE companies had relatively higher leverage before the pandemic and were vulnerable to stress. - Negative shocks to CRE prices can impact financial stability through: - the bank solvency channel, - a collateral channel, - nonbank financial institutions like pension funds (GFSR April 2021). - The 2020 FSAP’s corporate stress-testing exercise revealed that CRE firms experienced the largest increase in riskiness in an adverse scenario. - Riskiness within a sector was measured by the volume of debt across firms within that sector with a one-year default probability greater than 1.5 percent. - Policy tool noted as available: sectoral capital requirements (differentiated risk weights or sectoral capital buffer requirements) enabled by the introduction of CRDV/CRRII. ### Supervisory and macroprudential measures on CRE - Authorities have provided supervisory guidance to credit institutions on CRE lending. - Existing measures include: - CRE exposure and lending growth limits, - floors on debt-service capacity. - If risks intensify, the authorities should consider CRE sectoral capital requirements to limit future buildup of vulnerabilities in the sector (FSAP 2020). *Authorities’ contextual note: MCIs face a loan-to-value limit of 60 percent on commercial property which significantly reduces their risk exposure.* ### Authorities’ views on housing and macrofinancial risks - Authorities agree macrofinancial risks from surging house valuations amid high household leverage could warrant action. - They note a declining share of variable rate mortgages, but see scope for tighter income-based measures and mandatory amortization requirements. - The government will await recommendations from the SRC before deciding on interventions and noted tightening measures would require further analysis of effects on the housing market and the overall economy. - The government emphasized that reducing MID should not be considered independently of taxes on housing and other capital income taxation. - The government sees the macroprudential framework as functioning, including timeframe for the CCyB implementation and the SRC’s independence. ### Labor market: flexicurity, COVID measures, and unemployment - Denmark’s flexicurity model rests on three pillars: - (i) flexible hiring and firing; - (ii) a generous social safety net; - (iii) an extensive system of activation policies. - New and temporary COVID-19 labor measures: - Wage Compensation Scheme: - Employers can apply for wage compensation if 30% or more than 50 employees have been repatriated. - Compensation is 75% for salaried and 90% for non-salaried employees (cap at DKK 30,000 per month), employees not allowed to work. - Implemented March, expired end of Aug 2020; partly re-implemented Nov 2020; fully re-implemented Dec 2020. - New Work-Sharing scheme: - Work hours can be reduced by 80% but must be reduced by at least 20%, employees receive supplementary UB. - Implemented in Sep 2020 when wage compensation scheme expired. - Temporary additional support for vulnerable groups: increase in sickness, unemployment, parental and cash benefits. - Additional funds for upskilling. - Effectiveness and patterns: - The enhanced flexicurity measures and wage compensation scheme were effective in dampening the pandemic’s impact; labor market recovered in the second half of 2020 but recovery stalled by end-2020 amid the second wave. - Uptake of the wage compensation scheme was high during the first wave; during the second wave uptake was much lower reflecting stronger economic activity and a switch to the new work-sharing agreement. - Disparate impacts: - Unemployment among the young, low-skilled, and foreign-born—already high pre-pandemic—rose much higher in 2020, albeit similarly to peer countries. - Targeted labor policies and initiatives: - Expanded incentives for vocational education of in-demand skills (VET); unemployment benefits increased to 110 percent if the unemployed began vocational education of in-demand skills in 2020–2021. - A basic integration education (IGU) program (two-year course) launched in 2016; in 2020 the IGU program was expanded to include migrants that have been in Denmark for up to 10 years (from 5 years previously). - The IGU program: wages are subsidized; after finishing, employee receives a training certificate; company receives a bonus of DKK 20,000 after the first six months and again once the IGU has been completed. - Low participation of female refugees remains a concern. - Policy guidance: - As recovery gains momentum, shift from exceptional support to measures embedded in flexicurity; do not withdraw support prematurely. - Once recovery is entrenched and lockdowns lifted, focus on facilitating matching and reallocation of labor through upskilling and education; consider making the “positive list” more forward looking. - Increase labor supply via ongoing pension reform linking retirement age to life-expectancy and consider a comprehensive tax reform using targeted in-work benefits to alleviate inactivity traps. - Improve after-hours public childcare and simplify certification of foreign degrees to attract skilled foreign labor. ### Retirement and pension reform timelines - The pension reform links retirement age to life-expectancy: - retirement age planned to increase from 65½ years in 2019 to 67 years in 2022, - the voluntary early retirement pension age has gradually been raised since 2014 and will be 64 years in 2023. - In 2019, Parliament adopted a law introducing a new pension scheme for seniors with reduced physical work capacity. ### Reforms to boost investment and productivity - Context and objectives: - Recovery offers opportunity to address pre-COVID legacies and build forward better by boosting productivity and investments, including in green and ICT sectors. - Labor productivity growth has been weak partly due to low investments after the GFC; productivity growth is below the OECD average and weak in less knowledge-intensive service (KIS) industries. - Steps already taken: - “Business-oriented growth policy” targets six areas: Digitalization, Qualified labor, Venture capital, Cost of doing business, Competitiveness, and Good economic conditions. - 2018 digital growth reform package, Digital Hub Denmark, the Technology Pact, the Danish National Strategy for Artificial Intelligence, the Disruption Council, expanded public-private partnerships, Innovation Fund subsidies for innovation and R&D, and additional resources and lending schemes for the Danish Growth Fund. - Planned increase in public investment envisaged to reach about 3.7 percent of GDP in 2023. - Green investment and climate adaptation needs: - Staff analysis: investment needs for climate adaptation could be as high as 1.7 percent of GDP annually during 2020–2030. - Unofficial information indicates about DKK 50–75 billion (2.1–3.1 percent of GDP in total) might be necessary to guard Denmark against climate risks. - Estimated Public and Private Investment Needs by Sector (2018-2030) — DKK 100-180 billion distributed as: - Households (Energy efficiency & conversion of heat supply) 20%, - Industry (Energy efficiency and new technology) 10%, - Electricity (New renewable energy capacity installed) 60%, - Gas and District Heating (Biogas and new district heating capacity) 10%. - Policy recommendation: use fiscal space to raise public investment as much as efficiently possible while complying with the Budget Law and the medium-term objective; define tax framework for green investment including level and base of carbon taxation to provide clarity for private investment. - Additional measures to raise productivity and investment: - Nurture environment for high productivity sectors (KIS) and ensure adequate supply of human capital via technical and digital skills. - Strengthen institutional framework for competition and encourage broad-based innovation; welcome implementation of ECN+ directive. - Improve access to equity finance for SMEs and high-technology firms; review regulation for pension funds and ensure adequate resources for investment vehicles like the Danish Growth Capital Fund. - Rebalance taxation for start-ups and high-technology firms: - Consider relaxing the cap on the use of carry-forward losses, - Consider reducing taxation of dividends while ensuring anti-avoidance regulations, - Assess proper implementation of an incremental Allowance for Corporate Equity (ACE) to reduce debt bias and cost of capital. *Italic: International Monetary Fund staff summary of chapter content.* ### 48. Denmark is turning the pandemic threat into opportunities to advance the economy of ### 48. Denmark is turning the pandemic threat into opportunities to advance the economy of the future ### Context and recent performance - Prudent fiscal and financial policies before the pandemic led to a build-up of substantial buffers that were deployed swiftly during the pandemic and helped limit the immediate impact on activity (Annex I). - Activity declined in 2020 driven by weak private consumption and net exports, but the contraction was milder than in peer countries in part due to unprecedented policy support (paragraph 51). - The external position was stronger than the level consistent with medium-term fundamentals and desirable policies (paragraph 51). - The near-term outlook is for a rebound in activity, but risks remain high and are dominated by pandemic developments (paragraph 51). - Income inequality in Denmark is low by international standards (footnote/annotation in text). ### Authorities’ objectives and views - Authorities want to “restart” the economy by raising productivity and investment, including in green and digital sectors (paragraph 50). - Authorities plan increases in public investment and expect the private sector to step up green investment; they acknowledge investment needs for climate adaptation could be sizeable and point to a forthcoming national climate adaptation strategy that will include an assessment of the investment needs (paragraph 50). - Authorities see potential for the ACE (Allowances for Corporate Equity) to increase investments but note significant administrative challenges associated with its implementation (paragraph 50). - Authorities broadly agree that upgrading capital markets could improve access to equity finance for SMEs and that growth of KIS is an important contributor to continued productivity growth (paragraph 50). - Authorities note the recent implementation of the ECN+ directive in March 2021 and that it is too early to assess its efficiency (paragraph 50). ### Financial sector and macrofinancial vulnerabilities - The banking system is profitable, liquid, and highly capitalized, though in a challenging environment (paragraph 54). - Measures to support households and corporates mitigated liquidity and credit risks but impairments are likely to increase further once policy support is unwound (paragraph 54). - Staff welcome improvements to the AML/CFT framework which led to a third consecutive FATF upgrade of Denmark’s technical compliance ratings; robust implementation of reforms should continue (paragraph 54). - High and increasing household debt amid accelerating housing valuations remains a key vulnerability (paragraph 51). ### Housing, prudential, and tax recommendations - Tighten prudential tools and deploy coordinated tax and housing supply policies in response to high and increasing household leverage and accelerating housing valuations (paragraph 55). - Shift focus toward income-based measures, as LTV caps are less binding in the current environment with high house price growth (paragraph 55). - Tighten DTI restrictions for all loans irrespective of LTV ratios; DTI caps could be differentiated based on borrowers’ riskiness (paragraph 55). - Consider tighter limits on income-based measures for interest-only and floating-rate mortgages (paragraph 55). - Reduce mortgage interest deductibility in a manner consistent with the overall tax framework (paragraph 55). - Consider policies to promote housing supply (paragraph 55). ### Labor market, social protection, and human capital - The Danish “flexicurity” model—along with the continuation of the pension reform—would support labor supply and facilitate labor market reallocation (paragraphs 49 and 56). - As the recovery gains traction, shift emphasis from exceptional support to measures embedded in flexicurity; exceptional support should sunset once the recovery is entrenched (paragraph 56). - Prioritize measures that facilitate matching and reallocation of labor from contracting to expanding sectors through upskilling and education, especially for the young, unskilled and foreign-born (paragraph 56). - Continue implementation of the pension reform that links retirement age to life-expectancy to support labor supply over the long-term (paragraph 56). - Consider additional measures to increase labor supply and alleviate inactivity traps, including a comprehensive tax reform that uses targeted in-work benefits (paragraph 56). - Improve provision of after-hours public childcare (paragraph 56). - Simplify the certification of foreign degrees to help attract skilled foreign labor (paragraph 56). ### Investment, climate, and productivity policies - The recovery phase offers an opportunity to lift public and private investments thereby boosting potential growth and limiting scarring (paragraph 49). - Public investment should be raised as much as efficiently possible, while being compliant with the Budget Law and the medium-term objective (paragraph 57). - A prompt definition of the tax framework for green investment, including the level and base of carbon taxation, would reduce uncertainty and provide further incentives for private investments (paragraph 57). - To boost productivity growth, continue fostering an environment for high productivity sectors to expand, encourage broad-based innovation, and improve access to equity finance (paragraph 57). - Consider reducing the cap on the use of carry-forward losses to foster more start-up and high technology firms (paragraph 57). - Consideration should be given on how to implement an ACE, as it would reduce the debt bias and the cost of capital (paragraph 57). ### Staff appraisal—policy stance and priorities - Denmark’s public finances are sound with substantial fiscal space to support the recovery and facilitate green and digital transformations (paragraph 52). - Fiscal policy should prioritize COVID crisis support, facilitate reallocation, and support reforms for the economic transformation; if the recovery falters, Denmark should deploy its substantial fiscal space as needed (paragraph 52). - Once the recovery is fully entrenched, a plan to return to the medium-term objective of neutral stance remains appropriate (paragraph 52). - The fixed exchange rate policy has served Denmark well and provides a framework for low and stable inflation (paragraph 53). - As the recovery solidifies, targeted prudential tools should be deployed to maintain financial stability (paragraph 54). - Policies should support the recovery, safeguard the most vulnerable groups, enhance macrofinancial resilience, and facilitate green and digital transitions (paragraph 51). *Source: 1dnkea2021001 - 48. Denmark is turning the pandemic threat into opportunities to advance the economy of the future.* ### 58. It is recommended that the next Article IV consultation take place on the standard 12- ### It is recommended that the next Article IV consultation take place on the standard 12-month cycle. ### Context - Measures of wellbeing: Denmark ranks among the happiest countries (Happiness Score, 2018-2020 index values include 6.4 through 8.0 for listed countries with Denmark among higher scores). - Employment: High employment rates relative to EU peers (Employment Rates chart spans 65–85 percent for 2005–2019 across EU-28, Euro area, Denmark, Finland, Sweden, Norway). - Inequality: Low income inequality by international standards (Income ratio (P90/P10) and Gini Coefficients shown; Gini Coefficients for Denmark appear near the lower end of plotted OECD countries). - Public debt: "Public debt remained one of the lowest in the region in the runup to the pandemic, providing substantial buffers." - Investment: "Investment rate saw some pick-up after lagging peers for some time following the GFC." ### Recent developments and pandemic impact - Activity: "The pandemic hit Danish activity but the impact was one of the lowest in the region." - Sectoral effects (2020Q2 YoY percentage change): sectors with largest declines include Trade, Travel, Accommodation & Food and Arts, Entertainment & Recreation; Industry excl Construction and Information & Communication fared relatively better. - Exports: Exports of goods and services index fell from 2019Q4 = 100 to lower levels during 2020 (chart shows goods and services declines with services more affected). - External environment: "The pandemic hit major economies and trading partners, weakening external environment appreciably." - Vaccination: As of March 11, 2021, Denmark had administered vaccination shares among the highest in listed countries (Vaccination Administrated chart shows Denmark among top contenders; specific country order includes LVA, LUX, BEL, ..., DNK, MLT). ### Labor market - Employment and participation: "Employment and participation rates continue to rise." - Employment growth (YoY percent, SA): Total and Construction series show a drop in 2020 then recovery (chart range -4 to +6 percent for 2011–2020). - Unemployment: Harmonized unemployment rate series: 5.1 (2018), 5.0 (2019), 5.6 (2020), 5.6 (2021), 5.4 (2022), 5.2 (2023), 5.0 (2024), 5.0 (2025), 5.0 (2026) (Table 1, "Harmonized unemployment rate (percent)"). - Youth, low-skilled, and foreign-born unemployment: "Unemployment rates among the young, low-skilled and foreign born remain elevated." - Job vacancies: "Vacancies have recovered almost half of their drop" (Job Vacancies per 1,000 unemployed, SA chart). - Wages: "Wage growth has moderated." (Private sector hourly earnings YoY percent change series plotted alongside unemployment rate.) ### Financial system indicators - Capital adequacy: "Capital adequacy ratios are healthy" (Capital Adequacy Ratios chart: CAR and Tier 1 levels between about 20–35 percent historically). - Nonperforming loans: "Nonperforming loans net of provisions to capital remain low." (NPLs to total loans and net of provisions series show low values). - Profitability: "Lower net interest and fee income combined with higher provisions reduced bank earnings." (Decomposition of Income chart shows provisions and net interest income contributions). - Liquidity: "Liquidity remains high." (Liquid assets to total assets and to short-term liabilities charts indicate elevated ratios). - FX exposures: "FX exposures have remained steady." (Banks Exposure to FX chart). - Loans and deposits: Charts show loans to corporates and households growth and customer deposits trends. ### Housing market and household balance sheets - Credit growth: "Credit growth accelerated in 2020H2 driven by mortgage lending growth to households and small businesses." - Price developments: Housing valuations increased markedly; single family home prices increased particularly in the capital region; summerhouse prices rose substantially (Property Price Growth by Category shows single family, owner-occupied flats, summer homes). - Mortgage rates and structures: - Average mortgage rates (total loans, new loans) series plotted from 2010–2020 showing decline; example plotted values around 0.5–3.5 percent depending on period. - Stock of residential mortgages by type (percent of total, selected years): 2013 36.5, 2014 18.9, 2015 16.2, 2016 28.4, 2017 ... 2020 split shows Fixed Rate and Variable Rate and shares of No Repayments categories. - Pension and housing asset offset: "These large liabilities are counterbalanced by large housing and pension assets." - Household debt: "Danish households’ debt-to-income ratios are among the highest in advanced economies." (Household and NPISH Outstanding Debt to Gross Disposable Income plotted; Denmark shown among high values). - Pension & insurance assets: Household Pension & Insurance Assets, 2019 (Percent of GDP) listed with Denmark among high values (table/chart). ### Pension and insurance sector - Market performance: "Pension funds experienced large market losses in 2020Q1 but have since recovered." (Pension Fund Performance in 2020 chart in DKK Billions shows monthly decomposition: Shares etc., Bonds, Derivatives, Other, Total). - Foreign exposure: Insurance and pension fund foreign exposure share around 50.1–54.1 percent in 2018–2020 range (Insurance and Pension Fund Foreign Exposure Share chart shows values 50.1, 54.1, 47.0, 48.0...). - Asset composition: Low-rate environment pushed pension and insurance companies into alternative investments (Asset Composition chart shows Alternatives, Listed Shares, Bonds, Other liquid). - Market risk transfer: "Danish insurers have transferred some of this market risk to customers" — market rate product share (Market Rate Product Share of Insurance Provisions) plotted around 30–35 percent and rising; Retirement Savings Rate Type by Age chart shows younger customers shifting to unit-linked products. ### Key macroeconomic projections and indicators (Table 1, Selected Economic and Social Indicators, 2018–26) - Real GDP growth: - 2018: 2.2 - 2019: 2.9 - 2020: -2.7 - 2021: 2.6 - 2022: 3.3 - 2023: 1.9 - 2024: 1.8 - 2025: 1.8 - 2026: 1.8 - Private consumption growth (percent): - 2018: 2.7 - 2019: 1.4 - 2020: -1.9 - 2021: 2.8 - 2022: 3.6 - 2023: 2.3 - 2024: 2.2 - 2025: 2.2 - 2026: 2.2 - Gross national saving (percent of GDP): 2018 30.2; 2019 31.6; 2020 31.0; 2021 30.8; 2022 31.0; 2023 31.0; 2024 31.0; 2025 31.0; 2026 31.0 - Gross domestic investment (percent of GDP): 2018 23.1; 2019 22.7; 2020 23.2; 2021 23.0; 2022 23.6; 2023 23.7; 2024 23.8; 2025 23.9 - Output gap (percent of potential output): 2018 1.7; 2019 2.8; 2020 -1.7; 2021 -1.0; 2022 0.0; 2023 0.0; 2024 0.0; 2025 0.0; 2026 0.0 - Harmonized unemployment rate (percent): see Labor market subsection above. - CPI (year average): 2018 0.7; 2019 0.7; 2020 0.3; 2021 1.1; 2022 1.5; 2023 1.8; 2024 2.0; 2025 2.0; 2026 2.0 - General government gross debt: - 2018: 33.8 - 2019: 33.0 - 2020: 42.2 - 2021: 40.7 - 2022: 41.2 - 2023: 41.6 - 2024: 41.8 - 2025: 41.9 - 2026: 41.9 ### External sector (Table 2, Balance of Payments, 2018–26) - Current account (Billions of DKK): - 2018: 158.2 - 2019: 206.8 - 2020: 181.2 - 2021: 186.7 - 2022: 186.7 - 2023: 192.9 - 2024: 199.4 - 2025: 205.2 - 2026: 210.3 - Current account (percent of GDP): 2018 7.0; 2019 8.9; 2020 7.8; 2021 7.7; 2022 7.3; 2023 7.3; 2024 7.2; 2025 7.2; 2026 7.0 - Balance on goods (percent of GDP): ranges 3.5–5.5 across 2018–26 with example 2018 3.5; 2019 5.2; 2020 5.0. - Exports of goods & services (percent of GDP): 2018 56.3; 2019 58.3; 2020 54.3; projected 2026 56.6 - Gross external debt and reserves: Reserves coverage (months of imports) 4.7 (2018), 4.5 (2019), 5.1 (2020). ### International investment position (Table 3) - Assets (Billions of DKK): 2018 6,832; 2019 7,580; 2020 8,041 - Liabilities (Billions of DKK): 2018 5,353; 2019 5,785; 2020 6,612 - Net investment position (Billions of DKK): 2018 1,480; 2019 1,795; 2020 1,428 - Key composition notes: Portfolio investment and direct investment components reported; reserve assets and other investment series provided. ### Government finances (Tables 4 and 5, GFSM 2001 Statement of Government Operations, 2018–26) - Total revenues (Billions of DKK): 2018 1,154.7; 2019 1,238.1; 2020 1,227.8; 2021 1,238.3; 2022 1,277.6; 2023 1,325.7; 2024 1,369.7; 2025 1,437.3; 2026 1,495.4 - Total expenditures (Billions of DKK): 2018 1,139.1; 2019 1,149.9; 2020 1,254.5; 2021 1,319.2; 2022 1,301.5; 2023 1,343.4; 2024 1,385.6; 2025 1,436.1; 2026 1,494.1 - Overall balance (percent of GDP, Table 5): 2018 0.7; 2019 3.8; 2020 -1.1; 2021 -3.3; 2022 -0.9; 2023 -0.7; 2024 -0.6; 2025 0.0; 2026 0.0 - Primary balance (percent of GDP): 2018 0.3; 2019 3.5; 2020 -1.5; 2021 -3.6; 2022 -1.3; 2023 -1.0; 2024 -0.9; 2025 -0.2; 2026 -0.2 - Gross debt (percent of GDP): see General government gross debt in Key macroeconomic projections above. ### Public sector balance sheet (Table 6) - Public sector assets (Billions of DKK): 2018 2,273; 2019 2,480 - Public sector liabilities (Billions of DKK): 2018 1,150; 2019 1,208 - Net worth (Billions of DKK): 2018 1,123; 2019 1,273 - Assets and liabilities expressed as percent of GDP provided for 2012–2019 series. ### Financial system indicators (Table 7) - Regulatory capital to risk-weighted assets: 2013 22.3; 2014 21.0; 2015 21.8; 2016 23.2; 2017 23.8; 2018 23.3; 2019 24.6; 2020 25.3 - Core / Common Equity Tier 1 capital to risk-weighted assets: 2013 16.7; 2014 17.3; 2015 17.8; 2016 18.3; 2017 19.3; 2018 19.0; 2019 19.5; 2020 20.6 - Nonperforming loans to total gross loans: 2013 8.7; 2014 8.2; 2015 6.9; 2016 5.3; 2017 4.3 - Bank provisioning and coverage ratios: Bank provisions to Nonperforming loans 2013 51.0; 2014 50.3; 2015 50.5; 2016 51.0; 2017 54.3 - Liquidity indicators: Liquid assets to total assets and to short-term liabilities series reported (examples: Liquid assets to total assets around 30.9 in 2013; Liquid assets to short-term liabilities around 49.8 in 2013). - Profitability: ROA and ROE series provided with ROE (aggregated data on a parent-company basis) 2013 5.7; 2014 5.6; 2015 9.1; 2016 14.1; 2017 14.2; 2018 10.2; 2019 8.2; 2020 4.8 *International Monetary Fund staff compilation from chapter figures and tables in the provided Denmark country material.* ### Annex I. Policy Responses to COVID-19 ### Annex I. Policy Responses to COVID-19 ### Grants to business - Temporary compensation scheme for companies’ fixed costs. - Temporary compensation scheme for self-employed and freelancers. - Compensation scheme for the cancellation and postponement of events (e.g. concerts). - Sickness benefit reimbursement to employers of sick employees. - Temporary compensation scheme for freelancers with mixed income. - Temporary compensation scheme for the media, artists, folk schools, night schools, and seasonally dependent sectors during Christmas seasons. ### Employment support & Unemployment benefits - Temporary wage compensation. - The pool for initiatives in case of large-scale dismissals was expanded to a total of 120 million DKK. - Prolonged access to unemployment benefits including self-employed. - More flexible work-sharing arrangement and creation of a new work-sharing arrangement; suspension of employer financing for work-sharing participation except from new work-sharing arrangement. - Suspension of 225-hours work requirement to receive social assistance. - Economic support for high-risk employees. - Increased access to the economic reward for senior employees. - A pool of 30 million DKK for initiatives in case of dismissals in small and medium size enterprises. ### Boosting business activity - Boosting the construction sector and dependent industries as well as increasing liquidity for businesses in general. - Tax deductions for businesses’ R&D expenses were increased to 130 percent. - Increased tax deductions for summerhouse owners. - Emergency funds for restaurants to boost activity. - Emergency funds for construction companies. ### Upskilling and Education - Unskilled and skilled workers with outdated training are granted the right to higher unemployment benefits if they begin a vocational education. - The short courses for vocational education and training, which help unemployed adapting to new jobs here and now, are unified, strengthened and simplified. - Funds for upgrading skills. - Allocation of 50 million DKK to ensure an enhances reskilling effort in local areas particularly affected by the crisis. - Economic support to independent residential schools, independent vocational schools and other boarding schools. ### Consumption support to Households - Release of frozen holiday pay. Due to a new holiday pay law in 2020, one year's worth of holiday pay was frozen until employees retire. The frozen holiday pay is prematurely released to the employees in 2020 and 2021 to stimulate the economy. - Economic support for parents of children affected by COVID-19. - Persons who has received a public welfare benefit (unemployment benefit, social pension or student grant) for April 2020 receive 1000 DKK. ### Deferred taxes - Temporary deferral of payment deadlines for A-taxes (withholding tax) and labour market contributions in 2020. - Temporary deferral of payment deadlines for VAT rates for large businesses. - Temporary extension of tax periods for VAT for small and medium sized enterprises. - Temporary deferral of payment deadlines for B-taxes (provisional tax paid by self-employed businessmen). - Temporary deferral of payment deadlines for payroll tax for certain businesses. - Temporary deferral of payment deadlines for A-taxes (withholding tax) and labour market contributions in 2021. - Advanced payments of tax credits for deficits related to R&D. ### Loans - Interest free loans based on VAT rates and payroll tax rates. - Interest free loans based on A-taxes (withholding tax) and labour market contribution (2020 & 2021); deferral of payment deadlines for such loans to November 2021. - Loans and equity to start-ups and high growth enterprises. The Danish Growth Fund established two new lending schemes—targeted early-stage companies and venture-backed companies—as well as increase their equity investments. - Temporary extending the borrowing capacity for students. ### Guarantees - Two new loan guarantee schemes administered by Vækstfonden (The Danish Growth Fund), one for large companies and one for small and medium enterprises (SMEs). - Credit guarantee for Scandinavian Airlines (SAS). - Liquidity guarantee schemes for SMEs and large companies with export related activities administered by EKF Denmark's Export Credit Agency. - Strengthening the Travel Guarantee Fund. - Reinsurance scheme targeted companies using trade credit insurance. ### Equity - Recapitalization of SAS AB. - Established a recapitalization fund under which the Danish state will contribute as an investor of last resort. It will be operational till end 2023 (DKK 10 bn). *Source: Annex I. Policy Responses to COVID-19 (Denmark), IMF staff compilation.* ### 4. A new IMF working paper takes a closer look at Denmark’s carbon pricing strategy. ### 4. A new IMF working paper takes a closer look at Denmark’s carbon pricing strategy ### Carbon pricing as centerpiece of mitigation strategy - A robust and predictable carbon price provides across-the-board incentives for households and firms to adopt low-carbon technologies. - Recommended strategy elements: - Enhanced carbon pricing as the centerpiece. - Reinforcing mitigation incentives across different sectors. - Measures to ensure households and firms are not hit hard by the transition. - Mechanisms to scale up carbon pricing: - Apply a domestic carbon surcharge to power and industry emissions. - Automatically ramp up the domestic carbon tax on transportation and building emissions. - Impose a border carbon adjustment to address domestic competitiveness and leakage concerns (especially important until implemented at the EU level). - Role of sectoral instruments: - Complement carbon pricing with sectoral instruments such as “feebates” (revenue-neutral sliding scale of fees and rebates based on emission rates). ### Feebates and the vehicle sector (illustrative example) - Application: vehicle sector (largest source of domestically generated emissions from transportation in Denmark). - Illustrative feebate parameters and effects: - Feebate price: $1,000 per ton of CO2. - Impact on two vehicles: - A full electric Tesla Long Range AWD Model 3 would receive a subsidy of $14,000. - A gasoline Audi A5 would incur a tax of $6,000. - Intended effect: close the retail price gap between pricier electric vehicles and traditional ones to encourage sales of zero-emission cars. ### Distributional considerations and fiscal reform - Staff analysis on household impact and revenue: - Carbon price scenario: $100 per ton of CO2 in 2030. - Estimated average burden on households: 1.8 percent of consumption (via pricier consumption goods). - Estimated carbon tax revenue: around 1.6 percent of total consumption. - Revenue recycling options and fiscal offset: - By recycling carbon revenues—along with an additional fiscal adjustment of 0.2 percent—the household burden can be alleviated at minimal fiscal cost. - Alternative use: lower Denmark’s high marginal tax rates using carbon revenues to help incentivize labor supply. ### Agricultural sector: targeted measures and constraints - Sectoral importance and challenges: - Agriculture accounts for approximately 20 percent of total GHG emissions (currently double the share of an average EU country). - Agriculture takes up more than 60 percent of the surface area. - Use of subsidies under the EU’s Common Agricultural Policy (CAP) hampers price-based policies because most farmers operate on low margins and depend on CAP subsidies. - Policy implications: - Use non-price policies within the CAP framework to encourage emission reductions in agriculture. - Large-scale, long-term mitigation efforts (e.g., managing biogenic emissions such as fermentation facilities for biogas generation) require significant upfront investments that are not fully self-financing at present. - Consider subsidies and increasing the budget to convert environmentally valuable farmland into natural sites through the Multifunctional Land Redistribution Fund, including mobilization of private funds. ### Climate adaptation investment needs and coastal protection - Estimated adaptation investment needs: - Investment needs for climate adaptation could be as high as 1.7 percent of GDP annually between 2020 and 2030. This includes building new coastal protection infrastructure, upgrading investment projects, and retrofitting existing assets exposed to rising sea levels. - Unofficial estimates for guarding against climate risks: - DKK 50–75 billion (2.1-3.1 percent of GDP) might be necessary to guard Denmark against these climate risks (no nationally agreed number yet). - Policy planning: - A national climate adaptation strategy that will include an assessment of investment needs is expected to be finalized by end-2022. *International Monetary Fund — excerpt from the Denmark staff report* ### 7. Structural polices aimed at raising investments would help reduce the surplus. The ### 7. Structural polices aimed at raising investments would help reduce the surplus. The ### Structural policies and investment - The planned increases in public and private investments related to the green and digital transformation of the economy are expected to reduce the excess surplus. - Policies aiming at increasing equity financing through a gradual improvement in capital markets could further support a decrease in the current account. ### Current account, EBA gap, and REER assessments - Staff current account (CA) analysis: EBA gap (percent of GDP) = 3.3; COVID-19 Adj. = 0.3; Staff Gap = 3.6; implied REER gap (percent) = -7.7. - Applying an estimated elasticity of 0.47, the staff CA gap implies a REER gap of -7.7 percent in 2020, with a range between -5.5 to -9.8 percent. - Level REER model estimate: the krone is overvalued by about 11 percent. - Index REER model estimate: the krone is overvalued by almost 15 percent. - The REER index based on inflation is at its 25-year average level (indicating no over- or undervaluation). - The ULC-based REER suggests an undervaluation of about 5 percent. - Competitiveness indicators: no significant exchange rate misalignment suggested, but Denmark’s unit labor cost has risen faster than in major competitors (such as the euro area) over the past two decades, reducing competitiveness; this was counterbalanced by an increase in Denmark’s terms of trade driven by high-value industries such as pharmaceuticals. - A recent study by the DN finds changes in the exchange rate have only a modest impact on the current account (DN 2019). - The range of +/-1 percent of GDP is used to reflect uncertainty around the EBA estimated CA norm. ### Methodology for trade-adjusted imports (brief excerpt) - The analysis subtracts foreign value added (intermediate good imports) and adds the computed intermediate good imports to imports for each economy considered. - Intermediate imports are allocated to exporters based on total goods export shares in 2020. - The associated change in net exports is computed for 2020 compared with 2019. ### Reallocation shocks, methodology for labor market analysis - Reallocation shock measurement: constructed as a dispersion index capturing sectoral dispersion of stock returns (following Vu and Wu 2020). - Data: FTSE stock indices at the industry level following Industry Classification Benchmark (ICB); daily dispersion index averaged to monthly; sample of 15 economies (Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Japan, the Netherlands, Norway, Spain, Sweden, the United Kingdom, and the United States); sample period Jan 1995–Mar 2021. - Empirical approach: - Use local projections (Jorda 2005) in a panel framework at monthly frequency. - Controls: lagged unemployment, oil prices, VIX, country fixed effects. - Interaction terms: reallocation shock × level of ALMP expenditure to assess conditional responses. ### Findings on reallocation shocks and unemployment - Stock dispersion index in Denmark increased during the global financial crisis and during the pandemic. - Unconditional response: - Reallocation shocks tend to adversely affect unemployment in the near term. - The unconditional response of unemployment rate gradually increases, peaking at around 2 years. - A reallocation shock calibrated to a size around the global financial crisis and the pandemic would result in unemployment rate increasing, on average, by about ½ percentage point in the near term. - The impact is persistent but dissipates after around 2 years and is no longer statistically significant thereafter. - Conditional response with ALMP: - Active labor market policies (ALMP) mitigate the adverse impact of reallocation shocks on unemployment. - The conditional response of unemployment at the end of 6 months is smaller when ALMP is higher. - Given Denmark’s relatively high ALMP, reallocation shocks would have a much milder impact on Danish unemployment relative to other countries: the impact on unemployment rate, given Denmark’s level of ALMP, would be only about one-third to one-fifth of that of an economy with the average level of ALMP in the sample. ### Denmark-specific ALMP and labor market context - Denmark’s spending on ALMP (as percent of GDP) has increased since the mid-1990s (though it dipped around the GFC), and remains one of the largest among OECD countries. - Denmark’s flexicurity model: combines high labor market flexibility for firms with income security and extensive ALMP for workers (hiring incentives, job search-and-matching assistance, upskilling, education, retraining, subsidies to employers hiring the unemployed or unskilled). - Empirical evidence supports shifting policy emphasis as recovery gathers traction: from exceptional job retention schemes toward measures facilitating reallocation through ALMP. *International Monetary Fund — Denmark country analysis (excerpts).* ### 9. During the pandemic, job retention schemes—wage compensation and workshare ### During the pandemic, job retention schemes—wage compensation and workshare arrangements—helped cushion the impact on the Danish labor market ### Job retention schemes and labor market adjustment - Denmark’s flexicurity model is typically characterized by labor market adjustment along the extensive margin (i.e. number of workers) because firing and hiring is relatively easy and costless. - During the pandemic, adjustment occurred along the intensive margin (i.e. in terms of hours worked): unemployment remained fairly stable while hours worked decreased. - Newly introduced job retention schemes aimed to enhance and complement the flexicurity model and shield labor markets against the pandemic shock. - Effects of these schemes: - Protected incomes. - Helped reduce job separations, loss of skills and human capital—facilitating rehiring in the recovery and aiding reallocation. - Supporting evidence: Auray and Eyquem (2020) show, using a model-based analysis, that intensive margin adjustment during the pandemic would imply smaller and short-lived macroeconomic effects relative to extensive margin adjustment. ### Activation measures during 2020 and subsequent recovery - During 2020H1, amid the lockdown, activation declined as reflected by the lower number of persons in activation measures relative to pre-COVID. - As restrictions were eased, activation picked up with a focus on: - Guidance and upskilling. - To a lesser extent, company internship. - Policy relevance: activation measures that focus on training can be particularly relevant for the youth. ### Policy recommendations to facilitate reallocation and limit scarring - Shift from exceptional pandemic support to measures that facilitate reallocation as recovery gains traction. - Increase focus on matching and reallocation of labor from contracting to expanding sectors through upskilling and education. - Design policies to target the most-affected cohorts (for example, youth-targeted training). - Complementary policies beyond ALMP (active labor market policies) are important: - Reallocation towards greener jobs would support Denmark’s climate goals. - Maintain sound macroeconomic policies that support job creation (example cited: the pension reform that links retirement-age to life-expectancy). - Policies that boost labor supply and raise investment would help bolster potential growth and limit pandemic-induced scarring. ### Annex Box VII.1 — Potential growth and scarring: scenarios, assumptions, and quantitative results - Decomposition and baseline assumptions: - Potential growth decomposed into labor and labor productivity. - Baseline employment is assumed to increase by about 70k over 6 years. - Labor productivity is assumed to grow at about 1.2 percent in the medium term, up from about 0.8 percent pre-COVID. - Assumed path of capital stock in the baseline is consistent with investment-output ratio increasing by about 1 percentage point over 6 years. - Alternative scenarios and assumptions: - Adverse scenario: employment level is assumed to be some 25k smaller relative to the baseline—reflecting labor supply faltering due to reallocation bottlenecks and a reversal of the pension reform. - Favorable scenario: labor productivity growth is assumed to increase by an additional 0.2 percentage point—roughly one-half standard deviation based on Denmark’s historical data—reflecting an increase in capital intensity due to higher investment. - For illustration, the adverse and favorable scenarios assume similar near-term rebound as in the baseline; scenarios reflect alternative medium-term potential growth paths. - Quantitative outcomes from staff analysis: - Baseline: potential growth is projected to grow at about 1.8 percent in the medium term, implying an estimated medium-term output loss of about 1.1 percent relative to pre-COVID projections. - Adverse scenario: output loss in the medium term is estimated to be about 1.6 percent. - Favorable scenario: output loss in the medium term is estimated to be about 0.3 percent. - Policy implications drawn from scenarios: - Keeping up with labor supply—including through effective reallocation and continuation of the pension reform—and efforts to increase investment are key to limit scarring and support Denmark’s transition to the economy of the future. - Keeping up with labor supply is also highlighted as key for fiscal sustainability. *Source: 1dnkea2021001 - 9. During the pandemic, job retention schemes—wage compensation and workshare arrangements—(IMF staff report content).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1dnkea2021001.pdf_