## _cr04240

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---

### Executive Summary
- Background and outlook:
  - Between 1993 and 2000 Denmark experienced rapid economic growth supported by sound macroeconomic fundamentals and structural reform.
  - A slowdown began in 2001; global downturn reduced net exports in 2002 and business confidence, leading to a decline in investment in 2003.
  - Conditions appear to be in place for a return to healthy growth; Denmark is relatively well prepared to deal with fiscal pressures from population aging in the medium term.
- Agreed assessments:
  - Conditions appear to be in place for a return to growth close to the economy’s potential rate.
  - Domestic balance sheets are healthy. Monetary and fiscal policy are supportive. World recovery is strengthening and leading indicators suggest momentum.
  - Inflation pressures will remain subdued; capacity constraints are unlikely to be reached until the end of 2005.
  - Additional measures required to achieve structural employment targets underlying the medium-term sustainability strategy.
- Staff recommendations:
  - Strengthen constraints on public consumption expenditure by expressing the expenditure targets in nominal terms and introducing user fees in healthcare.
  - Prioritize reform of early retirement schemes, continue product market reforms, and further improve the tax system to increase incentives to work.
- Miscellaneous:
  - Authorities released the mission’s concluding statement and agreed to publication of the staff report.
  - Denmark has accepted the obligations of Article VIII, Sections 2, 3, and 4; exchange system free of restrictions on payments and transfers for current international transactions.
  - Denmark has subscribed to the Special Data Dissemination Standard; data provision adequate for surveillance.

### Near-Term Outlook and Macroeconomic Conditions
- Recent developments and indicators:
  - 2003 annual growth: 0.4 percent; output estimated roughly 1 percent below potential.
  - Unemployment rate rose from a trough of 5 percent in 2002 to 6½ percent.
  - As of April, the krone has appreciated by nearly 30 percent against the dollar since the low point in 2000 and by roughly 10 percent in real effective terms.
  - Headline HICP inflation is down below 1 percent.
- Demand contributions to GDP (selected series):
  - Real GDP growth: 2000: 2.8; 2001: 1.6; 2002: 1.0; 2003: 0.4; 2004 (staff): 1.8; 2005 (staff): 2.5.
  - Domestic demand: 2000: 2.4; 2001: 1.0; 2002: 1.8; 2003: 0.1; 2004: 2.2; 2005: 2.7.
    - Final domestic demand: 2000: 1.4; 2001: 1.7; 2002: 2.0; 2003: 0.6; 2004: 2.3; 2005: 2.8.
      - Consumption: 2000: -0.1; 2001: 0.6; 2002: 0.8; 2003: 0.6; 2004: 1.6; 2005: 1.7.
        - Private: 2000: -0.4; 2001: -0.1; 2002: 0.3; 2003: 0.5; 2004: 1.4; 2005: 1.5.
        - Public: 2000: 0.2; 2001: 0.7; 2002: 0.5; 2003: 0.1; 2004: 0.2; 2005: 0.2.
      - Fixed investment: 2000: 1.5; 2001: 1.1; 2002: 1.0; 2003: -0.1; 2004: 0.6; 2005: 1.0.
    - Inventories: 2000: 0.9; 2001: -0.7; 2002: -0.1; 2003: -0.4; 2004: -0.1; 2005: -0.1.
  - Net exports: 2000: 0.5; 2001: 0.6; 2002: -0.8; 2003: 0.3; 2004: -0.4; 2005: -0.2.
    - Exports: 2000: 5.5; 2001: 2.0; 2002: 2.2; 2003: 0.1; 2004: 1.5; 2005: 2.2.
    - Imports: 2000: 5.0; 2001: 1.4; 2002: 3.0; 2003: -0.2; 2004: 1.9; 2005: 2.4.
- Monetary and exchange rate context:
  - Denmark sole participant in ERM II within a band of +/- 2.25 percent; in practice the krone/euro rate has remained within about +/- 0.25 percent of central parity.
  - Policy interest rates adjusted simultaneously with those in the euro area; a spread of about 10 basis points on short-term interest rates reflects credibility of the peg.
  - Interest rate levels and differentials: short-term spread about 10 basis points.

### Fiscal Position and Public Finances
- Recent fiscal developments:
  - Fiscal surplus fell to 1.2 percent of GDP in 2003 from 1.6 percent in 2002.
- General government accounts (in percent of GDP):
  - Revenues: 2001: 57.1; 2002: 56.1; 2003: 56.0; 2004 (Prelim./Staff): 55.9.
  - Expenditure: 2001: 54.2; 2002: 54.6; 2003: 54.8; 2004: 54.7.
  - Balance: 2001: 2.8; 2002: 1.6; 2003: 1.2; 2004: 1.2.
  - Structural balance: 2001: 2.4; 2002: 1.6; 2003: 2.1; 2004: 2.0.
  - Primary structural balance: 2001: 4.0; 2002: 2.9; 2003: 3.2; 2004: 2.8.
  - Fiscal impulse (Change in primary structural balance): 2001: 0.0; 2002: 1.1; 2003: -0.3; 2004: 0.4.
  - Output gap: 2001: 0.7; 2002: 0.1; 2003: -1.1; 2004: -1.1.
- Policy action:
  - Government introduced a small package of fiscal measures on March 16, 2004 to help stimulate growth.

### Fiscal Package Details and Projections
- Authorities’ growth projections: 2.2 percent for 2004 rising to 2½ percent in 2005.
- IMF staff growth forecasts: 1.8 percent in 2004 rising to 2½ percent in 2005.
- Staff and authorities projected fiscal surplus:
  - Surplus around 1.2 percent of GDP in 2004.
  - Projected to increase to around 1.4 percent of GDP in 2005 (Tables 3 and 4); below authorities’ most recent forecast of 1.7 percent of GDP.
- Staff assessment of March 16 package:
  - Estimated to increase GDP growth in 2004 by between 0.2 and 0.5 percentage points (authorities’ estimate, depending on propensity to consume); staff judged impact likely small—perhaps at the lower end.
  - Package viewed as well-designed: brought forward reductions in labor income taxes and increased incentives to work while minimizing short- and medium-term fiscal impact.
  - Discretionary counter-cyclical interventions should be exceptional; reliance on automatic stabilizers recommended.
- Fiscal costs of the March 16 package (Billions of DKr):
  - Moving forward labor income tax cuts: 2004 = 3.9; 2005 = 2.5
  - Abolition of special pension savings: 2004 = -3.9; 2005 = -3.9
  - Moving forward use of social and health funds: 2004 = 0.6; 2005 = 0.0
  - Advancing execution of public investment: 2004 = 0.8; 2005 = 0.4
  - Strengthening activation and education: 2004 = 0.2; 2005 = 0.1
  - Total costs: 2004 = 1.6; 2005 = -0.9

### Medium-Term Strategy and Structural Issues
- Overarching objectives:
  - High and stable employment, fiscal policy sustainability, and favorable conditions for growth.
  - Price and exchange rate stability based on a credible commitment to a fixed exchange rate.
  - Fiscal framework: average general government budget surplus target of 1½–2½ percent of GDP over the medium term while making room for a reduction in the tax burden.
  - Debt objective: Halve government debt-to-GDP ratio to 27½ percent by 2010.
  - Public consumption growth target: real public consumption growth targeted to 0.7 percent in 2004 and 0.5 percent thereafter.
  - Structural employment: reductions in labor income taxes and reforms aimed to achieve a 2 percent increase in structural employment by 2010.
- Staff view and required actions:
  - Strategy appropriately designed; calls for fiscal surpluses through 2010 to reduce public debt and free resources for aging-related spending.
  - Two key challenging elements:
    - Real growth in public spending to be held to 0.5 percent.
    - Targets incorporate increase in structural employment of 1.6 percent of working age population and reducing NAIRU to 4½ percent by 2010 from roughly 5½ percent.
  - Staff recommended expressing expenditure target in nominal terms and considering user fees (healthcare) to contain demand pressures and generate revenue for labor market objectives.
  - Reorganization of local governments under consideration; decision expected before local elections in January 2006.

### Labor Market Reforms and Initiatives
- Overall job target: 2 percent increase in structural employment by 2010.
- Initiatives (verbatim descriptions):
  - Number of years of tertiary education that the state fully funds reduced to the minimum normally required to complete the program of study.
  - Incentives to postpone early retirement increased (1999).
  - Disability pension system reformed to ensure any ability to work is fully utilized.
  - Long-term sickness benefit programs changed to allow gradual reintegration into work; financial incentives increased for local governments to ensure reintegration occurs quickly.
  - Social benefits reduced for couples both receiving benefits; marginal incentives to take a job increased by slowing benefit withdrawal once employed (More People in Work, October 2002).
  - Labor market activation programs refocused to ensure employment (not simply participation) is the goal (More People in Work, October 2002).
  - For first seven years of residence, social assistance benefits to new immigrants and repatriated Danes reduced to 50 to 70 percent of level long-term residents receive; wage subsidy program introduced for recent immigrants (The Integration Package for Immigrants, March 2003).
- Staff emphasis:
  - Changes to early retirement schemes could have a more rapid impact on employment than other measures.
  - Further reductions in labor income taxes should be considered; removing nominal tax freeze on some property taxes could provide space to lower top marginal tax rate.

### Exchange Rate, Financial Sector, and Prices
- Exchange rate regime:
  - Krone central rate: CENTRAL RATE=7.460 with ERM II band +/-2.25 percent.
  - ERM II central fixed rate at DKr 746.038 per €100 (per Fund relations section).
  - Commitment to fixed exchange rate viewed as central pillar of macroeconomic stability.
- Inflation and wages:
  - Headline HICP inflation below 1 percent; reductions in taxes on alcohol and tobacco contributed to lower inflation.
  - Reduction in alcohol and tobacco taxes on October 1, 2003 contributes roughly 0.4 percentage points to the decline in year-over-year consumer price inflation.
  - Wages grew in 2003 at roughly 4 percent, supported by labor productivity growth.
  - Central wage framework sets benchmark of 3 to 3½ percent annual growth in labor cost over next three years.
- Financial stability:
  - Domestic balance sheets assessed as healthy.
  - Banking sector: asset quality high and loan losses minimal; some agricultural debtors under stress but share small; stress tests suggest sufficient buffers.
  - Insurance companies and pension funds: benefited from favorable equity market performance in 2003; solvency ratios healthy; liabilities linked to interest guarantees hedged.

### House Prices, Household Debt, and Financial Risks
- Housing and debt dynamics:
  - Since 1993 the most recent episode of house price gains: real house prices rising by over 5½ percent a year.
  - Household debt increased as homeowners shifted to mortgage secured loans; household income gearing (interest payments to disposable income) remains low by historical standards.
  - Household exposure to changes in short-term interest rates has increased.
  - Limited micro data: mostly liquidity constrained households amounted to roughly 30–40 percent of total households.
- Staff assessment:
  - Risks from rising house prices and household debt levels appear contained given low debt-servicing costs and substantial household assets.

### Sustainability Analysis and Stress Tests
- Public debt projections:
  - Staff baseline predicts decline in public debt-to-GDP ratio from 43.3 in 2003 to 32.7 in 2008.
  - Sensitivity tests suggest medium-term debt sustainability not at risk if authorities pursue fiscal consolidation.
  - Worst bound test (B2) predicts debt ratio at end of period increases by around 5 percentage points from current levels; in all other tests debt ratio falls.
- Selected stress-test outcomes (public sector debt ratio in percent of GDP):
  - Baseline: 43.3, 40.6, 37.7, 34.7, 31.6, 28.3.
  - A1: 43.3, 40.6, 37.7, 34.7, 31.6, 28.3; debt-stabilizing prim. bal. 1.3.
  - B1: 43.3, 43.1, 42.4, 40.2, 37.9, 35.8; debt-stabilizing prim. bal. 1.2.
  - B2: 43.3, 43.9, 46.0, 46.7, 47.4, 48.3; debt-stabilizing prim. bal. 1.6.
  - B3: 43.3, 43.0, 42.4, 40.2, 37.9, 35.7; debt-stabilizing prim. bal. 1.2.
  - B4: 43.3, 43.0, 42.7, 40.5, 38.3, 36.2; debt-stabilizing prim. bal. 1.2.
  - B5: 43.3, 44.6, 42.6, 40.4, 38.2, 36.0; debt-stabilizing prim. bal. 1.2.
  - B6: 43.3, 51.7, 50.0, 48.0, 46.0, 44.1; debt-stabilizing prim. bal. 1.5.

### External Sector and Vulnerability Indicators
- Current account and external positions:
  - Denmark registered current account surpluses through most of the 1990s; net investment position improved from about negative 30 percent of GDP in early 1990s to negative 15 percent of GDP in 2003.
  - Gross external debt increased from 115 to 130 percent of GDP during 1999–2003; net external debt declined from 34 percent of GDP to about 28 percent.
  - With sustained current account surplus projected, net investment position projected to strengthen further.
- Selected indicators (1999–2003):
  - Exports (annual percentage change, U.S. dollars): 2.5, 2.2, 1.6, 1.6, 1.9.
  - Imports (annual percentage change, U.S. dollars): 2.3, 2.2, 1.5, 1.6, 1.9.
  - Current account balance (percent of GDP): 1.8, 1.5, 3.1, 2.0, 2.9.
  - Official Reserves (billions of U.S. dollars, end-of-period): 22.6, 14.6, 17.6, 27.2, 37.7.
  - Total gross external debt: 114.8, 114.6, 115.0, 120.7, 131.3.
  - Net external debt: 33.6, 35.2, 34.4, 24.3, 28.3.

### Statistical, Surveillance, and Institutional Notes
- Denmark subscribes to SDDS; data coverage comprehensive and adequate for surveillance.
- Data issues: widening gap between exports in trade data (Danmarks Statistik) and balance of payments data (Danmarks Nationalbank); reconciliation not yet achieved.
- Institutional engagement: mission met with Minister for Finance, Governor of the Nationalbank, senior officials, regulatory and supervisory agencies, municipal governments, Economic Council, Welfare Commission, Association of Mortgage Banks, two major banks, and trade union and employers’ confederations.
- Denmark requested an FSAP planned for late 2005 in context of next Article IV consultation.

### Staff Appraisal — Key Conclusions and Policy Recommendations
- Overall assessment:
  - Denmark well positioned after a decade of structural reform and prudent fiscal management.
  - Conditions for return to healthy growth appear to be in place: accommodative fiscal and monetary policy, healthy balance sheets, favorable external competitiveness, and leading indicators point to resumption of growth close to potential.
  - Downside risks: household sector employment concerns and possible weakness in trading partner demand; risk of sharp retrenchment in house prices appears low.
- Fiscal policy recommendations:
  - March fiscal package supports recovery without undermining medium-term objectives; avoid making fiscal fine tuning a regular tool.
  - Contain public consumption; consider specifying spending targets in nominal terms.
  - Introduce user fees in healthcare to allocate scarce resources and contain demand pressures; revenues could provide room for other labor market objectives while respecting tax freeze in aggregate.
- Labor market recommendations:
  - Focus on groups with low participation (older and younger age groups, immigrants).
  - Changes to early retirement schemes likely necessary and could yield relatively rapid employment gains.
  - Further reductions in labor income taxes should be considered to mitigate tax-system constraints on labor supply.
- Product market recommendations:
  - Increase competition in goods markets; continue product market reforms to enhance competitiveness.

### Article IV Consultation Schedule, Fund Relations, and Key Projections
- Article IV consultation:
  - Proposed next Article IV consultation on the 24-month cycle; Denmark on 24-month cycle.
- Exchange rate and Fund positions (as of April 30, 2004):
  - Danish Kroner 6.206 per US$1 (present exchange rate May 19, 2004).
  - ERMII participation with 2¼ percent fluctuation margins vis-à-vis the euro; central fixed rate DKr 746.038 per €100.
  - Quota: 1,642.80 (SDR Million, Percent Quota 100.00).
  - Fund holdings of currency: 1,008.08 (SDR Million, 61.36 percent of quota).
  - Reserve Tranche position: 634.73 (SDR Million, 38.64 percent of quota).
  - SDR Department net cumulative allocation: 178.86 (SDR Million, 100.00 percent allocation); Holdings 38.99 (21.80 percent).
  - Outstanding Purchases and Loans: None. Financial Arrangements: None.
- Macroeconomic projections (selected):
  - Real GDP change (percent): 2002: 1.0; 2003: 0.4; 2004 (proj.): 1.8.
  - Medium-term staff projections (2005–09): 2005: 2.5; 2006: 2.3; 2007: 2.1; 2008: 1.9; 2009: 1.9.
  - CPI (year average): 2002: 2.3; 2003: 2.1; 2004 (proj.): 1.7.
  - Money market rate (April 2004): 2002: 3.5; 2003: 2.4; 2004: 2.1.
  - Exports (billions of DKr): 2002: 436.3; 2003: 428.9; 2004: 442.3.
  - Imports (billions of DKr): 2002: -376.2; 2003: -362.1; 2004: -385.3.
  - Current account (percent of GDP): 2002: 2.0; 2003: 3.0; 2004 (proj.): 1.8.
- Public finance and debt (selected):
  - General government revenues (percent of GDP): 2002: 56.1; 2003: 56.0; 2004: 55.9.
  - General government expenditure (percent of GDP): 2002: 54.6; 2003: 54.8; 2004: 54.7.
  - General government balance (percent of GDP): 2002: 1.6; 2003: 1.2; 2004: 1.2.
  - General government debt: 1999: 47.4; 2000: 45.4; 2001: 45.4; 2002: 43.3; 2003: 41.7.

### Key Numerical Targets and Indicators (selected)
- Target: 2 percent increase in structural employment by 2010.
- Fiscal surplus objective: between 1½ and 2½ percent of GDP.
- Annual growth in public consumption constrained to 0.5 percent.
- IMF staff growth forecasts: close to 2 percent in 2004; 2½ percent in 2005.
- Unemployment rate (percent): 6.4 (1998), 5.5 (1999), 5.1 (2000), 4.9 (2001), 4.9 (2002), 5.8 (2003), 6.0 (2004 proj.).
- Real GDP growth (change in percent): 2.5 (1998), 2.6 (1999), 2.8 (2000), 1.6 (2001), 1.0 (2002), 0.4 (2003), 1.8 (2004 proj.).
- Present exchange rate (May 19, 2004): Danish Kroner 6.206 per US$1.
- Money market rate (percent): 4.2 (1998), 3.3 (1999), 4.9 (2000), 4.6 (2001), 3.5 (2002), 2.4 (2003), 2.1 (2004 proj.).
- Government bond yield (percent): 4.9 (1998), 4.9 (1999), 5.7 (2000), 5.1 (2001), 5.1 (2002), 4.3 (2003), 5.0 (2004 proj.).
- Exports (In billions of DKr.): 322.0 (1998), 347.5 (1999), 405.3 (2000), 419.8 (2001), 436.3 (2002), 428.9 (2003), 442.3 (2004 proj.).
- Imports (In billions of DKr.): -296.7 (1998), -300.8 (1999), -351.1 (2000), -358.1 (2001), -376.2 (2002), -362.1 (2003), -385.3 (2004 proj.).
- Merchandise trade balance (f.o.b., In billions of DKr.): 25.3 (1998), 46.7 (1999), 54.1 (2000), 61.7 (2001), 60.1 (2002), 66.8 (2003), 57.1 (2004 proj.).

*IMF staff report: _cr04240 (2004), mission concluding statement and staff report as released by the authorities.*

### 2004. The mission, comprising Messrs. MacArthur (Head, PDR), Eskesen, and Hunt, and

### _cr04240 - 2004. The mission, comprising Messrs. MacArthur (Head, PDR), Eskesen, and Hunt, and

### Executive Summary
- Background and outlook:
  - Between 1993 and 2000 Denmark experienced rapid economic growth supported by sound macroeconomic fundamentals and structural reform.
  - A slowdown began in 2001. Fiscal measures to cool an overheating economy initially eased private consumption, while net exports and investment supported growth. The global downturn reduced net exports in 2002 and business confidence, leading to a decline in investment in 2003.
  - Conditions appear to be in place for a return to healthy growth. In the medium term, Denmark is relatively well prepared to deal with fiscal pressures from population aging.
- Agreed assessments:
  - Conditions appear to be in place for a return to growth close to the economy’s potential rate. Domestic balance sheets are healthy. Monetary and fiscal policy are supportive. The world recovery is strengthening and leading indicators suggest the pickup in the domestic economy witnessed late last year continues to gain momentum.
  - Inflation pressures will remain subdued. Although the impact of the reduction in indirect taxes and euro appreciation are temporary, capacity constraints are unlikely to be reached until the end of 2005.
  - Although Denmark is well placed to deal with the fiscal pressures of an aging population, additional measures will be required to achieve the structural employment targets underlying the medium-term sustainability strategy.
- Staff recommendations:
  - Strengthen constraints on public consumption expenditure by expressing the expenditure targets in nominal terms and introducing user fees in healthcare.
  - To achieve the structural employment targets, prioritize reform of early retirement schemes, continue progress in product market reforms, and further improve the tax system to increase incentives to work.
- Miscellaneous:
  - The authorities released the mission’s concluding statement and agreed to the publication of the staff report.
  - Denmark has accepted the obligations of Article VIII, Sections 2, 3, and 4. The exchange system is free of restrictions on payments and transfers for current international transactions.
  - Denmark has subscribed to the Special Data Dissemination Standard, and data provision is adequate for surveillance.

### Near-Term Outlook and Macroeconomic Conditions
- Recent developments:
  - Annual growth: 2003 annual growth was 0.4 percent; output estimated roughly 1 percent below potential.
  - Unemployment rate rose from a trough of 5 percent in 2002 to 6½ percent.
  - As of April, the krone has appreciated by nearly 30 percent against the dollar since the low point in 2000 and by roughly 10 percent in real effective terms.
  - Headline HICP inflation is down below 1 percent.
- Demand contributions to GDP (Selected years and items as reported):
  - Real GDP growth: 2000: 2.8; 2001: 1.6; 2002: 1.0; 2003: 0.4; 2004 (staff): 1.8; 2005 (staff): 2.5.
  - Domestic demand: 2000: 2.4; 2001: 1.0; 2002: 1.8; 2003: 0.1; 2004: 2.2; 2005: 2.7.
    - Final domestic demand: 2000: 1.4; 2001: 1.7; 2002: 2.0; 2003: 0.6; 2004: 2.3; 2005: 2.8.
      - Consumption: 2000: -0.1; 2001: 0.6; 2002: 0.8; 2003: 0.6; 2004: 1.6; 2005: 1.7.
        - Private: 2000: -0.4; 2001: -0.1; 2002: 0.3; 2003: 0.5; 2004: 1.4; 2005: 1.5.
        - Public: 2000: 0.2; 2001: 0.7; 2002: 0.5; 2003: 0.1; 2004: 0.2; 2005: 0.2.
      - Fixed investment: 2000: 1.5; 2001: 1.1; 2002: 1.0; 2003: -0.1; 2004: 0.6; 2005: 1.0.
    - Inventories: 2000: 0.9; 2001: -0.7; 2002: -0.1; 2003: -0.4; 2004: -0.1; 2005: -0.1.
  - Net exports: 2000: 0.5; 2001: 0.6; 2002: -0.8; 2003: 0.3; 2004: -0.4; 2005: -0.2.
    - Exports: 2000: 5.5; 2001: 2.0; 2002: 2.2; 2003: 0.1; 2004: 1.5; 2005: 2.2.
    - Imports: 2000: 5.0; 2001: 1.4; 2002: 3.0; 2003: -0.2; 2004: 1.9; 2005: 2.4.
- Monetary and exchange rate context:
  - Denmark has been the sole participant in ERM II within a band of +/- 2.25 percent; in practice the krone/euro rate has remained within about +/- 0.25 percent of the central parity.
  - Policy interest rates in Denmark have been adjusted simultaneously with those in the euro area; a spread of about 10 basis points on short-term interest rates reflects the credibility of the peg.
  - Interest rate levels and differentials noted: short-term spread about 10 basis points.

### Fiscal Position and Public Finances
- Fiscal developments:
  - Fiscal surplus fell to 1.2 percent of GDP in 2003 from 1.6 percent in 2002.
  - Summary of general government accounts (in percent of GDP):
    - Revenues: 2001: 57.1; 2002: 56.1; 2003: 56.0; 2004 (Prelim./Staff): 55.9.
    - Expenditure: 2001: 54.2; 2002: 54.6; 2003: 54.8; 2004: 54.7.
    - Balance: 2001: 2.8; 2002: 1.6; 2003: 1.2; 2004: 1.2.
    - Structural balance: 2001: 2.4; 2002: 1.6; 2003: 2.1; 2004: 2.0.
    - Primary structural balance: 2001: 4.0; 2002: 2.9; 2003: 3.2; 2004: 2.8.
    - Fiscal impulse (Change in primary structural balance): 2001: 0.0; 2002: 1.1; 2003: -0.3; 2004: 0.4.
    - Output gap: 2001: 0.7; 2002: 0.1; 2003: -1.1; 2004: -1.1.
- Policy action:
  - Given increasing slack and uncertainty in early 2004, the government introduced a small package of fiscal measures on March 16 to help stimulate growth (details referenced in Text Box 1 of source).

### Medium-Term Strategy and Structural Issues
- Medium-term challenges:
  - Aging population will generate fiscal pressures; Denmark is relatively well prepared but additional efforts are required to meet medium-term employment and public expenditure targets without increasing taxes.
- Recommended policy priorities:
  - Strengthen public expenditure discipline: express expenditure targets in nominal terms and introduce user fees in healthcare.
  - Achieve structural employment targets by:
    - Reforming early retirement schemes.
    - Continuing product market reforms.
    - Improving the tax system to increase incentives to work.
  - Continue progress on labor market initiatives that have supported high participation despite generous benefits (flexible recruitment and dismissal rules, strict requirements for active labor market programs, clear availability-for-work criteria).

### Exchange Rate, Financial Sector, and Prices
- Exchange rate and monetary conditions:
  - Krone central rate: CENTRAL RATE=7.460 with ERM II band +/-2.25 percent.
  - Nominal and real effective exchange rates showed appreciation in recent years (indexes referenced with January 1995 or 1998 baselines).
- Inflation and asset prices:
  - Headline HICP inflation below 1 percent; reductions in taxes on alcohol and tobacco contributed to lower inflation.
  - Wages grew in 2003 at roughly 4 percent, supported by labor productivity growth.
  - Equity prices recovered with international markets; the long upward trend in real housing prices appears to be tapering off.
- Financial stability:
  - Domestic balance sheets are assessed as healthy.

### Statistical, Surveillance, and Institutional Notes
- Data and surveillance:
  - Denmark has subscribed to the Special Data Dissemination Standard; data provision is adequate for surveillance (Appendix III).
  - Denmark has accepted Article VIII, Sections 2, 3, and 4 obligations; exchange system free of restrictions for current international transactions (Appendix II).
- Institutional engagement:
  - The mission met with Mr. Pedersen, the Minister for Finance; Ms. Andersen, Governor of the Nationalbank; senior government officials; representatives of regulatory and supervisory agencies; municipal governments; the Economic Council; the Welfare Commission; the Association of Mortgage Banks; the two major banks; and trade union and employers’ confederations.

*IMF staff report: _cr04240 (2004), mission concluding statement and staff report as released by the authorities.*

### 7. Denmark’s policies continue to be broadly in line with the Fund’s

### 7. Denmark’s policies continue to be broadly in line with the Fund’s

### Alignment with Fund advice
- Fund recommendations from earlier consultations influenced Danish policy thinking, particularly by focusing on economic fundamentals with an international view while domestic debate tends to be more politically motivated.
- Fund advice on overheating in the late 1990s was judged to have been "both correct and helpful."
- The Fund’s emphasis on spending discipline and structural reform helped generate domestic focus and public support for the medium-term sustainability strategy.

### The near-term outlook and policy stance
- Context and policy intent:
  - Discussions focused on prospects for a return to more rapid growth and the fiscal challenge of an aging population.
  - Growth had been on a slowing trend for the last three years; macro fundamentals reviewed included monetary and fiscal stance, balance sheets of households/firms/public sector, and external competitiveness.
  - Denmark adheres to a coherent medium-term strategy to ensure long-term fiscal sustainability while maintaining the welfare state without resorting to tax increases.
- Authorities’ stimulus package (March 16) aimed to increase household disposable income and consumption while limiting fiscal impact; estimated to increase GDP growth in 2004 by between 0.2 and 0.5 percentage points, depending on propensity to consume.
- Authorities’ growth projections:
  - Projected growth of 2.2 percent for 2004 rising to 2½ percent in 2005.
- IMF staff growth forecasts and risks:
  - Staff forecast growth of 1.8 percent in 2004 rising to 2½ percent in 2005.
  - Downside risks cited: employment uncertainty, high household debt inducing higher saving, weak signals of recovery in Europe, high oil prices, and potential euro appreciation undermining competitiveness.
  - Upside risk: fiscal stimulus plus stronger external/domestic demand could induce labor supply constraints within 2 years.
- Monetary and inflation outlook:
  - Agreement that price inflation is likely to remain below 2 percent over the near term.
  - Factors easing inflation: excess capacity, reductions in indirect taxes, and import price effects of an appreciating currency.
  - Capacity utilization constraints unlikely to be reached before 2006.
  - Central wage framework sets a benchmark of 3 to 3½ percent annual growth in labor cost over the next three years, roughly a full percentage point below the average rate of growth over the previous four years.
  - Reduction in alcohol and tobacco taxes on October 1, 2003 contributes roughly 0.4 percentage points to the decline in year-over-year consumer price inflation.
- Competitiveness:
  - Authorities noted sustained current account surpluses as evidence of favorable external competitiveness.
  - Concern that further euro appreciation would undermine competitiveness.
- Interest rates and exchange rate:
  - Interest rates at historical lows; monetary conditions tightened due to euro appreciation.
  - Authorities viewed further ECB easing as unlikely to have much impact on domestic demand.

### Fiscal stance, package details, and projections
- Staff and authorities projected the fiscal surplus to remain broadly unchanged in 2004:
  - Surplus around 1.2 percent of GDP in 2004.
  - Projected to increase to around 1.4 percent of GDP in 2005 (Tables 3 and 4), below the authorities’ most recent forecast of 1.7 percent of GDP.
- Staff assessment of March package:
  - Package provides a counter-cyclical impetus to growth; impact likely small—perhaps at the lower end of authorities’ estimate.
  - Package viewed as well-designed: brought forward reductions in labor income taxes and increased incentives to work while minimizing short- and medium-term fiscal impact.
  - Agreement that discretionary counter-cyclical interventions should be exceptional to avoid undermining credibility of medium-term targets; reliance on automatic stabilizers recommended for cyclical swings.
- Fiscal costs of the March 16 package (Billions of DKr) — as presented by the authorities:
  - Moving forward labor income tax cuts: 2004 = 3.9; 2005 = 2.5
  - Abolition of special pension savings: 2004 = -3.9; 2005 = -3.9
  - Moving forward use of social and health funds: 2004 = 0.6; 2005 = 0.0
  - Advancing execution of public investment: 2004 = 0.8; 2005 = 0.4
  - Strengthening activation and education: 2004 = 0.2; 2005 = 0.1
  - Total costs: 2004 = 1.6; 2005 = -0.9

### Medium-term strategy, targets, and structural policies
- Overarching medium-term objectives:
  - High and stable employment, fiscal policy sustainability, and favorable conditions for growth.
  - Price and exchange rate stability based on a credible commitment to a fixed exchange rate.
  - Fiscal framework intended to ensure government savings sufficient to maintain long-term sustainability of public finances in light of population aging without tax increases while maintaining main welfare-state elements.
- Key numeric targets and elements of Denmark’s medium-term fiscal framework:
  - Target: An average general government budget surplus of 1½–2½ percent of GDP over the medium term while making room for a reduction in the tax burden.
  - Debt objective: Halve the government’s debt-to-GDP ratio to 27½ percent by 2010.
  - Public consumption growth target: real public consumption growth targeted to 0.7 percent in 2004 and 0.5 percent thereafter.
  - Tax freeze: introduced in 2002 applying to both tax rates and taxes expressed in nominal terms.
  - Structural employment: reductions in labor income taxes and structural reforms aimed to achieve a 2 percent increase in structural employment by 2010.
- Staff view:
  - Staff viewed the strategy as appropriately designed to achieve medium-term sustainability objectives.
  - Strategy calls for fiscal surpluses through 2010 to reduce public debt and free resources for aging-related spending.
  - Noted progress: substantial fiscal surpluses continue; labor market participation rates among highest in OECD; structural employment has increased.
- Key medium-term challenges and required actions:
  - Two key challenging elements:
    - Real growth in public spending to be held to 0.5 percent, below the rate of GDP growth and well under the 1.6 percent average growth over the last five years.
    - Targets incorporate an increase in structural employment of 1.6 percent of the working age population, based on increasing participation rates and reducing the NAIRU to 4½ percent by 2010 from its currently estimated level of roughly 5½ percent.
  - Staff cautioned additional measures to control spending may be required given pressures (e.g., health care).
  - Staff recommended expressing the expenditure target in nominal rather than real terms to enhance transparency and enforceability and to better link to nominal fiscal surpluses needed for debt reduction.
  - Staff recommended considering user fees to better align demand for services with need and to generate revenue that could allow further reductions in labor income taxes; authorities noted the tax freeze prevented implementing user fees.
  - A reorganization of local governments under consideration to improve delivery of public services and harness economies of scale; decision expected before the next local elections in January 2006. Authorities imposed constraints to prevent excess capital expenditures prior to reorganization.
- Structural reform areas highlighted:
  - Labor market: focus on groups with relatively low participation rates—young, older workers, and immigrants; measures to speed students through education, reduce incentives for early retirement, increase incentives/opportunities for immigrants.
  - Product market reforms: needed to improve overall Danish competitiveness.
  - A comprehensive monitoring program in place though some initiatives are too recent to judge effectiveness.

### Labor market reforms and initiatives (aimed at increasing structural employment)
- Overall job target: 2 percent increase in structural employment by 2010 (through higher participation and lower NAIRU).
- Initiatives introduced (verbatim descriptions from source):
  - The number of years of tertiary education that the state fully funds has been reduced to the minimum normally required to complete the program of study.
  - Incentives to postpone early retirement have been increased (1999).
  - The disability pension system has been reformed to ensure that any ability to work is fully utilized.
  - Long-term sickness benefit programs have been changed so that reintegration into work can occur gradually and thereby sooner to avoid marginalization. Further, financial incentives have been increased for local governments to ensure that reintegration occurs as quickly as possible.
  - Social benefits have been reduced for couples that are both receiving benefits and the marginal incentives to take a job for those on social benefits have been increased by slowing the rate at which some benefits are withdrawn once employed (More People in Work, October 2002).
  - Labor market activation programs have been refocused to ensure that employment and not simply participation is the goal (More People in Work, October 2002).
  - For the first seven years of residence, social assistance benefits to new immigrants and repatriated Danes have been reduced to 50 to 70 percent of the level that long-term residents receive. A wage subsidy program has also been introduced for recent immigrants (The Integration Package for Immigrants, March 2003).

*IMF staff report summary as presented in the source document.*

### 23. The authorities recognized that achieving the targeted increases in labor supply

### _cr04240 - 23. The authorities recognized that achieving the targeted increases in labor supply

### Labor supply and welfare reform
- Authorities recognized that achieving the targeted increases in labor supply will require further reforms.
- Staff noted that measures to increase direct financial incentives were likely to be most effective.
- A reduction in the incentives for early retirement would be an important, if politically very sensitive, step.
- The recently formed Welfare Commission is to outline the reform options and stimulate public debate.
  - The first report from the Commission, to be published in late May, was expected to clarify the key issues.
  - The final report with policy options is planned for late 2005, after the elections.
- Staff: changes to early retirement schemes could have a more rapid impact on employment than other measures.

### Tax policy, labor compensation, and human capital incentives
- Denmark has one of the highest top marginal labor income tax rates amongst the OECD and it applies to almost 40 percent of employees.
- Wage compression has long been a feature in the Danish labor market.
- Observed undesirable effects attributed to tax and wage structures:
  - workers’ preferences for increased holidays over increased wages;
  - some worrying trends in tertiary educational attainment in Denmark relative to other industrial countries (Figure 13);
  - some of the employment difficulties faced by low-skilled workers.
- Staff recommendations:
  - Commended recent progress in reducing labor income taxes and argued that efforts to reduce the top marginal rate should be pursued.
  - Consideration should be given to allowing for greater wage dispersion.
  - Removing the nominal tax freeze that has been imposed on some components of property taxes could provide the space to lower the top marginal tax rate, shifting the tax burden from mobile to immobile factors.
- Authorities’ position:
  - Argued that full state funding of tertiary education and the quick pace of advancement for the highly educated helped to maintain sufficient incentives to invest in human capital.
  - Indicated that the egalitarian principles underlying wage compression and the partial freezing of property taxes were very popular and would be politically difficult to change.
- Staff appraisal:
  - Further reductions in labor income taxes should be considered.
  - Demographics are shrinking the relative size of the working age population, and policy should be focused on reducing the extent to which the structure of the tax system constrains labor supply.
  - Labor income taxes in Denmark continue to be amongst the highest in the OECD and there are some worrying signals that this may be undermining incentives to invest in human capital.

### Product market competition and regulatory reform (Box 5)
- Staff offered that increasing competition in goods markets was a necessary complement to efforts to increase labor supply.
- Legislation in 2002 increased penalties for anti-competitive behavior; authorities noted Denmark’s legal framework for competition policy meets the northern European standard, but strict enforcement will be required in practice.
- Progress noted in liberalization of the energy market; considerable improvements still possible in construction, transportation, rental housing, and retail.
- IMF’s Global Economic Model (GEM) simulations — estimated impact if goods and labor market efficiencies increased to match the best among industrial countries:
  - Long-run increase in real GDP of roughly 7 percent in Denmark and 12 percent in the euro area.
  - For Denmark, the increase in real GDP results from increases in the capital stock and in hours worked and is consistent with the Danish government’s medium-term target of an increase in structural employment of 2 percent.
- GEM simulation results (Percent deviation from baseline):
  - Denmark
    - GDP: 2.50 (5 years), 4.58 (10 years), 6.89 (Long run)
    - Hours worked: 1.72 (5 years), 2.36 (10 years), 3.12 (Long run)
    - Capital stock: 2.73 (5 years), 6.32 (10 years), 11.16 (Long run)
  - Euro Area
    - GDP: 4.48 (5 years), 8.34 (10 years), 11.76 (Long run)
    - Hours worked: 4.34 (5 years), 5.95 (10 years), 7.36 (Long run)
    - Capital stock: 4.68 (5 years), 13.36 (10 years), 21.67 (Long run)
- Results dependent on model calibration; both labor and product market reforms will be required. For further details see Denmark: Selected Issues (SM/04/218).

### Exchange rate regime and macroeconomic framework
- Authorities view Denmark’s fixed exchange rate in ERM II as a central pillar of their framework for macroeconomic stability.
- Commitment to the fixed exchange rate has underpinned macroeconomic policy for the last two decades.
- Staff agreed with the authorities’ positive assessment: inflation has been low and stable, and fiscal policy has been focused on ensuring fundamental savings and investment balances consistent with the peg.
- Eventual euro adoption remains the authorities’ favored exit strategy, but public support is lacking; a referendum on joining the euro was rejected by a small margin in 2000 and another is unlikely at least until after the next elections.
- Staff appraisal: Denmark’s fixed exchange rate system remains a cornerstone of the economic strategy; low spreads in interest rates vis-à-vis the euro attest to the credibility of the peg.

### Financial sector soundness and risks
- Banking sector:
  - Despite the three-year slowdown, the quality of banks’ assets remains high and loan losses have been minimal (Table A3).
  - Some debtors, notably in the agricultural sector, have come under stress, but the share of such loans is small and no systemic concerns were seen.
  - Authorities conduct periodic stress tests which suggest sufficient buffers to absorb significant risks.
  - Denmark has requested an FSAP planned for late 2005 in the context of the next Article IV consultation cycle.
- Insurance companies and pension funds:
  - Benefited from favorable equity market performance in 2003.
  - Solvency ratios remained healthy; potential for systemic problems considered extremely limited.
  - Risks related to liabilities linked to interest guarantees have been hedged through various financial instruments.
- Cross-border integration and regulation:
  - Further euro area integration presents challenges for supervision and requires regulatory harmonization amid increasing conglomeration and cross-border mergers.
  - One large Danish bank is merging subsidiaries across the Nordic region into a single bank chartered in Sweden and will operate in Denmark as a systemically-important branch.
  - Adoption of the EU’s financial services directive and Basel II will enhance cross-border cooperation.
  - Authorities noted the new regulations would effectively imply a loosening of provisioning and capital adequacy requirements for Danish banks; domestic banks are being encouraged to move gradually to the new lower levels of capital adequacy while aware of competitive pressures.

### House prices, household debt, and Box 6 findings
- Denmark has experienced three episodes of strong house price gains since the mid-1970s.
- The most recent episode since 1993 has been the longest expansion, with real house prices rising by over 5½ percent a year.
- The steady rise partly reflects increased demand associated with a reduction in mortgage interest rates and greater access to credit.
- Household debt developments:
  - Household debt has increased steadily as homeowners shifted to mortgage secured loans to repay bank debt and take advantage of lower interest rates of mortgage credits.
  - Household income gearing—the ratio of interest payments to disposable income—remains low by historical standards, reflecting low interest rate levels, but household exposure to changes in short-term interest rates has increased.
  - Compared to other countries, household debt as a ratio of gross disposable income appears high, but debt as a ratio of owner occupied housing prices has remained fairly stable.
  - Limited micro data showed that the mostly liquidity constrained amounted to roughly 30–40 percent of total households.
- Staff assessment: risks from rising house prices and household debt levels appear contained given low debt-servicing costs, substantial household assets, and that the recent increase in housing prices remains well below that in some other countries.

### Trade, statistics, and governance issues
- Denmark supports trade liberalization within the context of EU membership and intends to press for resuming negotiations under the Doha round.
- Authorities reiterated support for CAP reform and the EU’s flexibility on the “Singapore issues” (investment, competition, government procurement, and trade facilitation).
- Statistical coverage:
  - Denmark subscribes to the SDDS and its economic data coverage is comprehensive.
  - A gap between exports based on trade data (Danmarks Statistiks) and exports based on balance of payments data (Danmarks Nationalbank) has widened in recent years; ongoing discussions have not yet reconciled the two series.
- Development assistance:
  - Denmark maintains leadership in development assistance; staff encouraged continuation.
  - Although aid as a share of gross national income has fallen slightly in recent years, staff commended maintaining development assistance at a level representing at least 0.7 percent of gross national income.
- Anti-corruption and AML/CFT:
  - Denmark has adopted the OECD’s anti-bribery convention and has satisfied the 40 Financial Action Task Force (FATF) recommendations in the area of money laundering.
  - Denmark has completed the questionnaire on anti-money laundering and the financing of terrorism; based on responses and discussions during the Article IV consultation, the AML/CLFT regime appears to have a solid foundation.

### Staff appraisal — key conclusions and policy recommendations
- Denmark is well positioned after a decade of structural reform and prudent fiscal management; reforms in the mid 1990s increased structural employment and supported robust growth.
- Conditions for a return to healthy growth appear to be in place: accommodative fiscal and monetary policy, healthy balance sheets, favorable external competitiveness, and leading indicators point to resumption of growth close to potential.
- Downside risks: household sector employment concerns and possible weakness in trading partner demand. Risk of a sharp retrenchment in house prices undermining the recovery appears low.
- Fiscal policy:
  - The March fiscal package is expected to support recovery without undermining medium-term objectives.
  - Important to avoid generating the expectation that fiscal fine tuning will become a regular tool for short-run stabilization.
  - Medium-term focus on fiscal sustainability remains appropriate given fiscal pressures from aging.
  - Containing public consumption remains a cornerstone of strategy; consideration should be given to specifying spending targets in nominal terms.
  - Increasing healthcare costs represent a key risk; introducing user fees should be considered to allocate scarce healthcare resources more efficiently and contain demand pressures.
  - Revenues from user fees could provide fiscal room to achieve other labor market objectives while respecting, in aggregate, the tax freeze.
- Labor market:
  - Given high overall participation, achieving targeted increases in structural employment may require politically difficult measures, focusing on groups with low participation (older and younger age groups, first- and second-generation immigrants).
  - Changes to early retirement schemes are likely necessary and could yield relatively rapid employment gains.
  - Further reductions in labor income taxes should be considered to mitigate tax-system constraints on labor supply.

*Source: IMF staff report content provided in the supplied PDF excerpt.*

### 43. It is proposed that the next Article IV consultation be conducted on the 24-month

### _cr04240 - 43. It is proposed that the next Article IV consultation be conducted on the 24-month

### Article IV consultation schedule
- It is proposed that the next Article IV consultation be conducted on the 24-month cycle.
- Denmark is on the 24-month consultation cycle.
- The staff report for the last Article IV consultation (IMF Country Report No. 02/101) was discussed at EBM/02/47 (May 8, 2002).

### Exchange rate and Fund relations
- Participant in ERM2.
- Danish Kroner 6.206 per US$1.
- Exchange rate arrangements:
  - Denmark participates in the exchange rate mechanism II (ERMII).
  - Maintains 2¼ percent fluctuation margins vis-à-vis the euro with a central fixed rate at DKr 746.038 per €100.
- Fund membership and positions (as of April 30, 2004):
  - Quota: 1,642.80 (SDR Million, Percent Quota 100.00).
  - Fund holdings of currency: 1,008.08 (SDR Million, 61.36 percent of quota).
  - Reserve Tranche position: 634.73 (SDR Million, 38.64 percent of quota).
  - SDR Department net cumulative allocation: 178.86 (SDR Million, 100.00 percent allocation); Holdings 38.99 (21.80 percent).
  - Outstanding Purchases and Loans: None.
  - Financial Arrangements: None.
  - Projected Obligations to Fund: None.
  - Technical Assistance: None.
  - Resident Representative: None.

### Macroeconomic outlook and medium-term projections
- Real GDP (change in percent), selected years and staff projections:
  - 2002: 1.0
  - 2003: 0.4
  - 2004 (proj.): 1.8
  - Medium-term staff projections (2005–09): 2005: 2.5; 2006: 2.3; 2007: 2.1; 2008: 1.9; 2009: 1.9.
- Other real economy indicators (selected):
  - Net Exports: 2002: -0.8; 2003: -0.1; 2004 (proj.): -0.4.
  - Final Domestic demand: 2002: 2.0; 2003: 0.6; 2004 (proj.): 2.3.
  - Private consumption: 2002: 0.6; 2003: 1.1; 2004 (proj.): 3.0.
  - Gross fixed investment: 2002: 4.5; 2003: -0.4; 2004 (proj.): 2.5.
- Prices and labor costs:
  - CPI (year average): 2002: 2.3; 2003: 2.1; 2004 (proj.): 1.7.
  - GDP deflator: 2002: 1.6; 2003: 2.1; 2004 (proj.): 1.6.
  - Unit labor cost (manufacturing): 2002: 1.0; 2003: 3.2; 2004 (proj.): 1.3.
- Interest rates:
  - Money market rate (data for 2004 refer to April 2004): 2002: 3.5; 2003: 2.4; 2004: 2.1.
  - Government bond yield (data for 2004 refer to April 2004): 2002: 5.1; 2003: 4.3; 2004: 5.0.
- External sector (selected, in billions of DKr., unless noted):
  - Exports: 2002: 436.3; 2003: 428.9; 2004: 442.3.
  - Imports: 2002: -376.2; 2003: -362.1; 2004: -385.3.
  - Merchandise trade balance (f.o.b.): 2002: 60.1; 2003: 66.8; 2004: 57.1.
  - Current account (percent of GDP): 2002: 2.0; 2003: 3.0; 2004 (proj.): 1.8.
- Reserves and exchange-rate indices:
  - Nominal effective exchange rate (1995=100): 2002: 93.3; 2003: 89.3; 2004: 96.7.
  - Real effective exchange rate (1995=100): 2002: 97.0; 2003: 101.3.

### Public finance and debt
- General government (percent of GDP), selected series:
  - General government revenues: 2002: 56.1; 2003: 56.0; 2004: 55.9.
  - General government expenditure: 2002: 54.6; 2003: 54.8; 2004: 54.7.
  - General government balance: 2002: 1.6; 2003: 1.2; 2004: 1.2.
  - General government structural balance: 2002: 1.6; 2003: 2.1; 2004: 2.0.
  - General government debt: 1999: 47.4; 2000: 45.4; 2001: 45.4; 2002: 43.3; 2003: 41.7.
- Public finance composition (selected, percent of GDP, Table 4 highlights):
  - Total Expenditures: 2004: 54.7.
  - Total Revenues: 2004: 56.0.
  - Surplus: 2004: 1.2.
  - Gross Debt: 2004: 41.7.

### Sustainability analysis (fiscal and external)
- Fiscal sustainability (summary of staff analysis):
  - The staff’s baseline scenario predicts a decline in the public debt to GDP ratio from 43.3 in 2003 to 32.7 in 2008.
  - Sensitivity tests suggest medium-term debt sustainability is not at risk if the authorities pursue a course of fiscal consolidation.
  - The alternative scenarios and bound tests suggest little risk of sustainability problems.
  - The worst outcome in the bound tests (test B2) only predicts that the debt ratio at the end of the period will increase by around 5 percentage points from current levels.
  - In all other tests the debt ratio falls over the projection horizon.
- External sustainability: (section headline present; no additional numeric details provided in the supplied excerpt beyond those in external sector bullets above).

### Data quality, statistical framework, and observability
- Denmark has a full range of statistical publications; the quality and timeliness of the economic database are very good and generally adequate for surveillance purposes.
- Denmark subscribes to the Fund’s Special Data Dissemination Standard (SDDS); metadata are posted on the Dissemination Standards Bulletin Board.
- Data issues highlighted:
  - The gap between exports based on trade data (Danmarks Statistik) and exports based on balance of payments statistics (Nationalbank Danmark) has widened; different sources and methodologies are the source of the discrepancy and reconciliation has not been achieved.
  - The authorities introduced new data on monetary financial institutions conforming to ESA95, expanding coverage (e.g., money market funds, small banks, cooperative banks).
  - Data for the central bank and other depository corporations are reported to STA on a timely and regular basis.

*Source: IMF staff report content in _cr04240 - 43 (tables and appendices as provided).*

### 3. External debt sustainability does not appear to be an issue in Denmark. Denmark has

### _cr04240 - 3. External debt sustainability does not appear to be an issue in Denmark. Denmark has

### External debt sustainability — key findings
- Denmark registered current account surpluses through most of the 1990s and its net investment position improved from about negative 30 percent of GDP in early 1990s to negative 15 percent of GDP in 2003.
- Gross external debt increased from 115 to 130 percent of GDP during 1999–2003, accompanied by a substantial increase in gross external assets; net external debt declined from 34 percent of GDP to about 28 percent.
- With a sustained current account surplus projected over the medium-term, Denmark’s net investment position is projected to strengthen further.
- Table A3 provides a summary set of external and financial vulnerability indicators (selected items shown below).

### Net investment position (Table A2) — selected series (percent of GDP)
- Net investment position: -32, -27, -27, -24, -25, -24, -13, -17, -17, -18, -15 (1993–2003 series as shown).
- Net investment position, excluding direct investment: -33, -28, -27, -27, -29, -26, -15, -17, -19, -19, -15 (1993–2003 series as shown).
- Assets (selected): 87, 72, 71, 84, 98, 111, 145, 161, 161, 159, 170 (1993–2003 series as shown).
- Liabilities (selected): 120, 99, 98, 108, 123, 136, 157, 178, 178, 177, 185 (1993–2003 series as shown).

### Indicators of external and financial vulnerability (Table A3) — selected 1999–2003 values
- Exports (annual percentage change, in U.S. dollars): 2.5, 2.2, 1.6, 1.6, 1.9 (1999–2003).
- Imports (annual percentage change, in U.S. dollars): 2.3, 2.2, 1.5, 1.6, 1.9 (1999–2003).
- Terms of trade (annual percentage change): 1.4, 1.1, 0.2, 0.4, 2.1 (1999–2003).
- Current account balance (percent of GDP): 1.8, 1.5, 3.1, 2.0, 2.9 (1999–2003).
- Capital and financial account balance (incl. errors but excl. reserves): -1.6, 3.6, -4.8, -1.0, 1.3 (1999–2003).
- Official Reserves (in billions of U.S. dollars, end-of-period): 22.6, 14.6, 17.6, 27.2, 37.7 (1999–2003).
- Broad money to reserves ratio: 3.0, 4.3, 3.5, 2.8, 2.5 (1999–2003).
- Total gross external debt: 114.8, 114.6, 115.0, 120.7, 131.3 (1999–2003).
  - Of which: General government debt: 28.3, 24.8, 22.5, 21.2, 18.1 (1999–2003).
- Net external debt: 33.6, 35.2, 34.4, 24.3, 28.3 (1999–2003).
- Gross external debt to exports ratio: 284.6, 245.2, 242.3, 254.3, 286.4 (1999–2003).
- External interest payments to exports (in percent): 12.7, 12.2, 12.4, 10.8, 9.4 (1999–2003).

### Public sector debt sustainability framework (Table A1) — baseline and stress-test highlights
- Public sector debt (general government gross debt, selected years): 78.0, 73.5, 69.3, 65.1, 61.2, 56.2, 53.0, 47.4, 45.4, 45.7, 43.3 (1993–2003 series as shown).
  - Foreign-currency denominated share (selected years): 13.4, 12.6, 11.9, 11.1, 9.9, 7.6, 7.5, 6.7, 6.3, 6.2, 6.0 (1993–2003 series as shown).
- Change in public sector debt (selected): 11.9, -4.6, -4.2, -4.2, -3.9, -4.9, -3.3, -5.6, -2.0, 0.3, -2.3 (1993–2003).
- Identified debt-creating flows (4+7+12) (selected): 2.0, -2.8, -1.1, -2.5, -3.6, -3.2, -5.7, -5.5, -4.5, -2.7, -2.3 (1993–2003).
- Primary deficit (percent of GDP, selected series as shown): -4.3 -4.2 -4.1 -5.1 -6.1 -6.5 -8.0 -6.9 -6.9 -5.2 -4.6 -4.4 -4.5 -4.6 -4.6 -4.4 (multi-year series as shown).
- Revenue and grants (percent of GDP, selected): 58.1, 58.5, 57.3, 58.1, 57.6, 57.9, 58.6, 56.5, 57.1, 56.1, 56.0 (1993–2003).
- Primary (noninterest) expenditure (percent of GDP, selected): 53.8, 54.3, 53.2, 52.9, 51.5, 51.4, 50.7, 49.6, 50.2, 50.9, 51.4 (1993–2003).
- Automatic debt dynamics (percent of GDP, selected): 6.4, 1.4, 3.0, 2.6, 2.4, 3.3, 2.3, 1.4, 2.3, 2.5, 2.3 (1993–2003).
- Residual, including asset changes (2-3) (selected): 9.8, -1.8, -3.1, -1.7, -0.3, -1.7, 2.4, -0.1, 2.5, 3.1, 0.0 (1993–2003).
- Public sector debt-to-revenue ratio (selected): 134.2, 125.6, 121.0, 112.1, 106.3, 97.2, 90.3, 84.0, 79.5, 81.4, 77.4 (1993–2003).
- Gross financing need (percent of GDP, selected): 30.5, 31.7, 30.4, 27.4, 23.0, 22.7, 17.1, 16.3, 15.0, 16.8, 17.6 (1993–2003).
- Gross financing need (in billions of Euro, selected): 35.8, 40.0, 40.2, 38.6, 34.4, 35.3, 27.9, 27.9, 26.7, 30.7, 33.0 (1993–2003).

### Key macroeconomic and fiscal assumptions (selected)
- Real GDP growth (in percent, projected average series shown): 0.0, 5.5, 2.8, 2.5, 3.0, 2.5, 2.6, 2.8, 1.6, 1.0, 0.4, 1.8, 2.5, 2.3, 2.1, 1.9, 1.8 (table series as shown).
- Average nominal interest rate on public debt (in percent): 11.0, 9.1, 9.1, 9.3, 9.3, 9.0, 8.8, 8.6, 8.8, 8.3, 7.7, 7.6, 7.6, 7.6, 7.6, 7.6, 7.6 (series as shown).
- Average real interest rate (percent): 9.6, 7.4, 7.4, 6.8, 7.1, 8.0, 7.0, 5.6, 6.7, 6.7, 5.6, 6.0, 6.0, 5.9, 5.5, 5.4, 5.7 (series as shown).
- Inflation rate (GDP deflator, in percent): 1.4, 1.7, 1.8, 2.5, 2.2, 1.0, 1.8, 3.0, 2.1, 1.6, 2.1, 1.6, 1.6, 1.7, 2.1, 2.2, 1.9 (series as shown).
- Growth of real primary spending (deflated by GDP deflator, in percent, series shown): 3.9, 6.4, 0.6, 2.1, 0.1, 2.4, 1.1, 0.7, 2.8, 2.4, 1.4, 2.1, 2.1, 2.1, 1.8, 1.7, 1.9.
- Debt-stabilizing primary balance: (debt-stabilizing prim. bal. entries appear in scenario table; see scenario bullets below).

### Stress tests (selected scenario outcomes, public sector debt ratio in percent of GDP)
- Baseline: 43.3, 40.6, 37.7, 34.7, 31.6, 28.3 (projected path under baseline assumptions).
- A1 (Key variables at historical averages in 2004-08): 43.3, 40.6, 37.7, 34.7, 31.6, 28.3, debt-stabilizing prim. bal. 1.3.
- B1 (Real interest rate = historical average + 2 SD in 2004 and 2005): 43.3, 43.1, 42.4, 40.2, 37.9, 35.8, debt-stabilizing prim. bal. 1.2.
- B2 (Real GDP growth = historical average - 2 SD in 2004 and 2005): 43.3, 43.9, 46.0, 46.7, 47.4, 48.3, debt-stabilizing prim. bal. 1.6.
- B3 (Primary balance = historical average - 2 SD in 2004 and 2005): 43.3, 43.0, 42.4, 40.2, 37.9, 35.7, debt-stabilizing prim. bal. 1.2.
- B4 (Combination of 2–4 using one standard deviation shocks): 43.3, 43.0, 42.7, 40.5, 38.3, 36.2, debt-stabilizing prim. bal. 1.2.
- B5 (One-time 30 percent real depreciation in 2004): 43.3, 44.6, 42.6, 40.4, 38.2, 36.0, debt-stabilizing prim. bal. 1.2.
- B6 (10 percent of GDP increase in other debt-creating flows in 2004): 43.3, 51.7, 50.0, 48.0, 46.0, 44.1, debt-stabilizing prim. bal. 1.5.

### IMF staff update (Statement by the IMF Staff Representative, August 2, 2004) — salient points
- Denmark’s GDP growth in Q1 2004 was somewhat faster than expected; 12-month growth registered 1.4 percent. Staff considers GDP growth for 2004 likely to be just above 2 percent, up from the 1.8 percent in the staff report.
- Recent fiscal data show a strong underlying position. The general government fiscal outcome for 2003 was a surplus of 1.2 percent of GDP. Q1 2004 data showed an improvement in the surplus driven by slowing expenditure growth and a pick-up in revenue collections.
- The Welfare Commission’s first report concludes that under current policies Danes will draw more in benefits over their lifetimes than they contribute; the commission will offer specific policy options before year end and a final report is expected in late 2005.
- Political agreement reached on reorganizing local governments: division of tasks across three levels, enlargement of average municipality size, and replacement of 14 counties with 5 regions; reform planned to take effect in January 2007.

### Statement by Danish authorities (Benny Andersen, Alternate Executive Director for Denmark, August 2, 2004) — outlook and policy stance
- Economic prospects:
  - Danish Finance Ministry sees above-trend GDP growth of 2.2 percent in 2004 and 2.5 percent in 2005.
  - Unemployment expected to decline from current 6½ percent to around 5¼ percent in 2005.
  - Authorities view recent stimulus package as well-designed and counter-cyclical; tax reductions aimed at strengthening labor supply with frontloading in 2004.
  - Capacity constraints not likely before late 2005 or in 2006 given slack in the economy.
- Medium-term policy framework:
  - Authorities support medium-term fiscal framework and exchange rate anchor.
  - Fiscal objective: current and planned policies toward 2010 should fulfill long-term fiscal sustainability, requiring fiscal surpluses of 1½-2½ percent of GDP on average toward 2010 and additional structural initiatives to increase employment.
  - With tax reductions and the tax freeze assumed to remain to 2010, key policy requirements: contain real public consumption growth to ½ percent per year in 2005–2010 and implement reform initiatives to raise structural employment by some 2 percent.
- Fiscal policy issues and measures:
  - Staff recommended expressing expenditure targets in nominal terms and considering user fees, including in health care. Authorities note pros and cons of nominal versus real targets and stress importance of nominal monitoring for ex post evaluation.
  - Spending discipline has improved: for the average of 2002 and 2003, nominal public consumption grew by 4 percent a year; preliminary figures show real spending grew by 1½ percent per year on average but decelerated from 2002 to 2003.
  - Agreed targets for 2004 imply real consumption growth of less than ½ percent in 2004 (original target was 0.7 percent).
  - User payments are substantial in parts of the health sector (prescription and non-prescription medicine, private hospitals, dental care, eye care).
  - Government favors outsourcing and extension of citizens’ “free choice” between private and public providers (child care, elderly care); reform of division of tasks between local, regional and central governments to create larger units and better market opportunities for private providers.

*Source: IMF staff report materials and appendices as provided in the supplied content.*

### 12.      The medium-term policy framework requires structural reforms, in addition to those

### _cr04240 - 12.      The medium-term policy framework requires structural reforms, in addition to those

### Medium-term policy framework and goals
- Medium-term strategy calls for fiscal surpluses between 1½ and 2½ percent of GDP.
- Annual growth in public consumption constrained to 0.5 percent.
- Target of a 2 percent increase in structural employment by 2010.
- Denmark already fulfills the Lisbon employment objectives.

### Structural employment and labor-supply reforms
- Staff estimate: structural reforms can raise structural employment by almost 2 percent by 2010.
- Labor supply efforts focus on groups with relatively low participation rates: the young, older workers, and immigrants.
- Further steps planned to increase participation among these groups.
- Reduction in incentives for early retirement identified as important but politically sensitive.
- Government established the Welfare Commission to promote public debate and propose concrete initiatives to increase labor supply.
- Recent policy measures:
  - Recent reduction of income taxes introduced to stimulate labor supply.
  - Focus on lower marginal tax rates in the middle-income range.
  - Introduction of an earned income tax credit to support distributional concerns and encourage participation by low/moderate earners.
- Staff suggestion: consider further changes in tax and labor compensation structures to increase incentives to supply labor or invest in human capital.
  - Efforts to reduce the top marginal tax rate should be pursued.
  - Removing the nominal tax freeze on some components of property taxes could provide space to reduce marginal tax rates.
- Wage and benefit design:
  - No legislated minimum wage in Denmark.
  - Government plays no direct role in wage setting under normal conditions, except as public employer.
  - Relatively high social benefits can set a floor to reservation wages, but unemployment benefits are conditional on strict availability-for-work requirements.
  - After 6 or 12 months of unemployment, mandatory participation in active labor market programs is required.
- Education and training:
  - Government conscious of need to further strengthen education and training, particularly in engineering and science majors.
  - Funds set aside to strengthen science teaching already in primary schools.

### Tax freeze and fiscal credibility
- Danish authorities emphasize the tax freeze is simple, widely understood, and credible.
- The freeze functions as a strong commitment device to arrest and reverse a longstanding upward trend in the tax burden.
- Authorities stand ready to implement additional measures if expenditure slippages emerge.
- Directors encouraged consideration of wider application of user fees and, for some, specifying spending targets in nominal terms.

### Product markets and competitiveness
- Increasing competition in goods markets is seen as a necessary complement to efforts to increase labor supply.
- Product market reforms are essential and will be continued within the framework of the government’s growth strategy.
- Directors emphasized wage moderation and improving labor market flexibility to avoid labor costs outstripping productivity growth and to limit real exchange rate appreciation pressures.

### Financial sector assessment and household balance sheets
- Danish banks: sound earnings and substantial profits; resilience strengthened significantly compared to 2002.
- Pressure on pension companies has subsided due to asset-price developments.
- Risks related to liabilities linked to interest guarantees largely hedged through financial instruments.
- Households' debt as a ratio to disposable income is still increasing, but payment ability improved due to low interest rates.
- Households in Denmark have higher debt relative to disposable income than other Nordic countries, but housing wealth as a ratio of income is higher in Denmark.
- Mortgage loan features:
  - Almost 60 percent of mortgage loans are fixed-rate.
  - Share of adjustable rate mortgages has increased significantly.
  - Introduction of loans free of repayment for up to 10 years (which may be rolled over) provides households with increased financial flexibility for temporary income shocks.
- Authorities look forward to the FSAP planned in the context of the next Article IV consultation cycle.
- Directors commended sound supervisory framework and efforts to strengthen it, particularly for insurance companies and pension funds.
- Directors welcomed planned participation in the Financial Sector Assessment Program and efforts to strengthen Anti-Money Laundering and Combating the Financing of Terrorism frameworks.

### Other policy positions and development assistance
- In the context of EU membership, Denmark supports further trade liberalization in the Doha round and market-oriented reform of the EU’s common agricultural policy.
- Since 1978, Denmark has consistently provided development assistance of more than 0.7 percent of gross national income.

### Executive Board assessment — key judgments and risks
- Directors commended sustained structural reform and strong fiscal policy grounded in a medium-term framework that led to fiscal surpluses and significant reduction in public debt.
- IMF staff forecast: growth close to 2 percent in 2004, increasing to 2½ percent in 2005.
- Directors saw good prospects for economic recovery in 2004 and for it to gather strength in 2005, conditional on external recovery and supportive policies.
- Main risks to outlook:
  - Recovery in key trading partners may be slower than expected.
  - Growth in private consumption may flag if employment pickup is delayed.
  - Potential impact on demand from future interest rate increases.
  - Risks from a sharp correction in housing prices appear well contained.
- Directors endorsed recent fiscal stimulus as well designed for the upturn but cautioned further stimulus should be exceptional to preserve credibility of medium-term targets.
- Directors welcomed reductions in labor income tax rates but encouraged consideration of further changes to increase incentives to work, greater wage dispersion, and better integration of immigrant labor.
- Directors emphasized complementary role of product market reforms and benefits of wider EU reforms.

### Key numerical indicators (selected)
- Target: 2 percent increase in structural employment by 2010.
- Fiscal surplus objective: between 1½ and 2½ percent of GDP.
- Annual growth in public consumption constrained to 0.5 percent.
- IMF staff growth forecasts: close to 2 percent in 2004; 2½ percent in 2005.
- Unemployment rate (percent): 6.4 (1998), 5.5 (1999), 5.1 (2000), 4.9 (2001), 4.9 (2002), 5.8 (2003), 6.0 (2004 proj.).
- Real GDP growth (change in percent): 2.5 (1998), 2.6 (1999), 2.8 (2000), 1.6 (2001), 1.0 (2002), 0.4 (2003), 1.8 (2004 proj.).
- General government balance (percent of GDP): 1.1 (1998), 3.2 (1999), 2.5 (2000), 2.8 (2001), 1.6 (2002), 1.2 (2003), 1.2 (2004 proj.).
- General government debt (percent of GDP): 56.2 (1998), 53.0 (1999), 47.4 (2000), 45.4 (2001), 45.7 (2002), 43.3 (2003), 41.7 (2004 proj.).
- Gross national saving (percent of GDP): 20.8 (1998), 21.9 (1999), 24.0 (2000), 24.4 (2001), 22.8 (2002), 22.5 (2003), 22.0 (2004 proj.).
- Current account (percent of GDP): -0.9 (1998), 1.8 (1999), 1.5 (2000), 3.1 (2001), 2.0 (2002), 3.0 (2003), 1.8 (2004 proj.).
- Present exchange rate (May 19, 2004): Danish Kroner 6.206 per US$1.
- Money market rate (percent): 4.2 (1998), 3.3 (1999), 4.9 (2000), 4.6 (2001), 3.5 (2002), 2.4 (2003), 2.1 (2004 proj.).
- Government bond yield (percent): 4.9 (1998), 4.9 (1999), 5.7 (2000), 5.1 (2001), 5.1 (2002), 4.3 (2003), 5.0 (2004 proj.).
- Exports (In billions of DKr.): 322.0 (1998), 347.5 (1999), 405.3 (2000), 419.8 (2001), 436.3 (2002), 428.9 (2003), 442.3 (2004 proj.).
- Imports (In billions of DKr.): -296.7 (1998), -300.8 (1999), -351.1 (2000), -358.1 (2001), -376.2 (2002), -362.1 (2003), -385.3 (2004 proj.).
- Merchandise trade balance (f.o.b., In billions of DKr.): 25.3 (1998), 46.7 (1999), 54.1 (2000), 61.7 (2001), 60.1 (2002), 66.8 (2003), 57.1 (2004 proj.).

*Source: IMF staff report and Executive Board assessment, 2004 Article IV Consultation with Denmark.*

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