## _cr04244

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### Executive Summary — Background and Outlook
- Supported by a strong fiscal stimulus, the economy underwent only a mild downturn in 2002-03, with growth remaining well above the EU average.
- Economic activity expected to pick up steadily as the global recovery gains strength.
- Inflation pressures remain low due to strong productivity gains, economic slack, and falling import prices.
- Labor market weakness contributed to wage moderation.
- Riksbank policy rate: cut to 2 percent (historic low) after cuts of 25 basis points in February 2004 and 50 basis points in early April 2004.
- Fiscal position: weakened as new spending initiatives jeopardize expenditure ceilings and delay return to structural surplus target of 2 percent.
- Financial markets: took in stride the rejection of the euro in the September 2003 referendum.
- Key quantitative indicators and projections (selected):
  - Current account surplus: rose from 5.4 percent of GDP in 2002 to 6.4 percent of GDP in 2003.
  - Stock market: rose by 30 percent in 2003; by around 6 percent in the first five months of 2004.
  - Unemployment: reached a high of 6 percent in February 2004 from 4.5 percent a year earlier.
  - CPI (annual change, percent): 2.6 (2001), 2.4 (2002), 2.1 (2003), 0.4 (2004 proj.), 1.2 (2005 proj.)
  - Real GDP (percentage changes): 0.9 (2001), 2.1 (2002), 1.6 (2003), 2.5 (2004 proj.), 2.6 (2005 proj.)
  - Exports (percentage changes): 0.2 (2001), 1.2 (2002), 5.5 (2003), 8.5 (2004 proj.), 6.1 (2005 proj.)
  - Imports (percentage changes): -2.5 (2001), -1.9 (2002), 5.0 (2003), 7.5 (2004 proj.), 7.7 (2005 proj.)

### Policy Setting and Short-Term Outlook
- Fiscal framework components:
  - Structural surplus target of 2 percent of GDP at the general government level.
  - Expenditure ceilings for the central government.
  - Balanced budget rule for local authorities.
- Timing and prospects:
  - Surplus target last met in 2001.
  - Official expectation a year earlier: target would be reached in 2005; new Spring 2004 Budget initiatives preclude meeting target at least until 2007.
  - Official estimates: cumulative deviations from the surplus target would rise to 4 percent of GDP by 2006 under present policies.
- 2004 budget: broadly neutral; overall balance of general government planned to show a modest surplus.
- Outlook 2004–05:
  - Adjusted for calendar effects, output expected to rise by around 2 percent in 2004 (rather than unadjusted forecast of 2½ percent).
  - Recovery unlikely to yield substantial employment gains over the coming year.
  - Risks: evenly balanced — external demand stimulus could be larger (especially if the krona remains undervalued); protracted labor market weakness or persistent excess manufacturing capacity could hold back recovery.

### Monetary Policy, Krona Valuation, and Inflation Pass-Through
- Mission view: monetary policy would need to be tightened if upside risks began to materialize as the recovery proceeded.
- Riksbank stance: keeping rates on hold at 2 percent was appropriate for now; eventual tightening would have to occur earlier rather than later if fiscal policy was not adequately tight.
- Exchange rate assessments:
  - Riksbank officials concurred krona remained undervalued; staff estimate of undervaluation around 10 percent (macroeconomic balance approach and PPP panel estimation adjusted for terms of trade, relative productivity and income flows on net foreign assets).
  - Markets expected further appreciation given growth, productivity gains, and large current account surpluses.
- Inflation pass-through: significant appreciation would tend to dampen inflation; pass-through could be protracted.

### Inflation Targeting, Communication, and CPI Measurement
- Clarify target variable: underscore role of the CPI as the only target variable.
- Forecast focus: CPI over a one- to two-year horizon; highlight measures of underlying inflation to avoid countering transitory shocks.
- Suggested refinements: make explicit the role of judgment in inflation assessments and consider extending the forecast horizon beyond two years.
- CPI methodological change: Statistics Sweden’s method change from January 2005 expected to lead to recorded inflation rate being 0.2 percentage point per year lower; this measurement change would have a one-off effect of appearing to raise the inflation target.

### Financial System Health and Household/Corporate Balance Sheets
- Bank sector:
  - Bank profitability has risen; cost reductions contributed.
  - Tier 1 capital of the major banks at just over 7 percent; regarded as satisfactory.
- Household sector:
  - Household debt to disposable income: up from 90 percent in the mid-1990s to about 120 percent.
  - Interest payments: 5 percent of disposable income, compared with 11 percent in the early 1990s.
  - Household assets exceed liabilities.
  - Riksbank simulations: even a relatively steep rise in interest rates would not significantly impair households’ ability to service debt.
  - Rise in house prices largely explained by structural supply shortages.
  - Conclusion: household sector does not constitute a significant risk to the banks as a whole.
- Corporate sector:
  - Corporate borrowing from banks has been declining; ability to service debt has improved.
- Supervisory stance: risks appear well contained; supervisory authorities alert to emerging imbalances.

### Fiscal Policy Framework and Medium-Term Outlook
- Key pillars: structural fiscal surplus target and expenditure ceilings.
- Structural surplus timing: structural surplus of general government not likely to reach 2 percent target before 2007 at the earliest under present projections.
- Expenditure ceilings:
  - Margins under central government expenditure ceilings have been exhausted; used largely for discretionary spending.
  - Authorities have resorted to ad hoc measures (shifting expenditures between years, increasing tax expenditures) to keep within ceilings.
  - Main risks to expenditure projections: smaller decline in sickness absence than projected fall of 18 percent and a delayed pick-up in employment.
  - Ceilings for 2007 likely to include margins for cyclical spending, as recommended by staff.
- Tax policy:
  - Prospects for significant reduction in tax burden have dimmed; phased income tax reduction step on hold since 2002.
  - Authorities accept, in principle, reducing high marginal tax on labor desirable to raise labor supply but prioritize improving incentives within existing tax-benefit system.
  - High marginal effective tax rates on domestic savings could be eased by increasing threshold of wealth tax and reducing exemptions.
  - Mission’s view: raising corporate taxation to offset revenue losses from lowering/abolishing wealth tax would adversely affect investment.

### Local Government Finances and Intergovernmental Coordination
- Local authorities’ finances strained due to demographic changes and central government policy priorities.
- Balanced budget rule constrains responses; many municipalities and county councils have cut costs and at times raised local income taxes.
- Policy options: improve coordination (require medium-term plans from local authorities; reduce uncertainty regarding central grants); use of balancing grants recommended.
- Long-term sustainability:
  - Current spending on health and long-term care: around 9 percent of GDP, projected to rise to over 12 percent of GDP in 2050.
  - Planned build-up of assets to be drawn down later rests on meeting general government surplus target; continued slippages could put long-term sustainability at risk.

### Structural Policies, Labor Supply, and Immigration
- Structural reform record strong in EU comparisons (public finances, employment, labor force participation among older workers, R&D investment, Kyoto progress).
- Remaining scope: reduce sickness absence, promote competition in product markets, improve labor market functioning.
- Long-term labor supply challenge:
  - Working-age population projected to grow very slowly over five decades; entire rise of 5 percent (0.1 percent per year) due to immigration.
  - Effective labor supply expected to fall due to aging native-born population, low participation among immigrants, and falling average working hours.
  - Authorities stress enhancing economic integration of immigrants; Sweden did not impose special transition rules for labor market access for citizens from the ten new member states.
  - Mission view: easing high wage compression would facilitate absorption of low-skilled immigrants; review incentive structure in education to encourage earlier workforce entry.

### Sickness Absence — Incidence, Costs, and Policy Implications
- Incidence and trends:
  - Rate of sickness absence: 5.2 percent (average over 1995–2003).
  - Female absence rate over same period: 7 percent.
  - Including people on disability pension, almost 15 percent of working age population was away from work in 2003.
- Fiscal and economic costs:
  - Sickness-related public transfers, including disability pensions: 4.6 percent of GDP in 2003.
  - In 1990–99, sickness benefits averaged 1.4 percent of GDP.
  - Employers pay sick benefit at 80 percent of wages for first 20 days of illness.
- Policy measures and debate:
  - Government goal: halve sickness absence between 2002 and 2008.
  - Recent initiatives increase responsibilities of parties and emphasize fast rehabilitation.
  - Employer’s obligation period to be cut to first two weeks and compensation rate slightly raised — overall incentive impact ambiguous.
  - Mission argument: reducing the replacement rate would need to be a key element to achieve the authorities’ halving goal.
  - Authorities intend to tighten administration of sickness insurance; indicated the marginal cut introduced last year will be reversed from 2005.

### Labor Supply and the Tax-Benefit System
- Tax-benefit system has important disincentive effects on labor supply; recent income tax cuts mitigated effects but interactions across programs matter.
- Decisive reform necessary to improve incentives, raise potential growth, and ease fiscal pressures.
- Recommended measures:
  - Cutbacks in entitlements coupled with reduction in high tax burden on labor to encourage effective labor supply.
  - Sizeable steps to reach targets (80-percent employment rate; halving social assistance and sickness leave).
  - Re-assess education incentives to reverse declining youth participation.
  - Improve integration of immigrants into labor force; foreign-born population expected to be main source of labor supply.

### Competition, Product Markets, and Housing
- Need to strengthen competition; barriers significant in construction, pharmaceuticals, and retail trade.
- Swedish price level remains significantly above EU average.
- Housing market issues:
  - Administrative rent controls and large public ownership inhibit efficient rental market development.
  - Dysfunctional housing market has depressed housing investment and hampered labor mobility.
  - Officials see little prospect of significant deregulation of rental housing given social objectives.
  - Recommendation: move towards a more market-oriented rental approach that preserves social policy objectives.

### External Sector, Balance of Payments, and Debt Sustainability
- Current account (selected): rose from 5.4 percent of GDP in 2002 to 6.4 percent of GDP in 2003; staff projection for 2004: 6.4 percent of GDP (Table figures show current account as percent of GDP series including 6.4 for 2003 and 6.4 for 2004 1/).
- Exports and imports (Table 3, billions): exports series rising to 211.0; imports series negative entries to -171.7 (selected annual values reported).
- External vulnerability indicators:
  - Effective exchange rate annual change examples: -2.1, -1.4, 0.3, -8.4, 1.6, 4.8, 3.8.
  - Real effective rate (based on ULC) examples: -1.6, -3.0, -0.6, -9.2, 2.4, 5.8, 4.8.
- Debt sustainability and stress tests:
  - Public sector debt-to-GDP projections (baseline): 62.6 (1999), 52.9 (2000), 54.4 (2001), 52.6 (2002), 51.9 (2003), 52.1 (2004), 51.5 (2005), 50.6 (2006), 49.5 (2007), 48.4 (2008), 47.5 (2009).
  - Stress-test scenarios (A1–A3; B1–B6) assess sensitivity to shocks (e.g., GDP growth shocks, exchange rate depreciation, interest rate increases).

### Fund Relations, Institutional Details, and Appendix Notes
- IMF status: Joined 08/31/51; Article VIII.
- Quota and Fund holdings (Appendix I): Quota 2,395.50 SDR Million (100.00 percent of quota); Fund holdings of currency 1,483.76 (61.94 percent); Reserve position in Fund 911.75 (38.06 percent).
- Charges/Interest projected obligations to Fund: 1.14 (2004), 2.30 (2005), 2.30 (2006), 2.30 (2007), 2.31 (2008).
- IMF staff update (Statement by IMF Staff Representative, August 4, 2004):
  - Economic activity picking up; unemployment rose from 5.3 percent in May 2004 to 5.8 percent in June 2004.
  - CPI rose by 0.5 percent in the year to June 2004; underlying inflation 1 percent.
  - Riksbank policy rate unchanged at 2 percent on June 23, 2004.
  - Krona reached three-month low of Skr 9.2 per euro at end-July 2004; trade-weighted index: krona depreciated by 1 percent during June–July 2004.
- Executive Board assessment (PIN No. 04/86, August 9, 2004) — key conclusions:
  - Keep interest rates on hold near term with tightening as recovery gathers speed, especially if fiscal stance not restrictive.
  - Safeguard structural surplus target of 2 percent of GDP; most Directors encouraged more ambitious fiscal adjustment in 2005–06.
  - Improve fiscal coordination between central and local governments; consider balancing grants.
  - Revitalize structural reform agenda: tax-benefit reform, reduce sickness absence, integrate immigrants, strengthen product market competition.
  - Financial system sound; continue careful monitoring of property value and interest rate risks.
  - Praise for official development assistance at 0.7 percent of GNP.

*Source: Executive Summary and selected sections of IMF staff report (_cr04244) as provided in the source document.*

### Executive Summary  .....................................................................................................

### Executive Summary

### Background and Outlook
- Supported by a strong fiscal stimulus, the economy underwent only a mild downturn in 2002-03, with growth remaining well above the EU average.
- Economic activity is expected to pick up steadily as the global recovery gains strength.
- Inflation pressures remain low thanks to strong productivity gains, economic slack, and falling import prices.
- Persistent weakness in the labor market contributed to wage moderation.
- With inflation forecast to remain below the 2 percent target, the Riksbank eased policy aggressively in early 2004, cutting its policy rate to a historic low of 2 percent.
- Although still comfortable in the EU context, the fiscal position has weakened as new spending initiatives jeopardize the expenditure ceilings and further delay the return to the structural surplus target of 2 percent.
- Financial markets took in stride the rejection of the euro in the September 2003 referendum.

Key quantitative indicators and projections (selected from text)
- Policy rate: cut to 2 percent (historic low).
- Current account surplus: rose from 5.4 percent of GDP in 2002 to 6.4 percent of GDP in 2003.
- Stock market: rose by 30 percent in 2003; by around 6 percent in the first five months of 2004.
- Unemployment: reached a high of 6 percent in February 2004 from 4.5 percent a year earlier.
- Inflation and labor statistics (annual change in percent, selected series):
  - CPI: 2.6 (2001), 2.4 (2002), 2.1 (2003), 0.4 (2004 proj.), 1.2 (2005 proj.)
  - Underlying inflation: 2.8 (2001), 2.6 (2002), 2.3 (2003), 0.9 (2004 proj.), 1.1 (2005 proj.)
  - Nominal wage (corporate sector): 4.1 (2001), 3.9 (2002), 3.3 (2003), 3.3 (2004 proj.), 3.5 (2005 proj.)
  - Labor productivity (corporate sector): 0.4 (2001), 4.1 (2002), 3.7 (2003), 3.2 (2004 proj.), 2.5 (2005 proj.)
  - Unit labor costs (corporate sector): 4.7 (2001), -0.4 (2002), 1.2 (2003), -0.4 (2004 proj.), 1.2 (2005 proj.)
  - Employment: 1.9 (2001), 0.1 (2002), -0.2 (2003), -0.5 (2004 proj.), 0.7 (2005 proj.)
  - Hours worked: 0.5 (2001), -1.2 (2002), -1.3 (2003), 0.1 (2004 proj.), 0.7 (2005 proj.)
  - Open unemployment rate: 4.0 (2001), 4.0 (2002), 4.9 (2003), 5.5 (2004 proj.), 5.2 (2005 proj.)
  - Output gap (percent of potential output): -0.1 (2001), -0.1 (2002), -0.9 (2003), -1.2 (2004 proj.), -1.0 (2005 proj.)
- GDP and demand (percentage changes):
  - Real GDP: 0.9 (2001), 2.1 (2002), 1.6 (2003), 2.5 (2004 proj.), 2.6 (2005 proj.)
  - Domestic demand: -0.2 (2001), 0.9 (2002), 1.0 (2003), 1.6 (2004 proj.), 3.0 (2005 proj.)
  - Consumption: 0.6 (2001), 2.0 (2002), 1.5 (2003), 1.8 (2004 proj.), 2.0 (2005 proj.)
    - Private consumption: 0.4 (2001), 1.4 (2002), 1.9 (2003), 2.2 (2004 proj.), 2.8 (2005 proj.)
    - Government consumption: 0.9 (2001), 3.2 (2002), 0.6 (2003), 1.1 (2004 proj.), 0.7 (2005 proj.)
  - Gross fixed capital formation: -1.0 (2001), -3.0 (2002), -2.0 (2003), 1.5 (2004 proj.), 8.1 (2005 proj.)
  - Exports: 0.2 (2001), 1.2 (2002), 5.5 (2003), 8.5 (2004 proj.), 6.1 (2005 proj.)
  - Imports: -2.5 (2001), -1.9 (2002), 5.0 (2003), 7.5 (2004 proj.), 7.7 (2005 proj.)

### The Policy Setting and Short-Term Outlook
- The fiscal framework is well-designed but adherence has slipped in recent years, primarily due to rising discretionary spending.
- The fiscal framework components:
  - Structural surplus target of 2 percent of GDP at the general government level.
  - Expenditure ceilings for the central government.
  - Balanced budget rule for local authorities.
- The surplus target was last met in 2001.
- Official expectation a year earlier: target would be reached in 2005; new spending initiatives in the Spring 2004 Budget now preclude meeting the target at least until 2007.
- Official estimates suggest cumulative deviations from the surplus target would rise to 4 percent of GDP by 2006 under present policies.
- The 2004 budget is broadly neutral; overall balance of general government planned to show a modest surplus.
- New spending initiatives: labor market programs, social assistance, increased grants to local authorities—resulting in only a marginal rise in the structural balance and narrow margins under expenditure ceilings.
- Monetary policy: Riksbank eased policy in early 2004 due to falling inflation; cuts of 25 basis points in February 2004 and 50 basis points in early April 2004 to 2 percent; rate left unchanged in May signaling neutral bias.
- Outlook 2004–05:
  - Adjusted for calendar effects, output expected to rise by around 2 percent (rather than unadjusted forecast of 2½ percent), implying lower utilization of resources.
  - Recovery is unlikely to yield substantial employment gains over the coming year.
  - Supportive monetary and fiscal policy and rising household confidence should stimulate private consumption; improved demand and profits should assist business investment revival.
  - Barring a sustained spike in oil prices, strong productivity gains and moderate wage increases expected to keep inflation below 2 percent.
  - Risks: evenly balanced—external demand stimulus could be larger (especially if the krona remains undervalued); protracted labor market weakness or persistent excess manufacturing capacity could hold back recovery.

### Policy Discussions — Major Themes
- Discussions focused on:
  - The stance of short-term policies for growth, employment and inflation in 2004–05.
  - Prospects for attaining the medium-term fiscal surplus target and growing risks to the fiscal rules framework.
  - Necessity of addressing rising tensions in public finances: pressures on expenditures, local authority finances, and tax-transfer system distortions.
  - Need to strengthen structural agenda in tax, labor, and product markets in light of demography, EU enlargement, and globalization.

Key policy conclusions and recommendations (from mission/staff view)
- Monetary policy:
  - Keeping rates on hold was appropriate for now; monetary policy would need tightening if upside risks materialize.
- Fiscal policy and fiscal framework:
  - Important to maintain a firm commitment to expenditure ceilings as fiscal framework is under strain.
  - Staff recommended a more ambitious fiscal adjustment in 2005-06 to meet the structural surplus target.
  - Safeguarding the surplus target is central to maintaining confidence in the fiscal framework.
- Public finances and tax-transfer system:
  - Tensions evident in pressures on expenditures, local government finances, and distortions from the tax-transfer system.
  - Reform of the tax-benefit system to encourage effective labor supply was highly desirable to raise potential growth and reduce fiscal tensions amid demographic transition.
  - Greater policy coordination between central and local government would help smooth local revenue fluctuations and alleviate local tax increases.
- Structural policies:
  - Faster progress desirable in tax, labor, and product market reform.
  - Encouraging effective labor supply identified as the most important long-term challenge.
  - Authorities saw scope for progress in reducing sickness absence, promoting greater competition in product markets, and improving labor market functioning.
- Financial system risks:
  - Despite some concern about rising household debt, the financial system remained sound.

### Monetary Policy and the Financial Sector
- Riksbank inflation forecast (June 2004 Inflation Report, central scenario published soon after discussions):
  - Projects 12-month inflation at just over 1 percent by mid-2005, steadily rising to around 2¼ percent by mid-2006.
- Riksbank assessment of risks:
  - Domestic-side risks viewed as broadly balanced; expected strong productivity growth would help restrain costs as resource utilization rises.
  - Upside risks dominated by possibility that global and Swedish upturns could be stronger than expected and that geopolitical factors could lead to sustained high oil prices.
  - High oil prices could create risk of second-round wage effects.
  - Local authority wage outcomes for 2005 could be higher than expected.
  - Upside risks would begin to predominate beyond the one-year horizon.

*Source: Executive Summary of staff report (text provided).*

### 13.      Looking ahead, there was agreement that monetary policy would need to be

### _cr04244 - 13.      Looking ahead, there was agreement that monetary policy would need to be

### Monetary policy, krona valuation, and inflation pass-through
- Mission view: monetary policy would need to be tightened if upside risks began to materialize as the recovery proceeded.
- Riksbank stance: decision to keep the policy rate on hold for now was viewed as appropriate by the mission.
- Timing caveat: eventual tightening would have to occur earlier rather than later if the stance of fiscal policy was not adequately tight.
- Exchange rate assessments:
  - Riksbank officials concurred that the krona remained undervalued, though their estimate of the extent of undervaluation was lower than the staff’s.
  - Staff’s latest estimate (macroeconomic balance approach and PPP panel estimation adjusted for terms of trade, relative productivity and income flows on net foreign assets) suggests an undervaluation of around 10 percent.
- Market expectations: markets expected the krona to appreciate further given prospects for solid growth, productivity gains, and sustained large current account surpluses.
- Inflation pass-through: any significant appreciation would tend to dampen inflation, although recent evidence for Europe and research by the Riksbank suggested that the pass-through could be protracted.

### Inflation targeting, communication, and CPI measurement
- Clarify target variable: Riksbank officials agreed communication could be improved by underscoring the role of the CPI as the only target variable.
- Forecast focus: with expectations anchored to the CPI, the Riksbank has focused its forecast on the CPI over a one- to two-year horizon while highlighting various measures of underlying inflation to avoid countering transitory shocks.
- Avoiding confusion: occasional confusion about the precise target variable could be avoided by making explicit the role of judgment in inflation assessments and by extending the forecast horizon beyond two years; Riksbank officials have considered the latter option.
- CPI methodological change: planned change in Statistics Sweden’s method of calculation of the CPI from January 2005 is expected to lead to the recorded inflation rate being 0.2 percentage point per year lower as compared to the one based on the current method.
  - Impact on target: this measurement change would have a one-off effect of appearing to raise the inflation target and this is being explained by the Riksbank in its communication to the public.

### Financial system health and household/corporate balance sheets
- General assessment: indicators of financial system health remain favorable.
- Bank sector:
  - Bank profitability has risen, partly reflecting cost reductions.
  - Banks have strengthened their balance sheets further in the context of greater competition.
  - Tier 1 capital of the major banks has continued to increase and, at just over 7 percent, is regarded as satisfactory by the authorities.
- Household sector:
  - Household debt ratio: debt to disposable income up from 90 percent in the mid-1990s to about 120 percent.
  - Interest payments: only 5 percent of disposable income, compared with 11 percent in the early 1990s.
  - Household assets exceed their liabilities.
  - Riksbank simulations suggest even a relatively steep rise in interest rates would not significantly impair households’ ability to service debt.
  - Rise in house prices largely explained by structural supply shortages.
  - Conclusion: household sector as a whole does not constitute a significant risk to the banks.
- Corporate sector:
  - Corporate borrowing from banks has been declining for some time, reflecting falling private investment.
  - Corporate ability to service debt has improved.
- Supervisory stance: risks in the financial system appear well contained and the supervisory authorities are alert to signs of any emerging imbalances.

### Fiscal policy framework and medium-term outlook
- Key pillars: structural fiscal surplus target and the expenditure ceilings continue to be the key pillars of the authorities’ fiscal strategy.
- Structural surplus timing: on present projections, the structural surplus of the general government was not likely to reach the target of 2 percent before 2007 at the earliest.
  - Officials did not see this as damaging to policy credibility and emphasized Sweden’s fiscal target was considerably more ambitious than set by the EU countries within the Stability and Growth Pact (SGP).
- Mission view: Sweden’s own fiscal framework should remain the touchstone for assessing fiscal conduct given its role in providing a cushion for demographic impacts and room for maneuver in downturns.
- Expenditure ceilings:
  - Margins under the central government expenditure ceilings have been exhausted as they have been used largely for discretionary spending.
  - In the past two years, authorities have resorted to ad hoc measures—such as shifting expenditures between years and increasing use of tax expenditures—to keep within the ceilings.
  - Officials conceded ceilings were under continuous strain amid relatively slow growth, rising demand for healthcare, childcare and education, and emphasis on social programs.
  - Budgetary outlook for 2004 indicative of these pressures.
  - Main risks to expenditure projections in the Spring budget stemmed from the possibility of a smaller decline in sickness absence than the projected fall of 18 percent and a delayed pick-up in employment.
  - Officials underscored firm commitment to expenditure ceilings but acknowledged further resort to one-off measures could not be ruled out.
  - Ceilings for 2007, to be set in the next budget, are likely to include margins for cyclical spending, as recommended by the staff.
- Tax policy and reform:
  - Prospects for a significant reduction in the tax burden have dimmed further.
  - Fourth and final step of phased reduction in income taxes has been on hold since 2002; government intends to implement remaining step when fiscal position allows.
  - Authorities accepted, in principle, the view that reducing the high rate of marginal tax on labor was desirable to raise labor supply and potential growth, but placed priority on improving incentive structure of the existing tax-benefit system rather than reducing taxes.
  - High marginal effective tax rates on domestic savings could be eased and fairness improved by increasing the threshold of the wealth tax and reducing exemptions.
  - Mission’s view: raising corporate taxation to make up for revenue losses from lowering or abolishing the wealth tax would adversely affect investment and be contrary to international trends.

### Local government finances and intergovernmental coordination
- Fiscal strain: finances of local authorities, responsible for the provision of the bulk of public services, continue to be strained.
- Causes: pressures reflect demographic changes and central government policy priorities.
- Responses: constrained by the balanced budget rule, many municipalities and county councils have tried to cut costs and have at times raised local income taxes.
  - Rising local tax rates have partially offset central government tax cuts.
- Policy options considered: improve coordination between central and local governments such as by requiring local authorities to specify medium-term plans and reduce uncertainty regarding central grants.
- Long-term sustainability: Sweden in a relatively favorable position to meet long-term demographic challenges due to moderate gross public debt and the 1999 pension reforms introducing an automatic balancing mechanism to ensure long-term actuarial balance.
  - Current spending on health and long-term care: around 9 percent of GDP, projected to rise to over 12 percent of GDP in 2050.
  - Planned build-up of assets to be drawn down later rests critically on meeting the target for general government surplus.
  - Continued slippages in adhering to the target could put long-term fiscal sustainability at risk.

### Structural policies, labor supply, and immigration
- Structural reform record: authorities viewed their record as among the best in the EU, with high rankings under the Lisbon strategy in areas including public finances, employment, labor force participation among older workers, investment in R&D, and progress towards Kyoto targets.
- Remaining scope: further progress possible in reducing sickness absence, promoting greater competition in product markets, and improving labor market functioning.
- Long-term labor supply challenge:
  - Working-age population projected to grow very slowly over the coming five decades, with the entire rise of 5 percent (0.1 percent per year) due to immigration.
  - Effective supply of labor expected to fall due to aging of native-born population, low labor participation rates among immigrants, and falling average working hours.
  - Authorities stressed importance of enhancing economic integration of immigrants; Sweden did not impose special transition rules for labor market access for citizens from the ten new member states.
  - Mission view: easing high wage compression would facilitate absorption of low-skilled immigrants; review incentive structure in education to encourage entry into workforce at a younger average age.

### Sickness absence: incidence, costs, and policy implications
- Incidence and trends:
  - Rate of sickness absence was 5.2 percent in Sweden on average over the period 1995–2003.
  - Absence rate for female workers in the same period was 7 percent.
  - Including people on disability pension, almost 15 percent of the working age population was away from work in 2003.
- Fiscal and economic costs:
  - Sickness-related public transfers, including disability pensions, amounted to 4.6 percent of GDP in 2003.
  - In 1990–99, sickness benefits averaged 1.4 percent of GDP, second only to the Netherlands in the OECD.
  - Employers currently pay sick benefit at 80 percent of wages for the first 20 days of illness.
  - Costs in terms of forgone output are likely to be substantial.
- Policy measures and debate:
  - Government goal to halve sickness absence between 2002 and 2008.
  - Recent initiatives aim to increase responsibilities of all parties and emphasize fast rehabilitation.
  - Employer’s obligation period will be cut to first two weeks of sickness absence and compensation rate will be slightly raised, making overall incentive impact ambiguous.
  - Mission argument: reducing the replacement rate would need to be a key element of any package designed to achieve the authorities’ goal of reducing sickness absence to half its 2002 level by 2008.
  - Authorities intend to tighten administration of the sickness insurance system to minimize abuse and misuse; officials saw no prospect of lowering sickness benefits and indicated the marginal cut introduced last year will be reversed from 2005.

*IMF staff report content as provided in the source document.*

### 24.      The authorities agreed that the tax-benefit system had important disincentive

### _cr04244 - 24.      The authorities agreed that the tax-benefit system had important disincentive

### Labor supply and the tax-benefit system
- The tax-benefit system had important disincentive effects on labor supply.
- Recent income tax cuts mitigated these effects, and the system also provided many positive incentives (for instance, public spending on child care and care of the elderly helped promote high female participation).
- Incentives were greatly influenced by the interaction of various social welfare programs and labor market institutions; a systematic evaluation of these complex interactions was necessary to fashion an effective policy response.
- A decisive reform of the tax-benefit regime was necessary to:
  - improve incentives,
  - raise potential growth,
  - ease fiscal pressures.
- Policy measures recommended:
  - Cutbacks in entitlements, coupled with a reduction in the high tax burden on labor, to encourage greater effective labor supply in the face of population ageing and the sharp fall in hours worked.
  - Sizeable steps required to realize authorities’ labor market and social policy objectives such as the target of 80-percent employment rate and the goals of halving the number of people on social assistance and sickness leave.
  - Re-assess incentive structure in the education system to help reverse declining youth participation.
  - Recognize the role of incentives in sickness absence; the decision to reverse the small reduction in the replacement rate of sickness benefits introduced last year was characterized as clearly unhelpful.
  - Improve integration of immigrants into the labor force as the main source of labor supply over the coming years is expected to be the foreign-born population.

### Competition, product markets, and housing
- Need to strengthen competition in product markets.
- Competition had increased substantially in the past decade, but barriers remained significant, especially in:
  - the construction sector,
  - the pharmaceuticals sector,
  - the retail trade sector.
- The Swedish price level remained significantly above the EU average.
- Authorities considered encouraging greater competition between public and private sectors in the provision of public services.
- Administrative controls on rent-setting and large public ownership of housing, particularly in the rental sector, may inhibit development of an efficient rental market.
- The lack of a properly functioning housing market has:
  - depressed housing investment,
  - tended to hamper labor mobility.
- Officials saw little prospect of significant deregulation of rental housing because such a step was seen as contrary to the overriding objective of ensuring affordable housing to everyone.
- Strengthening competition in product markets would:
  - raise consumer welfare,
  - have positive spillover effects on the labor market.
- Recommendation: move towards a more market-oriented approach to the rental market that would preserve social policy objectives.

### External trade policy and development assistance
- Sweden played a positive role in efforts to revitalize the Doha Development Agenda.
- Authorities strongly supported elimination of subsidies to farm exports and substantial reduction of domestic support to agriculture in the advanced countries.
- Continued advocacy of liberal access to exports from low-income developing countries.
- Sweden’s official development assistance was 0.7 percent of GNP, described as one of the highest in the world.
- The authorities were commended for their high level of official development assistance.

### Macroeconomic performance and outlook (Staff appraisal)
- Sweden’s economic performance over the past decade was described as impressive in the comparative context of the European Union, with:
  - satisfactory growth,
  - macroeconomic stability grounded in fiscal rules and an inflation targeting framework with high credibility,
  - reforms placing the public pension system on a sound financial footing.
- A notable feature of recent growth was a strong rise in productivity, helping to bring inflation well under the target of 2 percent.
- The mirror image of the rise in productivity had been a continuing fall in employment and sharply rising unemployment, both open and latent.
- Sweden should build on recent successes by reviving the agenda for structural reform which had lost momentum in the last couple of years.
- With inflation projected to be below target over the next two years, a policy of keeping rates on hold for the near term would be appropriate.
  - As domestic restraints recede and upside risks from the projected upturn at home and abroad predominate, inflation was expected to rise gradually and the policy rate would need to be raised in due course.
  - If the fiscal stance was insufficiently restrictive as the recovery gathered speed, monetary policy would need to be tightened earlier rather than later.

### Monetary policy conduct and communication
- The Riksbank’s conduct of monetary policy and success in achieving the inflation target have earned it high credibility.
- There may be room for clearer communication:
  - On occasion some confusion about the target variable and horizon had arisen.
  - Suggested refinements: be more explicit about the role of judgment in assessments and extend the forecast horizon beyond two years.
- The outcome of the recent round of wage negotiations testified to the Riksbank’s ability to guide expectations.

### Fiscal policy, rules, and local-central coordination
- Safeguarding the fiscal surplus target of two percent of GDP over the business cycle was central to maintaining confidence in Sweden’s medium-term fiscal framework.
- Although the framework had a good track record, efforts to attain the target for the general government had slackened in the recent past.
- Recommendation: a more ambitious fiscal adjustment in 2005–06 through forceful measures to rein in public spending to demonstrate commitment to achieve the target.
- Authorities should:
  - adhere strictly to the expenditure ceilings and ensure margins are restricted to cyclical spending,
  - note that the ceilings had no margins left for error this year and spending on sickness and disability benefits might not slow as much as expected,
  - prepare a coherent medium-term plan to contain public spending without resorting to ad hoc steps such as shifting expenditure between years and additional tax expenditures.
- Scope for tax cuts had narrowed further even as they were needed to provide impetus to work effort and saving.
  - The tax burden of the general government, already one of the highest in the world, was likely to rise further as local governments tried to balance their budgets.
  - As international competition over tax bases intensified, a review of the complex capital tax system, encompassing taxation of wealth, inheritance, and gifts, was warranted.
- Rising tax burden reflected insufficient policy coordination between central and local governments.
  - Intention to encourage local authorities to specify more clearly their medium-term spending plans could improve fiscal coordination.
  - Use of balancing grants from the central government would help smooth fluctuations in local revenue and prevent procyclical increases in tax rates.

### Financial system and statistics
- The financial system remained sound:
  - Bank profitability had improved,
  - Capital adequacy and loss provision remained at satisfactory levels.
- Household debt had kept rising, but low interest expenses and higher home values considerably mitigated its burden.
- Credit risks appeared well contained, though risks associated with a significant decline in property values or a rise in interest rates warranted careful monitoring.
- Sweden’s provision of economic statistics was adequate for the purpose of Fund surveillance.

*Source: _cr04244 - 24.      The authorities agreed that the tax-benefit system had important disincentive*

### 42.      Sweden is expected to remain on the standard 12-month consultation cycle.

### _cr04244 - 42.      Sweden is expected to remain on the standard 12-month consultation cycle.

### Output, demand, and growth
- Real GDP growth (selected entries, Table 1): 3.6, 4.6, 4.3, 0.9, 2.1, 1.6, 2.5, 2.5 (series displayed as "Real GDP3.64.64.30.92.11.62.52.5").
- Growth composition (Figure 1): consumption is the main driver; weak investment (gross fixed capital formation) limits growth; contribution from net external demand is stable.
- Comparative growth (Figure 1): "Growth recovery is slightly more pronounced than in the EU." (EU15 Average shown vs Sweden in real GDP growth series).

### Labor market
- Open unemployment rate (Table 1): 6.5, 5.6, 4.7, 4.0, 4.0, 4.9, 5.5, 4.8 (series displayed as "Open unemployment rate (in percent)6.55.64.74.04.04.95.54.8").
- Participation in labor market programs (Table 1): 4.1, 3.3, 2.6, 2.5, 2.6, 2.1, 2.3, 2.0 (series displayed as "Participation in labor market programs (in percent)4.13.32.62.52.62.12.32.0").
- Employment-population ratio and participation: participation is stable; unemployment has been rising (Figures 2).

### Inflation and expectations
- CPI (HICP) series (Table 1): 1.0, 0.6, 1.3, 2.7, 2.0, 2.3, 0.7, 2.0 (series displayed as "CPI  2/1.00.61.32.72.02.30.72.0").
- Headline inflation: "Headline inflation is declining..." (Figure 3).
- Underlying inflation: "...underlying inflation declines..." (CPI, UND1X, UNDINHX series in Figure 3).
- Inflation expectations: "expectations are edging down slightly." (Figure 3; series shown for households and manufacturing firms).

### Exchange rate and competitiveness
- Nominal exchange developments (Figure 4): "The krona is appreciating against the US dollar and is broadly stable against the euro..."
- Effective exchange rates (Figure 4): "leading to weaker competitiveness." (Real rate indices based on relative consumer prices and normalized unit labor costs; indices with 1995=100).

### Asset prices and interest rates
- Asset prices: "Asset prices have been rising recently..." (Figure 5: real estate prices and stock market indices shown).
- Interest rates: "nominal interest rates have declined..." (Figure 5: three-month interbank, repo, ten-year bond yield series).
- Interest rate differentials: "...but less than in the euro area." (Three-month T-bill differential Sweden-Germany and ten-year bond yield differential Sweden-Germany shown).

### Fiscal position and public debt
- General government overall balance (Table 2): 1.9, 2.3, 5.1, 2.9, -0.3, 0.5, 0.3, 0.6, 1.1 (series displayed as "Overall balance1.92.35.12.9-0.30.50.30.61.1").
- Primary balance (Table 2): 3.3, 3.8, 6.0, 3.8, 0.7, 0.5, 0.5, 0.9, 1.5 (series displayed as "Primary balance3.33.86.03.80.70.50.50.91.5").
- General government debt (Table 1 and Table 2): 69.4, 62.7, 52.8, 54.4, 52.6, 51.9, 52.1, 50.7 (series displayed as "General government debt   69.462.752.854.452.651.952.150.7" and in Table 2 "Gross public debt (in percent of GDP)69.462.752.854.452.651.952.151.550.6").
- Fiscal assessment (Figure 6): "the fiscal position has weakened... the trend decline in expenditures has come to an end... preventing a faster improvement in the debt burden."
- General government revenue and expenditure (Table 2, percent of GDP):
  - Total revenue: 60.1, 60.1, 59.8, 57.2, 55.4, 56.1, 55.9, 55.5, 55.4 (series displayed as "Total revenue60.160.159.857.255.456.155.955.555.4").
  - Total expenditure: 58.2, 57.7, 54.7, 54.3, 55.7, 55.7, 55.6, 55.0, 54.3 (series displayed as "Total expenditure58.257.754.754.355.755.755.655.054.3").
  - Interest payments: 5.5, 4.8, 4.1, 3.2, 3.2, 3.2, 2.4, 2.5, 2.6 (series displayed as "Interest payments5.54.84.13.23.22.22.42.52.6").

### Sickness compensation and sick leave
- Historical association (Figure 7): "Increasing generosity of sickness compensation system has been associated with a surge in sick leave days."
- Noted policy and system changes (Figure 7 timeline): increases in compensation levels (e.g., from 65 to 80%; to 90%), reductions and changes in waiting and employer periods (e.g., waiting period reduced from 3 to 1 day; 14-day employer period introduced; waiting day abolished; reintroduced later), and taxation of benefits in some reforms.
- Total days of paid sick leave per person in labor force show a long-run increase associated with these policy changes (Figure 7 series for Men, Women, Total).

### External sector and balance of payments
- Current account (Table 3, billions of US dollars): 9.7, 10.7, 9.9, 9.7, 13.0, 19.3, 21.7, 19.6, 20.0, 21.3, 22.6, 24.0 (series displayed as "Current account9.710.79.99.713.019.321.719.620.021.322.624.0").
- Current account as percent of GDP (Table 3): 3.9, 4.3, 4.1, 4.4, 5.4, 6.4, 6.4, 5.6, 5.5, 5.6, 5.7, 5.8 (series displayed as "as a percentage of GDP3.94.34.14.45.46.46.45.65.55.65.75.8").
- Exports of goods and services (Table 3, billions): 105.5, 106.9, 110.7, 100.2, 108.4, 133.1, 157.0, 168.5, 177.4, 187.8, 199.1, 211.0.
- Imports of goods and services (Table 3, billions): -90.0, -91.5, -96.9, -86.7, -91.6, -112.0, -131.8, -143.4, -149.8, -156.4, -164.0, -171.7.
- Financial and capital account (Table 3): Capital and financial account values show net outflows in several years (e.g., -3.2, -6.6, -1.0, -3.0, -12.2, -22.7, -21.7, -19.6, -20.0, -21.3, -22.6, -24.0).

### External and financial vulnerability indicators
- Exports and imports growth (Table 4, percent change in U.S. dollars): Exports 3.0, 1.4, 3.5, -9.4, 8.1, 22.8, 18.0 (series displayed as "Exports of goods and services (annual percentage change, in U.S. dollars)3.01.43.5-9.48.122.818.0"); Imports 6.1, 1.6, 5.9, -10.5, 5.7, 22.3, 17.6.
- Central Bank reserves (Table 4, end period, billions of US$): 16.9, 18.0, 16.3, 14.8, 19.3, 22.4 (series displayed as "Central Bank reserves (end of period, in billions of U.S. dollars)16.918.016.314.819.322.4...").
- Effective exchange rate annual change (Table 4): -2.1, -1.4, 0.3, -8.4, 1.6, 4.8, 3.8 (series displayed as "Effective exchange rate (annual percentage change)-2.1-1.40.3-8.41.64.83.8").
- Real effective rate (based on ULC, annual change) (Table 4): -1.6, -3.0, -0.6, -9.2, 2.4, 5.8, 4.8.
- Financial sector indicators (Table 4, selected):
  - Consolidated public sector gross debt (end of period): 69.4, 62.7, 52.8, 54.4, 52.6, 51.9, 52.1.
  - 3-month T-bill yield (nominal, percent): 3.4, 3.4, 4.0, 3.7, 3.6, 2.6, 2.0.
  - General stock index (annual percent change): 16.9, 71.0, -11.9, -19.8, -41.7, 29.0, 31.4.
  - Real estate price index (annual percent change): 9.6, 9.2, 11.0, 8.0, 6.3, 6.6, 7.4.
  - Credit to households (growth rate, percent, end of period): 6.6, 9.0, 7.5, 8.9, 9.3, 10.1, 10.4.
  - Tier 1 capital ratio in four major banks (March): 6.9, 7.9, 6.9, 7.0, 7.1, 7.4, 7.4.
  - Banks' return on equity after tax in four major banks: 14.2, 16.0, 15.7, 13.0, 10.1, 12.3.
  - Nonperforming loans in four major banks (percent of lending, March): 2.6, 1.8, 1.6, 1.5, 1.2, 1.2, 1.2.

### Debt sustainability and stress tests
- Public sector debt-to-GDP projections (Table 5 baseline): 62.6 (1999), 52.9 (2000), 54.4 (2001), 52.6 (2002), 51.9 (2003), 52.1 (2004), 51.5 (2005), 50.6 (2006), 49.5 (2007), 48.4 (2008), 47.5 (2009).
- Debt-stabilizing primary balance (Table 5, illustrative entries): "Debt-stabilizing primary balance 11/" with projected public sector debt series; alternative scenarios and bound tests provided (A1–A3; B1–B6) showing sensitivity of debt path to shocks (e.g., B2: "Real GDP growth is at historical average minus two standard deviations in 2005 and 2006" yields higher projected debt ratios in the stress tests table).
- External debt sustainability (Table 6 baseline): External debt (net foreign liabilities) trajectory from 34.4 (1999) down to -1.1 (2005) and further negative projections (improving net foreign asset position); identified external debt-creating flows and automatic debt dynamics reported.
- External stress tests (Table 6): Alternative scenarios and bound tests B1–B6 assess vulnerability to shocks (nominal interest, real GDP growth, GDP deflator, non-interest current account, combination shocks, one-time 30 percent nominal depreciation).

### Fund relations and institutional details
- IMF membership and arrangements (Appendix I): "Status: Joined 08/31/51; Article VIII."
- Quota and Fund holdings (Appendix I): Quota 2,395.50 SDR Million (100.00 percent of quota); Fund holdings of currency 1,483.76 (61.94 percent); Reserve position in Fund 911.75 (38.06 percent).
- SDR Department (Appendix I): Net cumulative allocation 246.53 SDR Million (100.00 percent); Holdings 113.80 (46.16 percent).
- Outstanding purchases and loans: None. Financial arrangements: None. Technical assistance: None. Resident representative: None.
- Projected obligations to Fund (Appendix I, charges/interest): 1.14 (2004), 2.30 (2005), 2.30 (2006), 2.30 (2007), 2.31 (2008) (table shows "Charges/Interest 1.14 2.30 2.30 2.30 2.31").

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

### APPENDIX                                                                                                II              

### _cr04244 - APPENDIX II

### IMF staff update (Statement by the IMF Staff Representative, August 4, 2004)
- Economic activity continues to pick up speed, led by the strength of exports; rising industrial orders augur well for industrial production and exports, but the recovery has yet to spur growth in employment.
- Unemployment rate rose from 5.3 percent in May 2004 to 5.8 percent in June 2004.
- Inflation slowed further in June 2004:
  - Consumer price index rose by 0.5 percent in the year to June 2004, compared with a 12-month rate of 0.7 percent in May 2004.
  - Measure of underlying inflation was 1 percent.
- Riksbank policy rate left unchanged at 2 percent on June 23, 2004.
- Exchange rate developments (June–July 2004):
  - Krona reached a three-month low of Skr 9.2 per euro at end-July 2004.
  - Krona remained strong against the U.S. dollar.
  - Trade-weighted index: krona depreciated by 1 percent during June–July 2004.

### Public Information Notice — Article IV consultation (PIN No. 04/86, August 9, 2004)
Background and recent developments
- Downturn in 2002-03 was relatively mild; growth remained well above the EU average.
- Expansionary fiscal policy in 2002 underpinned private consumption; private investment remained weak.
- Recovery resumed in second half of 2003 driven by exports and household demand supported by low interest rates.
- Strong rise in productivity contributed to growth and dampened inflation pressures.
- Inflation fell toward the 2 percent target and continued to decline in early 2004 due to base-year effects, falling import prices, and strong productivity growth.
- Unemployment increased sharply in the year to early 2004; average duration of unemployment increased and youth unemployment rose.
- High sickness absence contributed to fall in average hours worked; sickness absence leveled off in 2003 but long-term sick shifting to disability pension continued to reduce labor supply.
- Competitiveness and external position:
  - Krona appreciated by over 6 percent in effective terms in the year to March 2004 (reflecting weaker U.S. dollar).
  - Krona appreciated by 3 percent in real effective terms, measured by relative unit labor costs.
  - Current account surplus rose from 5.4 percent of GDP in 2002 to 6.4 percent of GDP in 2003.
- Monetary policy:
  - Policy rate cut by 25 basis points in February 2004 and by another 50 basis points in early April 2004 to 2 percent.
  - Rate at same level as in the euro area; Riksbank left rate unchanged in May and June 2004.
- Fiscal policy:
  - Budget for 2004 is broadly neutral; only a marginal rise in the structural surplus of general government expected.
  - Fiscal framework targets a structural surplus of 2 percent of GDP with expenditure ceilings for central government and balanced budget rule for local authorities.
  - New spending initiatives in Spring 2004 Budget mean surplus target not expected to be met until at least 2007.
  - Margins under expenditure ceilings are narrow.

Outlook and risks
- Economic activity expected to pick up steadily in 2004–05 as global recovery gathers pace.
  - Staff projection: Adjusted for calendar effects, output expected to rise by around 2 percent in 2004 (rather than unadjusted forecast of 2½ percent).
- Supportive monetary and fiscal stances and rising household confidence should stimulate private consumption.
- Improved demand prospects and better manufacturing profits should assist revival in business investment.
- Barring sustained spike in oil prices, strong productivity gains and moderate wage increases expected to keep inflation below 2 percent target.
- Risks:
  - Recovery unlikely to be accompanied by substantial employment gains in the coming year, potentially holding back consumer spending.
  - Persistent excess capacity in manufacturing could postpone pickup in business investment.
  - External demand stimulus could be larger if krona remains undervalued.

### Executive Board assessment (key conclusions and recommendations)
- Praise for Sweden’s strong economic performance grounded in fiscal and monetary frameworks and productivity gains.
- Need to revitalize structural reform agenda to address demographic transition and global integration.
- Monetary policy:
  - With inflation projected below target over next two years, keeping interest rates on hold for the near term is appropriate.
  - Monetary tightening will be needed as the recovery gathers speed, especially if fiscal stance is not adequately restrictive.
  - Riksbank success in achieving inflation target praised; room to refine communications strategy by making explicit the role of judgment in inflation assessments and extending forecast horizon beyond two years.
- Fiscal policy:
  - Fiscal framework has good track record and fiscal position remains favorable in comparative EU context.
  - Emphasis on safeguarding the structural surplus target of 2 percent of GDP to maintain confidence.
  - Most Directors encouraged a more ambitious fiscal adjustment in 2005–06 to demonstrate commitment to the surplus target.
  - Directors noted no margins left for error in expenditure ceilings; strict adherence to expenditure ceilings is key.
  - Caution against use of ad hoc measures to meet fiscal targets as they could undermine transparency and credibility.
- Subnational finances:
  - Rising tensions in public finances evident at local government level; local authorities have raised income tax rates to meet balanced budget requirement amid increasing service demands.
  - Encourage improved fiscal coordination between central and local governments and consider use of balancing grants from central government.
- Structural and labor market policies:
  - Need to reform tax-benefit regime to improve work incentives and increase labor supply.
  - Importance of reducing sickness absence, better integration of immigrants into the labor force, and reversing declining youth participation.
  - Mobilize public support to address incentive aspects of sickness absence.
  - Strengthen competition in product markets; barriers to competition remain significant in some sectors; recommend faster pace of structural reforms.
- Financial sector:
  - Sweden’s financial system viewed as sound; bank profitability improved; capital adequacy and loan loss provisions at satisfactory levels.
  - Household debt has continued to rise; low interest expenses and higher home values mitigate burden.
  - Encourage continued careful monitoring of risks from property values or a rise in interest rates.
- Development assistance:
  - Praise for Sweden’s role in Doha Development Agenda and official development assistance at 0.7 percent of GNP.

### Selected economic indicators (as reported)
- Real GDP (percent change): 1998 3.6; 1999 4.6; 2000 4.3; 2001 0.9; 2002 2.1; 2003 1.6; 2004 1/ 2.5; 2005 1/ 2.6
- Domestic Demand (percent change): 1998 4.4; 1999 3.5; 2000 3.9; 2001 -0.2; 2002 0.9; 2003 1.0; 2004 1/ 1.6; 2005 1/ 3.0
- CPI (Harmonized index of consumer prices, percent change): 1998 1.0; 1999 0.6; 2000 1.3; 2001 2.7; 2002 2.0; 2003 2.3; 2004 1/ 0.7; 2005 1/ 2.0
- Open unemployment rate (in percent): 1998 6.5; 1999 5.6; 2000 4.7; 2001 4.0; 2002 4.0; 2003 4.9; 2004 1/ 5.5; 2005 1/ 5.2
- Participation in labor market programs (in percent): 1998 4.1; 1999 3.3; 2000 2.6; 2001 2.5; 2002 2.6; 2003 2.1; 2004 1/ 2.3; 2005 1/ 2.0
- Gross national saving (percent of GDP): 1998 21.1; 1999 21.8; 2000 22.6; 2001 22.2; 2002 22.1; 2003 22.1; 2004 1/ 21.6; 2005 1/ 21.4
- Gross domestic investment (percent of GDP): 1998 17.2; 1999 17.5; 2000 18.5; 2001 17.7; 2002 16.8; 2003 15.8; 2004 1/ 15.2; 2005 1/ 15.8
- General government balance (percent of GDP): 1998 1.9; 1999 2.3; 2000 5.1; 2001 2.9; 2002 -0.3; 2003 0.5; 2004 1/ 0.3; 2005 1/ 0.6
- Structural balance (percent of potential GDP, adjusted for one-off effects): 1998 -0.9; 1999 0.5; 2000 3.8; 2001 3.0; 2002 -0.2; 2003 1.1; 2004 1/ 1.2; 2005 1/ 1.3
- General government debt (percent of GDP): 1998 69.4; 1999 62.7; 2000 52.8; 2001 54.4; 2002 52.6; 2003 51.9; 2004 1/ 52.1; 2005 1/ 51.5
- M0 (12-month percent change): 1998 5.1; 1999 11.9; 2000 2.0; 2001 8.8; 2002 -0.9; 2003 2.7; 2004 ...; 2005 ...
- M3 (12-month percent change): 1998 2.5; 1999 9.7; 2000 2.8; 2001 6.7; 2002 4.5; 2003 3.1; 2004 ...; 2005 ...
- Credit to non-bank public (12-month percent change): 1998 6.9; 1999 5.6; 2000 9.1; 2001 8.8; 2002 4.2; 2003 2.7; 2004 ...; 2005 ...
- Three-month interbank rate (year average): 1998 4.9; 1999 3.6; 2000 3.6; 2001 4.1; 2002 3.9; 2003 3.9; 2004 ...; 2005 ...
- Ten-year government bond yield (year average): 1998 5.9; 1999 4.3; 2000 5.6; 2001 4.8; 2002 5.2; 2003 4.6; 2004 ...; 2005 ...
- Trade balance (percent of GDP): 1998 6.2; 1999 6.2; 2000 5.7; 2001 6.2; 2002 6.9; 2003 7.0; 2004 1/ 7.5; 2005 1/ 7.2
- Current account (percent of GDP): 1998 3.9; 1999 4.3; 2000 4.1; 2001 4.4; 2002 5.4; 2003 6.4; 2004 1/ 6.4; 2005 1/ 5.6
- International reserves (in billions of US dollars): 1998 16.9; 1999 18.0; 2000 16.3; 2001 14.8; 2002 19.3; 2003 22.4; 2004 ...; 2005 ...
- Reserve cover (months of imports of goods and services): 1998 2.3; 1999 2.4; 2000 2.0; 2001 2.1; 2002 2.6; 2003 2.4; 2004 ...; 2005 ...
- Exchange rate regime: Floating exchange rate
- Present rate (May 31, 2004): US$ 1 = Skr 7.4515
- Nominal effective rate (1995=100): 1998 101.1; 1999 99.7; 2000 100.0; 2001 91.6; 2002 93.1; 2003 97.5; 2004 ...; 2005 ...
- Real effective rate (1995=100, based on relative normalized unit labor cost in manufacturing): 1998 103.8; 1999 100.6; 2000 100.0; 2001 90.8; 2002 93.0; 2003 98.3; 2004 ...; 2005 ...

Sources listed in table: Statistics Sweden; Riksbank; Ministry of Finance; Datastream; INS; and IMF staff estimates. (Staff projections noted as 1/.)

### Statement by Sweden’s Executive Director and Senior Advisor (Jon A. Solheim and David Farelius, August 4, 2004) — key points
- Authorities appreciated staff discussions and the report; noted a change of tone between main staff report and concluding statement and welcomed the more nuanced views.
- Authorities agree fiscal and monetary frameworks have served Sweden well; emphasize importance of preserving credibility of policy framework.
- After three-year period of growth lower than potential, activity expected to pick up in 2004 and 2005 following international upswing.
  - Average rate of growth during 2001–2003 was 1.5 per cent for Sweden, compared to 1.1 per cent for EU-15 and 1 per cent for the euro area.
- Inflationary pressure remains low; in response Riksbank reduced interest rates by another 0.75 percentage points since the consultation in 2003.
- Authorities agree on importance of sound macroeconomic framework to promote high and sustainable growth and employment.

*Source: IMF — Public Information Notice No. 04/86 and associated Appendix (as of June 15, 2004; statements dated August 4, 2004 and August 9, 2004).*

### 4. The central target for fiscal policy, adopted by the Government and Parliament, is to

### 4. The central target for fiscal policy, adopted by the Government and Parliament, is to 

### Fiscal policy: central target, framework, and near-term plans
- Central target: maintain a surplus in general government finances equivalent to 2 per cent of GDP on average over the business cycle.
- Main aim: strengthen the financial position of the general government sector in preparation for the consequences of demographic changes expected over the coming decades.
- Additional rationale: preserve sufficient scope for countercyclical variations of the fiscal balance without moving into a situation of excessive deficit.
- Underpinning mechanisms:
  - System of nominal expenditure ceilings for the central government budget.
  - Balanced budget requirement for the local authorities.
- Recent strains: framework has come under more considerable strain due to weaker economic activity and increasing expenditure pressure at the local level.
- Government commitment and measures:
  - Government remains firmly committed to the fiscal framework and the fiscal targets.
  - In last year’s Spring Fiscal Policy Bill the Government proposed a number of expenditure cuts to avoid a breach of the expenditure ceilings.
  - If fiscal development is weaker than expected, the Government is prepared to take further measures to ensure expenditure ceilings are respected.
- Projections and timing:
  - According to projections of this year’s Spring Fiscal Policy Bill, fiscal developments will by and large be in line with the surplus target over the coming years.
  - According to current expenditure plans the structural surplus will gradually approach 2 per cent in 2006.
  - The Government is reluctant to take further measures to increase the structural surplus until a decisive reduction in unemployment has been achieved, to avoid jeopardizing the projected upswing in the labor market.
- Comparative assessment:
  - The surplus target is considerably more ambitious than those set by the EU within the Stability and Growth Pact.
  - Fiscal performance of Sweden is still among the best in the EU and the OECD.
- On staff proposals:
  - Government has taken note of staff proposals to strengthen the fiscal policy framework and will consider them when refining the framework.
  - Government does not share staff’s view on the need to trim back the welfare state to lower tax rates.
  - Tax cuts will be considered if they can be afforded, without jeopardizing the fiscal policy targets and the quality of public services.

### Monetary policy: recent actions, outlook, and communication
- Recent context:
  - Monetary policy conducted against sharply falling inflation in 2003 and early 2004, largely related to an expected downward adjustment in energy prices after large price rises in early 2003.
  - Recurrent assessments that inflation one to two years ahead would be somewhat below the inflation target warranted a more expansionary monetary policy.
- Policy action:
  - The Riksbank lowered the repo rate in two steps in February and April from 2.75 to 2.0 per cent.
- Inflation outlook:
  - Inflation expected to be relatively stable in the coming year and projected to increase gradually thereafter.
  - Inflation is forecast to be in line with the Riksbank’s target towards the end of the forecast period one to two years ahead.
- Statistical change and implications:
  - Statistics Sweden will change the way it calculates the inflation rate as of January 2005.
  - The rate of inflation as measured according to the new method is expected to average 0.2 percentage points lower per year than with the current method.
  - Forecasts of inflation from January 2005 refer to the new definition.
  - The change is expected to imply a sudden drop in the registered inflation rate in January 2005; allowing this technical change to filter through gradually may be appropriate to avoid irregularity in monetary policy.
- Longer-term stance:
  - The repo rate is low in historical terms, indicating it will need to be raised in the longer term.
  - Future stance will depend on new information on economic developments in Sweden and abroad and the effects these may have on inflation prospects in Sweden.
- Exchange rate assessment:
  - The Riksbank agrees with the staff report that the krona is undervalued, although the extent of undervaluation is quite uncertain.
  - The most recent inflation forecast was based on an assumption of an appreciation of some two per cent during the coming two years.
- Communication and transparency:
  - The Riksbank published in 1999 a statement clarifying circumstances under which deviations from the inflation target can be tolerated; principles have been applied since and appear well understood by financial markets.
  - The inflation target remains defined in terms of the CPI, but various definitions of underlying inflation are used to characterize the persistent component of CPI inflation.
  - Identifying sources of transitory movements in inflation and presenting analyses pedagogically and transparently remains difficult.
  - The Riksbank is continuously developing forecasting methods for persistent inflation movements and will examine a longer forecast horizon if deemed appropriate.
- Financial stability:
  - In line with the Financial Stability Report published in June, the Riksbank agrees with the staff report that risks in the financial system appear well contained.

### Structural policies: employment, sick leave, welfare state, and market competition
- Overarching challenge: raise and maintain a high level of employment; financing of the Swedish welfare state is dependent on a high level of employment; increased employment helps contain upward pressure on local government tax rates.
- Employment target:
  - A target that at least 80 per cent of those between 20 and 65 years of age shall be employed by the year 2004 has been adopted by the Government.
  - According to current projections the target will not be reached in 2004, partly due to unfavorable demographic conditions.
- Sick leave concerns and measures:
  - Government shares staff concerns about sick leave developments.
  - Several measures have been taken to curb the negative trend of recent years.
  - Government intends to present a new proposal for dealing with high sickness costs:
    - Employer will be responsible for the first two weeks (instead of three) of sickness plus 15% of the cost for the remaining sickness period or until the person is granted a more permanent benefit.
    - Purpose: improve incentives for employers to take active action to prevent and deal with work-related sickness.
  - Taken together, planned and implemented measures are expected to lead to a decline in the sick leave rate.
  - There are already clear signs that the number of people on sick leave has started to decline.
- Monitoring and policy stance:
  - Government will closely monitor developments in sick leave and employment figures and will take action if needed to ensure corresponding targets are reached over the medium term.
  - Cutting replacement rates will not be a preferred means of achieving employment/sick-leave targets because such a step would seriously conflict with important social policy objectives.
  - Preferred approach: rely on administrative controls and a more uniform and strict application of existing rules.
- Welfare state and growth:
  - Government does not agree with staff that the welfare state needs to be scaled down to improve conditions for economic growth.
  - No simple, straightforward connection between the size of the welfare state and economic growth.
  - Over the last ten years the Swedish economy has done better than many other OECD countries, despite Sweden’s welfare state being one of the largest in the OECD area as a percentage of GDP.
  - Many expenditure items counted as part of the welfare state (notably subsidies to child care and the care for the elderly) are likely positively connected with economic growth as they support a high labor supply.
- Competition and housing market:
  - Government agrees with staff on the need to strengthen competition in certain markets.
  - Government is aware of problems in the housing market and that the current system is not working properly in all respects.
  - Challenge: find a solution that does not compromise fundamental principles of Swedish housing policy.
  - Desire to maintain strong tenure rights rules out a completely market-based system.

*Source: _cr04244 - 4. The central target for fiscal policy, adopted by the Government and Parliament, is to*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04244.pdf_