## _cr05196

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### Executive summary and macro outlook
- Economic growth rebounded strongly from a brief slowdown beginning in late 2002.
- GDP is expected to grow at above-potential rates in both 2005 and 2006; the output gap is expected to close in 2005 and inflationary pressures to begin to rise.
- Petroleum revenues guarantee strong fiscal and current account surpluses for many years; the Government Petroleum Fund (GPF) holds the bulk of these revenues invested abroad.
- The non-oil central government structural deficit has consistently exceeded the 4-percent rule specified in Norway’s fiscal guidelines (adopted in 2001) for 2002–04; the 2005 budget involves further slippage despite strong growth and high oil prices.
- Monetary policy has achieved low and stable core inflation under a flexible inflation-targeting regime since 2001 (Norges Bank target: 2.5 percent over a 1-to-3 year horizon).
- Key near-term projections (staff projections as of March 2005):
  - GDP: 2004 = 2.9; 2005 = 3.7; 2006 = 2.8.
  - Mainland GDP: 2004 = 3.5; 2005 = 3.8; 2006 = 3.0.
  - Consumer prices: 2004 = 0.4; 2005 = 1.4; 2006 = 2.1.
  - Unemployment (percent of labor force): 2004 = 4.4; 2005 = 4.0; 2006 = 4.0.
  - Current account balance (percent of GDP): 2004 = 13.7; 2005 = 16.2; 2006 = 14.9.

### Inflation developments and monetary policy
- Core inflation near 1 percent since late 2003—well below the 2.5 percent target.
- Structural factors restraining inflation:
  - Falling import prices (manufactures, increasing share from low-price countries such as China and India).
  - Intensified domestic competition in retail, air transport, and telecommunications.
  - Chapter 1 finds import price falls reduced annual inflation by more than ½ percentage point on average since 2002.
- Monetary stance and recommendations:
  - Intervention rate set at 1.75 percent in March 2004 and remained since.
  - Monetary Conditions Index indicates conditions still very supportive; policy interest rates low for more than a year.
  - Staff recommendation: begin gradual withdrawal of monetary stimulus during 2005 as output gap closes and inflationary pressures rise.
  - Transparency improvements at Norges Bank: publish monetary policy strategy document with inflation report; provide more detailed press releases; staff suggested publishing minutes (authorities argued against).

### Fiscal policy, fiscal rule, and medium-term plan
- Fiscal framework:
  - Fiscal guidelines (2001): set non-oil central government structural deficit to 4 percent of GPF assets (assumed long-run real return).
  - In early 2005, assets of the GPF were 78 percent of GDP (supplementary tables give a range of GPF in percent of GDP: 2004 = 60.0; 2005 = 70.9; 2006 = 83.4; 2007 = 96.8; 2008 = 108.2; 2009 = 117.5; 2010 = 124.1).
- Recent outturns and concerns:
  - Central government non-oil deficit in 2004 was 5.5 percent of GDP (2004 revised to 6.1 percent in supplementary information); structural non-oil deficit rose by 0.6 percent of GDP in 2004 and set to rise by another ½ percent of GDP in 2005 (staff calculations).
  - Structural non-oil balance (staff projections): 2004 = -4.5; 2005 proj. = -4.7; 2006 proj. = -4.8.
- Recommendations:
  - Close the gap between actual deficits and the 4-percent rule; avoid slippage in the 2005 budget; use windfalls and savings (e.g., lower sickness benefits) to narrow the gap.
  - Adopt a medium-term fiscal plan with spending ceilings, deficit objectives, and concrete measures to return to the 4-percent rule sooner than budget envisages.
  - Continue saving extra oil revenues (policy in revised 2005 budget saves extra oil revenues so deviation from the fiscal rule disappears in 2008).

### Financial system assessment and FSAP/FSSA recommendations
- Overall assessment:
  - Financial system well managed, well supervised, sound and competitive.
  - Banks well positioned: sound capital positions, strengthened risk management, improved profitability.
  - Insurance and pension sectors reinforced positions but remain susceptible to adverse market movements.
- Household debt and financial stability risks:
  - Household debt rising and may become an increasing risk factor over time; household debt ratios (selected figures): household debt (percent of disposable income less the return on insurance claims): 125.8, 124.5, 127.7, 132.4, 145.1, 144.9, 154.4, 164.5 (end-period series).
  - Credit from domestic sources (percentage change; end of period): 10.2, 8.3, 8.3, 12.4, 9.8, 8.7, 11.0, 13.2.
- FSAP/FSSA key recommendations (summary):
  - Monitor household debt and housing market evolution; examine bank exposure concentrations to vulnerable sub-groups.
  - Given reduced mortgage risk weighting under Basel II, consider additional capital requirements under “Pillar 2.”
  - Monitor market and liquidity risks in payments and securities settlement; further reduce risks.
  - Continue cross-border crisis management work with Nordic authorities; ensure coordinated contingency plans for a major problem at the largest bank, DNB-NOR.
  - Reexamine deposit guarantee arrangements and state ownership in DNB-NOR; in interim, entrench commercial autonomy and accountability.

### Labor market, welfare programs, and structural policies
- Labor market strengths and risks:
  - Employment picked up; unemployment edged down to 4.4 percent in January 2005 from 4.6 percent in mid-2003.
  - Nominal wage increases reduced to 3¾ percent in 2004 (from >5 percent during 1999–2003); real wages rose significantly due to very low inflation.
  - High wage increases relative to trading partners have caused competitiveness deterioration for the exposed sector; real exchange rate appreciated substantially.
- Sickness and disability programs:
  - National Insurance Scheme outlays were 13.5 percent of GDP in 2004.
  - Replacement rates are very high (100 percent for the sickness program); staff recommends re-examining replacement rates and tightening administrative controls.
  - Hours lost to sickness fell in 2004 after tighter medical examinations in July 2004, but decline small relative to past increases.
- Product markets and state ownership:
  - Competition law strengthened; competition increasing in several sectors.
  - State ownership remains very high; progress in privatization slow. Staff recommends reducing state ownership in commercial enterprises to avoid uneven playing field and enable corporate governance mechanisms.

### Pension reform, long-term sustainability, and financing gap simulations
- Government pension reform (Parliament decision, May 26) key elements:
  - Index benefits to the simple average of wages and prices instead of wages.
  - Adjust benefits for life expectancy.
  - Base benefits on lifetime earnings; abolish the 40-year cap on insurable earnings.
  - Establish mandatory minimum requirements for second-pillar occupational pensions beginning January 1, 2006.
- Expected fiscal effects:
  - Pension Commission estimates reforms would improve fiscal balance by 2–3 percent of GDP by 2050; authorities estimate about two-thirds of reduction due to improved work incentives.
  - Table (Pension Financing Shortfall; in percent of trend mainland GDP):
    - Pension expenditure without reform: 9.8 (2005) and 19.4 (2050); Change 9.7
    - 4 percent of GPF: 3.1 (2005) and 5.8 (2050); Change 2.7
    - Savings from reform proposal: 3.0
    - Remaining financing gap: 4.0
    - Memorandum: GPF assets: 77.4 (2005) and 145.0 (2050); Change 67.6
- Long-run simulation highlights (Appendix I):
  - Simulation 1 (no reform): financing gap turns negative before 2020 and rises to about 7 percent of GDP by 2050.
  - Simulation 2 (government reform): financing gap turns negative in 2030 and rises to about 4 percent of GDP by 2050.
  - Simulation 3 (reform + higher oil prices): financing gap does not turn negative until 2038 and is about 2 percent of GDP in 2050.
  - Simulation 4 (reduced non-pension spending path): even with constrained non-pension spending growth, gap turns negative after 2050.
- Conclusion: reforms materially reduce but do not eliminate long-term financing gap; linking GPF and pensions and continuing to invest assets abroad important to mitigate Dutch disease and political spending pressure.

### Selected exact macro and fiscal indicators (staff projections and historical figures)
- Selected growth and price series (annual percent change unless stated):
  - Private consumption: 2004 = 4.3; 2005 = 4.5; 2006 = 4.0.
  - Public consumption: 2004 = 1.4; 2005 = 2.0; 2006 = 1.8.
  - Gross fixed investment: 2004 = 8.9; 2005 = 10.0; 2006 = 5.0.
  - Exports of goods and services: 2004 = 1.3; 2005 = 4.0; 2006 = 2.6.
  - Wages (in full-time equivalents): 2004 = 3.8.
- Central government (percent of mainland GDP; staff projections as of March 2005 / revised 2005 budget figures):
  - Central government revenues: 2004 = 57.1; 2005 = 60.4; 2006 proj. = 58.7.
  - Central government non-oil revenues: 2004 = 40.1; 2005 = 39.8; 2006 proj. = 39.8.
  - Central government expenditures: 2004 = 47.6; 2005 proj. = 47.0; 2006 proj. = 46.7.
  - Central government overall balance: 2004 = 9.5; 2005 proj. = 13.4; 2006 proj. = 12.0.
  - Central government non-oil balance: 2004 = -6.1; 2005 proj. = -5.3; 2006 proj. = -5.1.
  - Structural non-oil balance: 2004 = -4.5; 2005 proj. = -4.7; 2006 proj. = -4.8.
- External and GPF indicators:
  - Current account balance (percent of GDP): 2004 = 13.7; 2005 proj. = 16.2; 2006 proj. = 14.9.
  - Exports (goods and services, percent of GDP): 2004 = 109.5; 2005 proj. = 128.9; 2006 proj. = 125.6.
  - Oil and natural gas component of goods exports (percent of GDP): 2004 = 50.1; 2005 proj. = 63.4; 2006 proj. = 60.4.
  - Government Petroleum Fund (in percent of GDP): 2004 = 60.0; 2005 proj. = 70.9; 2006 proj. = 83.4; 2007 proj. = 96.8; 2008 proj. = 108.2; 2009 proj. = 117.5; 2010 proj. = 124.1.
- Financial sector indicators (selected end-period series):
  - Central Bank international reserves (billion U.S. dollars): 23.4, 19.1, 23.8, 27.9, 23.5, 32.4, 37.7, 44.3.
  - Gross public debt (end of period): 27.5, 26.2, 26.8, 30.0, 29.2, 36.1, 44.9, 44.9.
  - 3-month T-bill yield (eop, percent p.a.): 3.7, 7.9, 5.6, 7.2, 6.9, 6.8, 2.4, 1.8.
  - Housing price index (percentage change; end of period): 10.8, 6.8, 18.6, 9.8, 7.7, 2.8, 4.1, 10.5.
  - Private non-financial enterprise debt (percent of cash surplus): 500.5, 547.2, 603.1, 664.9, 618.4, 657.8, 662.1, 568.4.

### Policy recommendations — prioritized actions
- Monetary policy:
  - Begin gradual tightening in 2005 as recovery proceeds and inflationary pressures rise.
  - Continue to improve communication on the inflation-targeting framework and policy stance to mitigate exchange rate appreciation concerns.
- Fiscal policy:
  - Close the gap with the 4-percent fiscal rule; avoid further slippage in 2005 and use windfalls to narrow the gap.
  - Adopt a medium-term fiscal plan with spending ceilings, deficit objectives, and concrete measures to return to the 4-percent rule.
  - Consider higher property taxes as part of future tax reform rounds.
- Structural and social programs:
  - Re-examine very high sickness and disability replacement rates; tighten administrative controls and consider raising employers’ share of sickness contributions to discourage shifting employees into schemes.
  - Accelerate progress in reducing state ownership and ensure state-owned commercial enterprises operate on a commercial basis.
- Financial stability:
  - Monitor rapid growth in consumer/household debt; implement FSAP/FSSA recommendations promptly (monitor mortgage concentration, consider Pillar 2 capital measures, strengthen payments system resilience).
- Pensions and long-term sustainability:
  - Adopt pension reform measures (indexation, life-expectancy adjustment, lifetime earnings basis) and complement with alignment of disability/early retirement replacement rates and removal of subsidies to early retirement to improve fiscal outcomes.

_International Monetary Fund — Staff Report for the 2005 Article IV Consultation (Supplementary Information), June 1, 2005._

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

### _cr05196 - Executive Summary ......................................................................................................

### Background

- Economic growth rebounded strongly from a brief slowdown that began in late 2002.
- GDP is expected to grow at above-potential rates in both 2005 and 2006. As a result, the output gap is expected to close this year, and inflationary pressures to begin to rise.
- Declines in the prices of some domestic services and imported goods, which have held inflation well below the 2.5 percent target, appear to be waning.
- Petroleum revenues guarantee strong fiscal and current account surpluses for many years.
- The non-oil central government structural deficit has consistently exceeded the target set in Norway’s fiscal guidelines, and the 2005 budget involves further slippage despite strong growth and high oil prices.

- Norway has enjoyed strong economic performance, underpinned by a sound macroeconomic policy framework.
  - Real GDP growth has generally outpaced the EU average.
  - Labor markets perform very well by international comparison, with relatively high employment and participation rates, and low unemployment rates.
  - Large oil and gas revenues—Norway is the third largest oil exporter in the world—ensure substantial fiscal and current account surpluses for many years.
  - The bulk of these revenues have been invested abroad by the Government Petroleum Fund (GPF).
  - Fiscal guidelines are in place to control the non-oil fiscal deficit, although the key 4-percent rule has not been met in the three years (2002–04) since its inception.
- Monetary policy has achieved low and stable core inflation under a flexible inflation target since 2001. Norges Bank aims for a core inflation rate of 2.5 percent over a 1-to-3 year horizon (changed last year from a 2-year horizon).

- Economic developments since late 2002:
  - Norges Bank held policy rate near 7 percent through most of 2002, contributing to a significant appreciation of the krone and slower activity.
  - NB reversed course in late 2002 and cut interest rates sharply through 2003; in March 2004 the intervention rate was set at 1.75 percent, where it has remained.
  - Supportive monetary stance, high oil prices, rising house prices, strengthening consumer and business confidence, and an improved world economy contributed to a 3.5 percent increase in real mainland GDP in 2004, well above the staff estimate of potential of 2½ percent.
- Definitions and notes:
  - Henceforth, “GDP” refers to mainland GDP—excluding the oil and gas sector.
  - In 2004, total GDP grew less than mainland GDP because of planned oilfield maintenance and, to a lesser extent, brief strikes.

### Policy discussions and assessment

- Monetary policy
  - The monetary stance should begin to tighten in the course of this year.
  - This tightening is widely anticipated by private sector analysts, especially after Norges Bank, in late February, signaled a shift from a policy of maintaining low rates.
  - The inflation targeting framework, in place since 2001, has been gaining credibility, and recent changes have further improved transparency.
  - Exchange rate appreciation remains a concern; authorities should continue efforts to communicate both the framework and policy stance.

- Fiscal policy
  - The authorities should make a greater effort to close the gap between the deficit and the rule specified by the fiscal guidelines (adopted in 2001).
  - Otherwise, the credibility of the guidelines may be jeopardized, which could put unwanted upward pressure on the currency.
  - Staff recommended the adoption of a medium-term fiscal plan.
  - Staff welcomed the tax reform in the 2005 budget, but argued for higher property taxes.
  - The non-oil central government structural deficit has consistently exceeded the 4-percent rule; the 4-percent rule has not been met in 2002–04.

- Financial system
  - The FSAP found the financial system in good health and well supervised.
  - Concern was expressed that the high growth of consumer debt could, over time, pose an increasing risk.
  - The FSSA makes a number of recommendations.

- Structural issues and labor market
  - Labor market performance is strong by international comparison but may be threatened by the rapid growth of the sickness and disability programs.
  - The sickness program was tightened somewhat, and time lost from sickness fell last year, but more administrative measures will probably be needed.
  - Staff recommends the authorities re-examine very high replacement rates.
  - Product markets are becoming more competitive, and the new competition law should help.
  - Progress in reducing the very high level of state ownership has been slow.

### Key findings and statistics (selected from tables and figures)

- Quarterly/Annual projections and indicators (as presented in Table 1; staff projections as of March 2005):
  - Private consumption: 2004 = 4.3; 2005 = 4.5; 2006 = 4.0.
  - Public consumption: 2004 = 1.4; 2005 = 2.0; 2006 = 1.8.
  - Gross fixed investment: 2004 = 8.9; 2005 = 10.0; 2006 = 5.0.
  - Export of goods and services: 2004 = 1.3; 2005 = 4.0; 2006 = 2.6.
  - GDP: 2004 = 2.9; 2005 = 3.7; 2006 = 2.8.
  - Mainland GDP: 2004 = 3.5; 2005 = 3.8; 2006 = 3.0.
  - Unemployment (percent of labor force): 2004 = 4.4; 2005 = 4.0; 2006 = 4.0.
  - Consumer prices: 2004 = 0.4; 2005 = 1.4; 2006 = 2.1.
  - Wages (in full-time equivalents): 2004 = 3.8.
  - Central government revenues (percent of mainland GDP): 2004 = 57.9; 2005 = 59.6; 2006 = 58.0.
  - Central government non-oil revenues: 2004 = 40.6; 2005 = 40.1; 2006 = 40.1.
  - Central government expenditures: 2004 = 47.7; 2005 = 47.2; 2006 = 46.8.
  - Central government overall balance: 2004 = 10.2; 2005 = 12.4; 2006 = 11.1.
  - Central government non-oil balance: 2004 = -5.5; 2005 = -5.4; 2006 = -5.1.
  - General government financial balance: 2004 = 14.6; 2005 = 15.6; 2006 = 14.3.
  - General government non-oil balance: 2004 = -5.6; 2005 = -5.5; 2006 = -5.1.
  - Current account balance (percent of GDP): 2004 = 13.7; 2005 = 16.2; 2006 = 14.9.
  - Current account non-oil balance: 2004 = -6.3; 2005 = -6.0; 2006 = -6.0.

- External indicators (Table 2, select items and projections):
  - Exports (goods and services, percent of GDP): 2004 = 109.5; 2005 = 128.9; 2006 = 125.6.
  - Exports of goods (percent of GDP): 2004 = 82.5; 2005 = 99.1; 2006 = 95.7.
    - Oil and natural gas component of goods exports: 2004 = 50.1; 2005 = 63.4; 2006 = 60.4.
  - Imports (percent of GDP): 2004 = 74.0; 2005 = 83.0; 2006 = 84.4.
  - Trade balance (percent of GDP): 2004 = 35.5; 2005 = 46.0; 2006 = 41.2.
  - Current account balance (in percent of GDP): 2004 = 34.4; 2005 = 46.4; 2006 = 43.1.
  - Net foreign assets (in percent of GDP): 2004 = 64.3; projections rise thereafter (e.g., 2007 = 88.9; 2010 = 117.1).
  - Government Petroleum Fund (in percent of GDP): 2004 = 67.9; projected 2005–10: 76.8, 85.9, 93.5, 99.7, 101.0, 107.2.

- Monetary and exchange rate context (Figure 2 and related text):
  - Intervention rate set at 1.75 percent in March 2004 and remained since.
  - Monetary Conditions Index indicates monetary conditions are still very supportive.
  - Policy interest rates have been low for more than a year; differentials with the euro area are small.
  - The krone appreciated in 2004.

- Labor market and wages (Figure 3 and text):
  - Employment picked up; unemployment edged down to 4.4 percent in January 2005 from 4.6 percent in mid-2003.
  - Nominal wage increases reduced to 3¾ percent in 2004, compared with more than 5 percent a year during 1999–2003.
  - Real wages rose significantly because of very low inflation.
  - Productivity-improving rationalizations left unit costs broadly stable.
  - High wage increases relative to trading partners have caused a deterioration in competitiveness for the exposed sector.

### Boxes and specific policy points

- Box 1 — Policy Recommendations and Implementation
  - Monetary policy: Fund recommended maintaining a supportive stance in light of very low inflation; recommended policy transparency. Norges Bank has enhanced transparency (governor’s appearances before parliament, external evaluation, publishing the monetary strategy document).
  - Fiscal policy: Fund recommended reducing the non-oil central government structural budget deficit more rapidly to 4 percent of the Government Petroleum Fund. The 2005 budget involved further slippage relative to that target. Authorities have not introduced a multi-year fiscal plan. Authorities submitted to parliament reforms proposed by a high level pension commission and implemented most recommendations of a high level tax commission, including a reduction in labor taxation.
  - Structural policy: Tighter administrative controls were placed on the sickness program, but authorities have not considered lowering high replacement rates. Competition has increased; progress in privatization has been limited.

- Box 2 — The Fiscal Policy Framework
  - The Government Petroleum Fund (GPF) established in 1990; since 1995 the bulk of petroleum revenue invested abroad.
  - In early 2005, assets of the GPF were 78 percent of GDP.
  - Fiscal guidelines (adopted in 2001; effective 2002) specify the non-oil central government structural deficit be 4 percent of the assets of the GPF (the assumed long-run real rate of return). Temporary deviations permitted over the business cycle or for extraordinary changes in GPF value.
  - Objectives of the guidelines: intergenerational equity (preserve the real value of assets), allow some current spending, mitigate Dutch disease effects (GPF invested abroad), and insulate the annual budget from oil price shifts while retaining fiscal stabilization role.

### Staff recommendations and concerns

- Tighten monetary stance during the year as recovery proceeds and inflationary pressures rise.
- Continue to improve communication on the inflation targeting framework and policy stance to mitigate exchange rate appreciation concerns.
- Close the gap between actual deficits and the fiscal guidelines’ 4-percent rule; adopt a medium-term fiscal plan.
- Consider higher property taxes as part of tax reform measures.
- Re-examine very high sickness and disability replacement rates; implement further administrative measures to contain program growth.
- Monitor and address rapid growth in consumer debt to mitigate financial system risks; implement FSAP/FSSA recommendations.
- Accelerate progress on reducing high levels of state ownership.

*IMF Country Report: Executive Summary (pages excerpted).*

### 4.      Inflation has been surprisingly low, in part because of structural factors. Core

### _cr05196 - 4.      Inflation has been surprisingly low, in part because of structural factors. Core

### Inflation developments and structural factors
- Core inflation has been near 1 percent, well below the inflation target, since late 2003.
- Two structural factors helped hold down prices:
  - Falling import prices, reflecting trends in world prices of some manufactures (especially electronics and clothing) and an increasing share of imports from low-price countries (principally China and India).
  - Intensified domestic competitive forces in the retail, air transportation, and telecommunication sectors, cutting margins and consumer prices.
- Chapter 1 of the selected issues paper finds import price falls reduced annual inflation by more than ½ percentage point on average since 2002.

### Recent fiscal outturns and budget projections
- Central government non-oil deficit in 2004 was 5.5 percent of GDP, somewhat higher than the budget target of 5.2 percent of GDP.
  - The 2004 slippage reflected spending overruns, notably benefits to households and transfers to local government.
- On staff calculations:
  - The structural non-oil budget deficit rose by 0.6 percent of GDP in 2004.
  - The structural non-oil budget deficit is set to rise by another ½ percent of GDP in 2005.
- For 2005 the deficit is set to narrow only very slightly as stronger economic growth and lower interest payments are offset by tax cuts in a reform package.

### Labor market, output gap, and short-term outlook
- Staff projects real mainland GDP growth of about 3¾ percent in 2005.
- Staff projects growth to slow to 3 percent in 2006.
- The budget, released in October, projects 3.1 percent for 2005; the April Consensus Forecast is 3.5 percent for 2005 and 2.6 percent for 2006.
- Three years of high growth are expected to eliminate excess capacity—staff estimates the output gap will turn positive in 2005—and inflation is projected to rise gradually.
- Risks to the outlook include:
  - Further house-price rises boosting household consumption.
  - Higher-than-expected petroleum-sector investment if oil prices remain high or rise.
  - Sharp increases in interest rates causing house-price declines (risk judged limited as debt-service burdens were below historical norms).
  - A sharp world slowdown reducing exports and oil prices.
  - Dissipation of structural factors restraining prices, which could raise inflation faster than expected.

### Monetary policy assessment and recommendations
- The mission argued that inflationary pressures were beginning to surface and Norges Bank (NB) should start withdrawing monetary stimulus during 2005.
- Rationale:
  - Closing output gap and tightening labor markets increase pressures on prices and wages.
  - Substantial falls in import and service prices appeared to have largely come to an end.
  - Low interest rates have helped fuel very high credit growth, especially to households, posing potential financial stability risks.
- NB signaled a shift toward gradual tightening; private analysts moved forward their estimate of rate increases from September to mid-year following the governor’s annual address.
- The flexible inflation-targeting framework appears to have gained credibility:
  - Surveys show medium-term inflation expectations anchored near 2.5 percent.
  - Staff analysis suggests NB targets inflation rather than output or the exchange rate.
- Transparency improvements noted:
  - NB publishes the monetary policy strategy document with the inflation report (at the beginning of the strategy period).
  - NB provides more details in the press release following policy meetings.
  - The mission suggested publishing minutes of policy meetings to enhance transparency; authorities argued against this practice.

### Fiscal rule, credibility concerns, and policy recommendations
- Key issue: persistent deviation from the 4-percent fiscal rule since its inception in 2002; the rule has never been met.
  - The mission agreed temporary deviations in 2002 and 2003 could be justified by the stock market crash and economic slowdown, but not in 2004 or 2005 given strong growth and rapidly increasing GPF.
  - Potential deviations in the 2005 budget are larger than in the 2004 budget and are expected to last until 2010 (a year later than in the 2004 budget).
- Mission recommendations:
  - Avoid slippage relative to the 2005 budget; any increases in oil revenues should be used to narrow the gap with the 4-percent rule rather than increase the non-oil deficit.
  - Use savings from unexpectedly lower spending on sickness benefits for deficit reduction.
  - Exercise restraint in the 2006 budget to ensure return to the 4-percent rule.
  - Return to the 4-percent rule sooner than envisaged in the budget to preserve medium-term fiscal credibility and avoid upward pressure on the real exchange rate.
  - Adopt a medium-term fiscal plan to buttress existing fiscal guidelines—examples of useful components include multi-year spending ceilings, deficit objectives, and concrete measures to achieve them.
- Authorities’ positions and comments:
  - Authorities acknowledged slippage was difficult to reconcile with guidelines and emphasized commitment to return to the 4-percent rule.
  - Authorities had considered a medium-term fiscal plan but decided against opening fiscal guidelines; they publish three-year fiscal projections, though not binding.
  - Authorities reported no adverse market reaction to the 2005 budget.

### Exchange rate, competitiveness, and “Dutch disease” considerations
- Wage increases have tended to outstrip those elsewhere; the real exchange rate on a unit labor cost basis has appreciated substantially in recent years.
- In 2004, the nominal exchange rate was about 33 percent overvalued compared to PPP (based on WEO data).
- Staff equilibrium current account analysis suggests the krone is undervalued by 10–25 percent.
- Evidence on “Dutch disease” effects is somewhat mixed; Chapter 3 of the selected issues paper concludes the fiscal policy framework has tended to mitigate these effects.

### 2005 tax reform package (budget measures)
- The reform package largely follows recommendations of a high-level advisory committee and aims to reduce tax arbitrage between labor and capital income.
- Key elements:
  - Lowers labor taxes.
  - Exempts companies from taxation of dividends and capital gains on shares to fulfill EEA non-discrimination requirements.
  - Reduces the wealth tax.
  - Raises the normal and reduced VAT rates by 1 percentage point, to 25 and 7 percent.
  - Reduces the VAT rate on food from 12 to 11 percent.
  - Eliminates the tax on imputed rent (increasing the advantage of housing); the committee’s recommendation to raise property taxes was not implemented.
- On an accrual basis, the reforms will reduce revenue by 0.3 percent of GDP in 2005.

### Long-term fiscal sustainability and pension reform
- The key long-term fiscal issue is the rise in spending associated with population aging.
  - Official estimates indicate aging-related spending, mainly pensions, will rise by almost 10 percent of GDP by 2050.
  - On current estimates the return from petroleum wealth will fall short of covering this increase, even if the 4-percent rule is followed.
- Pension reform:
  - The mission emphasized the importance of adopting the government’s pension reform package in the year under review.
  - The size of the projected increase in pension spending mainly reflects the immaturity of the system: many current pensioners did not contribute for the 40 years needed to qualify for full benefits, and they are being replaced by those who did.
  - Demographics are not particularly adverse: by 2050 the UN estimates the old-age dependency ratio will rise by 17 percentage points in Norway (compared to 24 percentage points in western Europe, 15 percentage points in Sweden, and 16 percentage points in Denmark).
  - According to OECD data, replacement rates are slightly below the OECD average (68.7 percent for an average earner).

*Source: _cr05196 - 4.      Inflation has been surprisingly low, in part because of structural factors. Core*

### 18.      The proposed reform package would cut long-term outlays, while the provisions

### 18.      The proposed reform package would cut long-term outlays, while the provisions 

### Pension Reform: measures and fiscal impact
- Key cost-cutting reforms proposed by the government (based on Pension Commission recommendations):
  - Relating pension benefits to lifetime income instead of the best 20 years.
  - Linking pension payments to life expectancy.
  - Indexing pensions to the average of wages and prices instead of wages.
- Expected effects:
  - Improve actuarial fairness and work incentives (including later retirement).
  - Strengthen long-term fiscal discipline by linking the GPF and pensions in the budget (presenting developments in the GPF and the National Pension Fund in relation to pension obligations).
- Pension Commission estimate:
  - Reforms would improve the fiscal balance by 2–3 percent of GDP by 2050.
  - Authorities estimate about two-thirds of the reduction is due to improved work incentives, including later retirement.
- Mission recommendations to make measures more effective:
  - (i) realigning the replacement rates of the disability program with those of the new pension replacement rates for those choosing to retire early,
  - (ii) phasing out the substantial government subsidy to early retirement programs.
- Note: Disability and early pension replacement rates are now roughly equal, but the reform would reduce the latter.

### Pension financing shortfall (authorities and staff analysis)
- If the 4-percent rule is followed:
  - GPF assets could rise to 145 percent of GDP in 2050.
  - This is almost 70 percentage points higher than today.
- However:
  - The rise in pension spending would outstrip the extra income from the GPF by some 4 percent of GDP.
- Table figures (Pension Financing Shortfall; In percent of trend mainland GDP):
  - Pension expenditure without the reform: 9.8 (2005) and 19.4 (2050); Change 9.7
  - 4 percent of GPF: 3.1 (2005) and 5.8 (2050); Change 2.7
  - Savings from reform proposal: 3.0
  - Remaining financing gap: 4.0
  - Memorandum item: GPF assets: 77.4 (2005) and 145.0 (2050); Change 67.6
- Mission and authorities agreed:
  - Linking the GPF to pensions could help insulate it from political spending pressures.
  - Emphasized importance of continuing to invest the funds abroad to avoid “Dutch disease” effects.

### Financial system: soundness and risks
- Overall assessment:
  - Norway’s financial system is well managed, well supervised, and sound overall.
  - FSAP found Norwegian banks well positioned with sound capital positions, strengthened risk management practices, and improved profitability.
  - Insurance and pensions sectors reinforced financial positions; life insurance companies and pension funds remain susceptible to adverse market movements.
- Household debt concerns:
  - Rising household debt may become an increasingly important risk factor over time.
  - Overall debt servicing costs relative to incomes are not currently high by historical standards but are expected to rise.
  - Distribution of debt and household asset buffers indicate some groups (such as the young) are more vulnerable.
  - A sharp rise in interest rates—especially if coupled with significant declines in house prices or in household incomes and employment—could hurt the banking sector.
  - Main transmission mechanism may be higher mortgage interest payments squeezing households, causing a fall in demand and raising business-sector credit risk.
- Payments system and supervision:
  - Main payments system and supervisory arrangements compare very favorably with international standards.
  - Unified financial supervision provided by the Financial Services Authority (FSA) with adequate de facto powers.
  - FSAP recommended a number of measures (see Box 4).

### FSAP: key recommendations (summary)
- Shorter-term stability-related issues:
  - Continue carefully monitoring the evolution of household debt and the housing market; examine whether banks have concentrations of exposures to more vulnerable sub-groups of household borrowers.
  - Given the reduced risk weighting of mortgages under Basel II, carefully consider whether additional capital requirements for banks should be required under “Pillar 2.”
  - Monitor risk of spillovers from two-tier payments arrangements and examine scope for increasing use of collateral in interbank market exposures.
  - Further reduce market and liquidity risks in securities settlement and retail payments systems.
  - Continue working with other Nordic authorities on cross-border crisis management and coordination of last-resort lending; domestically, ensure coordinated contingency plans for a major problem at the largest, partly state-owned bank, DNB-NOR.
- Structural and longer-term issues:
  - Reexamine key aspects of the deposit guarantee arrangements, including international comparability in coverage levels.
  - Examine whether netting of medium and smaller-sized interbank payments could be phased out.
  - Review continued desirability of state ownership in DNB-NOR; in interim, consider entrenching appropriate commercial autonomy and accountability for the bank.

### Financial sector indicators (selected exact figures from Table 5 and text)
- Central Bank international reserves (end of period, in billions of U.S. dollars): 23.4, 19.1, 23.8, 27.9, 23.5, 32.4, 37.7, 44.3
- Gross public debt (end of period): 27.5, 26.2, 26.8, 30.0, 29.2, 36.1, 44.9, 44.9
- 3-month T-bill yield (eop, nominal, in percent per annum): 3.7, 7.9, 5.6, 7.2, 6.9, 6.8, 2.4, 1.8
- Housing price index (percentage change; end of period): 10.8, 6.8, 18.6, 9.8, 7.7, 2.8, 4.1, 10.5
- Credit from domestic sources (percentage change; end of period): 10.2, 8.3, 8.3, 12.4, 9.8, 8.7, 11.0, 13.2
- Household debt (in percent of disposable income less the return on insurance claims): 125.8, 124.5, 127.7, 132.4, 145.1, 144.9, 154.4, 164.5
- Private non-financial enterprise debt (in percent of cash surplus): 500.5, 547.2, 603.1, 664.9, 618.4, 657.8, 662.1, 568.4
- Capital adequacy ratios, non-performing loans, credit growth, returns on assets and equity: indicators show capital adequacy remains adequate, non-performing loans reduced, credit growth picking up, and improving profitability in 2004.

### Structural issues: labor market, welfare programs, and product markets
- Sickness and disability programs:
  - These programs have expanded substantially in the past decade, reducing available labor input.
  - Outlays of the National Insurance Scheme were 13.5 percent of GDP in 2004.
  - Hours lost to sickness fell last year, probably reflecting tighter medical examinations beginning in July, 2004, but the fall was small relative to past increases.
  - Mission concerns and recommendations:
    - Review very high replacement rates—100 percent for the sickness program.
    - Tighter administrative controls.
    - Authorities suggested raising the share of employers’ contributions to the sickness scheme to discourage firms from shifting employees into the scheme.
- Wage bargaining and labor market flexibility:
  - Mission argued that further decentralizing wage bargains would enhance economic efficiency; narrow wage dispersion may impede labor reallocation and blunt incentives to accumulate human capital.
  - Authorities argued decentralization should be part of a wider reform package to avoid intensifying pressure for wage increases and macroeconomic imbalances.
  - A committee was reconsidering the 1977 employment protection law to allow more flexibility; new legislation was expected to be approved by the fall.
- Product markets and state ownership:
  - Competition law was strengthened and aligned with relevant EU law; Competition Authority active in several sectors.
  - Public ownership remains very high, including in commercial enterprises.
  - Mission argued state ownership in the commercial sector should be reduced to avoid the perception of an uneven playing field and to allow buyouts and takeovers.

### External trade and aid
- Norway has a liberal external trade regime.
- In Doha Development Agenda, Norway seeks:
  - Improve market access for non-agricultural products through comprehensive tariff reductions.
  - Further liberalize services.
  - Substantially reduce fisheries subsidies.
  - Narrow scope for protectionism under the Anti-Dumping Agreement.
- Agriculture:
  - Agricultural products produced in Norway remain heavily protected.
  - Mission reiterated advice to lower these barriers; authorities cite non-trade concerns (rural settlement, environment, food security).
- ODA:
  - Norway’s ODA for 2005 is expected to be about 1 percent of GNI, exceeding the UN target of 0.7 percent of GNI.

### Consultation frequency and surveillance
- Authorities expressed interest in a less frequent consultation cycle (moving from 12-month to 18- or 24-month) to redeploy Fund resources.
- Staff noted possibility of adopting less work-intensive procedure under current guidelines (shorter biennial discussions with concluding statement, smaller teams, shorter staff reports, lapse-of-time conclusion by the Board).

### Staff appraisal: macro outlook and policy guidance
- Economic performance:
  - Norwegian economy continues to perform well; growth picked up strongly in 2004 and expected to continue robustly.
  - Employment picking up; unemployment rate began to edge down.
  - Core inflation well below the 2.5 percent inflation target.
- Monetary policy:
  - Supportive monetary stance appropriate given very low inflation; gradual withdrawal of monetary stimulus should begin during the year.
  - Structural factors holding prices down are waning; next two-year wage settlement being negotiated in 2006 makes it important to keep inflationary pressures in check.
  - As Norges Bank raises interest rates, pressures for currency appreciation likely to intensify; steady and gradual policy tightening with good communication would mute the size of appreciation.
- Inflation-targeting framework:
  - Flexible inflation targeting and floating exchange rate serving Norway well; transparency and credibility improving.
  - Authorities should continue to enhance communication, emphasize that exchange rate is not an independent policy target, and build on recent transparency measures (publish monetary policy strategy at beginning of strategy period; provide more detailed discussion of interest rate decisions).
- Fiscal policy:
  - Broadly prudent and helped mitigate Dutch disease, but recurring deviations from the key fiscal rule should be corrected sooner than currently envisaged.
  - Overruns relative to the 4-percent rule in 2004 and especially 2005 are difficult to justify and could undermine credibility if repeated or increased.
  - Recommendations for 2005 and 2006:
    - Avoid slippage relative to the budget in 2005.
    - Use any windfalls from higher oil prices to narrow the gap with the 4-percent rule.
    - Use lower-than-expected outlays on the sickness program to cut the deficit.
    - Use the 2006 budget to recover ground lost in 2005.

*Source: _cr05196 - 18.      The proposed reform package would cut long-term outlays, while the provisions*

### 32.      The fiscal guidelines should be buttressed by a medium-term fiscal plan. Key

### _cr05196 - 32.      The fiscal guidelines should be buttressed by a medium-term fiscal plan. Key

### Medium-term fiscal plan and fiscal rule
- Key components recommended: spending ceilings, deficit objectives, and concrete measures to achieve them.
- A medium-term plan would be particularly useful to map out a specific and credible path for returning to the 4-percent rule.
- Building blocks already in place:
  - The Ministry of Finance has begun publishing multi–year fiscal projections.
  - The government has adhered to its policy of holding spending growth below GDP growth.
- Revised budget timing: the fiscal rule is to be met in 2008, rather than 2010 in the original budget.

### Tax reform
- The 2005 tax reforms:
  - Are welcomed for promising to reduce distortions and promote employment.
  - Have resulted in housing becoming even more favored than before; this issue needs to be addressed in the next round of reforms.
- Further tax reform should be accompanied by corresponding spending restraint to:
  - Hasten the return to the 4-percent fiscal rule.
  - Ensure preservation of the GPF for future generations.

### Pension reform and long-term implications
- The government’s proposed pension reforms are commendable: they will help contain cost increases while safeguarding adequate standards of living for the retired.
- Expected benefits:
  - Improved work incentives, sustaining the tax base and easing financial strain on the pension program.
- Complementary reforms recommended as soon as possible:
  - Align disability and early retirement replacement rates.
  - Withdraw public subsidies from early retirement programs.
- Linking the GPF to pensions will help protect it from spending pressures.
  - To avoid “Dutch disease” effects, the policy of investing the assets abroad should be continued.
- Fully resolving the pension problem will require sustained effort beyond the current reforms; development of necessary policies should begin as soon as possible.

### Labor market and social programs
- Norway’s labor market performs well.
- Risks and concerns:
  - Expanding sickness and disability programs threaten to undermine the labor force and are burdening public finances.
  - The decline in hours lost to sickness in 2004 is encouraging but may not be sustained.
- Recommended actions:
  - Further tightening of administrative controls to ensure only those truly sick or disabled qualify.
  - Re-examination of the very high replacement rate.

### Product markets, competition, and state ownership
- Progress welcomed:
  - Increase in competitive forces and modernization of the competition law.
- Remaining issues:
  - State ownership remains high; perception of an uneven playing field persists.
  - State ownership precludes normal takeovers, limiting a mechanism of corporate governance.
- Recommendations:
  - Further deregulation.
  - Vigorous action by the strengthened Competition Authority.
  - Greater progress on privatization of state-owned commercial enterprises.
  - Recent efforts to ensure such enterprises are run on a purely commercial basis are welcome.

### Financial sector and FSAP recommendations
- FSAP conclusion: the financial system is sound and well supervised but offered recommendations to ensure continued strong performance.
- Identified risk: rapid rise in household debt, which will become an increasing risk factor over time.
- Authorities are monitoring developments closely; financial stability analyses and publications are exemplary.
- Recommendation: implement the recommendations in the accompanying FSSA as soon as possible.

### Trade policy and official development aid
- Norway’s trade regime is generally quite liberal.
- Concern: high agricultural trade barriers should be reduced.
  - Global distortions are minor, but cost to Norwegian consumers (higher prices, limits on choice) is significant.
- Norway’s commitment to official development aid exceeds the UN target of 0.7 percent of GDP.

### Article IV consultation timing
- Proposal: next Article IV consultation with Norway to be held on the standard 12-month cycle.
- Subject to continued favorable economic conditions, staff would envisage reduced Board documentation and propose conclusion of the consultation on a lapse-of-time basis.

### Appendix I — Long-run fiscal sustainability: overview and technical assumptions
- Main long-run pressures:
  - Declining petroleum revenues and rising pension costs over the next four decades will increasingly threaten long-run sustainability.
  - Government net cash flow from petroleum products is projected to begin to decline in the next few years, and to dwindle to about 1 percent of GDP after 2050.
  - Pension expenditure projected to rise from 9¾ percent of GDP today to about 19½ percent of GDP in 2050.
- Technical assumptions:
  - Historical data from official sources; fiscal data from the central government budget (cash basis).
  - Deviation from the 4-percent fiscal rule in the 2005 budget is assumed to be closed by policies in addition to those considered in these simulations.
  - Non-oil revenues assumed constant in relation to GDP at their 2005 level; non-pension expenditures likewise (except in final simulation).
  - Potential growth rate of GDP assumed to be 2¼ percent.
  - Real return on the GPF assumed to be 4 percent.
  - Baseline assumes the 2005 budget oil projection; that is, the price in 2005 is about $37 per barrel.
  - Alternative oil price scenario: $47 a barrel, consistent with the spring 2005 World Economic Outlook.

### Appendix I — Simulation results (financing gap scenarios)
- Definition: financing gap = available flow of government revenue less pension expenditure; available revenue = non-oil revenue less non-pension expenditure + expected return (4 percent) on the GPF. A non-negative financing gap means pensions are affordable; a negative gap is not sustainable.
- Simulation 1 (no pension reform):
  - Financing gap would turn negative before 2020 and rise to about 7 percent of GDP by 2050.
  - (Figure 2, point A)
- Simulation 2 (with government’s current reform proposal):
  - Financing gap would turn negative in 2030 and rise to about 4 percent of GDP by 2050.
  - (Figure 3, point B)
- Simulation 3 (reform proposal + higher oil prices, spring WEO):
  - Financing gap does not turn negative until 2038 and is only about 2 percent of GDP in 2050.
  - (Figure 3, point C)
- Simulation 4 (path for lower non-pension spending to stave off negative gap until 2050, assuming current reforms and current WEO oil prices):
  - One such path: annual growth rate of real non-pension expenditure of 1.6 percent from 2006 to 2015, and of 2.25 percent (that is, trend GDP growth) thereafter.
  - Even in this case, the gap turns negative after 2050.
  - (Figure 4, point D)

### Appendix II — Fund relations and selected fiscal statistics (as of early 2005)
- Membership: Joined 12/27/45; Article VIII.
- Quota: 1,671.70 SDR Million = 100.00 percent of quota.
- Fund holdings of currency: 1,122.51 SDR Million = 67.15 percent.
- Reserve position in Fund: 549.19 SDR Million = 32.85 percent.
- SDR Department net cumulative allocation: 167.77 SDR Million = 100.00 percent; holdings 205.61 SDR Million = 122.55 percent.
- Exchange rate arrangement: krone classified as an independent float after adoption of an inflation targeting regime on March 29, 2001.

### Supplementary information: Revised 2005 budget and pension agreement (June 1, 2005)
- The supplement presents information on the revised 2005 budget (released on May 13) and an agreement on pension reform concluded on May 26.
- The new information does not change the staff appraisal.
- Underlying assumption changes for 2005:
  - Revised budget assumes real mainland GDP growth to be ½ percentage point higher than in the original 2005 budget and incorporates significantly higher oil prices, implying higher net petroleum revenue.
- 2004 outturn:
  - Central government non-oil budget deficit in 2004 revised from 5.5 percent of GDP to 6.1 percent of GDP, mainly owing to downward revisions to non-oil revenues of ½ percent of GDP.
  - Non-oil structural budget balance remained largely unchanged, at 4.5 percent of GDP.
  - Spending revised down by 0.1 percent of GDP.
  - Oil revenues revised downward by 0.3 percent of GDP.
- Changes for 2005 (revised vs. original):
  - Higher oil prices result in an appreciably larger overall budget surplus (including petroleum revenues).
  - The non-oil budget deficit is expected to remain little changed, at Nkr 74 billion or 5.4 percent of GDP.
  - An Nkr 4.8 billion (0.6 percent of GDP) decline in non-oil revenues expected to be almost exactly offset by a decline in expenditures, mainly due to a reduction in transfers to households.
  - Compared with the 2004 outturn, the revised 2005 non-oil deficit is expected to narrow by 0.7 percent of GDP, while the structural non-oil budget deficit will rise by ¼ percent of GDP.
  - Non-oil revenues expected to remain unchanged in percent of GDP as strong economic growth offsets declines in tax revenues attributable to net tax cuts.
  - Non-oil expenditures expected to decrease by 0.7 percent of GDP owing to reductions in government consumption and benefits to households, partly offset by an increase in transfers to local governments.

*International Monetary Fund — Staff Report for the 2005 Article IV Consultation (Supplementary Information), June 1, 2005*

### 6.      Higher oil prices and the higher overall budget

### 6.      Higher oil prices and the higher overall budget

### Higher oil prices and Government Petroleum Fund (GPF) growth
- Higher oil prices and the higher overall budget surplus will result in more rapid growth in the Government Petroleum Fund, compared to what is assumed in the original budget (the solid line versus the dashed line in the accompanying figure).
- Since in 2005–08, the structural non-oil central government deficits are assumed to be little changed (the shaded bars versus the striped bars)—that is, the extra oil revenues are to be saved, not spent—the deviation from the fiscal rule would disappear in 2008, two years earlier than in the original budget.
- After 2008, the relevant deficit follows the 4-percent rule.
- The policy of saving the extra oil revenues rather than spending them accords with the recommendations in the staff appraisal.
- Note: The fiscal rule sets the structural non-oil central government deficit to 4 percent of the assets of the GPF. The two lines in the text figure are 4 percent of the projected assets of the GPF.

### Fiscal rule and structural non-oil deficits (selected indicators from tables)
- Fiscal rule reference: Corresponds to 4 percent of GPF.
- Central government (budget definition) — Revenues and balances (in percent of mainland GDP, staff projections as of March 2005; fiscal projections based on the revised 2005 budget, published on May 13, 2005):
  - Revenues: 65.0 (2001), 57.0 (2002), 56.2 (2003), 57.1 (2004), 60.4 (2005), 58.7 (projection for 2006)
  - Of which: Non-oil revenues: 41.9 (2001), 41.7 (2002), 40.8 (2003), 40.1 (2004), 39.8 (2005), 39.8 (projection for 2006)
  - Expenditures: 44.3 (2001), 48.2 (2002), 47.6 (2003), 47.6 (2004), 47.0 (2005), 46.7 (projection for 2006)
  - Overall balance: 20.7 (2001), 8.8 (2002), 8.6 (2003), 9.5 (2004), 13.4 (2005), 12.0 (projection for 2006)
  - Of which: Non-oil balance: -0.1 (2001), -5.1 (2002), -5.3 (2003), -6.1 (2004), -5.3 (2005), -5.1 (projection for 2006)
  - Structural non-oil balance: -2.3 (2001), -3.2 (2002), -4.0 (2003), -4.5 (2004), -4.7 (2005), -4.8 (projection for 2006)
- General government financial balance (national accounts definition):
  - Balance: 17.7 (2001), 11.6 (2002), 9.5 (2003), 14.8 (2004), 18.9 (2005), 17.3 (projection for 2006)
  - Of which: Non-oil balance: -0.5 (2001), -3.9 (2002), -6.5 (2003), -5.3 (2004), -4.8 (2005), -4.6 (projection for 2006)
- Government Petroleum Fund (memorandum item, in percent of GDP):
  - 40.6 (2001), 39.8 (2002), 54.2 (2003), 60.0 (2004), 70.9 (2005), 83.4 (2006), 96.8 (2007), 108.2 (2008), 117.5 (2009), 124.1 (2010)
- Net public assets (in billions of krone, memorandum):
  - 1,097.5 (2001), 1,082.8 (2002), 1,308.2 (2003), 1,470.2 (2004), 1,763.3 (2005)
- Nominal GDP (in billions of krone):
  - 1,526.2 (2001), 1,519.1 (2002), 1,561.9 (2003), 1,685.6 (2004), 1,832.9 (2005)
- Nominal mainland GDP (in billions of krone):
  - 1,167.2 (2001), 1,212.6 (2002), 1,246.1 (2003), 1,307.5 (2004), 1,387.4 (2005)

### Pension reform (Parliament decision, May 26)
- Parliament agreed a pension reform which largely follows the government’s proposal. Key reform elements:
  - Benefits will be indexed to the simple average of wages and prices, rather than wages as now.
  - Benefits will be adjusted for life expectancy.
  - Benefits will be based on lifetime earnings.
  - The 40-year cap on insurable earnings will be abolished.
- Differences from the government proposal:
  - Benefits will be relatively higher for lower income workers, compared to the government’s proposal.
  - The flexible retirement age was not adopted; it will be the subject of further study regarding its interaction with early retirement schemes.
- Expected effects and recommendations:
  - These measures will help to ease the future pension burden.
  - It will be important to adopt the flexible retirement provisions to increase beneficial labor supply effects.
  - Such effects would be further enhanced by withdrawing tax support for early retirement and ensuring that disability and retirement benefits are aligned.
- Second pillar (occupational) pensions:
  - It was agreed to establish mandatory minimum requirements for second pillar pensions, beginning on January 1, 2006.
  - The broader second pillar system will help to diversify retirement income, relieving some of the burden from the public scheme.

### Selected macroeconomic projections and indicators (extracts)
- GDP (annual percent change): 2.7 (2001), 1.1 (2002), 0.4 (2003), 2.9 (2004), 3.7 (2005), 2.8 (2006 projection)
- Mainland GDP (annual percent change): 2.1 (2001), 1.4 (2002), 0.7 (2003), 3.5 (2004), 3.8 (2005), 3.0 (2006 projection)
- Unemployment (percent of labor force): 3.5 (2001), 3.9 (2002), 4.5 (2003), 4.5 (2004), 4.0 (2005), 4.0 (2006 projection)
- Consumer prices (annual percent change): 3.0 (2001), 1.3 (2002), 2.5 (2003), 0.4 (2004), 1.4 (2005), 2.1 (2006 projection)
- Exports of goods and services (annual percent change): 5.0 (2001), -0.8 (2002), 1.6 (2003), 1.3 (2004), 4.0 (2005), 2.6 (2006 projection)
  - Of which: Oil and gas exports: 8.8 (2001), 1.9 (2002), -0.6 (2003), 0.9 (2004), 2.8 (2005), 1.1 (2006 projection)
- Current account balance (in percent of GDP): 15.4 (2001), 12.8 (2002), 12.8 (2003), 13.7 (2004), 16.2 (2005), 14.9 (2006 projection)
  - Of which: Non-oil balance: -5.2 (2001), -5.3 (2002), -5.1 (2003), -6.3 (2004), -6.0 (2005), -6.0 (2006 projection)

*IMF staff estimates and projections as presented in the source document.*

### 1.75 percent for over a year—high oil prices, rising house prices, strengthening consumer and

### _cr05196 - 1.75 percent for over a year—high oil prices, rising house prices, strengthening consumer and

### Executive Board assessment — summary findings and recommendations
- Commended Norway’s strong fiscal and monetary policy framework and success in avoiding adverse effects of oil wealth.
- Welcomed economic recovery since 2004; noted robust growth and low unemployment underpinned by an accommodative monetary stance, rapid credit expansion, and high world oil prices.
- Observed that core inflation has been well below the 2.5 percent target rate for some time, reflecting slack from the 2002–03 downturn and structural factors (falling prices for some imports due to a shift toward low-cost countries; falling prices for some domestic services due to increased competition).
- Agreed expansion would continue into next year and beyond, barring a downturn in the world economy or a large drop in oil prices.
- Supported the flexible inflation targeting regime and welcomed refinements (publishing monetary policy strategy document at the beginning of the strategy period; expanded discussion of interest rate decisions) to enhance transparency.
- Recommended a gradual and measured withdrawal of monetary stimulus during the year, noting:
  - Slack in labor and product markets is diminishing.
  - Structural factors holding prices down may be waning.
  - Labor markets could become overheated in 2006 when two-year wage bargains are concluded.
  - Monetary tightening could put upward pressure on the currency, but that does not justify continued expansionary policy.
- Commended fiscal guidelines that set the non-oil central government structural budget deficit equal to an assumed long-run real return of 4 percent of Government Petroleum Fund assets.
  - Welcomed revised 2005 budget using extra oil revenues to reduce the non-oil deficit and bringing forward the date when fiscal guidelines are achieved to 2008.
  - Emphasized need for continued fiscal restraint, especially in run-up to elections, to address projected costs of population aging.
  - Warned that further breaching of the fiscal rule could damage fiscal credibility; called for complying with fiscal guidelines as quickly as possible.
  - Most Directors recommended reinforcing guidelines with a medium-term fiscal plan, building on existing multi-year projections and ceilings for spending growth.
- Welcomed 2005 tax reform (eliminating some distortions, promoting employment) but noted remaining weaknesses—particularly bias in favor of residential investment—and that spending restraint will be needed to offset expected adverse revenue effects.
- Noted rising pension costs as major long-term fiscal threat; welcomed parliamentary decision to adopt much of government’s pension reform package and urged adoption of flexible retirement age provisions; agreed Government Petroleum Fund should continue to be invested abroad.
- Welcomed Financial System Stability Assessment (FSSA) conclusion that financial system is sound, competitive, and well-managed; commended strong financial supervision and Nordic coordination.
  - Recommended implementing FSSA reforms to ensure continued financial-sector strength.
  - Cautioned that continued rapid credit expansion and rising household debt could pose increasing risks; urged close monitoring of credit developments.
- Recommended tightening administrative controls and reconsideration of very high replacement rates to check expansion of sickness and disability programs.
- Welcomed new competition law and increased competition in product markets; urged sustained momentum and vigorous action by competition authority.
- Considered further privatization beneficial given still-high state ownership, while recognizing policies to ensure state-owned enterprises operate on a commercial basis.
- Welcomed Norway’s generous development assistance and support for multilateral trade liberalization; encouraged reduction of still-high barriers to agricultural imports.

### Economic outlook and near-term projections
- Factors that contributed to the pickup in activity: high oil prices, rising house prices, strengthening consumer and business confidence, and an improved world economy.
- Outlook for 2005 and 2006 described as promising, with most propulsive factors expected to continue.
- Growth likely to fall off somewhat in 2006 as very high petroleum investment levels may not be sustained and expectation that central bank will begin to tighten policy.
- With the output gap closing and structural factors holding prices down waning, inflation is set to begin to rise.
- Wage increases so far in 2005 described as moderate; unemployment rate has edged down only gradually.
- Non-oil fiscal deficit has widened somewhat on a structural basis over past two years despite strong growth; pressures to spend more petroleum revenue are strong.
- 2005 budget foresaw a deviation from fiscal rule setting central government non-oil structural deficit at 4 percent of assets of the GPF, despite higher oil prices and therefore larger stock of assets than expected last year.

### Monetary policy — Norges Bank stance and recommendations
- Norges Bank’s key rate (the sight deposit rate) has been kept at 1.75 percent since March 2004.
- Staff and authorities judged supportive monetary stance appropriate given very low inflation.
- Advice: start gradual withdrawal of monetary stimulus in the course of the year.
- Real interest rates described as low.
- Inflation Report formulation for horizon: “Norges Bank sets the interest rate with a view to stabilizing inflation at the target within a reasonable time horizon, normally 1-3 years.”
- Executive Board (Norges Bank) considered raising the interest rate at the May 25 meeting but did not do so, given prospects of continued low inflation for a period ahead and to avoid deviating from market expectations.
- Monetary policy strategy updated to publish the strategy document at the beginning of the strategy period and to provide detailed discussion of interest rate decisions (including considered interest rate options).

### Fiscal policy framework and recommendations
- Fiscal framework aims at a non-oil deficit that over time equals expected real return of the Government Petroleum Fund, estimated at 4 percent.
- Guidelines allow transitory deviations over the business cycle and for extraordinary large changes in Fund value.
- Structural deficit has been larger than 4 percent of the Government Petroleum Fund for some years, partly due to weak asset prices in 2002 and adverse cyclical conditions.
- Authorities and staff agree spending of petroleum revenues should move toward the 4 percent track as cyclical conditions improve.
- Government proposed slightly reducing structural deficit in 2005 budget revision; given present oil price forecasts, a constant structural deficit in years ahead would align spending with expected return on the Fund in 2008.
- Staff argues for introduction of a medium-term fiscal plan (e.g., multi-year spending ceilings) to support fiscal guidelines; authorities note medium-term budget projections have been added and should be evaluated before moving to a binding expenditure rule.
- Fiscal rule sets sustainable path for non-oil structural deficit; spending must adjust as population ages—pension reform is important but must be supplemented by additional spending restraint or increased revenues to ensure long-run sustainability.

### Pension reform
- Parliament (Storting) reached agreement on pension reform on May 26; maintains important proposals from White Paper on National Insurance Scheme.
- Reform will strengthen link between contributions and benefits, strengthen elderly work incentives, and increase pension system financial sustainability.
- Need for further analysis before final decision on flexible retirement scheme; must clarify interaction between Contractual Early Retirement Scheme and National Insurance Scheme.
- Agreement changes link between pre-retirement earnings and pension entitlements toward a more compressed structure: lower replacement rates for higher incomes and higher rates for low incomes.
- Employers required to provide supplementary occupational pensions meeting minimum standards.
- For public sector occupational pension scheme, compensation ratio of two thirds of final pay to be kept unchanged; adjustments to include new life expectancy divisor and changed indexation supported.
- Further measures beyond current proposal will be needed to ensure long-term sustainability.

### Tax reform
- 2005 budget included first step of a three-year tax reform to reduce tax arbitrage between labor and capital income and address potential conflict with EEA obligations.
- Reform aims to make work more profitable and simplify tax system by scaling back allowance schemes and special provisions.
- Reform elements:
  - Lower marginal tax rates on labor income.
  - Increased marginal tax rate on share income exceeding a risk-free rent.
  - Increased taxation of share income combined with reduction of the wealth tax.
  - Government promised to halve the wealth tax by 2007, with aim of elimination subsequently.
- Tax on imputed rent from housing abolished from 2005.
- Government proposed tax reform accompanied by net tax cut over 2005–2007 corresponding to almost 0.8 percent of GDP in 2003.
- 2005 changes partly financed by a 1 percentage point rise in normal and reduced VAT rates.
- Staff noted the reform eliminates some distortions and promotes employment but that spending restraint will be needed to offset expected adverse revenue effects; remaining bias in favor of residential investment noted.

### Structural policy and product markets
- Large number of structural reforms implemented over last two decades to improve efficiency of financial and product markets; recent focus on production of public services.
- Further deregulation on the agenda in some sectors; Government proposed full liberalization of postal market as of January 1, 2007.
- Product market deregulations have reached a stage where active competition policy application may be more needed than large sector reforms.
- New competition law came into force last year; further steps to strengthen competition policy noted.
- Government shares view that state ownership in commercial sector should be reduced; privatization pursued gradually and pragmatically.
- Staff recommended reviewing desirability of state ownership in DnB-NOR.

### Financial system and FSSA findings
- FSSA concluded the Norwegian financial system is well managed, well supervised, sound, competitive, and well-managed overall.
- Authorities take note that rising household debt levels are a risk factor and that combination of guaranteed-return products and low interest rates is a challenge for pension providers.
- Staff concluded Kredittilsynet has operational independence; recommended increasing delegated powers to help ensure effective operational independence in future.
- Staff recommended formalizing coordination among Norges Bank, Kredittilsynet, and Ministry of Finance; authorities noted constitutional constraints and limited appropriateness of contractual arrangements under current system.
- Staff recommended reviewing key parameters of bank deposit insurance arrangements; government maintains current system is well designed and will take EU/EEA discussions into account.
- Directors cautioned that continuation of rapid credit expansion and rising household debt could pose increasing risks and urged close monitoring of credit developments.

### Selected economic indicators and staff projections (annual percent change unless stated)
- Private consumption: 2001 1.8; 2002 3.0; 2003 3.0; 2004 4.3; 2005 proj. 4.5; 2006 proj. 4.0
- Public consumption: 2001 5.8; 2002 3.7; 2003 1.4; 2004 2.0; 2005 proj. 1.8; 2006 proj. 1.8
- Gross fixed investment: 2001 -0.7; 2002 -1.0; 2003 -2.0; 2004 8.9; 2005 proj. 10.0; 2006 proj. 5.0
- Export of goods and services: 2001 5.0; 2002 -0.8; 2003 1.6; 2004 1.3; 2005 proj. 4.0; 2006 proj. 2.6
  - Of which: Oil and gas: 2001 8.8; 2002 1.9; 2003 -0.6; 2004 0.9; 2005 proj. 2.8; 2006 proj. 1.1
- Import of goods and services: 2001 0.9; 2002 0.7; 2003 2.2; 2004 9.0; 2005 proj. 7.9; 2006 proj. 5.0
- GDP: 2001 2.7; 2002 1.1; 2003 0.4; 2004 2.9; 2005 proj. 3.7; 2006 proj. 2.8
- Mainland GDP (excludes petroleum and ocean shipping): 2001 2/ 2.1; 2002 1.4; 2003 0.7; 2004 3.5; 2005 proj. 3.8; 2006 proj. 3.0
- Unemployment (percent of labor force): 2001 3.5; 2002 3.9; 2003 4.5; 2004 4.5; 2005 proj. 4.0; 2006 proj. 4.0
- Consumer prices: 2001 3.0; 2002 1.3; 2003 2.5; 2004 0.4; 2005 proj. 1.4; 2006 proj. 2.1
- Wages (in full-time equivalents): 2001 4.8; 2002 5.7; 2003 4.5; 2004 3.8
- Nominal effective exchange rate: 2001 2.9; 2002 8.8; 2003 -3.3; 2004 -2.1
- Broad money, M2 (end of period): 2001 9.3; 2002 8.3; 2003 1.9; 2004 7.6
- Domestic credit (end of period): 2001 9.7; 2002 8.9; 2003 6.8; 2004 8.8
- Three-month interbank rate (period average): 2001 7.4; 2002 7.1; 2003 4.3; 2004 2.2
- Ten-year government bond yield (period average): 2001 6.2; 2002 6.4; 2003 5.0; 2004 4.4

### Public finances (percent of mainland GDP; budget definition and staff projections)
- Central government revenues: 2001 65.0; 2002 57.0; 2003 56.2; 2004 57.1; 2005 proj. 60.4; 2006 proj. 58.7
  - Of which: Non-oil revenues: 2001 41.9; 2002 41.7; 2003 40.8; 2004 40.1; 2005 proj. 39.8; 2006 proj. 39.8
- Central government expenditures: 2001 44.3; 2002 48.2; 2003 47.6; 2004 47.6; 2005 proj. 47.0; 2006 proj. 46.7
- Central government overall balance: 2001 20.7; 2002 8.8; 2003 8.6; 2004 9.5; 2005 proj. 13.4; 2006 proj. 12.0
  - Of which: Non-oil balance: 2001 -0.1; 2002 -5.1; 2003 -5.3; 2004 -6.1; 2005 proj. -5.3; 2006 proj. -5.1
- Structural non-oil balance: 2001 -2.3; 2002 -3.2; 2003 -4.0; 2004 -4.5; 2005 proj. -4.7; 2006 proj. -4.8
- General government financial balance: 2001 17.7; 2002 11.6; 2003 9.5; 2004 14.8; 2005 proj. 18.9; 2006 proj. 17.3
  - Of which: Non-oil balance (general government): 2001 -0.5; 2002 -3.9; 2003 -6.5; 2004 -5.3; 2005 proj. -4.8; 2006 proj. -4.6
- Current account balance: 2001 15.4; 2002 12.8; 2003 12.8; 2004 13.7; 2005 proj. 16.2; 2006 proj. 14.9
  - Of which: Non-oil balance: 2001 -5.2; 2002 -5.3; 2003 -5.1; 2004 -6.3; 2005 proj. -6.0; 2006 proj. -6.0

### Statement highlights from Executive Director Jon A. Solheim (June 3, 2005)
- Authorities broadly concur with staff analysis.
- Mainland economy pickup since second half of 2003; employment has picked up but slower than GDP growth; sick leave rose substantially in recent years but fell appreciably through 2004, negatively affecting labor demand.
- EU enlargement increased labor immigration; seasonally adjusted unemployment rate was 4.5 percent in Q1 2005.
- Inflation continues low but expected to pick up; wage growth declined since 2002 (3.6 percent in 2004) and expected to decline further in 2005.
- In 2005, mainland growth expected well above trend driven by household demand, housing starts, and petroleum sector investment; upswing becoming more broadly based with improved export and manufacturing outlook; mainland fixed business investment stronger than expected.
- Growth in Mainland Norway GDP expected to slow further out reflecting projected fall in oil sector investment and gradually higher interest rates.
- Authorities note staff’s view that supportive monetary stance appropriate; Norges Bank’s March 2004 decision keeps sight deposit rate at 1.75 percent and the Bank’s view that a gradual rise in interest rates after a period is appropriate.
- Authorities note monetary strategy publication and transparency measures; monetary policy strategies drawn up every four months and published in Inflation Report.
- On fiscal policy, authorities reiterate guideline that non-oil deficit should over time equal expected real return of Government Petroleum Fund (4 percent) and stress gradual phasing to avoid Dutch disease.
- Authorities agree spending should move toward 4 percent track; revision of 2005 budget slightly reduced structural deficit; given oil price forecasts, a constant structural deficit would align spending with expected Fund return in 2008.
- Authorities note medium-term budget projections have been added and should be evaluated before specific moves toward binding expenditure rules.
- On pension reform, Storting agreement maintains important White Paper proposals; further analysis needed on flexible retirement scheme and interaction with early retirement schemes.
- Authorities support reduction of state ownership over time and note privatization pursued gradually; DnB-NOR ownership desirability review noted by staff.
- Authorities accept FSSA view that system is sound; take note of rising household debt risks and pension provider challenges; note constitutional constraints on formal delegation and contractual arrangements for financial stability coordination.
- Authorities open to longer Article IV consultation cycle; prefer 18- or 24-month cycle.

*Source: IMF staff report and Executive Board assessment as presented in the provided content unit.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05196.pdf_