## _cr07196

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### Executive Summary — Background and Outlook
- Real GDP growth was 4.6 percent in 2006 and has been above potential (estimated at 2½–3 percent) for 3 years.
- Core inflation was about 1 percent in 2006 and ticked up to 1.5 percent in March.
- Factors driving activity: strong external demand; high world prices for petroleum products (Norway was the world’s fifth largest oil exporter in 2006); supportive monetary conditions; somewhat expansionary fiscal stance.
- Labor costs have been moderate due to labor inflows from the new EU member countries, a substantial cyclical increase in the participation rate, strong productivity growth, low inflation, and the credible inflation targeting framework.
- Policy task: ensure continued noninflationary growth and long-term fiscal sustainability amid rising demand pressures and population aging.

- Authorities and staff agreed growth will remain strong, though moderating somewhat.
- April Consensus Forecast: real GDP growth is 3.7 percent in 2007 and 2.8 percent in 2008.
- Expected dynamics:
  - Strong employment and wages should help sustain consumption.
  - Rising interest rates expected to slow house-price increases and ease residential investment growth.
  - Petroleum investment growth expected to fall off its 2006 peak.
- Risks:
  - Unexpected changes to oil prices or world growth would affect incomes, investment, and exports.
  - Rapid credit growth—total credit has doubled since end-1999—may continue to fuel expansion and poses risks to households and banks.
  - Capacity constraints and reduced labor inflows could cause inflation to rise faster than projected.

### Monetary Policy — Assessment and Guidance
- Authorities and staff agreed further interest rate increases were needed to head off inflationary pressures.
- Underlying measures of inflation are still below the inflation target, but staff analysis suggests core inflation may be underestimating underlying inflationary pressures.
- Norges Bank (NB) stepped up the pace of interest rate increases and in its March 2007 Monetary Policy Report raised slightly its interest rate forecast.
- Mission judgment:
  - Monetary conditions have tightened substantially but remain somewhat expansionary.
  - Exchange rates not apparently misaligned.
  - Real interest rates calculated using expected (rather than actual) inflation were still below NB’s estimated neutral band of 2½ to 3½ percent.
  - Nominal interest rates were below what Taylor rules would suggest.
- Credibility and communication:
  - Surveys suggest medium-term inflation expectations remain anchored at 2.5 percent.
  - Staff argued for continued efforts to explain inflation targeting, including the monetary policy transmission mechanism.
- Noted tension: some private-sector interlocutors favored exchange rate stability; mission emphasized meeting the inflation target even if this meant some short-term krone appreciation.

### Financial System — Soundness and Risks
- Banks remain well capitalized and profitable, with low nonperforming loans and loan losses.
- NB’s December Financial Stability report suggests banks have capital to absorb large interest-rate shocks, although some would need to shore up their capital.
- International ratings of several banks, including the largest bank, have been upgraded.
- Implementation: The bulk of the recommendations of the 2005 FSAP have been implemented.
- Risks and vulnerabilities:
  - Prolonged rapid credit growth, steep house-price increases, and increasingly aggressive mortgage lending practices pose increasing risks.
  - Household debt (including that of young and poorer households) has risen sharply and stands at historically high levels.
  - More than 90 percent of mortgages carry floating interest rates.
  - Lending to nonfinancial enterprises has picked up sharply.
  - NB’s December Financial Stability report suggests house prices are some 10 percent above what could be explained by fundamentals (report stresses uncertainty).
  - Equity prices on the Oslo Stock Exchange have more than tripled since the beginning of 2003.
- Supervision and capital rules:
  - FSAN is closely monitoring credit developments and urging more cautious mortgage lending practices.
  - Rising proportions of mortgages carry floating-rates, interest-only payments, and very high loan-to-value ratios (sometimes exceeding 100 percent).
  - Five Norwegian banks approved to use IRB under Basel II face EU restriction not to reduce capital below 95 percent, 90 percent, and 80 percent of Basel I requirements in 2007, 2008, and 2009, respectively.
  - FSAN estimates Norwegian banks using IRB can reduce their capital under Basel II by 35–45 percent because mortgages constitute large shares of their assets.
  - FSAN argued scope for raising capital requirements is limited because foreign banks could switch from subsidiaries to branches.

### Fiscal Policy — Short-term Stance and Medium-term Outlook
- Staff welcomed that the relevant fiscal deficit would, for the first time, be 4 percent of Government Pension Fund (GPF) assets.
- Agreement: the deficit should be held below this benchmark until demand pressures ease.
- Short-term recommendations:
  - The 2007 budget outturn will most probably achieve the 4-percent rule, but the fiscal stance will nevertheless be somewhat expansionary.
  - The budget implies a central government non-oil structural deficit only marginally greater than 4 percent of the GPF.
  - Staff estimates the general government non-oil structural budget deficit is set to rise by about ½ percent of GDP in 2007.
  - Given the cyclical situation, any budgetary overperformance in 2007 should be used for deficit reduction.
  - Budgets for 2008 and beyond should aim for deficits well below 4 percent of the GPF until demand pressures ease.

- Medium-term and long-term projections under the 4-percent rule (staff estimates and projections):
  - GPF assets are expected to peak at 240 percent of mainland GDP in 2022 and gradually decline thereafter.
  - The non-oil deficit allowed by the rule peaks at 9½ percent of mainland GDP in 2023 and declines toward zero thereafter.
  - The key long-term fiscal issue is rising spending related to population aging; petroleum wealth will probably not cover these costs.
  - The 2007 budget projects pension spending will rise by about 10 percentage points of GDP by 2060.
  - Staff calculations suggest that, on current policies and projections, in 2060 income from the GPF will cover only about 2 percentage points of this gap.
  - Absent pension reform, large cuts in nonpension spending or tax increases would be required.

- Medium-term fiscal debate and recommendations:
  - With oil prices much higher than in 2001, the 4-percent rule implies the structural deficit will rise by some ¾ percent of GDP each year.
  - Staff argued tax cuts would promote growth, but authorities announced the ratio of revenue to GDP will be maintained at its 2004 level.
  - In the absence of tax cuts, real government spending (using the GDP deflator) could rise by some 4 percent a year.
  - Mission reiterated advice to adopt a medium-term plan to guide policy and reduce the risk of waste.
  - Authorities noted a spending ceiling might conflict with current fiscal guidelines; finance ministry already produces three-year fiscal projections.

### Pension Reform — Agreed Package and Remaining Gaps
- Parliament agreed a reform package to be implemented by 2010 with key features:
  - benefits based on lifetime earnings instead of the best 20 years;
  - benefits adjusted for life expectancy;
  - individual benefits actuarially neutral, with replacement rate depending on retirement age:
    - 26 percentage points lower for retirement at 62 (rather than 67);
    - 24 percentage points higher for retirement at 70;
  - benefits indexed to the simple average of wages and prices (minimum pension indexed to wages);
  - pensioners can work without loss of pension;
  - compared to the 2004 white paper proposals, low and medium-income households will receive somewhat more generous pensions.
- Authorities estimate the package would reduce pension outlays by about 3 percent of GDP by 2050.
- Mission concerns:
  - The agreed package would probably not ensure pension-system solvency (leaving a gap of more than 4 percent of GDP by 2060); further reform should be considered.
- Implementation issues:
  - Early retirement scheme (AFP) should be reformed; authorities will invite social partners to dialogue on AFP revision.
  - Disability pension benefits must be aligned with the overall system; a commission is to report on disability pensions in the first half of 2007.
  - Occupational pension schemes supplementing the public pension system were made mandatory for enterprises starting in 2006.

### Structural Policy — Labor Market, Sickness/Disability, and SOEs
- Labor market performance:
  - High employment and participation rates; low unemployment.
  - Influx of immigrants has moderated wage growth and eased monetary conditions.
- Sickness and disability:
  - Growing sickness and disability schemes identified as high priority.
  - Inclusive Workplace Agreement (since 2001, extended to end-2009) improved practices but did not meet targets for lower sickness inflows.
  - Administrative reform in 2004 reduced days lost; sick leave began to increase at end-2005.
  - A commission proposed new financial and accelerated activation measures; measures to be implemented in the year.
  - Mission endorsed OECD proposals: rigor in assessment, more frequent use of partial disability, enhanced responsibility of employers and employees, intensified rehabilitation, and reduction of generous replacement rates (notably sickness replacement at 100 percent).
- State-owned enterprises (SOEs):
  - Governance of the large state-owned sector is strong; recent reforms emphasized arms-length management, market-driven objectives, and transparency via explicit contracts.
  - Authorities benchmark SOE performance and plan no further privatization, citing public ownership benefits for long-term development and control over natural resources.
  - Mission noted state ownership can distort competition and suggested privatization could be appropriate in some cases.

### External Position and Exchange Rate
- Overall current account has a large surplus; the non-oil current account deficit has narrowed slightly despite increased imports of investment goods because of improving terms of trade.
- Exchange rate:
  - On a range of indicators, the exchange rate seems broadly appropriate.
  - Norway does not intervene in the exchange market.
  - The krone has been broadly stable in nominal effective terms and against the euro, although it has appreciated somewhat against the dollar.
  - In real terms it has appreciated on a unit labor cost basis, but is not far from its long-term average on a consumer price basis.
  - Purchasing power parity calculations suggest the krone is overvalued (Dutch disease effects), while staff CGER cross-country estimates suggest undervaluation due to investing petroleum revenue abroad.

### Data and Statistics
- Data are adequate for surveillance and in some instances very strong by international comparison.
- Recommended improvements: an improved labor force survey and an establishment survey to enhance analysis of labor market developments.
- Institutional note: collection of financial sector data moved from NB to Statistics Norway (SN).

### Financial Stability — Credit Growth, Housing, and Asset Markets (Detailed)
- Prolonged rapid credit growth, steep house-price increases, and increasingly aggressive mortgage lending practices pose increasing risks.
- Household debt to GDP series (1999−2006): 97.1, 112.4, 115.4, 117.1, 123.5, 132.8, 146.5, 152.5.
- More than 90 percent of mortgages carry floating interest rates; a rise in interest rates or an economic slowdown would rapidly affect borrowers.
- House prices have risen rapidly; NB’s December Financial Stability report suggests they are some 10 percent above fundamentals.
- Equity prices on the Oslo Stock Exchange have more than tripled since the beginning of 2003.

### Staff Appraisal — Key Messages and Recommendations
- Overview:
  - Norwegian economy entering fourth consecutive year of above-trend growth; wage and price inflation subdued; exchange rate broadly in line with fundamentals.
  - Two strong macro policy pillars: inflation targeting and fiscal guidelines.
- Emerging inflationary pressures and overheating risks:
  - Indicators point to mounting underlying inflationary pressures as mainland economy expected to grow strongly in 2007.
  - Credit and house-prices rising rapidly; credit expansion has moved beyond households into business borrowing.
  - Capacity utilization is high; labor markets tightened with near record employment growth and plunging unemployment.
- Monetary policy recommendation:
  - NB should continue to raise interest rates, pace depending on developments; tightening may cause temporary krone appreciation.
  - Continue public explanation of inflation-targeting framework.
- Financial sector recommendation:
  - FSAN should continue close monitoring; ensure banks remain well capitalized and provisioned; maintain sound lending practices and high asset quality.
- Fiscal policy recommendation:
  - 2007 mid-term budget review should seize opportunities to reduce the deficit.
  - 2008 and subsequent budgets should aim for deficit materially below 4 percent of the GPF until excess demand dissipates.
  - Tax cuts would be welcome for supply-side effects; adopt explicit medium-term fiscal framework (many elements already exist).
- Long-term challenge and pensions:
  - Implementation of parliamentary pension reform without delay; further reforms likely needed for long-term sustainability.
- Labor market and social programs:
  - Continue administrative reforms; reconsider high replacement rates to improve incentives to return to work.
- Product markets and SOE governance:
  - Maintain strong enforcement of competition laws; consider further privatization where appropriate.
- Data recommendation:
  - Expand labor force survey sample to publish monthly estimates; institute establishment survey.

### Article IV Scheduling
- It is proposed that the next Article IV consultation be held on a 24-month cycle.

### Macroeconomic Projections and Key Aggregates (Selected IMF staff projections as of March 2007)
- Real economy (change in percent, selected series 2002–08):
  - Private consumption: 3.1, 2.8, 5.6, 3.3, 4.3, 4.0, 3.2.
  - GDP: 1.5, 1.0, 3.9, 2.7, 2.9, 2.8, 3.6.
  - Mainland GDP: 1.4, 1.3, 4.4, 4.5, 4.6, 3.8, 2.7.
  - Consumer prices: 1.3, 2.5, 0.4, 1.6, 2.3, 0.8, 2.5.
- Balance of payments (percent of mainland GDP):
  - Current account balance: 15.7, 15.4, 16.4, 20.8, 23.0, 18.9, 21.5.
  - Non-oil balance: -6.5, -6.5, -8.4, -8.5, -8.7, -9.4, -9.5.
- Fiscal and public finance (selected series 2002–07):
  - Central government revenues (percent of mainland GDP): 56.4, 54.9, 55.1, 59.5, 63.7, 60.9, 64.1.
  - Central government overall balance (percent of mainland GDP): 8.7, 8.4, 9.2, 14.6, 19.9, 16.3, 19.5.
  - Government Pension Fund—Global (GPF) assets (percent of GDP, sample series): 49.4, 66.4, 74.6, 96.1, 114.1, 135.6, 153.8, 170.6 (projections and tables report series).
- Key financial soundness indicators (1999−2006 series):
  - Regulatory capital to risk-weighted assets: 12.0, 12.1, 12.6, 12.1, 12.4, 12.2, 11.9, 11.2.
  - Regulatory Tier 1 capital to risk-weighted assets: 9.3, 9.1, 9.7, 9.6, 9.7, 9.8, 9.6, 8.5.
  - Nonperforming loans to total gross loans: 1.3, 1.2, 1.3, 1.8, 1.6, 1.0, 0.7, 0.6.
  - Loans to Households as percent of total loans: 56.7, 56.0, 56.7, 58.2, 60.5, 64.4, 63.8, 61.5.
  - Household debt to GDP: 97.1, 112.4, 115.4, 117.1, 123.5, 132.8, 146.5, 152.5.
  - Net public assets (billions of NKr): 1,082.8, 1,309.3, 1,508.6, 1,943.0, 2,347.1, 2,745.2 (2002–07 series in Table 9).

### Revised 2007 Budget, Growth, and Monetary Policy (May 15, 2007)
- Growth in mainland Norway forecast at 3.7 percent in 2007.
- Unemployment rate expected to decline from an average of 3.4 percent in 2006 to 2½ percent in 2007.
- Norges Bank’s Executive Board assessed the key policy rate should be in the interval 4 – 5 percent in the period to the next Monetary Policy Report (June 27, 2007).
- March Monetary Policy Report suggested raising the interest rate gradually to about 5 percent in the course of 2007 and to a somewhat higher level by summer 2008.
- Staff estimates: by end-2009 households’ debt may exceed 230 percent of disposable income (Norges Bank projection noted).
- Authorities’ fiscal position and stance:
  - Revised Fiscal Budget for 2007: structural, non-oil deficit somewhat lower than in the approved budget and NOK 3.5 billion (0.2 percentage points) below the expected 4 percent real return on the fund.
  - Proposed revised budget implies a structural, non-oil budget deficit at 4.3 percent of mainland trend GDP, 0.6 percentage point higher than in 2006.
  - Authorities agree 2008 and subsequent budgets should aim for a deficit below 4 percent of the GPF until excess demand dissipates.

### Updated Fiscal Tables and Scenarios (Revised 2007 Budget Basis)
- Fiscal rule: central government structural non-oil deficit = 4 percent of GPF assets (with temporary deviations allowed).
- Selected structural non-oil balance series (percent of mainland GDP, projection samples):
  - Structural non-oil balance (based on 4-percent rule): -3.2, -3.6, -3.5, -3.6, -3.6, -4.2, -5.2, -5.7, -6.2 (table series).
  - Alternative updated series: -3.2, -3.6, -3.5, -3.6, -3.6, -4.2, -5.3, -6.0, -6.6.
  - 4 percent of GPF assets series: -2.0, -1.9, -2.5, -2.8, -3.6, -4.4, -5.2, -5.7, -6.2 (and alternative updated: -2.0, -1.9, -2.5, -2.8, -3.6, -4.4, -5.3, -6.0, -6.6).
- GPF assets (percent of mainland GDP) example series: 49.4, 66.4, 74.6, 96.1, 114.1, 134.2, 146.9, 160.1, ...
- Oil price assumption (NKr) example series: 197.9, 204.4, 254.1, 343.5, 411.8, 370.0, 358.0, 334.6, 323.0.
- WEO-based scenario series also provided for comparison (selected entries reported).

### IMF Executive Board Assessment — Summary of Policy Advice
- Commendations:
  - Strong rules-based monetary and fiscal frameworks and prudent management of oil wealth; high transparency of the GPF.
- Monetary policy:
  - Directors considered further gradual increases appropriate given demand pressures; recommended allowing assessment of effects and new information.
- Fiscal policy:
  - Directors emphasized continued fiscal restraint; recommended adoption of an explicit medium-term fiscal framework.
- Pension reform:
  - Welcomed parliamentary agreement; urged quick implementation and complementary reforms to early retirement and disability schemes.
- Financial sector:
  - Urged FSAN to ensure banks remain well capitalized and provisioned; monitor credit expansion, house prices, and aggressive lending practices.
- Labor market and social protection:
  - Recommended further measures to reduce sickness and disability inflows and review high replacement rates.
- Product markets and SOEs:
  - Stressed need to maintain a level playing field and consider privatization where appropriate; urged strong enforcement of competition laws.

*Source: Executive Summary and selected excerpts, _cr07196 — IMF staff report and informational annex for the 2007 Article IV Consultation (May 2007).*

### Executive Summary

### Executive Summary

### Background
- Real GDP growth has been above potential (estimated at 2½–3 percent) for 3 years, and was 4.6 percent in 2006.
- Core inflation was about 1 percent in 2006 and ticked up to 1.5 percent in March.
- Factors driving activity: strong external demand; high world prices for petroleum products (Norway was the world’s fifth largest oil exporter in 2006); supportive monetary conditions; somewhat expansionary fiscal stance.
- Labor costs have been moderate, reflecting labor inflows from the new EU member countries, a substantial cyclical increase in the participation rate, strong productivity growth, low inflation, and the credible inflation targeting framework.
- The task for policymakers: ensure continued noninflationary growth and long-term fiscal sustainability amid rising demand pressures and population aging.

### Outlook
- Authorities and staff agreed growth will remain strong, though moderating somewhat.
- April Consensus Forecast: real GDP growth is 3.7 percent in 2007 and 2.8 percent in 2008.
- Expected dynamics:
  - Strong employment and wages should help sustain consumption.
  - Rising interest rates expected to slow house-price increases and ease residential investment growth.
  - Petroleum investment growth expected to fall off its 2006 peak.
- Risks:
  - Unexpected changes to oil prices or world growth would affect incomes, investment, and exports.
  - Rapid credit growth may continue to fuel expansion—total credit has doubled since end-1999—but poses risks to households and banks.
  - Capacity constraints and reduced labor inflows could cause inflation to rise faster than projected.

### Monetary Policy
- Authorities and staff agreed that further interest rate increases were needed to head off inflationary pressures.
- Underlying measures of inflation are still below the inflation target, but staff analysis suggests core inflation may be underestimating underlying inflationary pressures.
- Norges Bank (NB) recently stepped up the pace of interest rate increases and in its March 2007 Monetary Policy Report raised slightly its interest rate forecast.
- Mission judgment:
  - Monetary conditions have tightened substantially but remain somewhat expansionary.
  - Exchange rates not apparently misaligned.
  - Real interest rates calculated using expected (rather than actual) inflation were still below NB’s estimated neutral band of 2½ to 3½ percent.
  - Nominal interest rates were below what Taylor rules would suggest.
- Credibility:
  - Surveys suggest medium-term inflation expectations remain anchored at 2.5 percent.
  - Staff argued for continued efforts to explain inflation targeting, including the monetary policy transmission mechanism.
- Noted tension: some private-sector interlocutors favored exchange rate stability, which could conflict with strict inflation targeting; mission emphasized meeting the inflation target even if this meant some short-term krone appreciation.

### Financial System
- The financial sector is thriving: banks remain well capitalized and profitable, with low nonperforming loans and loan losses.
- NB’s Financial Stability Report suggests banks have capital to absorb large interest-rate shocks, although some would need to shore up their capital.
- Recently, international ratings of several banks, including the largest bank, have been upgraded.
- Implementation: The bulk of the recommendations of the 2005 FSAP, which found the financial system sound and well supervised, have been implemented.
- Risks: rising risks associated with rapid loan expansion.

### Fiscal Policy
- Staff welcomed that the relevant fiscal deficit would, for the first time, be 4 percent of Government Pension Fund (GPF) assets.
- Agreement: the deficit should be held below this benchmark until demand pressures ease.
- To manage increasing petroleum revenues, staff recommended tax cuts rather than spending increases; current policy is to keep the revenue-GDP ratio at the 2004 level.
- Staff recommended a medium-term fiscal framework, although the authorities viewed the existing fiscal guidelines as fulfilling this role.
- Fiscal framework in place since 2002:
  - Fiscal guidelines hold the central government structural non-oil deficit to 4 percent of the assets of the Government Pension Fund-Global (GPF).
  - The 4-percent rule has never been met, but the guidelines have restrained deficits, insulated the budget from oil-market shocks, resulted in the bulk of petroleum revenues being saved, and restrained the increase in real exchange rates that would have resulted had revenues been spent instead.

### Structural Policy and Labor Markets
- Staff welcomed recent parliamentary agreement on pension reform and the intention to pursue complementary reforms; staff argued further reform should be considered to ensure long-term fiscal sustainability.
- Norwegian labor markets perform well, but the growing sickness and disability schemes were identified as a high priority.
- The mission argued for continued aggressive enforcement of competition law.
- Recommendation: maintain the strong governance system for state-owned enterprises and consider further privatization.
- Labor inflows:
  - Influx of immigrants widely believed to have moderated wage growth, allowing for easier monetary conditions.
  - Labor inflows from new EU member countries are large but not well measured; nonresident immigrants who work for six months or less, or commute across the border every day, are excluded from some data.

### External Position
- Overall current account has a large surplus; the non-oil current account deficit has narrowed slightly despite increased imports of investment goods because of improving terms of trade.
- Exchange rate:
  - On a range of indicators, the exchange rate seems broadly appropriate.
  - Norway does not intervene on the exchange market.
  - The krone has been broadly stable in nominal effective terms and against the euro, although it has appreciated somewhat against the dollar.
  - In real terms it has appreciated on a unit labor cost basis, but is not far from its long-term average on a consumer price basis.
- Purchasing power parity calculations suggest the krone is overvalued, reflecting some Dutch disease effects, while staff cross-country estimates using the CGER methodology suggest undervaluation, reflecting mitigation of those effects by the policy of investing petroleum revenue abroad.

### Data and Statistics
- Data are adequate for surveillance, and in some instances very strong by international comparison.
- Recommended improvements: an improved labor force survey and an establishment survey to enhance analysis of labor market developments.

*Source: Executive Summary, _cr07196 - Executive Summary.*

### 11.      However, prolonged rapid credit growth, the steep rise in house prices, and

### 11.      However, prolonged rapid credit growth, the steep rise in house prices, and

### Financial stability: credit growth, housing, and asset markets
- Prolonged rapid credit growth, steep house-price increases, and increasingly aggressive mortgage lending practices pose increasing risks.
- Household debt (including that of young and poorer households) has risen sharply and stands at historically high levels.
- Much of the increase has been in mortgages; historically mortgages have had low default rates, but:
  - More than 90 percent of mortgages carry floating interest rates.
  - A rise in interest rates or an economic slowdown would rapidly affect borrowers.
- Lending to nonfinancial enterprises has more recently picked up sharply.
- House prices have risen rapidly; NB’s December Financial Stability report suggests they are some 10 percent above what could be explained by fundamentals (the report stresses uncertainty of these calculations), posing a risk of correction.
- Equity prices on the Oslo Stock Exchange have more than tripled since the beginning of 2003, reflecting high oil prices and strong profits in the cyclical upswing.

### Supervision, mortgage lending practices, and bank capital
- The Financial Supervisory Authority (FSAN) is closely monitoring credit developments and urging more cautious mortgage lending practices.
- The mission expressed concern that lenders seemed increasingly aggressive, with rising proportions of mortgages carrying:
  - floating-rates;
  - interest-only payments; and
  - very high loan-to-value ratios (sometimes exceeding 100 percent).
- Authorities noted Norway does not have a “sub-prime” market and that loan losses are very low; some new instruments reflect catch-up to practices elsewhere.
- FSAN argued its scope for raising capital requirements was limited because foreign banks could switch from subsidiaries (supervised by FSAN) to branches (which are not), blunting the effect of such measures.
- The five Norwegian banks approved to use the internal ratings based (IRB) approach under Basel II are, according to the EU Directives, not allowed to reduce their capital to less than 95 percent, 90 percent, and 80 percent of that required under Basel I in 2007, 2008, and 2009, respectively.
- Because mortgages constitute large shares of their assets, Norwegian banks using IRB can reduce their capital under Basel II by 35–45 percent, according to FSAN estimates.

### Fiscal policy stance and short-term recommendations
- The 2007 budget outturn will most probably achieve the 4-percent rule, but the fiscal stance will nevertheless be somewhat expansionary.
- The budget implies a central government non-oil structural deficit only marginally greater than 4 percent of the GPF, but staff estimates the general government non-oil structural budget deficit is set to rise by about ½ percent of GDP in 2007.
- Given the cyclical situation, the mission argued any budgetary overperformance in 2007 be used for deficit reduction.
- Budgets for 2008 and beyond should aim for deficits well below 4 percent of the GPF until demand pressures ease; this is consistent with the fiscal guidelines, which explicitly allow for countercyclical policy.
- The authorities agreed countercyclical policy would be wise, but judged it too soon to assess windfalls in the year or discuss details of the 2008 budget.

### Medium-term fiscal outlook and the 4-percent rule
- With oil prices much higher than in 2001 (when the guidelines were set), the 4-percent rule implies the structural deficit will rise by some ¾ percent of GDP each year.
- One response could be to shift to a more restrictive fiscal rule to limit near-term spending rises and provide more long-term resources for population aging; neither authorities nor staff argued for such a change given the success of current guidelines.
- Within the guidelines, staff argued tax cuts would promote growth, but the authorities announced the ratio of revenue to GDP will be maintained at its 2004 level.
- In the absence of tax cuts, real government spending (using the GDP deflator) could rise by some 4 percent a year.
- The mission reiterated advice to adopt a medium-term plan to guide policy and reduce the risk of waste.
- Authorities noted a spending ceiling might conflict with current fiscal guidelines and revenue policy; the finance ministry already produces three-year fiscal projections.

### Fiscal projections, GPF dynamics, and long-term risks
- Under the 4-percent fiscal rule and the 2007 budget oil-price and recovery assumptions:
  - GPF assets are expected to peak at 240 percent of mainland GDP in 2022 and gradually decline thereafter.
  - The non-oil deficit allowed by the rule peaks at 9½ percent of mainland GDP in 2023 and declines toward zero thereafter.
- The key long-term fiscal issue is the rise in spending related to population aging; petroleum wealth will probably not cover these costs.
  - The 2007 budget projects pension spending will rise by about 10 percentage points of GDP by 2060.
  - Staff calculations suggest that, on current policies and projections, in 2060 income from the GPF will cover only about 2 percentage points of this gap.
  - The fiscal guidelines imply spending from petroleum wealth will rise (as percent of GDP) until the early 2020s and then gradually decline.
- In the long term, absent pension reform, large cuts in nonpension spending (including any build-up during the deficit expansion) or tax increases would be required.

### Pension reform: agreed package and remaining gaps
- Parliament agreed a package of reforms promising significant long-term budgetary savings; staff urged quick implementation.
- Key features of the agreed reform package (to be implemented by 2010):
  - benefits based on lifetime earnings instead of the best 20 years;
  - benefits adjusted for life expectancy;
  - individual benefits actuarially neutral, with the replacement rate depending on retirement age:
    - 26 percentage points lower for retirement at 62 (rather than 67);
    - 24 percentage points higher for retirement at 70;
  - benefits indexed to the simple average of wages and prices, rather than to wages as now (a minimum pension will be indexed to wages);
  - pensioners can work without loss of pension;
  - compared to the 2004 white paper proposals, low and medium-income households will receive somewhat more generous pensions.
- Authorities estimate the package would reduce pension outlays by about 3 percent of GDP by 2050, largely reflecting the life-expectancy adjustment and the change to indexation.
- Actuarial neutrality is designed to encourage later retirement, potentially raising general tax revenues (an effect not included in the cost-saving estimate).
- Occupational pension schemes supplementing the public pension system were made mandatory for enterprises starting in 2006.
- The mission argued the agreed package would probably not ensure pension-system solvency (leaving a gap of more than 4 percent of GDP by 2060), and therefore further reform should be considered.
- Implementation issues highlighted:
  - Early retirement scheme (AFP), run by social partners but subsidized by government, should be reformed; authorities will invite social partners to dialogue on AFP revision.
  - Disability pension benefits must be aligned with the overall system, especially indexation; a commission is to report on disability pensions in the first half of 2007.

### Structural policy: labor market, sickness/disability, and SOEs
- The Norwegian labor market performs very well by international standards, but rising enrollment in disability and sickness programs poses a risk and is imposing a significant fiscal burden.
- The Inclusive Workplace Agreement (since 2001, extended to end-2009) led to better practices in some enterprises but did not meet targets for lower sickness inflows.
- Administrative reform of the sickness program in 2004, with stricter medical examinations, led to declines in days lost; at end-2005 sick leave began to increase.
- A commission, headed by the Prime Minister, suggested new financial and accelerated activation measures to reduce sickness absence; measures are to be implemented in the year.
- Authorities noted the new Public Employment and Welfare Service, combining three welfare agencies, will promote a more integrated and efficient approach.
- The mission endorsed OECD proposals:
  - rigor in assessing potential beneficiaries;
  - more frequent use of partial disability;
  - enhancing responsibility of employers and employees;
  - intensified rehabilitation efforts; and
  - reduction of generous replacement rates, especially for sickness (with a 100 percent replacement rate) and for some disability groups.
- Governance of the large state-owned sector is strong; recent reforms emphasized arms-length management, market-driven objectives, and transparency via explicit contracts.
- Authorities benchmark SOE performance and find they perform well; they have no plans for further privatization, arguing public ownership ensures long-term development and control over natural resources.
- The mission noted state ownership could be distorting by:
  - causing competitors to perceive SOEs as having government deep-pocket advantages, dissuading expansion or entry; and
  - leaving SOEs not subject to market discipline of takeover.
- The mission suggested privatization would be appropriate in some cases.

*Source: IMF staff report excerpt (pages covering credit growth, financial stability, fiscal policy, pension reform, and structural policy).*

### 19.      Domestic competition is improving, and the Competition Authority (CA) has

### 19.      Domestic competition is improving, and the Competition Authority (CA) has

### Staff appraisal — overview
- The Norwegian economy is entering its fourth consecutive year of above-trend growth.
- Wage and price inflation have been remarkably subdued.
- The exchange rate seems broadly in line with fundamentals.
- Two strong macroeconomic policy pillars underpin performance: inflation targeting and the fiscal guidelines.
- Demand has been boosted and supply constraints eased by:
  - supportive monetary conditions following the 2002-03 slowdown;
  - an expansionary fiscal stance;
  - high world prices for petroleum products and other Norwegian exports and much weaker prices for imported goods;
  - labor inflows, especially from the new EU member countries;
  - increased competition and productivity in some domestic sectors.

### Emerging inflationary pressures and overheating risks
- Indicators point to mounting underlying inflationary pressures as the mainland economy is expected to grow strongly again in 2007.
- Credit and house-prices have been rising rapidly for some time.
- Credit expansion has moved beyond households with a sharp pick-up in business-sector borrowing.
- Capacity utilization is high.
- Labor markets tightened significantly in the past year:
  - near record employment growth;
  - a plunging unemployment rate;
  - increasing reports of labor shortages and, in some industries, rising wage drift.

### Monetary policy assessment
- Norges Bank’s (NB) decision to withdraw monetary stimulus, beginning in mid-2005, and the recent pick-up in the pace of interest rate increases, is welcome.
- Recommendation: Given prospective inflationary pressures, NB should continue to raise interest rates, with the exact pace depending on economic developments.
- Note: Monetary tightening may be accompanied by some temporary upward pressure on the exchange rate, described as a normal part of the monetary transmission mechanism.
- The inflation targeting framework with a flexible exchange rate is judged effective and appropriate.
- Recommendation: Authorities should continue to clearly explain the inflation-targeting framework and how it governs specific policy decisions.

### Financial sector soundness and risks
- The financial sector appears to be sound and well supervised.
- Risks identified:
  - prolonged strong credit expansion;
  - steep rise in house prices;
  - aggressive mortgage lending practices.
- These risks are especially relevant as interest rates rise or in the event of an economic slowdown.
- Recommendation: The Financial Supervisory Authority should continue close monitoring and ensure banks remain well capitalized and provisioned, maintain sound lending practices, and high asset quality.

### Fiscal policy stance and recommendations
- Fiscal policy remains prudent.
- In 2007, for the first time, the central government non-oil structural deficit is set to meet the target of 4 percent of the assets of the Government Pension Fund-Global (GPF), in line with the fiscal guidelines.
- Fiscal policy has a role in economic stabilization according to the guidelines.
- Recommendation: The 2007 mid-term budget review should seize any available opportunity to reduce the deficit.
- Recommendation: The 2008 and subsequent budgets should aim for a deficit materially below 4 percent of the GPF until excess demand dissipates to alleviate the burden on monetary policy and ease upward pressure on the real exchange rate.

### Medium-term fiscal management and structural considerations
- The fiscal guidelines have helped restrain spending but imply substantial deficit increases in the years ahead.
- Policy of saving petroleum revenues abroad has blunted “Dutch disease” effects.
- Concern: Deficit expansion under the guidelines warrants careful management.
- Recommendation: Tax cuts would be welcome for their desirable supply-side effects.
- Warning: Rapid increases in spending risk inefficient resource use and will have to be reversed beginning in the early 2020s as oil revenues wane.
- Recommendation: An explicit medium-term fiscal framework would help focus policy on medium-term considerations; many parts of such a framework already exist in Norway (notably the fiscal guidelines and the finance ministry’s multi-year budget projections).

### Long-term fiscal challenge — aging and pensions
- The most important long-term fiscal challenge is posed by the effects of population aging, expected to begin in the next decade.
- The recent broad-based parliamentary agreement on pension reform is welcome.
- Authorities intend to deal with outstanding issues, notably the early retirement scheme.
- Recommendation: Implementation of these reforms should take place without delay.
- Caution: The saving from the agreed reform will probably be insufficient to ensure long-term fiscal sustainability; further reform should be considered.

### Labor market performance and social programs
- The Norwegian labor market performs well:
  - high employment and participation rates;
  - low unemployment rates;
  - ability to absorb substantial numbers of immigrant workers.
- Risk: Sickness and disability programs pose risks.
- The merger of welfare agencies is welcome, but further administrative reforms will be required.
- Recommendation: High replacement rates should be reconsidered to sharpen beneficiaries’ incentives to return to work.

### Product markets, competition, and state ownership
- Product market performance is improving, but continuing efforts are needed to ensure strong competition.
- The governance system of the large publicly owned sector is strong and appropriate and needs to be maintained.
- Recommendation: Further privatization should be considered to ensure a level playing field and maximize benefits of competitive markets.
- Domestic competition has increased; further gains should be pursued notably through strong enforcement of competition and anti-cartel laws.

### Data, statistics, and surveillance
- Data are adequate for surveillance; transparency is very strong in some instances, including the GPF and SOEs.
- The task of collecting financial sector data was recently moved from NB to Statistics Norway (SN).
- Recommendation: Assessment of labor market conditions would be strengthened by expanding the sample size of the labor force survey to allow publication of monthly estimates, and by instituting an establishment survey to provide timely data on employment and wage developments.

*IMF staff appraisal (excerpt).*

### 31.      It is proposed that the next Article IV consultation be held on a 24-month cycle.

### _cr07196 - 31.      It is proposed that the next Article IV consultation be held on a 24-month cycle.

### Article IV scheduling
- It is proposed that the next Article IV consultation be held on a 24-month cycle.

### Growth and cyclical position
- Growth has been very strong in the past three years.
- Strong growth since 2003 has resulted in a growing positive output gap.
- Labor market and activity indicators:
  - Employed persons series rising (2000–2006 shown in thousands).
  - Unemployment rate has fallen to very low levels (plots show values falling toward 2.9 percent and below in the latest observations).
  - Vacancy rate increasing (right scale in chart reaches values up to and above 1.2 in plotted horizon).
  - Hours worked per employee in total economy have stopped falling relative to comparator countries.

### Inflation and wages
- Some measures of inflation have edged up.
- The inflation target is 2.5 percent; core inflation measures have been well below the inflation target of 2.5 percent.
- Falling import prices have contributed to low inflation for a period.
- Wages:
  - Nominal wages (12-month percent change) and real wages (12-month percent change) indicate moderation in wage costs.
  - Unit labor costs series (1992=100) shown across countries; Norway depicted relative to Denmark, Germany, Sweden.
- Inflation expectations (2-year horizon) are anchored near the target (plots show series for Experts, Employer organisations, Employee organisations with the target rate 2.5%).

### External sector and terms of trade
- Current account surpluses have surged.
- Gains in terms of trade have been substantial (Terms of Trade index, 1998=100, shows marked increase).
- Norway's market share of world exports has stopped falling (export shares by category plotted).
- Tables show:
  - Current account balance (percent of mainland GDP): 15.7, 15.4, 16.4, 20.8, 23.0 for 2002–06 (Table 2 / summary rows).
  - Net exports of oil and gas contribution in percent series (Table 1 and Table 2).

### Exchange rate developments
- Both nominal and ULC-based REER of the krone have recently drifted up.
- CPI-based REER remains close to its average for the 2000–06 period.
- Krone exchange rate series plotted vs euro and USD; NEER (2000=100) shown.

### Monetary conditions and policy stance
- Policy interest rate has been increased nine times since June 2005.
- Norges Bank kept policy rate at 1.75 percent from March 2004 to mid-2005; since then it raised the rate nine times.
- Interest rate differentials with the Euro area remain small.
- Real interest rates are still below neutral levels (plots of three-month real interest rate vs neutral rates).
- Rule-based indicators:
  - Simple monetary policy rules (Taylor rule, growth/Orphanides rule) suggest that interest rates should be higher than actual sight deposit rate.

### Financial sector performance and vulnerabilities
- Bank profitability and nonperforming loans:
  - Return on assets (after tax) in reported series around 0.4–1.0 percent in recent years (Table 4: values such as 1.0, 1.0, 0.8, 0.4, 0.6, 0.9, 0.9, 0.8).
  - Return on equity series reported (Table 4).
  - Non-performing loans to total gross loans declined to 0.6 percent (2006 Q3) from higher earlier levels.
- Credit and housing:
  - Credit growth (12-month percent change) has accelerated (series show double-digit growth in mid-2000s).
  - Mortgage lending is the main component of credit growth.
  - House Prices Index (1992 = 100) shows rapid growth; higher home prices have pushed up household debt.
  - Mortgage Loan-to-Value Ratios show a material share in high LTV buckets (Below 60%, 60-80%, 80-100%, Above 100% series).
  - Household debt to GDP series in the encouraged FSIs: household debt rose from 97.1 to 152.5 (percent of GDP) across 1999–2006 (Table 6 entries).
- Capital adequacy and margins:
  - Capital adequacy ratios are falling but remain adequate (Total capital and Tier 1 capital series).
  - Banks’ interest margins in Nordic countries have been declining.

### Fiscal position and Government Pension Fund
- Petroleum revenues ensure substantial fiscal surpluses; oil revenue has been saved abroad via the Government Pension Fund–Global (GPF).
- Fiscal balances (percent of GDP) show:
  - Central government overall balance series: 8.7, 8.4, 9.2, 14.6, 19.3, 19.1 for 2002–07 (Table 8 / summary).
  - General government financial balance series: 11.5, 9.3, 14.4, 21.6, 25.9, 24.7, 26.8 (Table 1 / summary for 2002–07).
- Government Pension Fund—Global (GPF) assets (percent of GDP) rising sharply (series reported: e.g., 49.4, 66.4, 74.6, 96.1, 114.1, 135.6, 153.8, 170.6 in projections table).
- Non-oil deficits have stabilized (non-oil balance percent of GDP series shows negative values that stabilized around -3.5 to -4.4 in recent years).

### Labor market and participation
- Employment and participation rates are high relative to comparators:
  - Employment Rate (population ages 15+) and for ages 55–64 show Norway near the top in Eurostat Q4 2006 comparisons.
  - Participation Rate (population ages 15+ and 55–64) also show Norway with high levels.

### Projections and key macro aggregates (selected, IMF staff projections as of March 2007)
- Real economy (change in percent) — selected rows from Table 1 / projections:
  - Private consumption: series include 3.1, 2.8, 5.6, 3.3, 4.3, 4.0, 3.2 for years 2002–2008 (row shows values for 2002–2008).
  - GDP: 1.5, 1.0, 3.9, 2.7, 2.9, 2.8, 3.6 for 2002–2008 (as in Table 1).
  - Mainland GDP: 1.4, 1.3, 4.4, 4.5, 4.6, 3.8, 2.7 for 2002–2008.
  - Consumer prices: 1.3, 2.5, 0.4, 1.6, 2.3, 0.8, 2.5 for 2002–2008.
- External projections (Table 2 / projections):
  - Exports of goods and services (percent of GDP) series and trade balance series indicate continued large external surpluses; current account balance projections remain very large as percent of GDP (see tabulated series: e.g., Current account balance 24.2, 27.7, 32.9, 46.7, 56.1, 48.0, 57.1, etc., in levels and percentages depending on table framing).
- Fiscal projections (Table 9 / Table 8 summaries):
  - Central government revenues and expenditures in percent of GDP and in billions of NKr shown; central government balance strong in 2005–07.

### Staff recommendations (selected, from Table 3 and Table 7)
- Monetary policy and transparency:
  - Enhance transparency of policy making.
  - Continue to explain the inflation-targeting framework to the public.
  - Move toward a neutral stance as the recovery takes hold; increase pace of withdrawal of monetary stimulus as growth and labor-market tightening warrant.
- Structural and competition policy:
  - Continue to foster competitive forces through further deregulation and vigorous action by the strengthened Competition Authority.
  - Pursue privatization (noting incumbent government had put further privatization on hold; state increased its share in energy sector via Statoil–Norsk Hydro merger in 2006).
- Welfare benefits and labor market policy:
  - Tighten administrative controls and review the very high replacement rates in sickness and disability schemes.
  - Decentralize wage bargains and reduce the tax wedge.
- Financial sector and supervision:
  - Monitor credit developments closely.
  - Implement the recommendations of the 2005 FSAP; consider more independence for FSAN.
  - Continue careful monitoring of household debt and housing market; examine banks’ concentrations of exposures to vulnerable sub-groups of household borrowers.
  - Given reduced mortgage risk weights under Basel II, consider additional requirements under "Pillar 2."
  - Continue work with Nordic authorities on cross-border crisis management and last-resort lending coordination; domestically ensure coordinated contingency plans for a major problem at the largest, partly state-owned bank, DNB-NOR.
  - Re-examine deposit guarantee arrangements and consider international comparability of coverage levels.
- Fiscal framework and taxation:
  - Adhere to fiscal guidelines and reduce upward deviation from the 4 percent rule.
  - Introduce a multiyear fiscal framework with spending ceilings.
  - Improve tax structure building on tax commission recommendations: reduce labor tax, reduce tax arbitrage opportunities, and raise tax rates on property.
- Pensions:
  - Implement the package of pension reforms proposed by the Pension Commission and agreed by political parties in 2005 (Parliament agreed main principles in May 2005 and a reform package in March 2007).

### Implementation status and institutional notes (selected)
- Monetary policy transparency has improved (governor’s appearance before parliament, publication of monetary strategy, outside evaluation).
- Norges Bank raised policy rate nine times since mid-2005; four consecutive increases in recent moves noted.
- The FSAN has urged more restrictive lending for housing purposes and continues close monitoring; implementation of many FSAP recommendations has been good, but some—such as delegating more independence to FSAN—are unlikely to be implemented under prevailing constitutional/administrative arrangements.
- Authorities are working with Nordic counterparts on cross-border crisis management; a Nordic crisis simulation planned for fall 2007.
- Securities settlement and retail payment systems are being reformed and upgraded (technical platform upgrade slated for 2008; DvP at broker level to be implemented).

### Key financial soundness indicators (selected numerical highlights from core and encouraged sets)
- Regulatory capital to risk-weighted assets: 12.0, 12.1, 12.6, 12.1, 12.4, 12.2, 11.9, 11.2 (1999−2006 series).
- Regulatory Tier 1 capital to risk-weighted assets: 9.3, 9.1, 9.7, 9.6, 9.7, 9.8, 9.6, 8.5 (1999−2006 series).
- Nonperforming loans to total gross loans: 1.3, 1.2, 1.3, 1.8, 1.6, 1.0, 0.7, 0.6 (1999−2006 series).
- Loans to Households as percent of total loans: 56.7, 56.0, 56.7, 58.2, 60.5, 64.4, 63.8, 61.5 (1999−2006 series).
- Household debt to GDP: 97.1, 112.4, 115.4, 117.1, 123.5, 132.8, 146.5, 152.5 (1999−2006 series in Table 6).
- Net public assets (billions of NKr): 1,082.8, 1,309.3, 1,508.6, 1,943.0, 2,347.1, 2,745.2 (2002–07 series in Table 9).

*International Monetary Fund — NORWAY: Staff Report for the 2007 Article IV Consultation — Informational Annex (May 10, 2007).*

### APPENDIX I: FUND RELATIONS

### APPENDIX I: FUND RELATIONS

### I. Article IV Consultation
- 2005 Article IV Consultation: Discussions held in Oslo during March 7–15, 2005. The Staff Report was considered by the Executive Board on June 3, 2005.
- 2007 Article IV Consultation:
  - Discussions held in Oslo during March 15-26, 2007.
  - Mission composition: Mr. Ford (head), Ms. Bordon, and Messrs. Gagales and Rossi; Mr. Jafarov involved in pre-mission preparation (all EUR).
  - Meetings: Ministry of Finance, Norges Bank, senior officials of other ministries and Statistics Norway, representatives of labor and business organizations, private sector analysts, and academics.
  - Participation: Mr. Bergundhaugen, Office of the Executive Director for Nordic-Baltic countries.
- Policy/statistical frameworks and obligations:
  - Norway has accepted the obligations of Article VIII, Sections 2, 3, and 4, of the Articles of Agreement.
  - Norway subscribes to the Special Data Dissemination Standard.
  - Economic statistics are satisfactory for surveillance purposes.
  - Norway is a member of the European Economic Area, providing for free movement of goods, services, labor, and capital with the European Union.
- Publication: The authorities intend to publish this report.

### II. Membership Status
- Joined 12/27/45; Article VIII

### III. General Resources Account (SDR Million and % Quota)
- Quota: 1,671.70 — 100.00%
- Fund holdings of currency: 1,534.10 — 91.77%
- Reserve position in Fund: 137.61 — 8.23%

### IV. SDR Department (SDR Million and % Allocation)
- Net cumulative allocation: 167.77 — 100.00%
- Holdings: 299.28 — 178.39%

### V. Outstanding Purchases and Loans
- None

### VI. Financial Arrangements
- None

### VII. Projected Obligations to Fund
- None

### VIII. Exchange Rate Arrangement
- Current arrangement for the krone: classified as an independent float, following adoption of an inflation targeting regime on March 29, 2001.
- Norway maintains an exchange system free of restrictions on payments and transfers for current international transactions, except for exchange restrictions maintained for security reasons that have been notified to the Fund pursuant to Decision No. 144-(51/52) (August 14, 1952).

### IX. Technical Assistance
- None (since 1998).

### X. Resident Representative
- None.

### Appendix II: Norway — Statistical Issues
- Norway maintains high standards in the provision of economic data, adequate for surveillance purposes.
- Transparency noted as very strong by international standards in some instances, including oil wealth, the GPF—Global, and SOEs.
- Data publication practices:
  - The Ministry of Petroleum and Energy and Statistics Norway regularly publish data on energy resources and activity (http://www.regjeringen.no/en/dep/oed/Documents-and-publications/Reports.html?id=35236; http://www.ssb.no/english/subjects/10/06/20/).
  - Norges Bank, manager of the GPF – Global, regularly publishes detailed (quarterly and annual) reports on the portfolio and performance of the fund (http://www.norges-bank.no/nbim/pension_fund/).
  - The Ministry of Trade and Industry regularly publishes state ownership reports (http://www.regjeringen.no/en/dep/nhd/Selected-topics/ownership/State-Ownership.html?id=382852).
- Institutional change: The task of collecting financial sector data was recently moved from NB to Statistics Norway (SN), which NB viewed as increasing its focus on its core monetary policy mission.

### Table of Common Indicators Required for Surveillance (As of April 26, 2007) — Memo Items (selected)
- Exchange Rates
  - Date of latest observation: Apr. 23, 2007
  - Date received: Apr. 24, 2007
  - Frequency of Data: D
  - Frequency of Reporting: D
  - Frequency of Publication: D
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities
  - Date of latest observation: Mar. 2007
  - Date received: Apr. 2007
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Frequency of Publication: M
- Reserve/Base Money
  - Date of latest observation: Mar. 2007
  - Date received: Apr. 2007
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Frequency of Publication: M
- Broad Money
  - Date of latest observation: Mar. 2007
  - Date received: Apr. 2007
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Frequency of Publication: M
  - Data Quality – Methodological soundness: O, O, O, LO
  - Data Quality – Accuracy and reliability: O, O, O, O, O
- Central Bank Balance Sheet
  - Date of latest observation: Mar. 2007
  - Date received: Apr. 2007
  - Frequency: M / M / M
- Consolidated Balance Sheet of the Banking System
  - Date of latest observation: Mar. 2007
  - Date received: Apr. 2007
  - Frequency: M / M / M
- Interest Rates
  - Date of latest observation: Apr. 23, 2007
  - Date received: Apr. 24, 2007
  - Frequency: D / D / D
- Consumer Price Index
  - Date of latest observation: Mar. 2007
  - Date received: Apr. 2007
  - Frequency: M / M / M
  - Data Quality – Methodological soundness: O, O, O, O
  - Data Quality – Accuracy and reliability: O, O, O, O, O
- Revenue, Expenditure, Balance and Composition of Financing – General Government
  - Date of latest observation: 2005
  - Date received: Apr. 2006
  - Frequency: A / A / A
  - Data Quality – Methodological soundness: LO, LNO, O, O
  - Data Quality – Accuracy and reliability: LO, O, O, O, LO
- Revenue, Expenditure, Balance and Composition of Financing – Central Government
  - Date of latest observation: Q4, 2006
  - Date received: Mar. 2007
  - Frequency: Q / Q / Q
- Stocks of Central Government and Central Government-Guaranteed Debt
  - Date of latest observation: Q4, 2006
  - Date received: Mar. 2007
  - Frequency: Q / Q / Q
- External Current Account Balance
  - Date of latest observation: Q4. 2006
  - Date received: Mar. 2007
  - Frequency: Q / Q / Q
- Exports and Imports of Goods and Services
  - Date of latest observation: Q4. 2006
  - Date received: Mar. 2007
  - Frequency: Q / Q / Q
  - Data Quality – Methodological soundness: O, O, O, O
- GDP/GNP
  - Date of latest observation: Q4. 2006
  - Date received: Mar. 2007
  - Frequency: Q / Q / Q
  - Data Quality – Methodological soundness: O, O, O, O
  - Data Quality – Accuracy and reliability: O, O, O, O, LO
- Gross External Debt
  - Date of latest observation: Q4. 2006
  - Date received: Mar. 2007
  - Frequency of Data: I
  - Frequency of Reporting: Q
  - Frequency of Publication: Q

(Notes from the table)
- Frequency codes: Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A), Irregular (I); Not Available (NA).
- Data quality assessments reflect the data ROSC published in July 2003, based on a mission during November 11–26, 2002. The assessments indicate whether international standards are fully observed (O), largely observed (LO), largely not observed (LNO), or not observed (NO).
- Accuracy and reliability assessments refer to standards concerning source data, statistical techniques, assessment and validation, and revision studies.

### Supplementary Information (Staff Report for the 2007 Article IV Consultation — Supplementary Information, Prepared by the European Department, Approved May 30, 2007)
- Purpose: Staff supplement reports on the Norwegian mid-term budget, released on May 15, 2007. It does not change the thrust of the staff appraisal. The PIN is attached.
- Revised 2006 fiscal estimates:
  - Central government non-oil structural deficit was only very slightly larger than 4 percent of the assets of Government Pension Fund-Global (GPF), by Nkr 0.5 billion.
  - Difference with original budget (which had indicated a larger overshooting of Nkr 7.3 billion (0.5 percent of mainland GDP)) reflects more buoyant revenue.
- 2007 projection and fiscal assessment:
  - The deficit is set to be 3.8 percent of GPF assets in 2007, which will leave it below 4 percent for the first time since the fiscal guidelines were put in effect in 2002.
  - Overperformance is in line with staff advice.
  - Rapid increase in GPF assets will make room for significant fiscal expansion, highlighting authorities’ and staff’s concern regarding increases in fiscal deficits owing to rapidly rising GPF assets.
  - In the absence of tax cuts, real government spending is set to rise by 3¾ percent in 2007, and the general government structural deficit, as estimated by staff, by ⅔ percent of GDP.

*APPENDIX I: FUND RELATIONS (As of February 28, 2007).*

### 4.      The attached tables have been updated in light of the revision to the 2007 budget.

### _cr07196 - 4.      The attached tables have been updated in light of the revision to the 2007 budget.

### Fiscal framework, GPF rule, and updated tables
- Fiscal rule: central government non-oil structural deficit should equal 4 percent of the assets in the Government Petroleum Fund-Global (GPF), with temporary deviations for specific reasons.
- 2007 revised National Budget projections are the basis for fiscal projections (fiscal projections are based on the revised 2007 budget, published on May 15, 2007).
- Tables updated to reflect the revision to the 2007 budget and include scenarios:
  - Based on the 4-percent rule (projections presented 2002–10 in percent of mainland GDP).
  - Higher oil price scenario (20 percent more than in the revised 2007 budget projections).
  - Based on WEO projections.

### Central government fiscal position under different oil prices (selected series, percent of mainland GDP)
- Structural non-oil balance (based on 4-percent rule, projections 2002–10): -3.2, -3.6, -3.5, -3.6, -3.6, -4.2, -5.2, -5.7, -6.2
- 4 percent of GPF assets (same sample): -2.0, -1.9, -2.5, -2.8, -3.6, -4.4, -5.2, -5.7, -6.2
- Non-oil expenditures (percent of mainland GDP): 46.4, 45.1, 44.5, 43.5, 42.4, 43.2, 44.3, 45.8, 46.5
- Increase in real terms (applying mainland GDP deflator): 13.0, -1.5, 3.1, 2.0, 2.0, 3.8, 5.4, 5.4, 3.7
- Government Pension Fund (GPF) assets (in percent of mainland GDP): 49.4, 66.4, 74.6, 96.1, 114.1, 134.2, 146.9, 160.1, ...
- Oil price assumption (in Norwegian krone): 197.9, 204.4, 254.1, 343.5, 411.8, 370.0, 358.0, 334.6, 323.0

- Alternative updated series (revised table):
  - Structural non-oil balance: -3.2, -3.6, -3.5, -3.6, -3.6, -4.2, -5.3, -6.0, -6.6
  - 4 percent of GPF assets: -2.0, -1.9, -2.5, -2.8, -3.6, -4.4, -5.3, -6.0, -6.6
  - Non-oil expenditures: 46.4, 45.1, 44.5, 43.5, 42.4, 43.2, 44.5, 46.0, 46.9
  - Increase in real terms: 13.0, -1.5, 3.1, 2.0, 2.0, 3.8, 5.7, 5.6, 3.9
  - GPF assets (percent of mainland GDP): 49.4, 66.4, 74.6, 96.1, 114.1, 138.0, 153.8, 169.9, ...
  - Oil price assumption (NKr): 197.9, 204.4, 254.1, 343.5, 411.8, 444.0, 429.6, 401.5, 387.6

- WEO-based series (selected):
  - Structural non-oil balance (WEO): -3.2, -3.6, -3.5, -3.6, -3.6, -4.2, -5.0, -5.8, -6.5
  - 4 percent of GPF assets: -2.0, -1.9, -2.5, -2.8, -3.6, -4.4, -5.0, -5.8, -6.5
  - Non-oil expenditures: 46.4, 45.1, 44.5, 43.5, 42.4, 43.2, 44.2, 45.8, 46.8
  - Increase in real terms: 13.0, -1.5, 3.1, 2.0, 2.0, 3.8, 5.1, 5.9, 4.2
  - GPF assets (percent of mainland GDP): 49.4, 66.4, 74.6, 96.1, 114.1, 133.6, 151.0, 168.7, 185.2
  - Oil price assumption (NKr): 197.9, 204.4, 254.1, 343.5, 411.8, 384.1, 416.2, 422.3, 427.8

- Sources for tables: Ministry of Finance; and IMF staff estimates.

### Macroeconomic projections and selected indicators (2002–08, percent or specified units)
- Real economy (change in percent, selected series):
  - Private consumption: 3.1, 2.8, 5.6, 3.3, 4.3, 4.0, 3.2 (2002–08)
  - Public consumption: 3.1, 1.7, 1.5, 1.8, 2.2, 2.8, 3.0
  - Gross fixed investment: -1.1, 0.2, 10.2, 11.2, 8.9, 5.7, 3.3
  - Export of goods and services: -0.3, -0.2, 1.1, 0.7, 1.5, 2.4, 4.9
    - Oil and gas exports: 2.4, -0.6, -0.5, -5.0, -5.4, -1.3, 7.3
  - Import of goods and services: 1.0, 1.4, 8.8, 8.6, 9.1, 5.5, 3.8
  - GDP: 1.5, 1.0, 3.9, 2.7, 2.9, 2.8, 3.6
  - Mainland GDP: 1.4, 1.3, 4.4, 4.5, 4.6, 3.8, 2.7
- Prices, wages, labor:
  - Consumer prices: 1.3, 2.5, 0.4, 1.6, 2.3, 0.8, 2.5
  - Wages (full-time equivalents): 5.7, 4.5, 3.8, 3.3, 4.3, ...
  - Unemployment (percent of labor force): 3.9, 4.5, 4.5, 4.6, 3.4, 2.8, 2.9
- Money and credit (end-period, 12-month percent change):
  - Broad money, M2: 8.6, 2.3, 7.8, 11.3, 13.3, ...
  - Domestic credit: 8.9, 6.8, 8.9, 13.1, 14.6, ...
- Interest rates (year average, in percent):
  - Three-month interbank rate: 6.9, 4.1, 2.0, 2.2, 3.0, ...
  - Ten-year government bond yield: 6.4, 5.0, 4.4, 3.7, 4.1, ...
- Balance of payments (percent of mainland GDP):
  - Current account balance: 15.7, 15.4, 16.4, 20.8, 23.0, 18.9, 21.5
  - Non-oil balance (current account component): -6.5, -6.5, -8.4, -8.5, -8.7, -9.4, -9.5
  - Trade balance (goods and services): 16.7, 16.2, 17.4, 22.1, 24.5, 20.0, 22.6
  - Net exports of oil and gas: 22.2, 21.9, 24.8, 29.3, 31.6, 28.3, 31.0
- Nominal GDP (billions of NKr): 1,532; 1,594; 1,743; 1,943; 2,148; 2,170; 2,338
- Nominal mainland GDP (billions of NKr): 1,225; 1,275; 1,355; 1,446; 1,563; 1,609; 1,705

### Public finance: central government and general government (selected levels and ratios)
- Central government (percent of mainland GDP, 2002–07):
  - Revenues: 56.4, 54.9, 55.1, 59.5, 63.7, 60.9, 64.1
    - Non-oil revenues: 41.3, 39.9, 38.7, 39.0, 39.6, 40.8, 40.8
  - Expenditures: 47.7, 46.5, 45.9, 45.9, 43.7, 44.5, 44.6
  - Overall balance: 8.7, 8.4, 9.2, 14.6, 19.9, 16.3, 19.5
  - Non-oil balance: -5.1, -5.2, -5.8, -4.5, -2.8, -2.4, -3.2
  - Structural non-oil balance (central govt, budget definition): -3.2, -3.6, -3.5, -3.6, -3.6, -4.2 (2002–07)
- General government (national accounts definition, percent of GDP, 2002–07):
  - Revenue: 66.6, 66.0, 69.2, 73.6, 77.5, 74.7
    - Oil revenue: 15.5, 15.9, 19.1, 23.6, 27.1, 22.8
  - Expenditure: 55.0, 56.8, 54.8, 53.1, 52.5, 53.8
  - Balance: 11.5, 9.1, 14.3, 20.4, 25.0, 20.9
  - Non-oil balance: -3.8, -6.7, -4.7, -3.1, -2.0, -1.9
  - Net assets (percent of GDP): 88.4, 102.7, 111.3, 134.4, 149.3, 169.8

### Detailed government accounts (billions of NKr and percent of GDP, 2002–07)
- Total revenue (billions of NKr): 815.1, 840.9, 937.3, 1,063.8, 1,211.9, 1,202.0
  - Oil revenue (billions of NKr): 166.7, 177.0, 225.7, 304.5, 368.4, 295.0
  - Non-oil revenue (billions of NKr): 649.6, 666.4, 713.2, 760.9, 845.2, 908.1
  - Financial income (billions of NKr): 75.1, 80.2, 84.7, 90.8, 118.4, 142.0
    - Return on the GPF (billions of NKr): 22.6, 25.8, 33.3, 36.9, 55.7, 72.3
- Total expenditure (billions of NKr): 674.0, 724.7, 743.2, 768.2, 821.1, 866.4
  - Non-oil expenditure (billions of NKr): 673.9, 725.9, 743.5, 769.1, 821.5, 866.4
  - Consumption (billions of NKr): 339.4, 358.7, 373.3, 390.0, 417.8, 443.7
  - Transfers (billions of NKr): 291.0, 318.5, 327.0, 337.6, 348.2, 369.6
  - Capital expenditure (billions of NKr): 15.8, 19.8, 18.7, 18.0, 22.7, 26.1
- Overall balance (billions of NKr): 141.1, 116.2, 194.1, 295.6, 390.9, 335.6
- Non-oil balance (billions of NKr): -46.8, -85.2, -63.6, -45.1, -32.0, -30.6
- Cyclically adjusted non-oil balance (billions of NKr): -41.4, -68.4, -53.7, -43.6, -43.0, -48.8
- Memorandum: Net public assets (billions of NKr): 1,082.8; 1,309.3; 1,508.6; 1,943.0; 2,333.9; 2,669.5
  - Percent of GDP: 88.4; 102.7; 111.3; 134.4; 149.3; 165.9
  - Nominal GDP (billions of NKr): 1,224.6; 1,274.8; 1,355.3; 1,446.0; 1,563.1; 1,608.9
  - Trend nominal GDP (billions of NKr): 1,236.3; 1,310.0; 1,375.1; 1,447.5; 1,541.3; 1,573.6
  - Output gap (percent): -0.9; -2.7; -1.4; -0.1; 1.4; 2.2

### IMF Executive Board assessment and policy recommendations (summary)
- Commendations:
  - Directors commended Norwegian authorities for strong rules-based monetary and fiscal policy frameworks and prudent management of oil wealth.
  - Robust economic expansion supported by strong export markets (notably petroleum) and supportive monetary conditions.
  - High transparency of the GPF has enhanced public ownership and government accountability.
- Monetary policy:
  - Underlying inflation has been below the inflation target of a 2.5 percent increase in consumer prices.
  - Norges Bank has been increasing interest rates since mid-2005; Directors considered further gradual increases appropriate given demand pressures.
  - Directors suggested maintaining a gradual pace to allow assessment of effects and new information; acknowledged possible upward pressure on exchange rate as part of transmission.
  - Directors welcomed inflation targeting and flexible exchange rate; recommended continued public explanation of policy framework.
- Fiscal policy and sustainability:
  - Fiscal guidelines have contributed to prudent fiscal policy; central government non-oil structural deficit close to 4 percent of GPF in 2006 and set to fall below 4 percent in 2007.
  - Directors emphasized need for continued fiscal restraint because cyclical boom, prospect of expanding deficits under fiscal guidelines, and projected large costs of aging.
  - Recommended adoption of an explicit medium-term fiscal framework to increase effectiveness of fiscal policy.
- Pension reform and long-term fiscal containment:
  - Directors welcomed parliamentary agreement on pension reform (benefits based on lifetime earnings, adjustment for rising life expectancy, actuarially neutral benefit structure, lower indexation).
  - Urged quick implementation and complementary reforms to early retirement and disability schemes.
  - Noted current estimates indicate reforms alone will not ensure long-term fiscal sustainability; further measures under consideration are welcome.
- Financial sector and macroprudential concerns:
  - Financial sector appears sound and well supervised; majority of 2005 FSAP recommendations adopted.
  - Risks noted: prolonged credit expansion, rapid house price rises, aggressive lending practices.
  - Directors urged Financial Supervisory Authority to ensure banks remain well capitalized and provisioned, follow prudent lending practices, and maintain high asset quality.
- Labor market and social protection:
  - Impressive labor market performance; rapid growth in sickness and disability enrollment poses challenges.
  - Welcomed reforms including merger of welfare agencies to improve case management.
  - Recommended further measures, including review of high replacement rates.
- Product markets and SOE governance:
  - Welcomed improving product market performance.
  - Stressed need to maintain level playing field between private sector and large state-owned sector via continued effective governance; suggested consideration of further privatization where appropriate.
  - Urged strong enforcement of competition and anti-cartel laws.

*Sources: Ministry of Finance; Norges Bank; Statistics Norway; International Financial Statistics; and IMF staff estimates.*

### 2007. In the Revised National Budget for 2007 presented on May 15, growth in mainland

### _cr07196 - 2007. In the Revised National Budget for 2007 presented on May 15, growth in mainland

### Growth and labor market
- Growth in mainland Norway (excluding petroleum and shipping) is forecasted at 3.7 percent in 2007.
- The unemployment rate is at a 20 year low.
- The unemployment rate is expected to decline from an average of 3.4 percent in 2006 to 2½ percent in 2007.
- Employment growth is strong.
- Inflow of workers from other countries has helped ease labor market pressures, but demand for labor remains high and many companies face difficulties finding qualified labor.

### Monetary policy
- The Norwegian authorities generally concur with staff’s assessment that further interest rate increases are needed to head off inflationary pressures.
- Norges Bank’s Executive Board assessed that the key policy rate should be in the interval 4 – 5 percent in the period to the publication of the next Monetary Policy Report on June 27, 2007.
- In the March Report, Norges Bank’s analysis suggested it would be appropriate to raise the interest rate gradually to about 5 percent in the course of this year and to a somewhat higher level in the period to the summer of 2008.
- Interest rate increases will be implemented gradually so the effects on economic developments can be assessed.
- Interest rate developments must be seen in light of prospects for inflation, output and employment; it normally takes some time for interest rates to impact prices via expectations, exchange rates or capacity utilisation.
- The key policy rate has been raised in response to the strong increase in capacity utilisation and associated inflation prospects; the rate was increased well ahead of an actual rise in underlying inflation.
- Different measures of short- and longer-term real interest rates indicate that real interest rates have approached a more normal level.
- Staff estimated real interest rates by combining short-term interest rates and a longer-term measure of inflation expectations; staff’s judgement that real interest rates are still expansionary appears based on combining different time horizons in the same calculation.
- The report emphasizes that monetary policy should strive to meet the inflation target even if this would mean some short-term appreciation of the krone.
- Norges Bank underscores that under an inflation targeting regime it is important to be mindful of the effects of higher interest rates on the krone exchange rate when inflation is low.
- Authorities agree monetary policy framework has been strengthened by increased transparency, improved governance and a well-articulated policy framework.
- Norges Bank regularly publishes assessments of the outlook for the key policy rate and emphasizes that openness about intended future interest rates helps market participants understand the central bank’s response pattern.
- Staff’s advice to continue efforts to explain inflation targeting, including the monetary policy transmission mechanism and how specific policy decisions are governed, has been noted.

### Fiscal policy
- The Norwegian fiscal framework aims at a gradual increase in the spending of petroleum revenues to a sustainable level.
- Over time the structural non-oil deficit shall correspond to the expected real return on the Government Pension Fund – Global (GPF), estimated at 4 percent.
- Long-term budget challenges from future increases in pension costs in the National Insurance Scheme and other age-related expenses underline the need for a prudent fiscal policy.
- The Government proposes a revised Fiscal Budget for 2007 with an estimated structural, non-oil deficit somewhat lower than in the approved budget and NOK 3.5 billion (0.2 percentage points) below the expected 4 percent real return on the fund.
- Newly released state accounts show that the use of petroleum revenues was on par with the 4 percent fiscal rule in 2006.
- The proposed revised budget for 2007 implies a structural, non-oil budget deficit at 4.3 percent of mainland trend GDP, 0.6 percentage point higher than in 2006; this increase must be seen in light of a major downward revision of the 2006 deficit in the final state accounts.
- The Norwegian authorities agree with staff that 2008 and subsequent budgets should aim for a deficit below 4 percent of GPF until excess demand dissipates.
- Authorities take note of staff’s view that an explicit medium-term fiscal framework would help prevent a rapid increase in spending, and agree such a framework largely exists (fiscal rule, government commitment to a stable tax level, multi-year budget projections).
- Given success of current guidelines for fiscal policy, staff does not argue for a change of fiscal guideline.
- Alternative fiscal rules examined in the Selected Issues paper imply already substantial central government savings increase significantly for the next 50 years to meet long-term fiscal challenges; challenges may alternatively be met by curbing future expenditure growth (e.g., ongoing pension reform, which is not included in calculations in the paper on alternative fiscal rules).
- The paper exaggerates the challenges when stating that the GPF will be exhausted in 5-6 decades.

### Pension reform and benefit entitlements
- Fundamentals in the Norwegian labor market are healthy with low unemployment and high participation rates, especially among women and older workers.
- Key to sustainable public finances long term is to keep labor supply high or preferably to increase it, which may be challenging with an ageing population and increasing inflow into sick leave, disability and early retirement schemes.
- Authorities share staff’s concern about the high proportion of the working population on sick leave, disability and other health related benefits, and agree measures should be taken to bring these numbers down.
- A white paper on work, welfare and inclusion policies released last fall proposes measures to bring people back to work; several measures to reduce sick leave were included in the 2007-budget and are now implemented.
- The Norwegian pension system is under revision with significant progress during the last two years; Parliament has reached an agreement settling the model for earning and drawing of old age pensions in the National Insurance Scheme as a foundation for the overall pension system.
- Important elements of the reform remain to be decided: redesign of occupational pensions in the public sector, adjustments of disability pensions and the labor market based early retirement scheme (AFP).
- A Government-appointed commission has released a report with proposals for reform of the disability pension system.
- The Government will soon invite the social partners to discuss the design of an adjusted early retirement scheme, in time to be included in the wage negotiations in 2008.
- The next phase of the reform will be challenging but important for establishing correct incentives for elderly people considering retirement and closing early exit routes.
- It is now more important to stress the need for completion of the ongoing pension reform than to recommend embarking on new ones.

### Financial stability
- Authorities agree with staff that the financial system in Norway is sound and well supervised.
- Over the last years Norwegian financial institutions have achieved very good results; in 2006 no overall losses were recorded in banks and, as in 2005, the cost trend in banks was favorable.
- Households’ debt has risen sharply the last seven years, driven by strong growth in house prices, a favorable economic climate and low interest rates.
- Debt has risen at a far higher rate than incomes, spurring a sharp increase in the debt burden.
- Projections by Norges Bank show that by the end of 2009 the households’ debt may exceed 230 percent of disposable income.
- Despite risks, especially the households’ debt burden, the outlook for financial stability is satisfactory.

### Structural policy
- Product markets have undergone considerable reforms through the 1990s and early 2000s to improve efficiency while securing service provision across the country.
- Competition has been enhanced by strengthening the competition law and competition authorities, and reform of sector regulation especially in network industries.
- Legal protection allows decisions by the Competition Authority to be challenged through appeal and in the courts; the Ministry of Government Administration and Reform is the appeal body but can overrule a decision only on the same legal basis as the Competition Authority.
- In certain cases of fundamental or great social importance, the full cabinet (King in Council) can overrule the competition provisions; there has been only one such decision under the Competition Act of 2004.
- Administrative fines can be challenged only in courts.
- State ownership is extensive, primarily due to the importance of the petroleum and hydroelectric power sectors; other state-owned companies perform functions not efficiently provided in competitive markets (electricity transmission, administration of national forests, etc.).
- Policy on state ownership was presented in a recent white paper; the Government aims at securing a strong public and national ownership.

*Source: _cr07196 - 2007. In the Revised National Budget for 2007 presented on May 15, growth in mainland*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr07196.pdf_