## _cr0752

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---

### Executive Summary — Reform program and labor market inclusion
- New center-right coalition launched an ambitious reform program to address exclusion from the labor market, focusing on:
  - Cutting taxes for low and average earners.
  - Pruning generous unemployment and sickness benefits.
  - Privatization of part of the large state-owned enterprise sector.
- Key elements of the government’s program (Box 1):
  - A ‘job deduction’ from income taxes for low and middle income earners amounting to about 1½ percent of GDP, with a planned second-stage increase in 2008.
  - Introduction of “New Start Jobs” as an employer subsidy to return those outside the labor market to work.
  - Reductions in employers’ social security contributions for young and older workers; selected service sectors targeted (some measures may not be feasible until 2008 due to EU state aid rules).
  - Tax reductions for purchase of household-related services.
  - Wealth tax rates to be halved to 0.75 percent as a prelude to elimination.
  - Unemployment benefits: replacement ratio to fall to 70 percent from 80 percent after 200 days.
  - Sickness benefits: cuts and stricter enforcement.
  - Labor market programs: substantial reduction and refocusing on “work-first”; abolish programs such as sabbaticals that run counter to that principle.
  - Privatization: government stake in state-owned companies to be reduced; sales expected to total around 7 percent of GDP over the next 3 years.

### Macroeconomic backdrop and outlook
- Recent performance and drivers:
  - Growth at close to 5 percent in 2006.
  - Upswing broad-based; household consumption expected to serve as the engine of growth going forward.
  - Investment and exports buoyant; household wealth and disposable income have risen.
- Labor market outcomes:
  - Over a fifth of the working-age population remains economically inactive despite strong growth.
  - Employment began to rise but headline unemployment declined only gradually; participation in active labor market programs rose.
  - Exact labor market indicators (2002–2008):
    - Total Unemployment Rate: 6.6, 7.0, 7.9, 8.5, 8.6, 8.3, 7.0 (for 2002–2008).
    - Open Unemployment Rate: 4.0, 4.9, 5.5, 5.8, 5.5, 5.8, 5.0 (for 2002–2008).
    - Labor Force Participation (percent of working-age population): 78.0, 78.0, 77.8, 78.3, 77.7, 77.7, 77.7 (for 2002–2008).
- Growth projections:
  - Sweden: GDP (percent change) by year 2002–2008: 2.0, 1.7, 4.1, 2.9, 4.8, 3.3, 2.2.
- Medium-term:
  - Growth expected to ease back in 2007–08 as monetary and fiscal stimulus fades; consumption projected to remain main support.
  - Potential growth expected to slow from around 2¾ percent to barely 2 percent by the end of the decade absent further institutional and incentive changes.

### Inflation, monetary policy, and exchange rate
- Inflation and monetary stance:
  - Inflation edging up toward the Riksbank’s target of 2 percent.
  - Wage inflation remained moderate in 2005–06 and was offset by unexpectedly strong productivity gains; cost pressures have emerged (higher energy prices and incipient wage pressures).
  - Riksbank raised the key policy rate from 1.5 percent in January 2006 to 3 percent in December 2006.
  - Markets expect continued further tightening—of about 100 basis points—in 2007.
  - Recommendation: Riksbank will need to tighten monetary policy further; use of the Riksbank’s own interest rate forecast would better anchor inflation expectations.
- Exchange rate and competitiveness:
  - The krona has appreciated 5 percent in effective terms over the past year and about 14 percent since late 2001; real appreciation around 8 to 10 percent.
  - Sweden’s competitive position remains strong; large actual and projected current account surpluses expected to lead to a positive international investment position by 2009.

### Fiscal policy, framework, and recommendations
- Fiscal stance and near-term impact:
  - Fiscal policy strongly pro-cyclical in 2006–07.
  - Structural surplus likely to fall below the 2 percent of GDP target in 2006.
  - Tax cuts in the 2007 budget (income, wealth and property taxes) amount to around 2 percent of GDP.
  - These cuts financed partially by lowering welfare benefits, raising unemployment insurance contributions, and reducing spending on labor market programs; net fiscal impact is expansionary, with the structural surplus projected to weaken substantially in 2006–07.
- Fiscal framework and staff advice:
  - Authorities intend to adhere to the structural surplus target of 2 percent of GDP and to clarify the framework.
  - Staff advocates:
    - Refining the fiscal framework to improve transparency and accountability.
    - Establishing some form of independent economic agency to monitor compliance and assess performance.
    - Further cuts in public spending to alleviate the pro-cyclical bias in the near term and create room for tax cuts in the medium term.
    - Greater use of private suppliers to deliver some public services to help relieve coming age-related pressures on public spending.
- Fiscal aggregates (general government, percent of GDP), selected items (2004–2009):
  - Total Revenue: 55.6 (2004), 56.3 (2005), 55.6 (2006), 53.6 (2007), 53.1 (2008), 52.8 (2009).
  - Total Expenditure: 54.0 (2004), 53.6 (2005), 52.8 (2006), 51.3 (2007), 50.5 (2008), 49.8 (2009).
  - Overall Balance: 1.6 (2004), 2.8 (2005), 2.8 (2006), 2.3 (2007), 2.6 (2008), 3.1 (2009).
  - Structural Balance: 1.8 (2004), 3.0 (2005), 1.7 (2006), 0.8 (2007), 1.2 (2008), 2.5 (2009).
  - Fiscal Stimulus: -0.9 (2004), -1.2 (2005), 1.2 (2006), 1.0 (2007), -0.4 (2008), -1.3 (2009).
  - Output Gap (percent of potential GDP): -0.2 (2004), -0.3 (2005), 1.5 (2006), 2.2 (2007), 2.0 (2008), 0.8 (2009).

### Risks, medium-term outlook, and policy sequencing
- Risks and timing:
  - Growth risks broadly balanced: possible slowdown in world growth offset by likelihood of stronger-than-projected domestic demand.
  - Pace and sequencing of reforms central to debate; some labor market reforms may initially raise headline unemployment before reducing it over the medium term as participants in labor market programs move into gainful work.
  - Sustaining political consensus behind the new policy paradigm emphasized.
- Policy sequencing recommendations:
  - Expenditure restraint critical to create room for additional tax cuts over the medium term.
  - Privatization and deregulation (including in housing market) recommended to raise efficiency and promote labor mobility.
  - Promote competition and reduce regulatory burdens (notably in construction) to enhance pay-off from labor market reforms.

### Section 11 — The government’s labor market strategy
- Objectives and measures:
  - Package aimed at addressing simultaneously unemployment and poverty traps.
  - Cut taxes for low and average earners to make employment more attractive for those outside the labor market.
  - Reductions in unemployment and sickness benefits intended to underline the dual role of social insurance as a safety net and as a support to facilitate the transition back to work.
  - Scheme to lower social security contributions for young and older workers to encourage employers to recruit and retain these groups.
  - Programs to focus on matching jobseekers with vacancies and raising competition in employment services.
- Implementation challenges and timing:
  - Changing entrenched behavior patterns acknowledged as challenging.
  - Implementation of measures to stimulate labor demand may face EU state aid constraints; timing of effects uncertain.
  - Authorities express confidence that employment will rise substantially over the next few years.
- Taxation strategy and fiscal constraints:
  - Authorities plan further tax cuts subject to maintaining a healthy fiscal surplus.
  - Staff view: high tax burden suggests ample scope for reducing taxation, but cutbacks in public consumption or transfers will be necessary to create room for further strategic tax cuts.
  - Authorities have ruled out cuts in public services; potential exists for using private suppliers in childcare, healthcare, and eldercare to lower costs.

### Privatization plans
- Government intends to sell a sizeable share of its stake in state enterprises—around 7 percent of GDP—with proceeds to be used to repay foreign debt.
- Expectation: a substantial portion will be taken up by foreign investors, raising foreign interest in Swedish capital markets.
- Potential effect: enhance competition in sectors where the state currently plays a major role, such as real estate, mortgage finance, and alcoholic beverages.

### Monetary policy and framework (detailed)
- With inflation expected to rise over the next two years, Riksbank expected to tighten monetary policy further.
- Real interest rates remain close to zero; monetary stance still quite accommodative.
- Riksbank officials' view: a neutral policy rate—consistent with an inflation target of 2 percent—would be about 4 percent.
- Conventional model-based indicators suggest the krona is undervalued; Riksbank has not intervened to influence the exchange rate in recent years.
- Riksbank is considering switching to using its own forecasts for interest rates consistent with achieving the inflation target; staff welcomes this change.
- A parliamentary evaluation reached a similar conclusion and should contribute to further evolution of the framework.

### Financial sector assessment and supervisory issues
- Financial sector remains stable:
  - Bank profitability high, capital levels adequate to absorb moderate shocks.
  - Asset quality improved significantly as household and corporate balance sheets strengthened.
  - Household debt has risen sharply; authorities view debt service burden as manageable even if interest rates rise beyond current market expectations.
  - Equity markets recovered; house price inflation showing signs of slowing.
- Supervisory needs:
  - Need to monitor asset prices, especially real estate, and banks’ exposure to highly leveraged transactions.
  - 2002 FSAP noted weaknesses in supervisory regime; recent difficulties revoking licenses of two small deposit-taking institutions underscore need to improve legislative framework for bank resolution.
  - Authorities drafting legislation to create an integrated framework for managing and unwinding troubled institutions.
  - A staff mission from the Monetary and Capital Markets Department will visit Stockholm in January 2007 to explore bank resolution issues and make recommendations.

### Staff appraisal: outlook, reforms, and recommendations
- Overall assessment:
  - New government’s reform agenda is timely and welcome.
  - Economy on course for another year of strong growth, though some slowing as output approaches capacity limits.
  - Incipient recovery in employment expected to strengthen, supported by new policy initiatives; total unemployment, including persons in labor market programs, should begin to fall.
  - Both monetary and fiscal policies set to remain supportive of demand.
- Key staff recommendations and views:
  - Reform program correctly centers on restructuring tax and benefit systems to steer more people toward gainful employment.
  - Tax cut aimed at low and average income earners, reduction in unemployment and sickness benefits, and revamping of labor market programs should boost employment, though magnitude and timing are uncertain.
  - High tax wedge needs to be reduced; room for further tax cuts must be found within fiscal framework constraints.
  - Expenditure restraint critical to create room for additional tax cuts over the medium term.
  - Fiscal framework could be refined to improve transparency, accountability, and reduce procyclical bias; independent economic agency could derive annual structural surplus target and translate it into a headline budget target.
  - With inflation rising toward the target, output at or above capacity, and substantial fiscal stimulus in 2006-07, there is scope for continued monetary tightening broadly in line with market expectations.
  - Financial system strengthened and remains stable, but asset prices—especially real estate—need close monitoring.
  - Pay-off from labor market reforms could be enhanced by initiatives to promote competition and reduce regulatory burden; evidence of informal barriers to entry in sectors such as construction suggests scope for improving competition and encouraging entrepreneurship.
  - Government plans to sell some holdings in state-owned enterprises are welcome; deregulation in the housing market would raise efficiency and promote labor mobility.

### APPENDIX I — Sweden: Fund relations (As of November 30, 2006)
- Membership and IMF Accounts:
  - Status: Joined 08/31/51; Article VIII
  - General Resources Account (SDR Million; Percent of Quota):
    - Quota: 2,395.50  100.00
    - Fund holdings of currency: 2,184.4  91.91
    - Reserve position: 211.10  8.81
  - SDR Department (SDR Million; Percent of Allocation):
    - Net cumulative allocation: 246.53  100.00
    - Holdings: 164.70  66.81
  - Outstanding Purchases and Loans: None
  - Financial Arrangements: None
- Projected Obligations to Fund (SDR Million; based on existing use of resources and present holdings of SDRs):
  - Forthcoming principal and charges/interest by year:
    - 2006 2007 2008 2009 2010
    - Principal
    - Charges/Interest
    - 3.333.333.323.32
    - Total
    - 3.333.333.323.32
- Exchange Arrangements:
  - The Krona has been floating since November 19, 1992.
  - Sweden has accepted the obligations of Article VIII (Sections 2(a), 3, and 4) and maintains an exchange system free of restrictions on current international transactions, apart from security-related measures duly notified to the Fund by the Riksbank on June 1, 2006 (EBD/06/79, June 23, 2006).
- Article IV Consultation:
  - Discussions for the 2005 Article IV consultation were held in Stockholm, May 16-25, 2005.
  - The staff report (IMF Country Report 05/343) was issued on September 15, 2005.
  - The consultation was concluded by the Executive Board on September 2, 2005.
- Technical Assistance: None
- Resident Representative: None

### Statement by Swedish Authorities (Tuomas Saarenheimo and Ms. Roos-Isaksson) — January 26, 2007
- Overview and priorities:
  - New Government faces three major challenges: demographic changes; globalization and structural changes; and the single greatest challenge—to increase employment.
  - Policy agenda emphasizes economic incentives to foster labor supply and increase labor demand.
  - NIER estimates measures in the 2007 budget bill likely to be significant and lasting, resulting in a lower unemployment rate and a higher potential labor force.
- Recent economic developments and views:
  - Authorities expect GDP growth around 4.5 percent in 2006 and then to decline somewhat in 2007 and 2008.
  - Employment growth strong during 2006 and expected to continue.
  - Authorities disagree with staff on resource utilization: NIER and Ministry of Finance estimate output gap close to zero in early 2007 and a structural balance as high as 3.1 percent of GDP in 2007.
  - Riksbank assesses the economy still has a certain amount of unutilized resources in the labor market.
- Fiscal policy and framework:
  - Maintaining a healthy fiscal budget surplus of utmost importance; commitment to surplus target and expenditure ceilings intact.
  - Plans to refine framework to increase transparency and facilitate ex-post evaluation; independent economic agency role should not be ex ante in suggesting budget targets.
- Monetary policy:
  - Framework: target annual change in consumer price index of 2 percent with a tolerance interval of plus/minus 1 percentage point.
  - Riksbank decided on January 16, 2007 to present its own interest forecasts in subsequent reports; policy rate increased from 1.5 percent in January 2006 to 3.0 percent in December 2006 with further increases expected in 2007.
- Financial sector:
  - Banking sector well positioned to cope with unexpected losses; authorities acknowledge shortcomings in bank resolution framework and welcome Fund mission.

### Conclusion — Board assessment and key quantitative indicators
- Board views:
  - Commended Sweden’s strong recent economic performance, rapid growth, and robust competitive position.
  - Noted strong growth has yet to translate into a durable revival in employment; welcomed government reforms to restructure tax-benefit system.
  - Urged caution given uncertainty surrounding cyclical estimates and major reforms.
  - Agreed Riksbank will need to tighten monetary policy further and saw scope for continued tightening broadly in line with market expectations.
  - Considered financial system sound and stable; recommended close monitoring of asset prices, especially real estate.
  - Encouraged promoting competition (notably in construction) and entrepreneurship; welcomed plans to sell some state-owned enterprise holdings.
- Key quantitative indicators (selected):
  - Real GDP growth: 2001: 1.1; 2002: 2.0; 2003: 1.7; 2004: 4.1; 2005: 2.9; 2006: 4.8; 2007-09 average (staff projections): 2.3.
  - Domestic Demand (percent change): 2001: -0.2; 2002: 0.7; 2003: 1.7; 2004: 2.1; 2005: 2.7; 2006: 4.3; 2007-09 average: 2.1.
  - CPI Inflation (percent change): 2001: 2.7; 2002: 1.9; 2003: 2.3; 2004: 1.0; 2005: 0.8; 2006: 1.6; 2007-09 average: 1.9.
  - Gross national saving (percent of GDP): 2001: 21.9; 2002: 21.7; 2003: 23.7; 2004: 23.1; 2005: 24.2; 2006: 24.2; 2007-09 average: 25.3.
  - Gross domestic investment (percent of GDP): 2001: 17.5; 2002: 16.6; 2003: 16.4; 2004: 16.3; 2005: 17.1; 2006: 18.3; 2007-09 average: 18.8.
  - General government balance (percent of GDP): 2001: 2.6; 2002: -0.5; 2003: -0.2; 2004: 1.6; 2005: 2.8; 2006: 2.8; 2007-09 average: 2.7.
  - Structural balance (percent of potential GDP, adjusted for one-off effects): 2001: 2.1; 2002: -0.4; 2003: 0.9; 2004: 1.8; 2005: 3.0; 2006: 1.7; 2007-09 average: 1.5.
  - General government debt (percent of GDP): 2001: 53.8; 2002: 52.0; 2003: 51.8; 2004: 50.7; 2005: 50.4; 2006: 46.3; 2007-09 average: 37.9.
  - Trade balance (percent of GDP): 2001: 6.3; 2002: 6.9; 2003: 6.8; 2004: 8.3; 2005: 7.6; 2006: 7.2; 2007-09 average: 6.8.
  - Current account (percent of GDP): 2001: 4.4; 2002: 5.1; 2003: 7.3; 2004: 6.8; 2005: 7.1; 2006: 6.0; 2007-09 average: 6.5.
  - International reserves (in billions of US dollars): 2001: 15.3; 2002: 17.4; 2003: 20.0; 2004: 22.4; 2005: 26.5.

*Source: _cr0752 - Executive Summary; IMF staff report (excerpt); APPENDIX I. SWEDEN: FUND RELATIONS (As of November 30, 2006); Public Information Notice (PIN) No. 07/15, February 7, 2007.*

### Executive Summary

### Executive Summary

### Reform program and labor market inclusion
- A new center-right coalition has launched an ambitious reform program to address exclusion from the labor market, focusing on:
  - Cutting taxes for low and average earners.
  - Pruning generous unemployment and sickness benefits.
  - Privatization of part of the large state-owned enterprise sector.
- Box 1 — Key elements of the new government’s program:
  - A ‘job deduction’ from income taxes for low and middle income earners amounting to about 1½ percent of GDP, with a planned second-stage increase in 2008.
  - Introduction of “New Start Jobs” as an employer subsidy to return those outside the labor market to work.
  - Reductions in employers’ social security contributions for young and older workers; selected service sectors targeted (some measures may not be feasible until 2008 due to EU state aid rules).
  - Tax reductions for purchase of household-related services.
  - Wealth tax rates to be halved to 0.75 percent as a prelude to elimination.
  - Unemployment benefits: replacement ratio to fall to 70 percent from 80 percent after 200 days.
  - Sickness benefits: cuts and stricter enforcement.
  - Labor market programs: substantial reduction and refocusing on “work-first”; abolish programs such as sabbaticals that run counter to that principle.
  - Privatization: government stake in state-owned companies to be reduced; sales expected to total around 7 percent of GDP over the next 3 years.

### Macroeconomic backdrop and outlook
- Recent performance and drivers:
  - Growth at close to 5 percent in 2006.
  - The upswing is broad-based, with household consumption expected to serve as the engine of growth going forward.
  - Investment and exports have also been buoyant; household wealth and disposable income have risen.
- Labor market outcomes:
  - Despite strong growth, over a fifth of the working-age population remains economically inactive.
  - Employment began to rise but headline unemployment declined only gradually; participation in active labor market programs rose.
  - Exact labor market indicators (2002–2008):
    - Total Unemployment Rate: 6.6, 7.0, 7.9, 8.5, 8.6, 8.3, 7.0 (for 2002–2008).
    - Open Unemployment Rate: 4.0, 4.9, 5.5, 5.8, 5.5, 5.8, 5.0 (for 2002–2008).
    - Labor Force Participation (percent of working-age population): 78.0, 78.0, 77.8, 78.3, 77.7, 77.7, 77.7 (for 2002–2008).
- Growth projections:
  - Sweden: GDP (percent change) by year 2002–2008: 2.0, 1.7, 4.1, 2.9, 4.8, 3.3, 2.2.

### Inflation, monetary policy, and exchange rate
- Inflation and monetary stance:
  - Inflation is edging up toward the Riksbank’s target of 2 percent.
  - Wage inflation remained moderate in 2005–06 and was offset by unexpectedly strong productivity gains, but cost pressures have emerged (higher energy prices and incipient wage pressures).
  - The Riksbank raised the key policy rate from 1.5 percent in January 2006 to 3 percent in December 2006.
  - Markets expect continued further tightening—of about 100 basis points—in 2007.
  - Recommendation: Riksbank will need to tighten monetary policy further; use of the Riksbank’s own interest rate forecast would better anchor inflation expectations.
- Exchange rate and competitiveness:
  - The krona has appreciated 5 percent in effective terms over the past year and about 14 percent since late 2001; real appreciation around 8 to 10 percent.
  - Sweden’s competitive position remains strong; large actual and projected current account surpluses are expected to lead to a positive international investment position by 2009.

### Fiscal policy, framework, and recommendations
- Fiscal stance and near-term impact:
  - Fiscal policy is strongly pro-cyclical in 2006–07.
  - The structural surplus is likely to fall below the 2 percent of GDP target in 2006.
  - The tax cuts in the 2007 budget (income, wealth and property taxes) amount to around 2 percent of GDP.
  - These tax cuts are financed partially by lowering welfare benefits, raising unemployment insurance contributions, and reducing spending on labor market programs, but the net fiscal impact is expansionary, with the structural surplus projected to weaken substantially in 2006–07.
- Fiscal framework and reform advice:
  - Authorities intend to adhere to the structural surplus target of 2 percent of GDP and to clarify the framework.
  - Staff advocates:
    - Refining the fiscal framework to improve transparency and accountability.
    - Establishing some form of independent economic agency to monitor compliance and assess performance.
    - Further cuts in public spending to alleviate the pro-cyclical bias in the near term and create room for tax cuts in the medium term.
    - Greater use of private suppliers to deliver some public services to help relieve coming age-related pressures on public spending.
- Fiscal aggregates (general government, percent of GDP), selected items (2004–2009):
  - Total Revenue: 55.6 (2004), 56.3 (2005), 55.6 (2006), 53.6 (2007), 53.1 (2008), 52.8 (2009).
  - Total Expenditure: 54.0 (2004), 53.6 (2005), 52.8 (2006), 51.3 (2007), 50.5 (2008), 49.8 (2009).
  - Overall Balance: 1.6 (2004), 2.8 (2005), 2.8 (2006), 2.3 (2007), 2.6 (2008), 3.1 (2009).
  - Structural Balance: 1.8 (2004), 3.0 (2005), 1.7 (2006), 0.8 (2007), 1.2 (2008), 2.5 (2009).
  - Fiscal Stimulus: -0.9 (2004), -1.2 (2005), 1.2 (2006), 1.0 (2007), -0.4 (2008), -1.3 (2009).
  - Output Gap (percent of potential GDP): -0.2 (2004), -0.3 (2005), 1.5 (2006), 2.2 (2007), 2.0 (2008), 0.8 (2009).

### Risks, medium-term outlook, and policy sequencing
- Growth risks and medium term:
  - Growth is expected to ease back in 2007–08 as monetary and fiscal stimulus fades; consumption is projected to remain the main support to activity.
  - Potential growth is expected to slow markedly over the medium term primarily due to demographics; potential growth projected to fall from around 2¾ percent to barely 2 percent by the end of the decade absent further institutional and incentive changes.
- Policy sequencing considerations:
  - Pace and sequencing of reforms are central to debate; timing and tactics important over a four-year electoral horizon.
  - Staff and authorities agree on the reform philosophy; sustaining consensus behind the new policy paradigm is emphasized.
  - Some labor market reforms may initially raise headline unemployment before reducing it over the medium term as participants in labor market programs move into gainful work.

*Source: _cr0752 - Executive Summary*

### 11.      The government’s labor market strategy is well designed to promote sustainable

### _cr0752 - 11.      The government’s labor market strategy is well designed to promote sustainable

### Labor market strategy: objectives and measures
- Package aimed at addressing simultaneously unemployment and poverty traps.
- Decision to cut taxes for low and average earners to make employment more attractive for those now outside the labor market.
- Reductions in unemployment and sickness benefits intended to underline the dual role of social insurance as a safety net and as a support to facilitate the transition back to work.
- Scheme to lower social security contributions for young and older workers to encourage employers to recruit and retain these groups.
- Programs will focus on matching jobseekers with vacancies and raising competition in employment services.

### Implementation challenges and timing
- Authorities acknowledge challenges in changing entrenched behavior patterns.
- Implementation of measures to stimulate labor demand (for example, planned cuts in social security contributions for selected sectors, such as services) faces challenges related, for instance, to EU rules on state aid.
- The time lag before policy changes start affecting behavior remains uncertain.
- Authorities express confidence that employment will rise substantially over the next few years.

### Taxation strategy and fiscal constraints
- Authorities plan further cuts in taxation, subject to the overriding constraint of maintaining a healthy fiscal surplus.
- Staff view: the high tax burden—among the highest in the world—suggests ample scope for reducing taxation.
- Government expects future tax reforms would be financed partly from dynamic economic gains arising from the first wave of cuts.
- Staff view: cutbacks in either public consumption or transfers will be necessary to create room for further strategic tax cuts.
- Authorities have ruled out cuts in public services, limiting their room for maneuver.
- Potential exists for using private suppliers to deliver the same quality of services at lower cost in childcare, healthcare, and eldercare.
- Government may nevertheless need to seek cuts in public consumption.

### Privatization plans
- New government plans to privatize some state-owned enterprises.
- Intends to sell a sizeable share of its stake in state enterprises—around 7 percent of GDP—with proceeds to be used to repay foreign debt.
- Expectation: a substantial portion will be taken up by foreign investors, raising foreign interest in Swedish capital markets.
- Potential effect: enhance competition in sectors where the state currently plays a major role, such as real estate, mortgage finance, and alcoholic beverages.

### Fiscal policy and framework
- Recent trend of pro-cyclical fiscal policy is set to continue in 2007.
- Staff estimates that the general government structural surplus will fall well below the 2 percent target, mainly reflecting the tax cuts.
- Authorities view the fiscal outcome for 2007 in the broader context of their agenda to streamline the welfare state and raise sustainable growth and employment.
- Government intends to refine the fiscal framework while preserving the target of a surplus of 2 percent of GDP over the cycle.
- Staff and authorities view the target as appropriate to ensure fiscal sustainability in the face of demographic challenges.
- 2007 budget actions: reduced reliance on tax expenditures and restored a three-year horizon for expenditure ceilings.
- Staff recommendation/support: an independent economic agency could derive the annual structural surplus target in a macroeconomic context and translate it into a headline budget target; authorities intend to move in this direction in the Spring 2007 Budget.

### Monetary policy and framework
- With inflation expected to rise over the next two years, the Riksbank is expected to tighten monetary policy further.
- Real interest rates remain close to zero; monetary stance remains quite accommodative.
- Riksbank officials' view: a neutral policy rate—consistent with an inflation target of 2 percent—would be about 4 percent.
- Degree of slack in the labor market would affect the pace of tightening.
- Conventional model-based indicators suggest that the krona is undervalued; Riksbank has not intervened in exchange markets with a view to influencing the exchange rate in recent years.
- Recent changes to the inflation targeting framework have improved clarity of monetary policy communication and provide a more internally consistent forecast.
- Riksbank is considering switching to using its own forecasts for interest rates that are consistent with achieving the inflation target; staff welcomes this as a step toward international best practice.
- A recent evaluation commissioned by the parliament arrives at a similar conclusion and should contribute to further evolution of the framework.

### Financial sector assessment and supervisory issues
- Financial sector remains stable.
- Bank profitability is high, and capital levels are adequate to absorb moderate economic shocks.
- Asset quality has improved significantly as household and corporate balance sheets have strengthened.
- Household debt has risen sharply; authorities view the debt service burden as manageable and estimate it will remain so even if interest rates rise beyond current market expectations.
- Equity markets have recovered; house price inflation is showing signs of slowing to a more moderate pace.
- Supervisors note the need to monitor asset prices, especially real estate, and banks’ exposure to highly leveraged transactions.
- Regional cross border supervisory cooperation is well-established and continuing to be enhanced.
- 2002 FSAP noted weaknesses in the supervisory regime; recent difficulties in revoking licenses of two small deposit-taking institutions underscore need to improve the legislative framework for bank resolution.
- Authorities are drafting legislation to create an integrated framework for managing and unwinding troubled institutions.
- A staff mission from the Monetary and Capital Markets Department will visit Stockholm in January 2007 to explore this issue in depth and make recommendations.

### Staff appraisal: outlook, reforms, and recommendations
- New government’s reform agenda is timely and welcome.
- Economy is on course for another year of strong growth, despite some slowing as output approaches capacity limits.
- Incipient recovery in employment expected to strengthen, supported by new policy initiatives; total unemployment, including persons in labor market programs, should begin to fall.
- Both monetary and fiscal policies set to remain supportive of demand.
- Reform program rightly centers on restructuring tax and benefit systems to steer more people toward gainful employment.
- Tax cut aimed at low and average income earners, reduction in unemployment and sickness benefits, and revamping of labor market programs should boost employment, though magnitude and timing are uncertain.
- High tax wedge needs to be reduced to raise incentives to work, but room for further tax cuts must be found within fiscal framework constraints.
- Government’s strong political commitment to sound public finances is welcome and reinforces credibility.
- Expenditure restraint will be critical to create room for additional tax cuts over the medium term.
- Fiscal framework could be refined further to improve transparency and accountability and to reduce procyclical bias; government’s intention to refine and clarify the framework is welcome.
- With inflation rising toward the target, output at or above capacity, and substantial fiscal stimulus in 2006-07, there is scope for continued monetary tightening broadly in line with market expectations.
- Recent framework changes have improved monetary policy clarity; further modifications (for example, using its own forecasts for interest rates consistent with the inflation target) would keep the Riksbank at the forefront of international best practice.
- Financial system has strengthened and remains stable, but asset prices—especially real estate—need close monitoring.
- Pay-off from labor market reforms could be enhanced by initiatives to promote competition and reduce regulatory burden; evidence of informal barriers to entry in sectors such as construction suggests scope for improving competition and encouraging entrepreneurship.
- Government plans to sell some holdings in state-owned enterprises are welcome; deregulation in the housing market would raise efficiency and promote labor mobility.
- The government’s course is described as both courageous and necessary; success will help ensure that the Swedish model of an inclusive society thrives amid demographic and globalization challenges.
- Sweden is expected to remain on the standard 12-month consultation cycle.

*Source: IMF staff report (excerpt).*

### APPENDIX I. SWEDEN: FUND RELATIONS

### APPENDIX I. SWEDEN: FUND RELATIONS (As of November 30, 2006)

### I. Membership and IMF Accounts
- Status: Joined 08/31/51; Article VIII

- General Resources Account (SDR Million; Percent of Quota)
  - Quota: 2,395.50  100.00
  - Fund holdings of currency: 2,184.4  91.91
  - Reserve position: 211.10  8.81

- SDR Department (SDR Million; Percent of Allocation)
  - Net cumulative allocation: 246.53  100.00
  - Holdings: 164.70  66.81

- Outstanding Purchases and Loans: None
- Financial Arrangements: None

### VI. Projected Obligations to Fund
- Projection basis: (SDR Million; based on existing use of resources and present holdings of SDRs)
- Forthcoming principal and charges/interest by year:
  - 2006 2007 2008 2009 2010
  - Principal
  - Charges/Interest
  - 3.333.333.323.32
  - Total
  - 3.333.333.323.32

- Arrears note: When a member has overdue financial obligations outstanding for more than three months, the amount of such arrears will be shown in this section.

### VII. Exchange Arrangements
- The Krona has been floating since November 19, 1992.
- Sweden has accepted the obligations of Article VIII (Sections 2(a), 3, and 4) and maintains an exchange system that is free of restrictions on the making of payments and transfers for current international transactions, apart from those imposed for security reasons, which have been duly notified to the Fund by the Riksbank on June 1, 2006 (EBD/06/79, June 23, 2006) in accordance with Executive Board Decision No. 144-(52/51).

### VIII. Article IV Consultation
- Discussions for the 2005 Article IV consultation were held in Stockholm, May 16-25, 2005.
- The staff report (IMF Country Report 05/343) was issued on September 15, 2005.
- The consultation was concluded by the Executive Board on September 2, 2005.

### IX–X. Technical Assistance and Representation
- Technical Assistance: None
- Resident Representative: None

### Statement by Swedish Authorities (Tuomas Saarenheimo and Ms. Roos-Isaksson) — January 26, 2007

#### Overview and Policy Priorities
- Authorities express appreciation for the Article IV consultations and note the value of dialogue with the new Swedish Government that took office in October 2006.
- The new Government faces three major challenges: demographic changes; globalization and structural changes; and the single greatest challenge—to increase employment.
- Policy agenda emphasizes economic incentives to foster labor supply and increase labor demand by making it easier and cheaper to employ people.
- Recent estimates by the National Institute of Economic Research (NIER) indicate that measures in the budget bill for 2007 are likely to be significant and lasting, resulting in a lower unemployment rate and a higher potential labor force.

#### Recent Economic Developments
- Authorities broadly agree with staff on near-term prospects, but differ on resource utilization for 2006 and the next two years.
- GDP growth expectations:
  - Expected to be high and around 4.5 percent in 2006 and then decline somewhat in 2007 and 2008.
- Growth drivers:
  - Private consumption growth due to increased private wealth and disposable income.
  - Increases in private investments and exports to some extent.
- Labor market:
  - Developments lag behind output, partly due to unexpectedly high productivity growth rate.
  - Employment growth has been strong during 2006 and is expected to continue to be high in the coming years.
  - Unemployment expected to gradually decline, although with some delay due to cutbacks in labor market programs and strong increase in labor supply.
- Comparison with staff:
  - Staff expects lower employment growth in 2006 and 2007 and a smaller increase in the labor force.

#### Fiscal Policy
- Authorities concur fiscal stance for 2007 and successive years should be seen within broader reform context.
- Maintaining a healthy fiscal budget surplus is of utmost importance.
- Commitment to fiscal targets (surplus target and expenditure ceilings) remains intact; future reforms designed to attain these targets.
- Authorities expect tax reforms in the 2007 budget bill and planned reforms to lower equilibrium unemployment, increase labor supply, and improve long-run fiscal position by broadening tax bases and reducing unemployment and sickness benefits.
- Disagreement with staff estimates:
  - Staff estimates a positive output gap of 1.5 percent of potential GDP in 2006 and 2.2 percent in 2007, and a structural surplus of less than 1 percent of GDP in 2007 and 2008.
  - NIER and the Ministry of Finance estimate the output gap to become close to zero in early 2007.
  - NIER estimates a structural balance as high as 3.1 percent of GDP in 2007.
  - Government views staff’s higher output gap estimate for 2006 as key source of discrepancy.
- Supporting indicators for authorities’ view:
  - Riksbank assesses the economy still has a certain amount of unutilized resources in the labor market.
  - No evidence of accelerating wages generally; labor shortages rare except in construction where wage increases remained moderate.
- Structural balance expectations:
  - In view of an output gap close to zero, structural balance expected to be close to actual net lending level.
- Fiscal framework assessment:
  - Expenditure ceilings consistently met since introduction in 1997.
  - Government’s latest assessment in the 2007 budget bill shows net lending surplus reached 2 percent of GDP on average in 2000-2006.
- Plans to refine framework:
  - Authorities aim to increase transparency and facilitate ex-post evaluation of fiscal targets.
  - Scrutinizing how to clarify link between nominal expenditure ceiling and surplus target.
  - Developing clear principles for technical adjustments of expenditure ceilings and analyzing effects of demographic developments and intergenerational distribution.
  - Measures to be presented in future budget bills.
- On independent economic agency:
  - Authorities emphasize role should not be ex ante in suggesting budget targets.
  - Possible role: evaluate ex post fulfillment of fiscal targets and evaluate methods/models used in fiscal policy implementation.
  - Government will take suggestion under consideration.

#### Structural Policies
- Authorities agree with staff on need to strengthen competition in some markets and reduce regulatory burden.
- Government strategy to improve business climate includes:
  - Lowering regulatory burden for enterprises.
  - Reducing number of state-owned enterprises.
  - Halving the wealth tax, with aim to abolish the wealth tax altogether within this Government’s term in office to increase availability of venture capital.
  - Opening the public sector to competition to encourage higher quality, greater accessibility and increased diversity in healthcare and social services.
  - First step: elderly care via a “Freedom of Choice” reform.

#### Monetary Policy
- Framework: target annual change in consumer price index of 2 percent with a tolerance interval of plus/minus 1 percentage point.
- Riksbank developments:
  - Continues to evaluate and develop monetary policy process.
  - In 2006, a specific statement was published to clarify goal and strategy.
  - On January 16, 2007 the Riksbank’s Executive Board decided to present its own interest forecasts in subsequent reports.
  - Change from constant interest rates to market interest rates as basis of forecast has been refined.
- Inflation developments:
  - Inflation was low and below target in 2005 and 2006, mainly due to unexpectedly high productivity growth, low pressure on wages, low growth of unit labor costs, slow growth of import prices, and appreciating krona.
  - For 2007 and 2008, productivity growth expected to slow down and employment to grow faster, implying higher unit labor cost growth and higher capacity utilization, generating higher inflation pressure.
  - Energy prices expected to level off.
  - Krona expected to appreciate somewhat further in real and nominal terms.
  - Inflation expected to increase gradually and be close to target two years from now, presupposing continued tightening of monetary policy.
- Policy rate path in 2006:
  - Increased from 1.5 percent in January to 3.0 percent in December.
  - Further increases expected in 2007.

#### Financial Sector
- Riksbank and authorities agree with staff that continued improvements in profitability have increased banking sector resilience.
- Banking sector well positioned to cope with unexpected losses and adverse domestic economic shocks.
- Authorities acknowledge shortcomings in legislative framework for managing distressed institutions and agree improvements are needed in bank resolution framework.
- Visit by Fund’s Monetary and Capital Markets Department staff mission welcomed.

*Source: APPENDIX I. SWEDEN: FUND RELATIONS (As of November 30, 2006).*

### Conclusion

### Conclusion

### Board communication and publication
- The Board looks forward to conveying the outcome of this Board discussion to the Swedish authorities to complete the constructive dialogue conducted during this consultation.
- The authorities intend to authorize publication of the staff report, in accordance with normal Fund procedures.

### Background and macroeconomic outlook
- A new center-right coalition government launched an ambitious program of economic reform aimed at addressing widespread exclusion from the labor market, centering on cutting taxation for low and average income earners, reducing unemployment and sickness benefits, and redefining labor market policies.
- A broad-based economic upturn is under way, spurred by strong global growth and supportive fiscal and monetary policies. Private consumption has been the engine of expansion, supported by a resurgence in investment and buoyant exports.
- The momentum of the recovery is expected to continue, although easing back in 2007-08 due to capacity constraints and fading policy stimulus.
- Growth is expected to ease back in 2007–08 as stimulative effects of monetary and fiscal policy fade and the positive output gap starts to close.
- Risks to the outlook are broadly balanced: a possible slowdown in world growth is offset by the likelihood of stronger-than-projected domestic demand.

### Inflation, labor costs, and monetary policy
- Wage inflation remained moderate during 2005–06 and, coupled with strong productivity gains, helped contain labor costs.
- Cost pressures have begun to emerge recently, reflecting the pass-through of higher energy prices and incipient wage pressures.
- Measures of expected inflation have been rising toward the inflation target as capacity utilization is at an all-time high and a sizeable positive output gap is projected to open.
- The Riksbank has begun to withdraw monetary stimulus: the key policy rate was raised in steps from a historic low of 1.5 percent in January 2006 to 3 percent in December.

### Fiscal stance and structural balance
- The structural surplus is estimated to fall below the 2-percent target in 2006, as buoyant tax revenues were offset by pre-election spending on job-creation programs.
- Tax cuts in the 2007 budget, including in income, wealth and property taxes, amount to around 2 percent of GDP. They would be financed partially by lowering welfare benefits, raising unemployment insurance contributions, and reducing spending on labor market programs.
- The staff projects a further fall in the structural surplus in 2007.
- Looking to 2008 and beyond, Directors underlined the need to achieve the surplus target of 2 percent of GDP over the cycle.
- Directors viewed expenditure restraint as critical to create room for additional tax cuts over the medium term.
- Directors encouraged refining the fiscal framework to improve transparency and accountability, noting that the fiscal surplus target lends itself to different interpretations and that clarifying the framework is welcome.
- The government decided to restore the three-year horizon of spending ceilings and reduce reliance on tax expenditures.
- Some Directors supported establishing an independent economic agency to provide ex post evaluations of adherence to fiscal targets.

### Exchange rate and external position
- The krona has remained broadly unchanged against the euro in recent years but has appreciated 5 percent in effective terms over the past year.
- Large actual and projected current account surpluses are expected to continue in the medium-term.

### Executive Board assessment and policy recommendations
- Directors commended Sweden’s strong recent economic performance, rapid growth, and robust competitive position.
- Directors noted that strong growth has yet to translate into a durable revival in employment and that a large section of the workforce remains excluded from the labor market; they welcomed government reforms aimed at restructuring the tax-benefit system to increase incentives to work.
- Directors took note of significant divergence between staff and authorities on the cyclical position and fiscal stance and urged caution given uncertainty surrounding cyclical estimates, especially during major reforms.
- Directors agreed that the Riksbank will need to tighten monetary policy further in the coming year and saw scope for continued tightening broadly in line with current market expectations.
- Directors viewed recent changes to the inflation targeting framework as improving clarity and transparency of monetary policy communication and welcomed the Riksbank’s decision to evolve the framework, including potential use of the Riksbank’s own forecasts of interest rates consistent with achieving the inflation target.
- Directors considered the financial system sound and stable, welcomed plans to improve the legislative framework for bank resolution, and recommended close monitoring of asset prices, especially real estate.
- Directors noted that labor market reform pay-offs could be enhanced by promoting competition (notably in construction) and encouraging entrepreneurship; they welcomed plans to sell some state-owned enterprise holdings.
- Directors praised Sweden’s high level of official development assistance.

### Key quantitative indicators (selected)
- Real GDP growth: 2001: 1.1; 2002: 2.0; 2003: 1.7; 2004: 4.1; 2005: 2.9; 2006: 4.8; 2007-09 average (staff projections): 2.3.
- Domestic Demand (percent change): 2001: -0.2; 2002: 0.7; 2003: 1.7; 2004: 2.1; 2005: 2.7; 2006: 4.3; 2007-09 average: 2.1.
- CPI Inflation (percent change): 2001: 2.7; 2002: 1.9; 2003: 2.3; 2004: 1.0; 2005: 0.8; 2006: 1.6; 2007-09 average: 1.9.
- Gross national saving (percent of GDP): 2001: 21.9; 2002: 21.7; 2003: 23.7; 2004: 23.1; 2005: 24.2; 2006: 24.2; 2007-09 average: 25.3.
- Gross domestic investment (percent of GDP): 2001: 17.5; 2002: 16.6; 2003: 16.4; 2004: 16.3; 2005: 17.1; 2006: 18.3; 2007-09 average: 18.8.
- General government balance (percent of GDP): 2001: 2.6; 2002: -0.5; 2003: -0.2; 2004: 1.6; 2005: 2.8; 2006: 2.8; 2007-09 average: 2.7.
- Structural balance (percent of potential GDP, adjusted for one-off effects): 2001: 2.1; 2002: -0.4; 2003: 0.9; 2004: 1.8; 2005: 3.0; 2006: 1.7; 2007-09 average: 1.5.
- General government debt (percent of GDP): 2001: 53.8; 2002: 52.0; 2003: 51.8; 2004: 50.7; 2005: 50.4; 2006: 46.3; 2007-09 average: 37.9.
- Trade balance (percent of GDP): 2001: 6.3; 2002: 6.9; 2003: 6.8; 2004: 8.3; 2005: 7.6; 2006: 7.2; 2007-09 average: 6.8.
- Current account (percent of GDP): 2001: 4.4; 2002: 5.1; 2003: 7.3; 2004: 6.8; 2005: 7.1; 2006: 6.0; 2007-09 average: 6.5.
- International reserves (in billions of US dollars): 2001: 15.3; 2002: 17.4; 2003: 20.0; 2004: 22.4; 2005: 26.5.

*Public Information Notice (PIN) No. 07/15, February 7, 2007.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr0752.pdf_