## _cr08379

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---

### Executive summary — background and macro-financial context
- Global liquidity crisis put the financial sector under severe stress but most banks have weathered the crisis well owing to strong initial positions and supportive policies.
- Crisis accelerated a downturn that began in 2007—after a two-year boom—and tilted macroeconomic risk towards recession.
- Inflation and labor market:
  - Nominal wage growth about 4.5 percent, implying real wage growth in excess of productivity growth.
  - Unemployment: the downward march ended in August; unemployment remains at a record low, well below the estimated NAIRU.
  - Inflation: accelerated to just under 5 percent in 2008 driven by food and energy prices and rising core inflation after wage acceleration; inflation expectations worsened starting mid-2007 but have since stabilized.
- External and competitiveness:
  - CGER analysis: REER well aligned—average overvaluation of less than 2 percent—but wage competitiveness eroded by slower productivity growth and faster real wage growth than trading partners.
  - REER high relative to recent norms; external current account surplus narrowing; Denmark’s share in global export markets declined.
- Financial sector soundness:
  - Most banks, including the half dozen largest, weathered the crisis well due to conservative investment strategies and sound regulation.
  - Large commercial banks account for about 80 percent of assets; specialized mortgage banks and large banks are well-capitalized; small and medium sized banks have slim excess capital buffers.
  - Direct exposure to U.S. subprime assets was limited; main contagion channels were increased risk aversion and drying-up of liquidity.
  - Small and medium sized banks reliant on money market funding were hardest hit, prompting mergers/takeovers and some central bank intervention.
- Fiscal position:
  - Debt ratio declined to a little over 20 percent; interest rate spreads on government debt negligible (though pushed up by the financial crisis).
  - A 4½ percentage point increase in the fiscal surplus since 2003 stemmed from cyclical factors (strong employment) and structural factors (rising North Sea oil and gas activities and lower net interest payments).
- Policy framework and implementation:
  - Authorities adhered to the euro peg and fiscal rules, allowed automatic stabilizers to operate, moved decisively to ensure banking system liquidity and reassure creditors.
  - Recent policy changes: marginal tax rate on labor income being cut (not financed by raising property taxes); more resources announced for the Danish Financial Supervisory Authority (DFSA) consistent with the 2006 FSAP recommendation.

### Outlook, medium-term projections, and downside risks
- Outlook summary:
  - Economic growth expected to drop below potential in 2008; output gap expected to turn negative in 2009. Recovery expected to begin in 2010.
- Medium-term scenario (selected series, percentage change unless otherwise indicated):
  - Real GDP: 2007 1.7, 2008 0.6, 2009 0.3, 2010 0.4, 2011 1.1, 2012 1.6, 2013 1.6
  - Real domestic demand: 2007 3.1, 2008 1.6, 2009 -0.2, 2010 0.3, 2011 1.1, 2012 1.9, 2013 1.9
  - Net exports 1/: 2007 -1.0, 2008 -0.4, 2009 0.4, 2010 0.2, 2011 0.0, 2012 -0.3, 2013 -0.3
  - Exports 1/: 2007 1.9, 2008 1.9, 2009 1.0, 2010 3.3, 2011 2.0, 2012 3.3, 2013 3.3
  - Imports: 2007 3.8, 2008 2.6, 2009 0.2, 2010 3.0, 2011 2.0, 2012 3.8, 2013 3.8
  - Current account 2/: 2007 1.1, 2008 0.9, 2009 0.5, 2010 0.8, 2011 0.8, 2012 0.6, 2013 0.4 (in percent of GDP)
  - Consumer Prices (Inflation): 2007 1.7, 2008 3.4, 2009 2.3, 2010 2.1, 2011 1.9, 2012 1.9, 2013 1.9
  - Average unemployment rate: 2007 2.8, 2008 1.8, 2009 3.0, 2010 3.7, 2011 4.0, 2012 4.0, 2013 4.0
  - Output gap 3/: 2007 2.3, 2008 1.0, 2009 -0.1, 2010 -0.7, 2011 -0.3, 2012 -0.1, 2013 0.0 (in percent of potential output)
  - Sources: Danmarks Nationalbank, Statistics Denmark, and IMF staff estimates.
- Downside risks highlighted:
  - More prolonged global recession could constrain export growth through 2010.
  - Tight liquidity could push up interest rates on adjustable rate mortgages that will reset in December—which amount to 13 percent of GDP.
  - Higher interest costs concurrent with rising unemployment could trigger household belt-tightening, a spike in mortgage defaults, further decreases in home values, second-round effects on investment and employment, and potentially pull the economy into a recession.
- Staff mark-down (Statement by IMF Staff Representative, December 19, 2008):
  - Third quarter data suggest lower GDP growth; GDP fell by ½ percent in Q3 2008.
  - Staff marked down growth projections to about zero in both 2008 and 2009; output gap projected to turn negative in 2009.
  - Table (medium-term outlook, 2008–11, selected):
    - Real GDP: 2008 0.0; 2009 0.0; 2010 0.5; 2011 1.1
    - Average unemployment rate: 2008 1.8; 2009 3.2; 2010 4.0; 2011 4.2
    - General government balance1/: 2008 3.0; 2009 0.0; 2010 -0.9; 2011 -0.6
    - Output gap2/: 2008 0.8; 2009 -0.3; 2010 -0.8; 2011 -0.7

### Housing and the business cycle (Box 2)
- Housing market assessment:
  - WEO estimates: Danish housing prices about 20 percent overvalued in December 2007.
  - Since December 2007, prices decreased only 2 percent.
  - House prices overshot fundamentals during the boom and have yet to correct fully.
- Transmission channels and risks:
  - Interest rate increases on adjustable mortgages combined with rising unemployment could depress construction, drive up unemployment, and weaken real estate loan portfolios.
  - House prices highly correlated with residential construction; construction’s high labor intensity implies large employment effects.
  - Impact on consumption could be large when compounded by high interest costs, a collapse in share prices and rising unemployment.
- Financial accelerator and banking risks:
  - Foreclosures from high variable-rate mortgage rates could depress home values and impair recovery on defaulted mortgages.
  - Banks could incur losses while balance-sheets are already weakened, possibly resulting in prolonged tight credit and higher borrowing costs.
- Policy responses and implications:
  - Peg to the euro stabilizes inflation by importing the ECB’s monetary stance; authorities reaffirmed the peg and took steps—including interest rate hikes—to support reserves and maintain euro liquidity.
  - October FX pressures pushed up the interest rate; authorities increased domestic interest rates (now 175 bps higher than the euro rate), buttressed reserves with proceeds of euro-denominated government borrowing, and arranged a currency swap with the ECB.
  - Interest rate hikes stemmed outflows but could push up mortgage financing costs when adjustable rates reset in December.
  - For 2009, mission and authorities agreed a close-to-neutral fiscal stance appropriate; adopted budget implied a fiscal injection of about 0.6 percent of GDP.
- Financial-stability framework (Agreement on Financial Stability):
  - Guarantee of claims: All deposits and other unsecured claims on banks belonging to the Private Contingency Association (PCA) are guaranteed; 133 banks—and 99 percent of deposits—are covered.
  - Winding up company (WUC): Banks below regulatory capital floor must allow a state-owned WUC to arrange for purchase or wind-up; all deposits and unsecured claims honored; shareholders lose control.
  - Burden sharing: PCA covers first DKK 35 billion of WUC losses (equivalent to 2 percent of GDP); beyond that the state covers losses and receives any profit earned by the WUC.
  - Level playing field: Guarantee covers all PCA member banks; can cover branches abroad only if host country has a similar guarantee; Act extends Deposit Guarantee Fund coverage to Danish branches of foreign banks.
  - Moral hazard and supervision: Act allows expelling banks that take greater risk under the umbrella, DFSA may dismiss board members or management.
  - Participating banks committed not to pay dividends, create new redemption programs or initiate new share purchases.
- Supervisory capacity and mortgage legislation:
  - Staff raised concern about adequacy of DFSA resources given intensified monitoring needs and expanded mandate under Basel II; authorities increased DFSA resources.
  - 2007 mortgage covered bond legislation tightens loan-to-value standards and aligns securitization techniques with mortgage banks’ “balance principles.”

### Financial sector developments, central bank response, and recapitalization considerations
- Market developments and central bank actions:
  - Danmarks Nationalbanken matched the ECB’s rate cuts in November and December, keeping spreads constant; interbank rates decreased in November.
  - Foreign exchange outflows stopped; maturing mortgage bonds rolled over successfully.
  - Spread vis-à-vis the ECB "currently stands at the somewhat elevated level of 1.75 percent."
  - From end-October, pressure on the krone eased; DNB bought back foreign exchange and followed ECB rate reductions announced on November 6 and December 4.
- Crisis background and bank resilience:
  - Global crisis exacerbated cyclical slowdown that began in early 2007 when housing boom ended and residential investment declined.
  - Most Danish banks started with healthy capital buffers; direct exposures to risky assets small; subsidiaries protected by restrictions on intra-group exposures.
  - Indirect contagion channels (risk aversion, liquidity freeze) hit small/medium banks particularly hard.
- Consideration of bank capital injections:
  - Authorities considering ways to increase banks’ capital buffers, including direct injections of state funds.
  - Principles for any banking package: i) aim only to avoid an actual credit crunch; ii) only well-run banks to access temporary financing; iii) government to get a return close to market-based return proportional to the capital injection.
  - Staff noted discussions on a new banking package aimed at preventing a credit crunch by injecting new capital, subject to adequate safeguards.
- Executive Board and directors’ views:
  - Directors commended authorities’ policies but noted conditions remain fragile due to market liquidity constraints and weakening global outlook.
  - Directors supported krone peg to the euro and urged macroeconomic policy to reflect ERMII participation.
  - Directors welcomed the new financial stability act and emphasized intensifying surveillance and ensuring DFSA resources under Basel II.
  - Directors took positive note of recapitalization discussions to prevent a credit crunch.

### Fiscal stance, sustainability, and reform priorities
- Fiscal stance and automatic stabilizers:
  - Denmark’s fiscal position among the strongest in the EU; historical surpluses enabled debt reduction and low interest spreads.
  - Proposed 2009 budget judged to strike a balance between allowing growth to slow and cushioning a severe recession; adds a discretionary positive impulse and relies mainly on automatic stabilizers.
  - Fiscal expansion: discretionary fiscal expansion almost 1 percent of GDP in 2009; personal income tax cuts and public demand growth each account for around one half.
  - First-year fiscal impulse to GDP growth estimated at 0.4 percent in 2009 (fiscal easing added 0.2 percent to GDP growth in 2008).
  - Households’ real disposable income expected to rise by "3¾ percent in 2009" due to fiscal easing, high wage growth, and lower energy prices.
  - Surplus/deficit path: surplus expected to fall from "4½ to 5 percent of GDP in 2005-07" to "3 percent of GDP this year" and around balance next year; in 2010 a deficit of "1.2 percent of GDP" is projected.
  - Public consumption expected to rise to "27¼ percent of GDP in 2010", the highest level since 1983 and above the indicative target of "26½ percent" set in the 2015-plan.
- Long-term fiscal sustainability and reforms:
  - Welfare Agreement (2006) raises age thresholds for voluntary early retirement pension starting 2019 and old age pension starting 2024, then indexes them to longevity; improved long-run structural fiscal balance by about 4 percentage points of GDP.
  - Remaining sustainability gap: tax freeze through 2015, personal income tax cuts effective 2009, and energy strategy create a sustainability gap of 0.8 percent of GDP that would need to be filled by a permanent increase in the structural balance by 0.8 percent of GDP.
  - Denmark: Fiscal Sustainability Gap table (selected items):
    - 2006 Convergence Program -0.2; Structural Changes and Revisions 0.2; 2006 Convergence Program (revised) 0.0; Subsequent Policies: Personal Income Tax Cuts -0.6; Tax Freeze to 2015 -0.3; Other Tax Changes 0.6; Energy Strategy -0.3; Public Consumption -0.1; Public Investment -0.1; Sustainability Gap -0.8.
  - Specific fiscal projections:
    - Structural surplus declines from over 2 percent of GDP in 2007 to about zero by 2015.
    - Public sector wage agreement locks in wage increases of 12 percent over the next three years.
    - Government’s 2015 plan targets structural surpluses in a ¾ to 1¾ percent of GDP range through 2010 and above zero through 2015, raising net government assets to about 10 percent of GDP in 2015.
  - Commissions and mandates:
    - Tax Commission: improve work incentives by lowering marginal tax rates on labor income; required to present a revenue-neutral overall package and cannot reverse the decline in the effective real estate tax rate caused by the tax freeze.
    - Labor Market Commission: improve long-term public finances; preliminary proposals include accelerating the Welfare Agreement’s program to raise the pension age, reduce the duration of unemployment benefits, shift active labor market programs toward on-the-job training, and improve recruitment of foreign labor.
- Policy recommendations and expenditure-side measures:
  - Upfront action needed to ensure fiscal sustainability; "difficult choices" required to make the welfare state compatible with labor market incentives and long-term fiscal balance.
  - Tax-reform recommendations: consider user fees, indexation of the tax on residential property, and reducing the deductibility of mortgage interest.
  - Expenditure-side recommendation: proposals presented by the Labor Market Commission "deserve careful consideration."
- Risks and implementation challenges:
  - Welfare Agreement fiscal benefits are back-loaded to 2019, risking political slippage.
  - Policy measures to achieve 2015 targets not yet identified.
  - Uncertainty regarding fiscal costs of ageing; staff and independent researchers suggest authorities’ assumptions might be too optimistic.
  - Opening borders to EU New Member States at end-2010 may create concerns about gaming eligibility rules.
  - Uncertainties in sustaining fiscal discipline at the local government level.

### Exchange rate arrangements, surveillance, and IMF relations
- Exchange rate regime:
  - Denmark participates in ERMII.
  - Maintains 2¼ percent fluctuation margins vis-à-vis the euro with a central fixed rate at DKr 746.038 per €100.
- Surveillance and data:
  - Denmark on 24-month Article IV consultation cycle.
  - Data provision adequate for surveillance; subscribes to the Fund’s Special Data Dissemination Standard.
- Fund relations and financial position (Appendix I highlights):
  - Membership: Joined March 30, 1946; accepted obligations of Article VIII.
  - Quota: 1,642.80 SDR Million — 100.00 percent quota.
  - Fund holdings of currency: 1,525.63 SDR Million — 92.87 percent.
  - Reserve Tranche position: 117.18 SDR Million — 7.13 percent.
  - SDR Department net cumulative allocation: 178.86 SDR Million — 100.00 percent; Holdings: 209.97 SDR Million — 117.39 percent.
  - Projected payments to the Fund (2009–2012): Charges/Interest: 0.01; 0.01; 0.01; 0.01; Total: 0.01; 0.01; 0.01; 0.01.
  - Appendix II: statistical appendix summary — data quality and timeliness generally very good.
- IMF staff recommendation: Denmark remain on the 24-month consultation cycle.

### Key quantitative indicators (selected, preserved exactly as presented)
- Real GDP (medium-term scenario, 2005–13): 2005: 2.5; 2006: 3.9; 2007: 1.7; 2008: 0.6; 2009: 0.3; 2010: 0.4; 2011: 1.1; 2012: 1.6; 2013: 1.6.
- Private consumption (2005–13): 2005: 5.2; 2006: 3.8; 2007: 2.3; 2008: 1.8; 2009: 0.8; 2010: 1.1; 2011: 2.4; 2012: 2.2; 2013: 2.2.
- Fixed investment (2005–13): 2005: 6.1; 2006: 14.0; 2007: 5.9; 2008: 0.0; 2009: -3.5; 2010: -2.6; 2011: -1.9; 2012: 2.4; 2013: 2.4.
- Current account (percent of GDP, 2005–13): 2005: 4.4; 2006: 2.9; 2007: 1.1; 2008: 0.9; 2009: 0.5; 2010: 0.8; 2011: 0.8; 2012: 0.6; 2013: 0.4.
- General government balance (percent of GDP, 2003–13): 2003: -0.1; 2004: 1.9; 2005: 5.0; 2006: 4.9; 2007: 4.8; 2008: 3.2; 2009: 2.1; 2010: 0.8; 2011: 0.4; 2012: 0.2; 2013: 0.3.
- General government gross debt (percent of GDP, 2003–13): 2003: 45.8; 2004: 43.8; 2005: 36.4; 2006: 30.4; 2007: 26.0; 2008: 21.3; 2009: 18.8; 2010: 17.5; 2011: 16.5; 2012: 15.7; 2013: 14.8.
- Unemployment (medium-term scenario, average unemployment rate, 2005–13): 2005: 5.1; 2006: 3.9; 2007: 2.8; 2008: 1.8; 2009: 3.0; 2010: 3.7; 2011: 4.0; 2012: 4.0; 2013: 4.0.
- Consumer Prices (CPI, year average, 2005–13): 2005: 1.8; 2006: 1.9; 2007: 1.7; 2008: 3.4; 2009: 2.3; 2010: 2.1; 2011: 1.9; 2012: 1.9; 2013: 1.9.
- Selected financial soundness indicators (2005–07, headline values):
  - Regulatory capital to risk-weighted assets: 2005: 13.8; 2006: 13.4; 2007: 13.2.
  - Tier 1 capital to risk-weighted assets: 2005: 10.6; 2006: 10.7; 2007: 10.2.
  - Nonperforming loans to gross loans: 2005: 0.8; 2006: 0.7; 2007: 0.4.
  - Liquid assets to total assets (selected years): 2005: 31.3; 2006: 30.4; 2007: 26.5; 2008: 24.4.
- Net investment position (2001–07, percent of GDP): 2001: -16.5; 2002: -16.4; 2003: -12.2; 2004: -5.3; 2005: 3.5; 2006: -1.6; 2007: -4.0.
- Additional PIN indicators (selected):
  - Real GDP growth (selected): 2004: "2.3"; 2005: "2.4"; 2006: "3.3"; 2007: "1.6"; 2008 proj.: "0.0"; 2009 proj.: "0.0".
  - Unemployment rate (in percent): 2004: "5.8"; 2005: "5.1"; 2006: "3.9"; 2007: "2.8"; 2008: "1.8"; 2009 proj.: "3.2".
  - CPI (year average) change (percent): 2004: "1.2"; 2005: "1.8"; 2006: "1.9"; 2007: "1.7"; 2008: "3.4"; 2009 proj.: "2.3".
  - General government balance (percent of GDP): 2004: "1.9"; 2005: "5.0"; 2006: "5.0"; 2007: "4.5"; 2008: "3.0"; 2009 proj.: "0.0".
  - General government gross debt (percent of GDP): 2004: "43.8"; 2005: "36.4"; 2006: "30.6"; 2007: "26.1"; 2008: "22.0"; 2009 proj.: "21.5".
  - GDP per capita (2006): "$50,818".
  - At-risk-of-poverty rate (2006): "12 percent".

### Staff views, policy assessment, and recommendations
- Overall assessment:
  - Authorities’ response to the crisis described as bold and well conceived; special liquidity measures and a public-private Financial Stability Agreement (including a broad guarantee of liabilities) are ensuring access to liquidity and bolstering creditor confidence.
- Macroeconomic policy mix:
  - Policy mix judged appropriate—higher interest rates to support the exchange rate peg and an expansionary budget to add a countercyclical thrust to automatic stabilizers.
  - Case for further discretionary easing is weak; some slowing is needed to stop the decline in competitiveness and automatic stabilizers should cushion the impact of a faster-than-anticipated slowdown.
- Financial surveillance and supervision:
  - Intensify financial sector surveillance and supervision; monitor liquidity risk more frequently and comprehensively.
  - Ensure DFSA has resources to recruit and retain staff under expanded Basel II mandate; recently agreed increase is welcome (authorities increased DFSA resources by "DKK 10 million" as part of the political agreement on financial stability).
- Fiscal policy and reforms:
  - Upfront action needed to secure long-term fiscal sustainability; further action required to offset recent tax cuts and spending commitments.
  - Consider tax reforms including user fees, indexation of residential property tax, and reducing deductibility of mortgage interest.
  - Expenditure-side measures and Labor Market Commission proposals merit careful consideration.

*Source: _cr08379 - Executive Summary; Box 2. Housing and the Business Cycle; APPENDIX I: DENMARK—FUND RELATIONS; Public Information Notice No. 08/148 (December 29, 2008); Statement by the IMF Staff Representative (December 19, 2008).*

### Executive Summary

### _cr08379 - Executive Summary

### Background
- The global liquidity crisis put the financial sector under severe stress but most banks have weathered the crisis well owing to strong initial positions and supportive policies.
- The crisis accelerated a downturn that had begun in 2007—after a two-year boom—and tilted the balance of macroeconomic risk towards recession.
- Inflation picked up in 2007, has started to slow, but the output gap is still high and unemployment is still near a 30-year low, resulting in still-fast wage growth.
- The boom swelled Denmark’s fiscal surpluses, reducing the government debt burden.
- Policy framework and near-term implementation:
  - Authorities adhered to the euro peg and fiscal rules which allow full play to automatic stabilizers while moving decisively to ensure banking system liquidity and reassure creditors.
  - Box 1: Implementation of Fund Policy Advice — Recent policy changes are in line with some but not all recommendations from the 2006 Article IV consultation: the marginal tax rate on labor income is being cut (not financed by raising property taxes), and more resources have been announced for the Danish Financial Supervisory Authority (DFSA) consistent with the 2006 FSAP recommendation.
- Labor market and prices:
  - Wage pressures: nominal wage growth about 4.5 percent, implying real wage growth in excess of productivity growth.
  - Unemployment: the downward march ended in August, but unemployment remains at a record low, well below the estimated NAIRU.
  - Inflation: accelerated to just under 5 percent in 2008 driven by food and energy prices and rising core inflation after wage acceleration; inflation expectations worsened starting mid-2007 but have since stabilized with the downturn in commodity prices and the global outlook.
- Competitiveness and external sector:
  - CGER analysis suggests the real effective exchange rate (REER) is well aligned—average overvaluation of less than 2 percent—yet wage competitiveness has been eroded by slower productivity growth and faster real wage growth than trading partners.
  - REER is high relative to recent norms, the external current account surplus has been narrowing, and Denmark’s share in global export markets has declined.
- Financial sector soundness:
  - Most banks, including the half dozen largest, have weathered the crisis well due to conservative investment strategies and sound regulation.
  - Large commercial banks account for about 80 percent of assets; specialized mortgage banks and large banks are well-capitalized, while small and medium sized banks have slim excess capital buffers.
  - Direct exposure to U.S. subprime assets was limited; main contagion channels were increased risk aversion and drying-up of liquidity.
  - Hardest hit were small and medium sized banks reliant on money market funding, prompting mergers/takeovers and some central bank intervention.
- Fiscal position:
  - Denmark’s fiscal position is among the strongest in the EU: the debt ratio declined to a little over 20 percent and interest rate spreads on government debt are negligible (though pushed up by the financial crisis).
  - A 4½ percentage point increase in the fiscal surplus since 2003 stemmed from cyclical factors (strong employment, reduced unemployment) and structural factors (rising North Sea oil and gas activities and lower net interest payments).

### Outlook and Risks
- Outlook:
  - Economic growth will drop below potential in 2008, and the output gap is expected to turn negative in 2009. Recovery is expected to begin in 2010.
  - Medium-term scenario (selected series, percentage change unless otherwise indicated):
    - Real GDP: 2007 1.7, 2008 0.6, 2009 0.3, 2010 0.4, 2011 1.1, 2012 1.6, 2013 1.6
    - Real domestic demand: 2007 3.1, 2008 1.6, 2009 -0.2, 2010 0.3, 2011 1.1, 2012 1.9, 2013 1.9
    - Net exports 1/: 2007 -1.0, 2008 -0.4, 2009 0.4, 2010 0.2, 2011 0.0, 2012 -0.3, 2013 -0.3
    - Exports 1/: 2007 1.9, 2008 1.9, 2009 1.0, 2010 3.3, 2011 2.0, 2012 3.3, 2013 3.3
    - Imports: 2007 3.8, 2008 2.6, 2009 0.2, 2010 3.0, 2011 2.0, 2012 3.8, 2013 3.8
    - Current account 2/: 2007 1.1, 2008 0.9, 2009 0.5, 2010 0.8, 2011 0.8, 2012 0.6, 2013 0.4 (in percent of GDP)
    - Consumer Prices (Inflation): 2007 1.7, 2008 3.4, 2009 2.3, 2010 2.1, 2011 1.9, 2012 1.9, 2013 1.9
    - Average unemployment rate: 2007 2.8, 2008 1.8, 2009 3.0, 2010 3.7, 2011 4.0, 2012 4.0, 2013 4.0
    - Output gap 3/: 2007 2.3, 2008 1.0, 2009 -0.1, 2010 -0.7, 2011 -0.3, 2012 -0.1, 2013 0.0 (in percent of potential output)
  - Sources cited for the outlook: Danmarks Nationalbank, Statistics Denmark, and IMF staff estimates.
- Downside risks:
  - Considerable downside risk: a more prolonged global recession could constrain export growth through 2010.
  - Tight liquidity could push up interest rates on adjustable rate mortgages that will reset in December—which amount to 13 percent of GDP.
  - Higher interest costs concurrent with rising unemployment could trigger household belt-tightening, a spike in mortgage defaults, further decreases in home values, second-round effects on investment and employment, and potentially pull the economy into a recession.

### Staff’s Views and Policy Assessment
- Overall assessment:
  - The authorities’ response to the crisis has been bold and well conceived.
  - Special liquidity measures and a public-private Financial Stability Agreement (which includes a broad guarantee of liabilities) are ensuring access to liquidity and should bolster creditor confidence.
- Macroeconomic policy mix:
  - The macroeconomic policy mix is appropriate—higher interest rates to support the exchange rate peg and an expansionary budget to add a countercyclical thrust to the strong stabilizing effect of Denmark’s automatic stabilizers.
  - At this point, the case for further discretionary easing is weak because some slowing is needed to stop the decline in competitiveness and automatic stabilizers will cushion the impact of a faster-than-anticipated slowdown.
- Fiscal sustainability:
  - The impressive fiscal reforms of the last few years have gone a long way towards closing the long term fiscal gap, but further action is needed to offset more recent tax cuts and spending commitments.

### Authorities’ Position
- Given slippage in wage competitiveness and a still strong cyclical position, the authorities were wary of fiscal expansion, preferring to rely on automatic stabilizers rather than discretionary policies.
- They are strongly committed to Denmark’s rule-driven policy framework, anchored by the exchange rate peg and a medium-term fiscal framework.
- Closing the long-term fiscal gap is a key priority, but the authorities consider it difficult to make further progress so soon after the major reforms in 2006.

### The Discussions
- A mission comprising Franek Rozwadowski (Head), Jay Surti, Allan Brunner, and Mali Chivakul (EUR) visited Copenhagen on September 22–October 2, 2008.
- Meetings included: the Minister of Finance; the Chairman of the Board of Governors of Danmarks Nationalbanken; the Deputy Director General of the Danish Financial Supervisory Authority; the Deputy Permanent Secretary, Ministry of Business and Economic Affairs; other senior officials; parliamentarians; representatives of trade unions and business associations; and financial institutions.

*Source: _cr08379 - Executive Summary*

### Box 2. Housing and the Business Cycle

### Box 2. Housing and the Business Cycle

### Housing market assessment and recent developments
- WEO estimates suggest that Danish housing prices were about 20 percent overvalued in December 2007.
- Since December 2007, prices have decreased only 2 percent, leaving them well above the level justified by fundamentals such as disposable income and construction cost.
- House prices overshot fundamentals during the recent boom and have yet to correct fully.

### Channels from housing to the real economy
- An increase in interest rates on adjustable rate mortgages combined with a rise in unemployment could trigger an abrupt adjustment, depressing construction, driving up unemployment, and weakening real estate-related loan portfolios.
- A drop in house prices would raise unemployment significantly due to a large impact on construction; house prices have been highly correlated with residential construction and construction’s high labor intensity implies a correspondingly high impact on employment.
- The impact on consumption could be large: although the correlation between consumption and home values has been low in the past, the impact could be large when compounded by high interest costs, a collapse in share prices and rising unemployment.

### Financial accelerator and banking sector risks
- Foreclosures resulting from high interest rates on variable-rate mortgages could depress home values and undermine recovery on defaulted mortgages.
- Banks would make losses when balance-sheets were already damaged by rising unemployment, falling household wealth and weaker corporate balance-sheets, potentially resulting in a longer period of tight credit and higher borrowing costs, delaying economic recovery.

### Policy responses and macroeconomic framework implications
- The peg to the euro stabilizes inflation by importing the ECB’s monetary stance; authorities have reaffirmed their commitment to the peg and taken steps—including interest rate hikes—to support foreign exchange reserves and maintain euro liquidity.
- Foreign exchange market pressures in October pushed up the interest rate; the authorities increased domestic interest rates (now 175 bps higher than the euro rate), buttressed reserves with the proceeds of euro-denominated government borrowing, and arranged a currency swap with the ECB.
- The interest rate hike stemmed outflows but could push up mortgage financing costs when adjustable rates are reset in December.
- Denmark’s fiscal rules aim for long-term sustainability (target range for the structural balance) and demand management (automatic stabilizers); authorities plan to rely on automatic stabilizers to cushion slowing demand without a discretionary fiscal impulse.
- For 2009, the mission and the authorities agreed that a close-to-neutral fiscal stance would be appropriate; the adopted budget implied a fiscal injection—over and above automatic stabilizers—of about 0.6 percent of GDP.

### Financial-stability framework (Agreement on Financial Stability)
- Guarantee of claims: All deposits and other unsecured claims on banks belonging to the Private Contingency Association (PCA) are guaranteed; 133 banks—and 99 percent of deposits—are covered.
- Winding up company (WUC): Banks whose capital falls below the regulatory floor must allow a state-owned WUC to arrange for purchase or wind-up; all deposits and unsecured claims are honored but shareholders lose control of the bank.
- Burden sharing: The PCA is set up as an insurance scheme. Member banks pay premia and make guarantees that, together, cover the first DKK 35 billion of losses incurred by the WUC (equivalent to 2 percent of GDP). Beyond that, losses are covered by the state, which also receives any profit earned by the WUC.
- Level playing field: The guarantee covers all PCA member banks; it can cover branches abroad only if the host country has a similar guarantee. The Act also extends the coverage of the regular Deposit Guarantee Fund to Danish branches of foreign banks.
- Addressing moral hazard and intensifying supervision: The Act has a framework for expelling a bank that takes on greater risk under the umbrella of the guarantee; alternatively the DFSA may dismiss members of the board of directors or order the bank to dismiss a member of its management board.
- Participating banks undertook not to pay dividends, create new redemption programs or initiate new share purchases.

### Supervisory capacity and mortgage legislation
- Staff raised concern about the adequacy of the DFSA’s resources given intensified monitoring needs and the expanded supervisory mandate under Basel II; authorities increased the DFSA’s resources as part of the political agreement on financial stability.
- The introduction of the mortgage covered bond legislation in 2007 tightens loan-to-value standards and provides incentives for commercial banks to strengthen market risk management by aligning securitization techniques more closely with the “balance principles” used by mortgage banks.

### Fiscal stance, structural plans, and sustainability issues
- Authorities plan a gradual decline in the structural surplus over the next six years—a sustained moderate fiscal expansion. The decline reflects demographic shifts, declining North Sea oil and gas revenues, and discretionary elements (tax freeze, personal income tax cuts, public sector wage agreement, and projected public consumption increases).
- Specific fiscal figures and projections:
  - Structural surplus declines from over 2 percent of GDP in 2007 to about zero by 2015.
  - Public sector wage agreement locks in wage increases of 12 percent over the next three years.
  - The government’s 2015 plan targets structural surpluses in a ¾ to 1¾ percent of GDP range through 2010 and above zero through 2015, raising net government assets to about 10 percent of GDP in 2015.
  - The adopted budget implies a fiscal injection of about 0.6 percent of GDP for 2009.
- Denmark’s fiscal automatic stabilizers are among the strongest in Europe; budgetary impact of a 1 percent change in GDP: Denmark 0.85, Italy 0.48, Sweden 0.79, France 0.46, Netherlands 0.76, Greece 0.42, Belgium 0.67, Spain 0.40, Finland 0.63, Portugal 0.38, Germany 0.51, Ireland 0.32, United Kingdom 0.50, Austria 0.31.

### Long-term fiscal policy and reforms
- The Welfare Agreement (2006) will raise the age thresholds for voluntary early retirement pension—starting in 2019—and old age pension—starting in 2024—and then index them to longevity; by reducing the old age dependency ratio the Welfare Agreement improved the long-run structural fiscal balance by about 4 percentage points of GDP.
- Remaining sustainability gap:
  - The tax freeze through 2015, the personal income tax cuts effective in 2009, and the government’s energy strategy create a sustainability gap that would be filled by a permanent increase in the structural balance by 0.8 percent of GDP.
  - Denmark: Fiscal Sustainability Gap table (selected items): 2006 Convergence Program -0.2; Structural Changes and Revisions 0.2; 2006 Convergence Program (revised) 0.0; Subsequent Policies: Personal Income Tax Cuts -0.6; Tax Freeze to 2015 -0.3; Other Tax Changes 0.6; Energy Strategy -0.3; Public Consumption -0.1; Public Investment -0.1; Sustainability Gap -0.8.
- Commissions and mandates:
  - Tax Commission mandate: improve work incentives by lowering marginal tax rates on labor income; commission is required to present a revenue-neutral overall package and cannot reverse the decline in the effective real estate tax rate caused by the tax freeze.
  - Labor Market Commission mandate: improve long-term public finances; preliminary proposals include accelerating the Welfare Agreement’s program to raise the pension age, reduce the duration of unemployment benefits, shift active labor market programs toward on-the-job training, and improve recruitment of foreign labor; these proposals have faced overwhelmingly negative public reaction.

### Risks and implementation challenges
- Risks to closing the longer-term fiscal gap include:
  - The Welfare Agreement’s fiscal benefits are back-loaded to 2019, creating risk that political commitment may falter closer to implementation.
  - Policy measures to achieve the 2015 plan targets have not yet been identified.
  - Uncertainty regarding fiscal costs of ageing, especially health and old-age care; staff and independent researchers suggest authorities’ assumptions might be too optimistic.
  - Opening borders to EU New Member States at end-2010 may create concerns about individuals gaming eligibility rules, potentially weakening fiscal sustainability.
  - Uncertainties in sustaining fiscal discipline at the local government level, though some recent reforms look promising.

*Source: Box 2. Housing and the Business Cycle (excerpt provided).*

### 24.      Denmark has weathered the global crisis well so far but conditions are still

### 24.      Denmark has weathered the global crisis well so far but conditions are still

### Overview
- Denmark's economy is described as "still cyclically strong" but "conditions are still fragile" because the weakening global outlook increases the risk of a severe downturn.
- Financial markets' shift toward risk-free liquid assets has: put pressure on the exchange rate peg; widened interest rate spreads—between krone and euro as well as between government bonds and mortgage bonds.

### Macroeconomic policy and the exchange rate peg
- The exchange rate peg has anchored inflationary expectations and kept interest rates within narrow spreads relative to the euro zone.
- The authorities' policy stance—steady fiscal policy through the crisis and readiness to raise interest rates in the face of reserve outflows—is welcomed.
- Macroeconomic policies need to be set in light of the exchange rate peg.

### 2009 budget and cyclical management
- The proposed 2009 budget "strikes a good balance" between allowing growth to slow and cushioning it from a severe recession.
- The 2009 budget proposal "adds a discretionary positive impulse to the automatic stabilizers" and is judged appropriate despite concerns about medium term sustainability.
- The 2007 cyclical slowdown was considered welcome given "record low unemployment and fast rising wages," but the global crisis raised the risk of a hard landing.

### Financial sector response and stability framework
- Authorities' responses to the financial crisis are characterized as "innovative, forceful, and timely."
- New liquidity facilities are "comprehensive."
- A collaborative approach to resolving problem banks "facilitated prompt decision-making and prevented contagion."
- The new financial stability act:
  - Introduces a blanket guarantee and a transparent procedure for pre-emptive resolution to help secure creditor confidence.
  - Includes a burden-sharing rule that protects the taxpayer but has contributed to a decline in banks' share values.
  - Imposes temporary, intrusive measures to improve incentives for prudent behavior: a dividend moratorium to strengthen capital buffers; greater powers for the DFSA to punish risk-taking; elimination of shareholder control in a wound-up bank to create incentives for preemptive private sector solutions.
  - Contains provisions that level the playing field in cross-border banking operations.

### Financial surveillance and supervision
- Importance of intensifying financial sector surveillance and supervision is underscored by current conditions.
- The DFSA's initiative to monitor liquidity risk "more frequently and comprehensively" is welcome.
- There is scope for further strengthening financial stability work.
- Ensuring the DFSA has resources to recruit and retain appropriate staff under its expanded mandate under Basel II is important; "the recently agreed increase is welcome."

### Competitiveness
- The REER is "well aligned," but recent trends are unsustainable: wages are rising faster than in trading partners while productivity is rising slower.
- Wage growth needs to slow so firms can rebuild profitability and stem the decline in Denmark’s export share; otherwise firms will be stressed by a simultaneous increase in costs and slowdown in demand.

### Fiscal sustainability and policy recommendations
- Upfront action is needed to ensure fiscal sustainability; the achievements of the past two decades do not close the long-term fiscal gap.
- "Difficult choices" are required to make the welfare state compatible with labor market incentives and long-term fiscal balance.
- Tax-reform recommendations:
  - Consider a broader set of measures, including user fees, the indexation of the tax on residential property, and reducing the deductibility of mortgage interest.
- Expenditure-side recommendation:
  - The proposals recently presented by the Labor Market Commission "deserve careful consideration."

### Development assistance and institutional recommendation
- Denmark is committed to maintaining development assistance at the internationally high level of 0.8 percent of gross national income.
- Staff recommends that Denmark remain on the 24-month consultation cycle.

### Key statistics and indicators (selected from source tables)
- Real GDP (medium-term scenario, 2005–13): 2005: 2.5; 2006: 3.9; 2007: 1.7; 2008: 0.6; 2009: 0.3; 2010: 0.4; 2011: 1.1; 2012: 1.6; 2013: 1.6.
- Private consumption (2005–13): 2005: 5.2; 2006: 3.8; 2007: 2.3; 2008: 1.8; 2009: 0.8; 2010: 1.1; 2011: 2.4; 2012: 2.2; 2013: 2.2.
- Fixed investment (2005–13): 2005: 6.1; 2006: 14.0; 2007: 5.9; 2008: 0.0; 2009: -3.5; 2010: -2.6; 2011: -1.9; 2012: 2.4; 2013: 2.4.
- Current account (percent of GDP, 2005–13): 2005: 4.4; 2006: 2.9; 2007: 1.1; 2008: 0.9; 2009: 0.5; 2010: 0.8; 2011: 0.8; 2012: 0.6; 2013: 0.4.
- General government balance (percent of GDP, 2003–13): 2003: -0.1; 2004: 1.9; 2005: 5.0; 2006: 4.9; 2007: 4.8; 2008: 3.2; 2009: 2.1; 2010: 0.8; 2011: 0.4; 2012: 0.2; 2013: 0.3.
- General government gross debt (percent of GDP, 2003–13): 2003: 45.8; 2004: 43.8; 2005: 36.4; 2006: 30.4; 2007: 26.0; 2008: 21.3; 2009: 18.8; 2010: 17.5; 2011: 16.5; 2012: 15.7; 2013: 14.8.
- Unemployment (medium-term scenario, average unemployment rate, 2005–13): 2005: 5.1; 2006: 3.9; 2007: 2.8; 2008: 1.8; 2009: 3.0; 2010: 3.7; 2011: 4.0; 2012: 4.0; 2013: 4.0.
- Consumer Prices (CPI, year average, 2005–13): 2005: 1.8; 2006: 1.9; 2007: 1.7; 2008: 3.4; 2009: 2.3; 2010: 2.1; 2011: 1.9; 2012: 1.9; 2013: 1.9.
- Selected financial soundness indicators (2005–08, headline values):
  - Regulatory capital to risk-weighted assets: 2005: 13.8; 2006: 13.4; 2007: 13.2.
  - Tier 1 capital to risk-weighted assets: 2005: 10.6; 2006: 10.7; 2007: 10.2.
  - Nonperforming loans to gross loans: 2005: 0.8; 2006: 0.7; 2007: 0.4.
  - Liquid assets to total assets (selected years): 2005: 31.3; 2006: 30.4; 2007: 26.5; 2008: 24.4.
- Net investment position (2001–07, percent of GDP): Net investment position: 2001: -16.5; 2002: -16.4; 2003: -12.2; 2004: -5.3; 2005: 3.5; 2006: -1.6; 2007: -4.0.

*Source: IMF Staff Report for the 2008 Article IV Consultation (Informational Annex).*

### APPENDIX I: DENMARK—FUND RELATIONS

### APPENDIX I: DENMARK—FUND RELATIONS

### I. Membership
- Status: Joined March 30, 1946.
- Denmark has accepted the obligations of Article VIII.

### II. General Resources Account
- Quota: 1,642.80 SDR Million — 100.00 percent quota
- Fund holdings of currency: 1,525.63 SDR Million — 92.87 percent
- Reserve Tranche position: 117.18 SDR Million — 7.13 percent

### III. SDR Department
- Net cumulative allocation: 178.86 SDR Million — 100.00 percent
- Holdings: 209.97 SDR Million — 117.39 percent

### IV. Outstanding Purchases and Loans
- None

### V. Financial Arrangements
- None

### VI. Projected Payments to the Fund
- Years: 2009, 2010, 2011, 2012
- Principal: (no amounts listed)
- Charges/Interest: 0.01; 0.01; 0.01; 0.01
- Total: 0.01; 0.01; 0.01; 0.01

### VII. Implementation of the HIPC Initiative
- Not applicable.

### VIII. Implementation of the Multilateral Debt Relief Initiative (MDRI)
- Not applicable.

### IX. Exchange Rate Arrangements
- Denmark participates in the exchange rate mechanism II (ERMII).
- It maintains 2¼ percent fluctuation margins vis-à-vis the euro with a central fixed rate at DKr 746.038 per €100.
- In accordance with UN resolutions and EU restrictive measures, Denmark applies targeted financial sanctions under legislation relating to:
  - Al-Qaeda or Taliban, and individuals, groups, and organizations associated with terrorism;
  - certain persons associated with the former Government of Iraq and its state bodies;
  - specific assets of certain persons associated with important government functions in Myanmar;
  - funds related to military activities in Somalia;
  - funds in relation to Mr. Milosevic and those persons associated with him;
  - funds, other financial assets and economic resources of individual members of the Zimbabwe Government and natural or legal persons associated with them;
  - certain claims by Libya, Liberia, Sudan, Republic of Congo, and the Haitian authorities.
- These restrictions have been notified to the Fund under Decision 144–(52/51).

### X. Article IV Consultation
- Denmark is on the 24-month consultation cycle.
- The staff report for the last Article IV consultation (IMF Country Report No. 06/341) was discussed at EBM/06/82 (September 29, 2006).

### XI. Technical Assistance
- None.

### XII. Resident Representative
- None.

### Appendix II: Denmark — Statistical Appendix (summary)
- Data provision is adequate for surveillance.
- The country has a full range of statistical publications, many on the Internet.
- The quality and timeliness of the economic database are generally very good.
- The country subscribes to the Fund’s Special Data Dissemination Standard.
- Metadata are posted on the Dissemination Standards Bulletin Board.
- Monetary and financial statistics:
  - New data on monetary financial institutions conform to ESA95.
  - Expanded coverage in Nationalbank’s statistical bulletin includes money market funds, small banks, and cooperative banks.
  - Some financial account data come from this enhanced source.
  - Data for the central bank and other depository corporations are reported to STA on a timely and regular basis.

### Denmark: Table of Common Indicators Required for Surveillance (as of November 11, 2008) — selected entries
- Exchange Rates: Date of latest observation 10/08; Date received 11/3/08; 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 9/08; Date received 10/31/08; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M
- Reserve/Base Money: 8/08; 10/21/08; M; M; M
- Broad Money: 8/08; 10/21/08; M; M; M
- Central Bank Balance Sheet: 8/08; 10/21/08; M; M; M
- Consolidated Balance Sheet of the Banking System: 8/08; 10/21/08; M; M; M
- Interest Rates: 9/08; 10/7/08; D; D; D
- Consumer Price Index: 9/08; 10/21/08; M; M; M
- Revenue, Expenditure, Balance and Composition of Financing — General Government: Q1 2008; 8/13/08; A; A; A
- External Current Account Balance: Q1 2008; 7/10/08; M; M; M
- Exports and Imports of Goods and Services: Q1 2008; 7/10/08; M; M; M
- GDP/GNP: Q2 2008; 10/21/08; Q; Q; Q
- Gross External Debt: 11/05; 04/06; Q; Q; Q
- International Investment Position: Q1 2008; 10/23/08

### Statement by the IMF Staff Representative (December 19, 2008) — key points
- Third quarter data suggest lower GDP growth than assumed in staff’s baseline scenario, implying weaker growth prospects.
- GDP fell by ½ percent in the third quarter of 2008, owing to weak investment and an unexpectedly strong shift to imports.
- Staff has marked down growth projections to about zero in both 2008 and 2009, with the output gap now projected to turn negative in 2009.
- Table: Denmark. Medium-term Outlook, 2008–11 (Percentage change, unless otherwise indicated)
  - Real GDP: 2008 0.0; 2009 0.0; 2010 0.5; 2011 1.1
  - Average unemployment rate: 2008 1.8; 2009 3.2; 2010 4.0; 2011 4.2
  - General government balance1/: 2008 3.0; 2009 0.0; 2010 -0.9; 2011 -0.6
  - Output gap2/: 2008 0.8; 2009 -0.3; 2010 -0.8; 2011 -0.7
  - Sources: Danmarks Nationalbank, Statistics Denmark, and IMF staff estimates.
  - 1/ In percent of GDP
  - 2/ In percent of potential output.
- The authorities indicated a continued preference for relying primarily on fiscal automatic stabilizers to manage the downturn.
- Consequently, the structural fiscal balance is broadly unchanged, but the projected slower growth and higher unemployment imply smaller fiscal surpluses in 2008–09 and larger deficits in 2010–11.

*Source: APPENDIX I: DENMARK—FUND RELATIONS (As of October 31, 2008).*

### 3.      Financial markets have calmed but the authorities are considering injecting

### 3.      Financial markets have calmed but the authorities are considering injecting capital into banks.

### Financial market developments and central bank response
- Danmarks Nationalbanken matched the ECB’s rate cuts in November and December, keeping spreads constant.
- Interbank rates decreased in November.
- Foreign exchange outflows stopped and maturing mortgage bonds were rolled over successfully.
- The spread vis-à-vis the ECB "currently stands at the somewhat elevated level of 1.75 percent."
- From the end of October, pressure on the krone eased and DNB was able to buy back foreign exchange, allowing it to follow the ECB interest rate reductions announced on November 6 and December 4.

### Crisis background and bank sector resilience
- The global financial crisis exacerbated a cyclical slowdown that began in early 2007 after a long upswing; the slowdown began when Denmark’s housing boom ended and residential investment declined.
- Most Danish banks, including the half dozen largest, started out with healthy capital buffers.
- Direct exposures to risky assets were small; Danish subsidiaries of foreign banks were protected by tight restrictions on intra-group exposures.
- Main contagion channels were indirect: increasing risk aversion and a liquidity freeze, affecting all banks and hitting small and medium-sized banks particularly hard, leading to mergers and takeovers.
- Authorities are considering ways of increasing banks’ capital buffers, including direct injections of state funds.

### Executive Board assessment and supervisory actions
- Directors commended authorities for policies that helped Denmark weather the global crisis, but noted conditions remain fragile due to market liquidity constraints and a weakening regional and global outlook.
- Directors supported the krone peg to the euro and noted macroeconomic policy should reflect Denmark’s participation in ERMII.
- Directors welcomed the new financial stability act for establishing clear rules and incentives, including a temporary dividend moratorium and powers for the DFSA to punish excessive risk-taking.
- Directors emphasized intensifying financial sector surveillance and supervision, including monitoring liquidity risk more intensively and comprehensively, and ensuring the DFSA has resources to fulfill its expanded mandate under Basel II.
- Directors took positive note of discussions on a new banking package aimed at preventing a credit crunch by injecting new capital into the banking sector, subject to adequate safeguards.

### Outlook, risks, and scenarios
- Economic growth is expected to remain weak through 2010 before recovering gradually; weaker-than-expected global growth or higher interest rates could drive the economy into a recession.
- The slowdown is expected to last 3-4 years.
- Risks highlighted:
  - Prolonged financial turmoil and tightened credit conditions.
  - Pressure on the Danish key refinancing rate spread vis-à-vis the euro area, which may impede Denmark’s ability to reduce interest rates.
  - Emergence of a credit crunch that would deny finance even to well-functioning, creditworthy households and companies, amplifying housing market adjustment.
- Authorities are considering models for recapitalising banks and have agreed on initiatives to make interbank markets function and to support the pension sector and stable exchange rate policy.

### Fiscal policy stance and effects
- Denmark’s fiscal position is among the strongest in the EU; historical surpluses enabled substantial debt reduction and low interest spreads on government debt.
- The proposed 2009 budget was viewed as striking a balance between allowing growth to slow and cushioning the economy from a severe recession.
- Fiscal policy is relatively expansionary: the discretionary fiscal expansion (direct budgetary impact) is almost 1 percent of GDP in 2009, with personal income tax cuts and public demand growth each accounting for around one half.
- The first year fiscal impulse to GDP growth of this easing is estimated to 0.4 percent in 2009 (fiscal easing added 0.2 percent to GDP growth in 2008).
- Households’ real disposable income is expected to rise by "3¾ percent in 2009" due to fiscal easing, high wage growth, and lower energy prices.
- Surplus and deficit path:
  - Surplus expected to fall from "4½ to 5 percent of GDP in 2005-07" to "3 percent of GDP this year" and around balance next year.
  - In 2010 a deficit of "1.2 percent of GDP" is projected.
- Public consumption expenditure is expected to rise to "27¼ percent of GDP in 2010", the highest level since 1983 and above the indicative target of "26½ percent" set in the 2015-plan.
- Automatic stabilisers in Denmark are noted as powerful and better timed than discretionary stimulus.

### Monetary and exchange rate policy considerations
- Authorities concurred the exchange rate peg to the euro has served Denmark well by anchoring inflation expectations.
- In October Denmark faced substantial tensions in foreign exchange markets for the first time in over 10 years, driven by a negative spread between Denmark’s lending rate and the ECB’s marginal rate and general moves out of smaller currencies.
- If the yield spread to the anchor currency is to narrow, further private capital imports are required.
- Short-term rates are expected to fall to a very low level, which may support the housing market and financial stability if turmoil is contained.

### Financial sector measures and design principles for interventions
- A new banking package is being discussed to inject new capital into the banking sector to prevent a credit crunch.
- Principles to be followed in designing a package:
  - i) The aim is only to avoid an actual credit crunch in Denmark.
  - ii) Only well-run banks should gain access to temporary financing.
  - iii) The government should get a return that is as close as possible to a market-based return in proportion to the capital injection made by the state.
- Staff concerns about DFSA resources: authorities increased DFSA resources by "DKK 10 million" as part of the political agreement on financial stability to strengthen DFSA work on credit risk.

### Structural challenges and reform agenda
- Demographic change: an increasing share of elderly people and a shrinking labor force will pressure public finances.
- The government’s 2015-plan aims to reduce public debt in favorable times and raise labor supply via structural reforms.
- Key targets: sustainable fiscal policies and structural surplus towards 2015; estimated structural requirements to meet fiscal targets are to improve public finances by "approximately 0.8 percent of GDP."
- Structural policy initiatives:
  - A Labor Market Commission tasked with proposals to raise unsubsidised employment by 20,000 persons; expected to finish in summer 2009.
  - A Tax Commission to present proposals by early 2009 for a reform aimed at a notable reduction in labor income taxation, including lower marginal tax rates.
- The report notes quantitative estimates of financing gaps hinge on underlying assumptions.

### Key quantitative indicators (selected, as presented)
- Real GDP growth: 2004: "2.3"; 2005: "2.4"; 2006: "3.3"; 2007: "1.6"; 2008 proj.: "0.0"; 2009 proj.: "0.0".
- Net Exports contribution to GDP growth: 2004: "-2.0"; 2005: "-1.1"; 2006: "-2.1"; 2007: "-0.3"; 2008 proj.: "-0.8"; 2009 proj.: "0.0".
- Domestic demand growth: 2004: "4.1"; 2005: "4.3"; 2006: "5.1"; 2007: "1.6"; 2008 proj.: "1.3"; 2009 proj.: "0.0".
- Unemployment rate (in percent): 2004: "5.8"; 2005: "5.1"; 2006: "3.9"; 2007: "2.8"; 2008: "1.8"; 2009 proj.: "3.2".
- CPI (year average) change (percent): 2004: "1.2"; 2005: "1.8"; 2006: "1.9"; 2007: "1.7"; 2008: "3.4"; 2009 proj.: "2.3".
- GDP deflator change (percent): 2004: "2.3"; 2005: "2.9"; 2006: "2.0"; 2007: "2.0"; 2008: "4.7"; 2009 proj.: "2.0".
- General government balance (percent of GDP): 2004: "1.9"; 2005: "5.0"; 2006: "5.0"; 2007: "4.5"; 2008: "3.0"; 2009 proj.: "0.0".
- General government gross debt (percent of GDP): 2004: "43.8"; 2005: "36.4"; 2006: "30.6"; 2007: "26.1"; 2008: "22.0"; 2009 proj.: "21.5".
- Exports of goods & services (percent of GDP): 2004: "45.4"; 2005: "49.0"; 2006: "52.0"; 2007: "52.3"; 2008: "55.4"; 2009 proj.: "56.6".
- Current account (percent of GDP): 2004: "3.1"; 2005: "4.4"; 2006: "3.0"; 2007: "1.1"; 2008: "1.5"; 2009 proj.: "0.8".
- Average DKr per US$ rate: 2004: "6.0"; 2005: "6.0"; 2006: "5.9"; 2007: "5.4".
- GDP per capita (2006): "$50,818".
- At-risk-of-poverty rate (2006): "12 percent".

*Public Information Notice (PIN) No. 08/148. December 29, 2008.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08379.pdf_