## _cr10220 ## Source details **Canonical URL:** [_cr10220](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10220.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10220.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10220.pdf.json) --- ### Executive summary and macro outlook - After a long boom, output fell 5 percent in 2009; unemployment rose to over 9 percent. - Downturn from peak to trough exceeded 6 percent of real output (peak end-2007 to trough). - Downturn mitigated by: sharp monetary easing, emergency financial sector support, bank capital-raising measures, fiscal relaxation, and a 15 percent real effective depreciation of the krona. - Output began to rise from mid-2009; growth prospects for 2010–11 uncertain given dented export markets and reversal of much earlier krona depreciation. - Staff and authorities judged keeping policies supportive appropriate given uncertainty. - Overall fiscal deficit projected to widen to over 2 percent of GDP in 2010. - Staff central case: export volumes grow by some 5 percent in 2010 and 4 percent in 2011; output could grow about 3 percent in 2010, slowing to 1.9 percent in 2011. - Riksbank projects output growth of 2.2 percent (90 percent confidence interval: -1 percent to 5 percent). ### Fiscal policy, measures, and framework - Fiscal relaxation in 2009 amounted to 3.3 percentage points of GDP in support to demand; budget balance swung from a surplus of 2½ percent of GDP in 2008 to a deficit of 0.8 percent of GDP in 2009. - Discretionary measures for 2009: 1.6 percentage points of GDP focused on tax cuts (personal, social contributions, corporate). - Specific 2009 fiscal measures (percent of GDP): - 2009 Budget Bill (Fall 2008) total 1.2 - Lower income tax 0.5 - 1 percent cut in social contributions 0.4 - CIT rate cut (from 28 to 26.3 percent) 0.2 - Lower taxes on pensions 0.1 - Spending increase (education, R&D) 0.2 - Other -0.2 - Supplementary budget (January 2009) total 0.3 - ALMPs 0.1 - Infrastructure investment 0.0 - Tax credits for home improvement 0.1 - 2009 Spring Fiscal Policy Bill (April 2009) total 0.2 - Assistance to the local governments 0.0 - Additional ALMPs 0.2 - Cumulative structural fiscal stimulus to 2010, net of savings in sick leave and entitlements, estimated at 1.8 percent of GDP; staff noted it appeared set to increase further in 2011 absent offsets. - Planned stimulus: - Further 2.3 percentage points of GDP planned for 2010—2.0 percentage points from new measures in Fall 2009 and Spring Bills 2010. - Further 1.6 percentage points of GDP discretionary stimulus planned for 2011. - Composition and multipliers: - Most discretionary stimulus 2009–11 via tax measures (permanent cuts in corporate tax, social security contributions, personal income tax, expansion of earned income tax credit). - Estimated multiplier: tax cuts 0.35 percent; equivalent expenditure measures 0.7 percent. - Fiscal balances and public debt: - Under authorities’ central case (growth 2½ percent in 2010) fiscal balance deteriorates from deficit of 0.8 percent of GDP in 2009 to 2.1 percent of GDP in 2010. - General government debt fell from 70 to 40 percent of GDP since 1993; projections remain below 45 percent of GDP over next 5 years even in adverse scenarios. - Ten-year average net lending now used to assess past savings; fiscal rules target a 1 percent of GDP surplus over the cycle. ### Monetary policy and crisis liquidity measures - Riksbank policy rate cut from 4¾ to ¼ percent; signaled intent to maintain low interest rates for an extended period. - Policy rate detail: since October 2008 repo rate cut by 450 basis points to 0.25 percent (status: Active as of earlier measures); later raised by 25 basis points to 0.5 percent on July 1 (first increase since the global crisis). - Liquidity and collateral measures: - Expanded eligible collateral and counterparties; accepted covered bonds; lowered minimum credit rating requirements for long-term securities (Status: Active). - New 3, 6, and 12-month term loan facilities (Discontinued and replaced by 28-day loan facility with a penalty rate, April 2010). - Temporary commercial paper facility (Discontinued September 3, 2009). - Issuance of treasury bills to invest funds raised in covered bonds (Discontinued February, 2009). - Foreign exchange liquidity: - Riksbank tapped U.S. Federal Reserve and ECB currency swap arrangements; reciprocal swap with Fed discontinued February 1, 2010; swap with ECB active. - Dollar term loan facilities (maturities 28 and 84 days) discontinued November 19, 2009. - National Debt Office borrowed externally SEK 100 billion (US dollars 15 billion) to boost international reserves. - Riksbank rationale for extraordinary measures: should not replace functioning markets; loans against collateral at repo rate plus surcharge. ### Financial sector policy, stability, and stress tests - Emergency financial sector support measures and bank capital actions helped attenuate downturn; exit from emergency measures has begun. - Core Tier 1 capital ratios for all large banks expected to remain above 8 percent even in a stress scenario given improved domestic and Baltic prospects. - Deposit insurance: raised from SEK 250,000 to SEK 500,000 on October 6, 2008 (Status: Active). Expected to be raised to SEK 1 million by end-2010. - Government guarantee scheme: October 2008 guarantee for medium-term borrowing of banks and mortgage institutions, total amount SEK 1.5 trillion; scheduled discontinuation extended to end-2010. - Government recapitalization scheme for banks: scheduled to be discontinued on February 17, 2011. - New bank resolution law (“Government Support to Credit Institutions Act” October 2008) gives National Debt Office power to take over a troubled bank under systemic risk and capital threshold (active). - Stabilization fund: sources are annual fees from banks; active. - Financial-stability outcomes: - Interbank spreads returned to pre-crisis levels. - Bank capital ratios strengthened; liquidity ratios broadly unchanged; credit to households continued to grow. - Krona developments: 15 percent real effective depreciation from mid-2008 to early 2009; since early 2009 krona appreciated by 10 percent in real effective terms. - Staff assessment: krona probably modestly undervalued at prevailing rates. - Banking performance (selected end-period figures, percent unless indicated): - Regulatory total capital to RWAs (Nordea / SEB / Handelsbanken / Swedbank): - 2007: 9.1 / 11.0 / 10.6 / 9.3 - 2008: 9.5 / 10.6 / 13.5 / 11.2 - 2009: 11.9 / 13.5 / 10.4 / 13.5 - Regulatory Tier 1 capital to RWAs: - 2007: 7.0 / 8.6 / 6.5 / 9.3 - 2008: 7.4 / 8.4 / 7.0 / 11.2 - 2009: 10.2 / 12.8 / 9.1 / 13.5 - Leverage (capital as percent of total assets): - 2007: 4.8 / 4.5 / 4.0 / 4.8 - 2008: 4.3 / 4.0 / 4.2 / 5.7 - 2009: 4.5 / 4.5 / 4.7 / 5.9 - Non performing loans to total gross loans: - 2007: 0.6 / 0.5 / 0.1 / 0.1 - 2008: 0.8 / 0.7 / 0.2 / 0.5 - 2009: 1.4 / 1.4 / 0.4 / 1.4 - Share of wholesale market funding: - 2007: 25.6 / 22.5 / 38.0 / 41.5 - 2008: 23.0 / 20.9 / 41.5 / 45.5 - 2009: 25.7 / 19.8 / 45.5 / 41.9 - Loans to public deposits: - 2007: 171.9 / 142.2 / 252.1 / 247.7 - 2008: 178.4 / 154.2 / 272.5 / 253.2 - 2009: 183.9 / 148.3 / 268.7 / 255.9 - Memorandum: Total assets in percent of GDP (Nordea / SEB / Handelsbanken / Swedbank): - Nordea: 120.3 (2007), 164.1 (2008), 170.9 (2009) - SEB: 76.5 (2007), 79.5 (2008), 74.7 (2009) - Handelsbanken: 60.7 (2007), 68.4 (2008), 68.7 (2009) - Swedbank: 52.5 (2007), 57.4 (2008), 58.1 (2009) - Stress test findings (Riksbank): - Main scenario projects credit losses in 2010 of ½ percent of total loans (down from 1½ percent a year ago). - Stress scenario projects credit losses rising to a total of 4 percent in 2010–12. - Even in adverse scenarios, all major banks projected to maintain core Tier 1 capital ratios well above 8 percent. - Remaining risks: banking operations abroad, euro and dollar liquidity risks, corporate sector vulnerabilities (non-durable consumer goods, services, construction, real estate). ### Cross-border banking, systemic risk measures, and contingency - Banking system size and globalization: - Banking system assets amount to over 350 percent of GDP; all financial institutions >550 percent of GDP. - Swedish banks’ total foreign assets reached 150 percent of GDP. - By end-2009, foreign claims in Nordics >50 percent of total foreign claims (less than 30 percent in 2002); claims in Baltics nearly 10 percent (up from 3 percent in 2002). - Loan claims on Baltic subsidiaries at end-2008 represented 35–45 percent of bank capital for affected banks. - Systemic risk metrics: - Simple aggregation of individual banks’ expected losses amounted to SEK 600 billion (19¼ percent of GDP) in spring 2009. - Systemic CCA 50th percentile VaR: SEK 120 billion (4 percent of GDP). - Systemic CCA 95th percentile VaR: SEK 210 billion (6½ percent of GDP). - As market perceptions improved, total expected losses fell to SEK 40 billion (1¼ percent of GDP). - Joint probability of default (JPoD) for sample rose to 1 percent in spring 2009. - Distress Dependence Matrix findings (selected): - 1-Apr-09 raw average (excluding own effects): Swedbank 0.41, Handelsbanken 0.68, Nordea 0.68, SEB 0.46; overall raw average 0.52. - 1-Apr-10 column average (excluding own effects): Swedbank 0.33, Handelsbanken 0.55, Nordea 0.46, SEB 0.31; overall raw average 0.39. - Network and tail-risk scenarios (extracts): - Three hypothetical tail-risk scenarios examined (10 percent cuts by top lenders; 50 percent cuts by GIIPS; Greek default). Results show Sweden sensitive to shocks from large economies via indirect channels. - Memorandum item: Sweden's international reserves e46.5 (in billions of US dollars) as presented in source. - Supervisory and cross-border coordination: - MOUs at EU level and with three Baltic countries signed; Nordic-Baltic stability group and new MOUs under preparation. - Identified gaps: MOUs often lack specific crisis-management arrangements and burden-sharing rules. - Policy options and recommendations: - Reflect idiosyncratic elements of foreign operations in Swedish capital and liquidity requirements. - Ensure liquidity requirements account for limited Riksbank foreign-currency resources. - Develop cross-border resolution frameworks in line with EU proposals. - Strengthen FSA supervisory capacity and crisis-management powers. - Consider risk-based fees for banks to fund stabilization (planned from 2011). ### Labor market, ALMPs, and unemployment - Labor market resilience: - Unemployment rose from about 6 percent to above 9 percent (highest since 1998), but less than the 11 percent initially expected. - Firms hoarded labor: temporary jobs (one-sixth of total) fell 10 percent but rose significantly since late-2009; permanent jobs fell only moderately. - Youth unemployment close to 30 percent. - Active Labor Market Policies (ALMPs): - ALMP spending focus: job search assistance, employment incentives, training. - Evidence: ALMPs contributed positively to total employment; estimated ALMP coefficient ~0.36 on total employment (significant at 5 percent). - Discretionary ALMP measures noted in fiscal packages: ALMPs 0.1 percent of GDP (supplementary budget), additional ALMPs 0.2 percent (Spring Bill). - Policy recommendations: maintain and target ALMPs; focus on youth programs; unwind temporary crisis measures timely to preserve incentives. - Empirical counterfactuals: - If labor market conditions had been like early 1990s, unemployment would have risen to over 10 percent and continued deteriorating until mid-2011. - If like Germany, unemployment would have risen more slowly but more persistently. ### Housing market and household vulnerabilities - House prices: rebounded significantly after a drop of some 10 percent that ended in early 2009. - Drivers: low interest rates, marked increase in variable rate mortgages, resilience of credit to households, supply constraints. - Andre (2010) suggests house price-to-rent ratio exceeded fundamentals by about 10–15 percent in 2009. - FSA proposal to penalize loan-to-value ratios above 85 percent to address vulnerabilities. - Household debt: - Household financial liabilities as percent of GDP: 62.5 (2003), 86.4 (2009) (selected series). - Household debt ratio reached unprecedented levels while interest ratio remained relatively low. - Policy advice: maintain close surveillance of housing and household borrowing; caution individual borrowers. ### Projections, key macro indicators, and scenarios (selected exact figures) - Real GDP (2004–2011): 4.2, 3.2, 4.3, 3.3, -0.4, -5.1, 3.0, 1.9 - CPI inflation (2004–2011): 1.0, 0.8, 1.5, 1.7, 3.3, 2.0, 2.2, 2.0 - Unemployment rate (2004–2011, percent): 6.3, 7.6, 7.0, 6.1, 6.2, 8.3, 9.3, 8.8 - Output gap (as percent of potential, 2004–2011): 0.6, 0.7, 1.4, 0.3, 0.1, -4.8, -2.0, -0.8 - Medium-term scenario (selected): - Real GDP (2007–2014): 3.3, -0.4, -5.1, 3.0, 1.9, 3.0, 3.5, 3.4 - Fixed investment (2007–2014): 8.9, 1.7, -16.0, 1.1, 1.7, 4.0, 6.5, 8.0 - Inflation (HICP annual average, 2007–2014): 1.7, 3.3, 2.0, 2.2, 2.0, 2.0, 2.0, 2.0 - Unemployment rate (2007–2014): 6.1, 6.2, 8.3, 9.3, 8.8, 8.3, 7.6, 6.8 ### Key policy recommendations and sequencing - Near term: - Presumption of further fiscal stimulus appropriate in 2010–11 given large output gap and low nominal policy rates, but be ready to tighten if upside scenarios materialize. - Monetary tightening should be gradual and cautious; if European market turmoil continues, consider delaying the start. - Financial sector: - Wean financial sector off contingent public support; sequence tightening of capital and liquidity requirements mindful of interactions with monetary stance. - Reflect foreign operations’ idiosyncrasies in Swedish capital and liquidity requirements; develop cross-border resolution frameworks; expand supervisory resources. - Update contingency “war games” and verify international reserve adequacy. - Consider creation of a special resolution framework separate from corporate bankruptcy with powers for supervisor-led resolution and creditor safeguards. - Fiscal framework reforms: - Preserve central role of the Swedish Fiscal Policy Council in assessing compliance. - Consider clearer binding corrective mechanism for surplus-target non-compliance and improve formulation of structural surplus target to reduce measurement discretion and procyclicality risk. - Labor market: - Maintain ALMPs targeted at job-search assistance and youth; avoid measures that could trap workers in reduced hours; preserve wage-setting flexibility. ### Staff appraisal — summary of outcomes and risks - Output peaked end-2007 and fell 5 percent in 2009; unemployment rose to over 9 percent. - Corporate positions, notably manufacturing exporters, deteriorated. - Output may be some 4 to 6 percent below capacity. - Policy response: sharp monetary relaxation, emergency financial support and bank capital actions, fiscal relaxation of 3 percentage points of GDP to a deficit of 0.8 percent of GDP in 2009, and 15 percent real effective krona depreciation. - Recovery signals: exit from emergency support begun; credit to households buoyant; core inflation and expectations near target; consumption held up; output rose from mid-2009. - Key risks: weak global demand for durables and investment goods; market stress in Europe prompting "search for strong sovereigns" and krona appreciation that could dent net exports and growth. - Riksbank assessment: 2010 growth could be as high as 5 percent or as low as -1 percent. *Source: _cr10220 — IMF staff report content unit.* ### Executive Summary ...................................................................................................... ### _cr10220 - Executive Summary ### Overview - After a long boom, Sweden was among the first to falter in the great recession: output fell 5 percent in 2009, and unemployment rose to over 9 percent. - The downturn from peak to trough exceeded 6 percent of real output (peak end-2007 to trough). - The downturn was mitigated by aggressive stabilization policies: sharp monetary easing, emergency financial sector support measures, bank capital-raising measures, fiscal relaxation, and a 15 percent real effective depreciation of the krona. - Output began to rise from mid-2009, but growth prospects for 2010–11 remain uncertain, including because market stress in Europe has dented export market growth prospects and reversed much of the earlier krona depreciation. ### Macro outlook and risks - Staff and authorities judged intentions to keep policies supportive as appropriate given uncertainty. - The overall fiscal deficit was projected to widen to over 2 percent of GDP in 2010. - If economic growth and employment turn out stronger than anticipated, the budget balance will improve correspondingly. - Inflation is set to decline given the large output gap and recent krona strength, even as a cautious tightening cycle is anticipated for monetary policy. - Continued uncertainty over European market strains could affect the timing of the anticipated monetary tightening cycle. ### Fiscal policy and framework - Fiscal relaxation in 2009 amounted to 3.3 percentage points of GDP in support to demand, with the budget balance swinging from a surplus of 2½ percent of GDP in 2008 to a deficit of 0.8 percent of GDP in 2009. - Of the 3.3 percentage points, 1.6 percentage points of GDP comprised discretionary measures for 2009, focused on taxes, including permanent cuts in personal, social contributions and corporate income tax. - Specific 2009 fiscal measures (in percent of GDP) included: - 2009 Budget Bill (Fall 2008) total 1.2 - Lower income tax 0.5 - 1 percent cut in social contributions 0.4 - CIT rate cut (from 28 to 26.3 percent) 0.2 - Lower taxes on pensions 0.1 - Spending increase (education, R&D) 0.2 - Other -0.2 - Supplementary budget (January 2009) total 0.3 - ALMPs 0.1 - Infrastructure investment 0.0 - Tax credits for home improvement 0.1 - 2009 Spring Fiscal Policy Bill (April 2009) total 0.2 - Assistance to the local governments 0.0 - Additional ALMPs 0.2 - The cumulative structural fiscal stimulus to 2010, net of savings in sick leave and entitlements benefits, was estimated at 1.8 percent of GDP; staff estimates noted it appeared set to increase further in 2011 absent further announced measures. - The 2010 Budget Bill tightened the 2012 expenditure ceiling by SEK 10 billion (0.3 percentage points of GDP) from its earlier announced level. - Sweden’s fiscal position: general government debt fell from 70 to 40 percent of GDP since 1993; projections for public debt in the next 5 years remain below 45 percent of GDP even in relatively adverse macroeconomic circumstances. - The budget outturn in 2009 was stronger-than-anticipated; staff estimate better-than-anticipated labor market developments account for roughly half of the overperformance on the budget balance. ### Monetary policy and framework - The Riksbank cut the policy rate from 4¾ to ¼ percent and signaled intent to maintain low interest rates for an extended period. - The Riksbank implemented a range of liquidity measures: expansion of eligible collateral and counterparties, longer term repo operations with a fixed interest rate, provision of dollar liquidity, establishment of a new credit facility to accept commercial paper as collateral to support credit growth. - The Riksbank did not apply discretionary intervention in foreign exchange markets, thereby accommodating krona depreciation. - The National Debt Office borrowed externally SEK 100 billion (US dollars 15 billion) to boost international reserves. - The Riksbank tapped U.S. Federal Reserve and ECB currency swap arrangements. - Demand for crisis-intervention measures has fallen with improved market conditions; several emergency lending operations (foreign currency and commercial paper) have been discontinued. ### Financial sector policy and stability - Emergency financial sector support measures and bank capital actions helped attenuate the downturn and facilitate recovery; exit from emergency measures has begun as financial strains eased. - Core Tier 1 capital ratios for all large banks are expected to remain above 8 percent even in a stress scenario given improved domestic and Baltic prospects. - The Financial Supervisory Authority proposed penalizing loan-to-value ratios above 85 percent to address housing market vulnerabilities. - Remaining risks include banking operations abroad and liquidity risks in euro and dollar markets; these should be reflected in Swedish capital and liquidity requirements in line with forthcoming global agreements. - Sweden’s indirect exposure to Euro Area peripherals remains a concern despite minimal direct exposures; priorities include updating “war games” to verify contingency plans and confirming that international reserves are at appropriate levels. - Steps to establish a special resolution regime to manage troubled financial institutions and to further raise resources for banking supervision were welcomed. ### Labor market and activation policies - Discretionary measures to avert a significant rise in unemployment were implemented, though on a smaller scale than elsewhere. - Active labor market policies (ALMPs) were strengthened and upgraded through job search assistance and training. - Crisis measures on labor market policies included job search assistance and matching, training programs, and additional ALMPs noted in fiscal measures above. ### Data and measurement issues - Tracking quarterly output developments during the downturn was difficult due to changing seasonal patterns and rebasing to the chained-volume method (reference year to 2008 with May 6 data release and to 2009 with May 28 data release). - Staff re-estimated seasonally adjusted GDP data using fixed seasonal factors based on estimated seasonality up to 2006Q3; this confirmed the broad shape of the recession in the latest release but suggested the recession started a little later. *Source: _cr10220 - Executive Summary.* ### Box 3. The Status of Crisis Intervention Measures ### Box 3. The Status of Crisis Intervention Measures ### Measures to increase krona liquidity - Policy rate: - Since October 2008, the repo rate was cut by 450 basis points to 0.25 percent. - Status: Active. - Collateral policy: - The Riksbank expanded a collateral policy framework by fully accepting covered bonds and lowering the minimum credit rating requirements for long-term securities pledged as collateral. - Status: Active. - Term loan facility: - The Riksbank set up new 3, 6, and 12-month loan facilities to facilitate banks’ access to longer-term funds. - Status: Discontinued and replaced by 28-day loan facility with a penalty rate (April 2010). - Temporary commercial paper facility: - The Riksbank established a new temporary credit facility using commercial paper as collateral (with a maturity of up to one year) to facilitate the supply of credit for non-financial companies. - Status: Discontinued (September 3, 2009). - Issuance of treasury bills to invest the funds raised in covered bonds to boost covered (mortgage) bond market. - Status: Discontinued (February, 2009). - Emergency liquidity assistance: - The Riksbank granted emergency liquidity assistance to Kaupthing Bank Sverige AB and Carnegie Investment Bank AB (both SEK 5 billion). Later, Kaupthing Bank was liquidated, while the licensing of Carnegie Investment Bank BA was revoked. - Status: All repaid by March 2009. ### Measures to increase foreign exchange liquidity - Foreign exchange swap facilities: - The Riksbank and U.S. Fed set up temporary reciprocal swap facilities ($30 billion). A separate swap facility was also established with the ECB. - Status: With the Fed discontinued (February 1, 2010); with the ECB, active. - Dollar term loan facilities: - A new dollar term loan facilities (with the maturity of 28 and 84 days) were offered. - Status: Discontinued (November 19, 2009). ### Measures to support banks’ capital and assure market confidence - Deposit insurance: - On October 6, 2008, the deposit guarantee was raised from SEK 250,000 to SEK 500,000, and the coverage was broadened to include all types of deposit in accounts. - Status: Active. Expected to be raised to SEK 1 million by end-2010. - Government guarantee scheme: - In October 2008, the government approved a debt guarantee scheme for the medium-term borrowing of banks and mortgage institutions. The total amount of guarantee was set at SEK 1.5 trillion. An institution applying to the guarantee would pay fees and be subject to restrictions on remuneration for senior management. - Status: Scheduled to be discontinued at end-April 2010 but extended to end-June 2010, and further to end-2010. - Government recapitalization scheme: - The recapitalization scheme is intended for banks and other credit institutions. The government’s capital takes the form of shares or hybrid capital (Tier 1 capital). Participating institutions are subject to restrictions on remuneration for senior management. - Status: Scheduled to be discontinued on February 17, 2011. - A new bank resolution scheme: - In October 2008, the government enacted “Government Support to Credit Institutions Act” which gives the National Debt Office power to take over a troubled bank if there is a serious systemic risk and bank capital falls below 25 percent of the regulatory requirement. - Status: Active. - A stabilization fund: - This was to finance government measures to support the financial system (the sources of the funds are annual fees from banks and other credit institutions). - Status: Active. ### Outcomes, financial-stability developments, and macro effects - Financial-sector support and supervision actions: - Deposit guarantee doubled and extended to all types of deposits; new bank recapitalization and debt guarantee schemes introduced; supervisory liaison with those in the region intensified; several banks with the largest Baltic exposures made rights issues and stopped dividend payments to raise capital positions well above prudential requirements. - A modest bank stability charge, levied on banks non-equity liabilities, has been introduced and will eventually form a fund of 2 percent of GDP available to finance bank rescues (¶55). - Exchange-rate developments: - The krona depreciated by 15 percent in real effective terms from mid-2008 to early 2009, supporting net exports and activity. - Since early 2009, the krona has appreciated by 10 percent in real effective terms. - Staff assessment: the krona is still probably modestly undervalued at prevailing rates (Box 4 and Figure 5). - Financial market indicators and bank balance sheets: - Interbank spreads over expected policy rates have returned to pre crisis levels. - Bank capital ratios have strengthened by all standard measures; liquidity ratios are broadly unchanged. - This has supported continued growth of credit to households. - Performance indicators for four major Swedish banks (selected end-period figures, in percent unless otherwise indicated): - Regulatory total capital to risk-weighted assets (Nordea / SEB / Handelsbanken / Swedbank): - 2007: 9.1 / 11.0 / 10.6 / 9.3 - 2008: 9.5 / 10.6 / 13.5 / 11.2 - 2009: 11.9 / 13.5 / 10.4 / 13.5 - Regulatory Tier 1 capital to risk-weighted assets: - 2007: 7.0 / 8.6 / 6.5 / 9.3 - 2008: 7.4 / 8.4 / 7.0 / 11.2 - 2009: 10.2 / 12.8 / 9.1 / 13.5 - Leverage (capital as a percent of total assets): - 2007: 4.8 / 4.5 / 4.0 / 4.8 - 2008: 4.3 / 4.0 / 4.2 / 5.7 - 2009: 4.5 / 4.5 / 4.7 / 5.9 - Non performing loans to total gross loans: - 2007: 0.6 / 0.5 / 0.1 / 0.1 - 2008: 0.8 / 0.7 / 0.2 / 0.5 - 2009: 1.4 / 1.4 / 0.4 / 1.4 - Share of wholesale market funding: - 2007: 25.6 / 22.5 / 38.0 / 41.5 - 2008: 23.0 / 20.9 / 41.5 / 45.5 - 2009: 25.7 / 19.8 / 45.5 / 41.9 - Loans to public deposits: - 2007: 171.9 / 142.2 / 252.1 / 247.7 - 2008: 178.4 / 154.2 / 272.5 / 253.2 - 2009: 183.9 / 148.3 / 268.7 / 255.9 - Memorandum item: Total assets in percent of GDP: - Nordea: 120.3 (2007), 164.1 (2008), 170.9 (2009) - SEB: 76.5 (2007), 79.5 (2008), 74.7 (2009) - Handelsbanken: 60.7 (2007), 68.4 (2008), 68.7 (2009) - Swedbank: 52.5 (2007), 57.4 (2008), 58.1 (2009) - Real economy and inflation developments: - Output began to rise from mid-2009, but remains well below capacity. - Personal consumption held up; housing market buoyant and growing through 2009 after modest fall in 2008. - Personal savings rates fell slightly after a long secular upward trend. - Firms hoarded labor: temporary jobs (one-sixth of total) fell 10 percent but have risen significantly since late-2009; permanent jobs fell only moderately. - Spring 2010 multi-year wage settlements settled on rises of some 2½ percent. - Export sector rebounded since late-2009; new orders for industry and exports strengthened supporting strong growth recorded in 2010Q1. - Measures of underlying inflation remained in positive territory even as the headline measure went negative for a time; inflation expectations remained anchored within the inflation target range. - Housing market: - House prices rebounded significantly after a drop of some 10 percent that ended in early 2009. - Factors: low interest rates, marked increase in share of new variable rate mortgages, resilience of credit to households, constraints on new housing supply. - Andre (2010) suggests that the house price-to-rent ratio exceeded fundamentals by about 10–15 percent in 2009. *IMF Staff Summary: Box 3. The Status of Crisis Intervention Measures* ### 17. Uncertainties about export prospects are ### _cr10220 - 17. Uncertainties about export prospects are ### Uncertainties and export prospects - Termination of various global stimulus measures has particular impact on durables and investment-related spending. - If global “self sustaining” aggregate demand has not resumed by the time these measures expire, Sweden is particularly exposed. - Market stress in Europe has prompted a “search for strong sovereigns” that potentially increases capital inflows into Sweden, reversing much of the earlier krona depreciation. If this continues, prospects for net exports and growth will be dented. ### Exchange rate, external flows, and net exports - Sweden’s flexible exchange rate could provide a buffer, supporting activity even if some adverse risks materialize. - Continued “safe haven” capital inflows into Sweden could produce appreciation of the krona and attenuate the impetus to growth. - Since early 2010, capital inflows have intensified upward pressures on the krona, providing additional disinflationary impetus and compounding concerns for the growth outlook. ### Projections, scenarios, and key macro forecasts - Riksbank projects output growth of 2.2 percent, with a 90 percent confidence interval ranging from a fall of 1 percent to growth of 5 percent. - Staff central case (supported by global conditions): - Export volumes are expected to grow by some 5 percent in 2010 and 4 percent in 2011. - Output could grow by about 3 percent in 2010, slowing down to 1.9 percent in 2011. - These staff projections are higher than Riksbank projections as of April of 2.2 percent for 2010 but lower than 3.7 percent projected by Riksbank for 2011. - Given considerable excess domestic capacity, fixed investment is expected to remain weak even if export growth is strong; household consumption is not likely to drive growth strongly, with permanent employment projected to grow slowly. ### Output gap and potential output risks - The output gap is likely to remain large for 2010: estimates suggest it will narrow only a little in 2010, to somewhere between 3 and 6 percent of potential output. - Medium-term potential output growth has been dented by the contraction in gross domestic fixed investment and may be compounded if hysteresis effects appear in labor markets. ### Fiscal policy: stance, plans, and implications - With nominal monetary policy rates close to effective floors, continued fiscal support is appropriate in 2010–11 while remaining ready to tighten if upside scenarios emerge. - Fiscal measures and plans: - A further 2.3 percentage points of GDP of stimulus is planned for 2010—2.0 percentage points of which comprise new measures outlined in the Fall 2009 and Spring Bills 2010. - A further 1.6 percentage points of GDP of discretionary stimulus is planned for 2011. - The nominal expenditure ceilings rise by SEK 10 billion in both 2013 and 2014 (1 percent ) from the lowered 2012 ceiling. - Composition and multipliers: - Most discretionary stimulus over 2009–11 is accounted for by tax measures, including permanent cuts in corporate tax, social security contributions and personal income tax, and an expansion of the earned income tax credit. - Estimated multiplier of such tax cuts is 0.35 percent, compared with 0.7 percent from equivalent expenditure measures. - Fiscal balance implications: - Under the fiscal authorities’ central case assumption of growth of 2½ percent in 2010, the fiscal balance will deteriorate from a deficit of 0.8 percent of GDP in 2009 to 2.1 percent of GDP in 2010. - The structural fiscal balance and compliance with the balance target are highly uncertain given uncertainties in the output gap and stabilizers; strains on observance of the balance target may rise, especially if 2011 stimulus is not offset. - Policy recommendation: - Presumption of further stimulus is appropriate given strong fiscal fundamentals and a large output gap, but if by the fall of 2010 the medium-term outlook is stronger, some policy tightening will be necessary, balancing monetary and fiscal action. If stronger outlook is accompanied by further appreciation of the exchange rate, offsets to planned structural fiscal stimulus for 2011—perhaps implying overall consolidation if competitiveness concerns mount—should support monetary tightening. - The Swedish Council for Fiscal Policy should prepare detailed public assessments to support credibility given the increasing number of indicators used to assess compliance with the balance target. ### Monetary policy: stance and guidance - Inflation excluding mortgage interest rates has consistently remained within the target range; nominal wage growth remains moderately positive; inflation expectations remain well anchored. - House prices have been recovering, supported by bank lending to households continuing to grow at 10 percent (year-on-year). - The authorities have indicated that a tightening cycle will begin in summer 2010, but: - Inflation pressures are not expected to rise for now given large output gap and uncertain export/growth prospects. - Tightening should be gradual and cautious; if market turmoil in Europe continues, this could provide grounds to delay it. - The stance of monetary policy will remain highly accommodative, without threatening the inflation target. - Policy framework changes: - In June, the Riksbank abolished +/-1 percent tolerance interval around the inflation target rate to strengthen communication. ### Financial sector policy: vulnerabilities and recommendations - Banking and sectoral developments: - Swedish bank capital has been raised; non-banks solvency ratios have recovered; exit from extraordinary support measures has begun; the Riksbank has begun tightening conditions for its term repo operations. - The authorities decided to maintain the debt guarantee scheme until end-2010, which was scheduled to be terminated effective end April 2010. - Stress test findings: - Riksbank’s main scenario projects credit losses in 2010 of ½ percent of total loans, down from 1½ percent a year ago. - The stress scenario shows credit losses rising to a total of 4 percent in 2010–12. - Even in adverse scenarios, all major banks are projected to maintain core Tier 1 capital ratios well above 8 percent. - Remaining risks: - Corporate sector financial position is uncertain; heightened credit risks exist in non-durable consumer goods and services, construction, and real estate sectors. - Significant banking operations abroad expose banks to credit, reputational, and euro/dollar liquidity risks in stressed markets. - Policy recommendations: - Reflect idiosyncratic elements of foreign operations in Swedish capital and liquidity requirements. - Ensure liquidity requirements take into account that Riksbank resources available to satisfy foreign-currency liquidity needs are limited. - Develop cross-border resolution frameworks further in line with EU proposals. - Maintain close surveillance of housing and household borrowing and caution individual borrowers. *Source: _cr10220 - 17. Uncertainties about export prospects are (IMF staff).* ### 39. More broadly, with confidence broadly restored, bank regulatory arrangements ### _cr10220 - 39. More broadly, with confidence broadly restored, bank regulatory arrangements ### Financial regulatory objectives and sequencing - Aim: wean the financial sector off extensive contingent public support, including for too-big-to-fail banks and their dependence on Riksbank liquidity (¶39). - Policy sequencing guidance: - Tightening liquidity and capital requirements should be taken in light of their impact via credit conditions on the monetary stance (and vice versa) (¶39). - In scenarios in which monetary tightening is appropriate, such measures should accompany (if not preceded) actions to raise central policy rates (¶39). - In other scenarios, such steps should be taken only insofar as—and in ways that—they do not indirectly tighten the monetary stance (¶39). - Any such steps should be taken on the basis that further adjustments may be needed in light of prospective international agreement on banking regulations (¶39). ### Tail risks, contagion, and contingency preparedness - Concern: ability to manage tail risks remains a concern given potential deepening or widening of strains in the Euro Area periphery that could affect third countries to which Swedish financial firms are exposed (¶40). - Indicators of spillovers: market data for large Swedish banks show apparent spillover effects (Attachment II) (¶40). - Priority actions: - Verify adequacy of contingency plans, including assessment of liquidity risks in the financial system (¶40). - Verify supervisory and crisis management readiness (¶40). - Verify the level of international reserves, given continued reliance of Swedish banks on substantial wholesale funding (Attachment II) (¶40). - Consider extending the emergency nationalization toolkit to include a special resolution framework for financial institutions (Box 6; ¶55) (¶40). ### Strengthening supervisory capacity and crisis management framework - Fundamental need: strengthen micro and macro supervisory capacity and review crisis management framework, including capacity to deal with possible strains in the financial sector (¶41). - Ongoing reform initiative: reviews by a government commission expected to be completed within two years (¶41). - Key issues for reform (¶41): - (i) Division of labor on micro and macro prudential regulations among the Ministry of Finance, the Riksbank, the Financial Supervisory Authority, and the National Debt Office. - (ii) Macro prudential tools. - (iii) A bank resolution framework and a deposit insurance scheme. - (iv) International reserve management. - (v) Supervisory capacity building. - Design principles: maintain effective communication and coordination between all authorities, with appropriate accountability, and retain the independence of monetary policymaking (¶41). ### AML/CFT updates - 2006 FATF assessment report suggested some weaknesses in Sweden’s AML/CFT framework (¶42). - Actions taken: - Sweden implemented the third EU Money Laundering Directive on March 15, 2009 (¶42). - The FSA issued new regulations and guidelines governing measures against money laundering and terrorist financing on May 15, 2009 (¶42). ### Proposals to strengthen Sweden’s financial stability framework (Box 5) - Bank resolution framework: - October 2008: “Government Support to Credit Institutions Act” gives the National Debt Office power to grant credit guarantees and, if there is a serious systemic risk and bank capital falls below 25 percent of the regulatory requirement, take over a troubled bank (¶55; Box 5). - Scheme first applied in resolving the Carnegie Investment Bank failure in late 2008 (Box 5). - Prompt Corrective Action: a Prompt Corrective Action style ladder is needed, covering all banks and fully empowering the FSA to take the full range of supervisory corrective actions (Box 5). - Supervisory capacity: FSA constrained by high staff turnover; would benefit from greater funding, including to allow more thorough on-site inspections (Box 5). - Deposit insurance scheme: current legal framework disburses funds only after failed bank is placed into bankruptcy; insolvency process can be initiated by an unpaid creditor or by the failed bank itself, but not by the FSA; process could be lengthy; clarity needed on authorities’ ability to obtain relevant information about balance sheets of troubled banks at an early stage (Box 5). - Cross-border coordination: major uncertainties exist on resolving cross-border crises in a coordinated way; MOUs at EU level and with three Baltic countries signed; new MOUs between the Nordic and Baltic economies under active preparation (Box 5). - Non-bank financial institution supervision: a number of non-bank financial institutions raise deposits but are neither subject to FSA supervision nor reporting requirements (Box 5). ### Rationale for a special resolution framework (Box 6) - Current tools: public fund injections (including partial to full nationalization) and corporate bankruptcy; nationalization effective in early 1990s crisis and Carnegie Investment Bank in late 2008 (Box 6). - Challenges with reliance on corporate bankruptcy: Custodia case—lengthy judicial reviews after revocation of its license led to higher government costs and public costs (Box 6; footnote 1). - Timeline in Custodia case: FSA attempted to revoke license in January 2006 but was unable to place it into bankruptcy; shareholders placed the institution into bankruptcy in August 2006; during the interim the institution continued to accept deposits and asset values declined, increasing losses covered by deposit insurance (Box 6, footnote 1). - Recommended design features: - A special resolution framework separate from corporate bankruptcy to enhance effective and least-cost crisis management (Box 6). - FSA, rather than creditors or shareholders, should have the sole power to put the institution into resolution procedure immediately at a predetermined capital level after revoking its license (Box 6). - Resolution law should allow a receiver or liquidator appointed by a public body to use all resolution methods: acquisition by a private sector purchaser, bridge bank, partial transfer of deposits and assets to a good bank (Box 6). - Ensure appropriate creditor safeguards so that no creditor of a resolved bank is left any worse off than without the special resolution framework (Box 6). - International precedent: Canada, Japan, the United Kingdom, and the United States have special regime laws for bank insolvency administered by the supervisor or the deposit protection agency (Box 6). ### Banking system performance highlights (Figures 8–9) - Non-performing loan ratios increased, particularly in Baltic subsidiaries (Figure 8). - Regulatory Tier 1 capital to RWAs rose (June 2009 Riksbank stress test average ratios for four major banks) (Figure 8). - Moody’s KMV expected default frequency fell for major banks (Figure 8). - Liquid assets to total assets improved for all banks and for four major banks (Figure 8). - Banks’ lending and deposits: government support measures and Riksbank liquidity provisions are shown alongside deposits and lending (Figure 8). - Non-bank financial sector: - Life insurance company assets rebounded (Figure 9). - Solvency ratios for life and non-life insurance companies increased (Figure 9). - Corporate sector debt has fallen, but corporate capacity to cover interest expense continued to deteriorate; corporate default risks remain elevated (Figure 9). - Household debt ratio reached an unprecedented level, while the interest ratio remains relatively low (Figure 9). - Moody’s KMV expected default frequency comparisons for Sweden, Germany, Denmark shown (Figure 9). ### Labor market policies and outcomes - Labor market resilience: held up much stronger than expected compared with early 1990s downturn; youth unemployment remains close to 30 percent (¶43). - Two sets of actions taken: - Reform Program for Growth and Employment increased resources for preparatory and vocationally-oriented training and improved information for job seekers via Public Employment Services (¶44). - Reductions in direct taxation in the 2009–10 stimulus packages (¶49, 58) aimed to support growth of new sectors and avoid hysteresis effects in unemployment (¶44). - OECD recommendations and Swedish actions (Table, Labor Market Policies–Structural Reforms): - Reduce marginal taxes on labor income: lower threshold for state income tax was raised in 2009; employer social security contributions reduced; in-work tax credit expanded through 2011 (Table). - Reform sickness and disability benefit schemes: tightened administration, time limits on eligibility and measures for rehabilitation have lowered sickness absence rates (Table). - Reform employment protection legislation: no significant action on permanent contracts; trial periods and duration of temporary contracts were extended (Table). - Further reforms suggested: - Rebalance employment protection between regular and temporary workers to ease shifting workers from over-invested sectors to more productive uses (¶45). - Maintain wage-setting flexibility given 70 percent unionization (¶45). - Note: further expansion of direct measures may contribute only marginally given already high public spending on active measures (¶45). ### Authorities’ views on macroeconomic and sectoral stance - General agreement: authorities agreed with overall staff assessment (¶46). - Recent recovery: decisive macroeconomic and financial stabilization policies and eased regional/global conditions secured a rebound in exports and output from mid-2009, accelerating in Q1 2010; household consumption and services buoyant; working hours adjusted flexibly; employment begun rising; core inflation and inflation expectations held close to target; financial sector resilience strengthened (¶47). - Outlook and policy stance: output gap remains large and Sweden remains vulnerable to global shocks; return to “normal” macroeconomic policy settings is signaled via reaffirmation of fiscal rules and advancing anticipated commencement of monetary tightening cycle, but stance remains highly accommodative in near term and will tighten prudently over time (¶48). - Fiscal policy and framework: - Discretionary stimulus of some 1½ percent of GDP in 2009 to address uncertainties and support long-term efficiencies; stimulus composition included reductions in personal and corporate taxes, increased allocations to active labor market and business support initiatives, and added transfers to municipalities (¶49). - 2009 budget balance outturn unexpectedly strong due to buoyant employment/household incomes, savings from tightening eligibility for entitlement programs, low take-up rates for some discretionary support, and reductions in size of automatic stabilizers following reforms (¶50). - Additional discretionary fiscal stimulus of 2¼ percentage points of GDP provided in 2010, balanced across income tax reductions and spending on municipalities (¶51). - Fiscal rules: ten-year average of net lending now used to assess past savings; average surplus from 2000 dropped; Swedish Fiscal Policy Council central to assessments and indicates 2010 policies remain appropriate under the rules (¶52). - Monetary policy and framework: - Riksbank advanced anticipated commencement of tightening cycle to summer 2010 based on strong showing from late-2009 and concern with housing market; timing and extent under review with European developments taken into account; stance remains highly accommodative in near term (¶53). - Decision to remove the tolerance interval around the inflation target considered appropriate; Executive Board provides full assessments in all cases (¶54). - Financial sector policy and framework: - Vulnerabilities have receded and bank capital reinforced (June 2010 FSR) (¶55). - Capacity to manage troubled institutions confirmed in practice; 2008 bank resolution law provides framework for crisis management via nationalization (¶55). - Guiding principle: former shareholders should bear their full burden; adoption in October 2008 of the “bank stability fee” of 0.0018 percent on bank non-equity liabilities (doubling in 2011) to prefund interventions in future (¶55). - Options to extend instruments available to manage weak institutions will be reviewed by a government commission reporting within two years (¶55). *Source: _cr10220 - 39. More broadly, with confidence broadly restored, bank regulatory arrangements* ### 56. The housing market remains a concern for consumer and macroeconomic stability ### 56. The housing market remains a concern for consumer and macroeconomic stability ### Housing market and microprudential measures - Preemptive steps taken to cool the market include repeated reminders by Executive Board members that new borrowers taking variable rate mortgages should be aware that rates will rise. - Proposals for penalties on new mortgages with loan-to-value ratios above 85 percent have been presented by the FSA board ((¶31). ### Debt guarantee scheme, contingency planning, and reserves - The debt guarantee scheme was extended to end-2010—with its duration now governed by EU agreement on such schemes. - Tests of contingency planning continue, and the level of international reserves will be assessed in this context (¶35, 40). ### Labor market policies and framework - Unemployment remains a key concern, notwithstanding stronger employment outturns than anticipated. - Active labor market initiatives will therefore remain extensive, supported by further reductions in income taxation to raise incentives to work. - With a “realistic” attitude from both sides of industry evident in the “local crisis” wage agreements and in the recent multi-year settlements, reduced employment protection is not needed in order to strengthen broader economic performance (¶44–45). ### Staff appraisal — downturn, policy response, and outcomes - Output peaked at end-2007, and fell 5 percent in 2009. - Unemployment has risen to over 9 percent. - Corporate financial positions—notably of manufacturing exporters—have deteriorated. - Output may be some 4 to 6 percent below capacity. - Policy response included: - Sharp relaxation of monetary policy. - A slew of emergency financial sector support measures, and actions raising bank capital. - Fiscal relaxation of 3 percentage points of GDP to a deficit of 0.8 percent of GDP in 2009. - A 15 percent real effective depreciation of the krona. - These policies occurred against the background of Sweden’s credible inflation targeting, freely floating exchange rate, and budgetary frameworks—with public debt sustainably below 45 percent of GDP. ### Recovery signals and remaining uncertainties - Earlier financial strains have eased and exit from emergency financial sector support measures has begun. - Credit to households remained buoyant. - Concerns with a deflationary spiral have been erased—with core inflation and inflation expectations remaining close to target throughout. - Personal consumption held up firmly, and firms hoarded labor to a far greater extent than in the 1990s. - Output began to rise from mid-2009. - Risks to growth remain elevated: global demand for consumer durables and investment and intermediate goods—where Sweden specializes—lags the global recovery. - Market stress in Europe has prompted a market “search for strong sovereigns” which has reversed much of the earlier krona depreciation, denting prospects for net exports and growth. - Riksbank assessment: growth in Sweden in 2010 could be as high as 5 percent or as low as -1 percent. ### Fiscal policy assessment and recommendations - The budget anticipates a further increase in the deficit to over 2 percent of GDP in 2010. - The budget includes tax reductions and increased transfers to municipalities, summing to 2¼ percent of GDP. - These measures respond to concerns with output prospects and, as indicated by the Swedish Fiscal Policy Council, are fully consistent with fiscal stability and the framework of fiscal rules. - If economic growth and employment turn out to be stronger than anticipated, the budget balance will do likewise. - The tax reductions in the 2009–10 budgets will help to boost structural flexibility. - The current fiscal rules—targeting a surplus of 1 percent of GDP across the cycle, supported by medium-term expenditure ceilings—remain well suited for Sweden. - Any changes should reinforce the central role of the Swedish Fiscal Policy Council in assessing compliance. ### Monetary stance - Recent Riksbank announcements indicated the anticipated tightening cycle would be brought forward to mid-2010. - Inflationary pressures remain well contained. - Given the large output gap and recent krona strength, the immediate outlook is for core inflation to continue to fall. - The tightening cycle should be gradual and cautious. - Continued uncertainty over the implications of market strains in Europe could provide grounds to consider the appropriate time for its start. - Decision to retire the tolerance interval around the inflation target avoids raising unnecessary concern when headline inflation falls outside the range. - Accountability under the adjustment is retained by the occasional publication of the principles guiding how policymakers use their discretion within the inflation targeting framework. ### Financial stability assessment and recommendations - The Riksbank Financial Stability Report indicates that core Tier 1 capital ratios for all large banks will remain above 8 percent even in a stress scenario. - This assessment is stronger than previous assessments, partly reflecting the improved outlook for the Baltics. - The Financial Supervisory Authority’s proposal to penalize loan-to-value ratios above 85 percent will help to address vulnerabilities. - Risks remain, including those from banking operations abroad and from liquidity risks in euro and dollar markets. - Recommendation: These elements should continue to be reflected in Swedish capital and liquidity requirements in line with forthcoming global agreements on such arrangements. - Recommendation: Cross-border resolution frameworks should be developed further, in line with EU proposals. ### Managing tail risks and contingency planning - While direct exposures to Euro Area peripherals are minimal, Sweden is exposed indirectly. - Priority: update “war games” to verify contingency plans. - These exercises would also confirm that international reserves are at appropriate levels. - Steps to establish a special resolution regime to manage troubled financial institutions and to further raise resources for banking supervision are welcome. - Any reforms to the architecture of macroprudential institutions should: - Maintain effective communication and coordination between all authorities, - Provide appropriate accountability, - Retain the independence of monetary policymaking. *Source: _cr10220 - 56. The housing market remains a concern for consumer and macroeconomic stability* ### 70. Sweden should remain on the standard 12-month consultation cycle. ### Sweden should remain on the standard 12-month consultation cycle. ### Recommendation - Sweden should remain on the standard 12-month consultation cycle. ### Real economy (selected historical and forecast figures) - Real GDP (2004–2011): 4.2, 3.2, 4.3, 3.3, -0.4, -5.1, 3.0, 1.9 - Domestic Demand (2004–2011): 2.1, 2.9, 3.8, 4.6, 0.2, -5.0, 2.2, 1.7 - CPI inflation (2004–2011): 1.0, 0.8, 1.5, 1.7, 3.3, 2.0, 2.2, 2.0 - Unemployment rate (in percent, 2004–2011): 6.3, 7.6, 7.0, 6.1, 6.2, 8.3, 9.3, 8.8 - Gross national saving (percent of GDP, 2004–2011): 23.6, 24.6, 27.2, 28.8, 28.1, 23.8, 23.3, 24.9 - Gross domestic investment (percent of GDP, 2004–2011): 17.0, 17.7, 18.7, 20.3, 20.4, 16.6, 17.4, 18.6 - Potential Real GDP (2004–2011): 3.1, 3.2, 3.5, 3.6, 0.0, -0.3, 0.2, 0.6 - Output Gap (as a percent of potential, 2004–2011): 0.6, 0.7, 1.4, 0.3, 0.1, -4.8, -2.0, -0.8 ### Public finance (selected indicators) - General government balance (2004–2011, percent of GDP): 0.6, 2.0, 2.4, 3.8, 2.5, -0.8, -2.2, -1.5 - Total Revenues (percent of GDP, 2004–2011): 53.3, 54.5, 53.8, 53.6, 52.6, 52.7, 51.5, 52.0 - Total Expenditures (percent of GDP, 2004–2011): 52.7, 52.5, 51.4, 49.8, 50.2, 53.5, 53.7, 53.5 - Structural balance (as a percent of potential GDP, 2004–2011): 0.0, 0.7, 0.7, 2.0, 2.4, 1.7, 0.1, 0.6 - General government gross debt (percent of GDP, 2004–2011): 51.2, 51.0, 45.9, 40.9, 38.3, 42.3, 42.7, 42.4 ### Money, credit, and interest rates (selected) - Credit to non-financial corporations and households (12-month percent change, selected years): 5.2, 9.5, 12.1, 12.1, 12.0, 6.2 - Repo rate (year average): 2.1, 1.7, 2.3, 3.5, 4.1, 0.7 - Ten-year government bond yield (year average): 4.4, 3.4, 3.7, 4.2, 3.9, 3.3 ### External sector and reserves - Current account (percent of GDP, 2004–2011): 6.7, 6.9, 8.5, 8.4, 7.6, 7.2, 5.9, 6.6 - Trade balance (percent of GDP, 2004–2011): 8.0, 7.7, 7.8, 7.2, 7.3, 6.7, 6.8, 7.0 - Foreign Direct Investment, net (2004–2011): -2.9, -4.5, 0.7, -2.3, 1.2, -5.1, -2.0, -0.4 - International reserves (in billions of US dollars, 2004–2011): 22.4, 26.5, 28.3, 30.5, 30.7, 41.6, 48.0, 45.0 - Reserve cover (months of imports, 2004–2011): 2.0, 2.1, 2.0, 1.8, 1.9, 3.2, 3.2, 2.8 ### Exchange rates and competitiveness - Nominal effective rate (2000=100, selected years): 101.5, 99.2, 99.7, 101.9, 100.5, 91.0 - Real effective rate (2000=100, note 1): 91.0, 86.8, 82.0, 86.6, 88.4, 87.0 ### Medium-term scenario and forecasts (2007–14, selected series) - Real GDP (2007–2014): 3.3, -0.4, -5.1, 3.0, 1.9, 3.0, 3.5, 3.4 - Private consumption (2007–2014): 3.7, -0.1, -0.8, 3.2, 1.5, 2.0, 2.5, 3.0 - Fixed investment (2007–2014): 8.9, 1.7, -16.0, 1.1, 1.7, 4.0, 6.5, 8.0 - Current account (percent of GDP, 2007–2014): 8.4, 7.6, 7.2, 5.9, 6.3, 6.4, 6.4, 6.5 - Inflation (HICP annual average, percent, 2007–2014): 1.7, 3.3, 2.0, 2.2, 2.0, 2.0, 2.0, 2.0 - Unemployment rate (2007–2014): 6.1, 6.2, 8.3, 9.3, 8.8, 8.3, 7.6, 6.8 - Potential output (2007–2014): 3.6, 0.0, -0.3, 0.2, 0.6, 2.1, 3.3, 4.1 - Output gap (percent of potential, 2007–2014): 0.3, 0.1, -4.8, -2.0, -0.8, 0.0, 0.3, -0.5 ### Financial system structure (2002–09, selected items) - Total financial system assets (2002–2009, in millions of SEK / percent of GDP): 9,186,817 (100.0 / 375.9), 14,952,386 (100.0 / 478.3), 16,893,874 (100.0 / 525.7), 17,581,651 (100.0 / 547.1) - Total banking sector assets (memorandum item): 6,838,534 (74.4 percent of financial system assets / 279.9 percent of GDP) in earliest year shown; 13,197,960 (75.1 percent of financial system assets / 410.7 percent of GDP) in last year shown - Four major banks, total assets (selected years, in millions of SEK / percent of total assets / percent of GDP): 5,760,842 / 62.7 / 235.7; 9,491,189 / 63.5 / 303.6; 11,665,716 / 69.1 / 363.0; 11,438,287 / 65.1 / 355.9 - Memorandum: Nominal GDP (in millions of SEK, selected years): 2,443,630; 3,126,018; 3,213,659; 3,108,002 ### Financial soundness indicators: banks (2003–09, selected) - Regulatory capital to risk-weighted assets (2003–2009): 10.5, 10.6, 10.5, 10.5, 10.2, 10.7, 13.0 - Regulatory Tier I capital to risk-weighted assets (2003–2009): 8.0, 8.3, 7.7, 7.8, 7.5, 8.1, 10.9 - Nonperforming loans to total gross loans (2003–2009): 2.0, 1.2, 0.9, 0.8, 0.6, 1.1, 2.0 - Loan-loss provisions to nonperforming loans (2003–2009): 49.4, 66.2, 69.7, 56.1, 58.3, 49.1, 55.4 - Return on assets (net income as percent of average total assets, 2003–2009): 0.6, 0.7, 0.8, 0.8, 0.8, 0.5, 0.3 - Liquid assets as percent of total assets (2003–2009): 4.4, 5.2, 5.0, 5.0, 5.0, 4.0, 6.3 - Customer deposits as percent of total (non-interbank) loans (2003–2009): 50.6, 52.6, 50.2, 53.8, 51.4, 46.1, 47.1 - Noninterbank loans to noninterbank deposits (2003–2009): 142.6, 130.8, 137.4, 135.7, 139.8, 139.6, 144.8 ### Financial soundness indicators: non-banks and markets (2003–09, selected) - Household financial liabilities as percent of GDP (2003–2009): 62.5, 65.4, 69.6, 72.3, 74.7, 77.4, 86.4 - Debt stock as percent of GDP (non-financial sector borrowing from financial sector, selected): 53.9, 51.6, 54.1, 54.2, 60.9, 65.6, 64.8 - Total debt stock as percent of GDP (selected): 74.5, 70.4, 72.6, 70.7, 79.8, 93.6, 91.2 - OM Stockholm Stock Exchange Index (annual percent change, selected): 29.2, 16.0, 30.5, 18.7, -5.7, -38.8, 43.7 - Real estate prices (year on year percent change, one- or two dwelling buildings, selected): 6.1, 10.0, 10.5, 10.5, 11.3, -2.0, 5.8 ### Balance of payments and international investment position (selected forecasts and levels) - Current Account Balance (in SEK billions, 2007–2014 forecasts): 264, 246, 225, 196, 225, 240, 255, 273 - Trade Balance (in SEK billions, 2007–2014 forecasts): 224, 235, 209, 224, 239, 257, 274, 294 - Exports of G&S (in SEK billions, 2007–2014): 1,581, 1,686, 1,478, 1,579, 1,656, 1,733, 1,837, 1,959 - Imports of G&S (in SEK billions, 2007–2014): 1,357, 1,452, 1,269, 1,355, 1,416, 1,476, 1,563, 1,665 - Swedish Assets Abroad (in SEK billions, 2007–2014): 7,511, 7,880, 7,973, 8,585, 9,103, 9,672, 10,271, 10,905 - Swedish Liabilities Abroad (in SEK billions, 2007–2014): 7,559, 8,324, 8,574, 9,122, 9,612, 10,131, 10,682, 11,263 - International Investment Position (in SEK billions and percent of GDP, selected): -48 (SEK billions), -1.5 (percent of GDP) in earliest; -601 (SEK billions), -19.3 (percent of GDP) at trough; improving to -357 (SEK billions), -8.9 (percent of GDP) by 2014 forecast ### General government financial accounts and fiscal metrics (2007–14, selected) - Total Revenue (in SEK billions, 2007–2014): 1,640, 1,661, 1,612, 1,644, 1,733, 1,848, 2,008, 2,106 - Total Expenditure (in SEK billions, 2007–2014): 1,524, 1,583, 1,637, 1,714, 1,782, 1,843, 1,933, 2,046 - Primary balance (SEK billions, 2007–2014): 171, 131, 12, -38, -11, 49, 124, 109 - Overall balance (SEK billions, 2007–2014): 116, 78, -25, -70, -49, 57, 56, 60 - Total Revenue (percent of GDP, 2007–2014): 53.6, 52.6, 52.7, 51.5, 52.0, 52.8, 54.3, 54.0 - Total Expenditure (percent of GDP, 2007–2014): 49.8, 50.2, 53.5, 53.7, 53.5, 52.3, 52.3, 52.5 - Primary balance (percent of GDP, 2007–2014): 5.6, 4.1, 0.4, -1.2, -0.3, 1.4, 3.4, 2.8 - Overall Balance (percent of GDP, 2007–2014): 3.8, 2.5, -0.8, -2.2, -1.5, 0.1, 2.0, 1.5 - Structural Balance (percent of GDP, 2007–2014): 2.2, 1.7, 1.5, 0.1, 0.6, 1.2, 1.5, 1.6 - Fiscal Impulse (expansionary +, percent of GDP, 2007–2014): -1.4, 0.6, 0.1, 1.4, -0.5, -0.6, -0.2, -0.1 - Gross Public Debt (percent of GDP, 2007–2014): 40.9, 38.3, 42.3, 42.7, 42.4, 40.2, 36.0, 32.7 - Nominal GDP (in billions of SEK, 2007–2014): 3,126; 3,214; 3,108; 3,293; 3,421; 3,594; 3,795; 4,002 - Output gap (percent of potential, 2007–2014): 0.3, 0.1, -4.8, -2.0, -0.8, 0.0, 0.3, -0.5 ### Assessment of Sweden’s fiscal framework (Attachment I, summary) - Sweden’s fiscal policy framework originated after the early 1990s crisis when public debt exceeded 70 percent of GDP and the general government deficit peaked at 12 percent of GDP. - Since 1993, fiscal consolidation has been underpinned by numerical fiscal rules and budget institutions. - In the run-up to the global financial crisis, Sweden built strong public finance buffers, with structural surpluses in all but one year since 2000 and public debt falling to a low of 38 percent of GDP. - During 2008–09, the structural surplus declined slightly from 2.3 to 2.2 percent of GDP while the headline fiscal balance deteriorated from 2.5 to -0.8 percent of GDP. - Sweden adhered to its fiscal rules while delivering substantial fiscal stimulus amid a real output contraction of 7 percent from peak to trough in 2008–09. - By mid-2009, more than half the countries in Europe with national fiscal rules had modified or suspended them; as of May 2010, only two countries avoided excessive deficit procedures under the EU Stability and Growth Pact—Sweden and Estonia. *Italic: Source — IMF staff report content unit _cr10220 - 70. Sweden should remain on the standard 12-month consultation cycle.* ### 4. This note assesses how Sweden’s rules have managed to hold up. The objective is to ### 4. This note assesses how Sweden’s rules have managed to hold up. The objective is to ### B. The Fiscal Framework - The fiscal framework consists of: - A nominal expenditure ceiling introduced in 1997 covering primary spending of the central government and spending of the old age pension system; is determined three years in advance in the budget and then approved by parliament; and is considered binding; - A balanced budget requirement for local governments introduced in 2000; - A surplus target for the general government also introduced in 2000, though lowered from 2 percent surplus over the cycle to 1 percent over the cycle in April 2007. - Supporting institutions and mechanisms: - The Swedish fiscal policy council established in 2007 (one of 7 fiscal councils worldwide) provides independent evaluation of government fiscal policies. - Complementary institutions: National Institute for Economic Research, National Financial Management Authority, National Audit Office — evaluate and carry out independent forecasts of macroeconomic and fiscal policies. - Central government’s top-down budget approach gives parliament responsibility for fiscal aggregates and strengthens expenditure control. - Broad domestic consensus: - High degree of social and political consensus on safeguarding long term public finances and on the role of the rules-based framework, rooted in Sweden’s fiscal crisis experience in the early 1990s. ### C. Assessing how well the rules have worked - Guiding questions: - a. Have the rules delivered anti cyclical fiscal policy? - b. Was the fiscal stimulus delivered during the crisis appropriately, timely, temporary and targeted? - c. Have the rules delivered long term credibility? - Evidence on cyclicality and expenditure behavior: - Expenditures generally show a countercyclical pattern over time and revenues appear pro cyclical (Text Figure; Figure 1). - Transfers and consumption appear strongly counter-cyclical over 1970–2009; gross fixed capital formation less counter-cyclical. - Tax revenues and social contributions appear particularly pro cyclical. - Expenditures also appear countercyclical when compared to growth surprises in 1999–2009: positive GDP shocks typically met with lower-than-projected expenditures. - Measured as the deviation of in total expenditure relative to planned expenditure, and actual real GDP growth, relative to projections. - Formal estimation (fiscal reaction function) highlights: - Dependent variable: cyclically adjusted primary balance (CAPB). - Explanatory variables include: lagged CAPB, debt level, fiscal rules coverage index, controls for changes in policy regime. - Results: - The underlying fiscal balance in Sweden is countercyclical. - The coefficient on the output gap is positive: cyclical upturn (downturn) tends to improve (deteriorate) the CAPB. - The fiscal rules index coefficient is positive and significant: higher index values lead to lower deficits or higher surpluses. - This coefficient is much larger for Sweden than the EU-14 average, suggesting fiscal rules have a stronger role in Sweden. - Reported estimation coefficients (summary table): - Sweden (1994-2009): Lagged output gap 0.88 (3.89)***; Lagged CAPB 0.33 (2.48)**; Lagged debt ratio 0.10 (2.50)**; Fiscal rules index 1.39 (2.04)* - EU-14 (1990-2009): Lagged output gap 0.00 (0.02); Lagged CAPB 0.66 (13.79)***; Lagged debt ratio 0.03 (3.07)***; Fiscal rules index 0.33 (1.96)* - t values reported in parentheses. *, **, and *** denote significance at the 10, 5 and 1 percent level. - Crisis response: automatic stabilizers and discretionary measures - Sweden’s automatic stabilizers are large, roughly 0.55 for 2003 by OECD estimates. - Floden (2009) estimated budget elasticity for 2009 at 0.53. - Roughly two thirds of the fiscal deterioration during 2008–10 is explained by automatic stabilizers. - The government implemented discretionary measures of close to 4 percent of GDP. - Budgetary Impact of a 1 Percent Change in GDP (selected country values as presented): - Denmark 0.59; Finland 0.48; Sweden 0.55; Euro area average 0.48; France 0.53; Austria 0.47; Italy 0.53; Greece 0.47; Netherlands 0.53; Portugal 0.46; Norway 0.53; United Kingdom 0.45; Belgium 0.52; Spain 0.44; Germany 0.51; Ireland 0.38. - Sweden: Discretionary Fiscal Measures, 2009–11 (In percent of GDP, totals and components by year) - Total: 2009 1.6; 2010 2.4; 2011 1.6 - Revenues: 2009 1.1; 2010 1.3; 2011 1.4 - Lower income tax: 2009 0.5; 2010 0.8; 2011 0.7 - 1 percent cut in social contributions: 0.4 (year not explicitly assigned in source table) - CIT rate cut (from 28 to 26.3 percent): 0.2 - Lower taxes on pensions: 2009 0.1; 2010 0.4; 2011 0.5 - Tax credits for home improvement: 0.1 - Other: -0.2; 0.1; 0.1 - Expenditure: 2009 0.5; 2010 1.0; 2011 0.2 - Spending increase (education, R&D): 0.2 - ALMPs: 2009 0.3; 2010 1.0; 2011 0.2 - Other: 0.0 - Source: 2009, 2010 Budget Bills and 2009, 2010 Spring Bills. - Timing and temporary nature: - Automatic stabilizers provided immediate stimulus; primary fiscal balance expected to improve automatically as activity recovers. - Fiscal stabilizers in Sweden respond more to the labor market given taxes on labor income make up two thirds of total tax revenues. - During the current downturn a smaller unemployment response to output, compared to historical patterns, contributed to a stronger than expected fiscal outturn for 2009. - Nominal expenditure ceilings and countercyclical room: - The 3-year in advance nominal expenditure ceilings mean that when inflation declines, real spending allowed by the nominal ceiling increases. - If inflation is one percentage point below projections in a given year, real spending implied by the nominal expenditure ceiling is some ½ a percentage point of GDP higher than anticipated. - Targeting: - Lack of household survey data for 2009 limits assessment of targeting efficiency. - Macroeconomic data indicate a stabilizing impact on household consumption from lower taxes and higher transfers. - Aggregate implementation choices and margins: - A greater part of discretionary measures were implemented on the revenue side despite higher estimated multipliers on the expenditure side. - Some 0.3 percent of GDP in stimulus-related grants to local government were recorded in 2010 instead of 2009 to maintain buffers; the expenditure ceiling was met with a margin of 0.8 percent of GDP (some SEK 24 billion). - Have the rules delivered long term credibility? - Three stylized facts supporting Sweden’s credibility: - Sweden has a solid history of fiscal discipline and achieving fiscal targets. - Markets have noticed: Sweden’s market risk premium has steadily come down and remains low. - During European sovereign stress, Swedish bond prices have fallen and the premium over German bonds has at times become negative. - Empirical evidence on bond yields: - An empirical model (Tang (2009)) links government bond yields to market stress (VIX), global risk free rate, public debt, net IIP and government balances. - Findings: - Sovereign bond yields were weighed down earlier in the crisis—presumably by concerns about Sweden’s banking sector—but these concerns have abated with Swedish bond yields recovering strongly. - Since end-2008, Swedish bond yields have consistently been below levels predicted by the model, with the residual widening since end-2009. This reflects the increasing premium placed on sovereign fiscal credentials; the gap between actual and fitted values reflects Sweden’s strong fiscal fundamentals and the rules framework. ### D. Conclusion - Main conclusion: - Sweden’s experience shows that a well designed fiscal framework of rules and institutions can deliver strong budgetary outcomes when underpinned by political consensus. - The national consensus regarding the fiscal rules framework has allowed policymakers to build buffers during boom times. - Limitations and areas for strengthening: - Fiscal policy appears to have become slightly pro cyclical in 2009, indicating that in sharp downturns rules-based frameworks must balance the trade-off between sufficient counter-cyclical response and consistency with numerical rules; this depends on labor market response. - The current rules framework does not have formal corrective mechanisms for when targets are not observed (e.g., formal procedures for informing parliament of reasons for non compliance and proposed corrective measures), relying instead on voter response. - Strengthening the formulation of the structural surplus target could improve counter-cyclicality and credibility: - The Fiscal Policy Council criticized the structural surplus target as too imprecise for careful monitoring because it relies on the correct definition of the business cycle, which is difficult to estimate precisely. - An increasing number of fiscal indicators used to assess compliance risks giving fiscal authorities too much discretion and weakening the surplus target as a binding constraint. - The lack of specific corrective mechanisms to address slippages from the target presents a problem. *Prepared by Rita Babihuga.* ### 24. Possible remedies should be careful not to tilt policies in a pro cyclical direction. One ### _cr10220 - 24. Possible remedies should be careful not to tilt policies in a pro cyclical direction. One ### Procyclicality and surplus-target design - Evaluating the surplus target "over a well-defined period" and introducing "a clear binding corrective mechanism in the event of non-compliance" could eliminate the need for several indicators to assess compliance with the target. - Risk: A model that evaluates the surplus target over a well-defined period "without taking the output gap into consideration" "risks increasing pro cyclicality." - Alternative (Boije et. al., (2009)): define the target directly in terms of structural net lending and correct deviations from the structural net lending target only when "the output gap permits." This approach "does correct for the risk of pro cyclicality." - Countervailing concern: "this target could also be problematic given the difficulty in measuring structural balances," which is why "the Swedish authorities have rejected this approach." ### Role of the Fiscal Policy Council and indicators - Recommendation: "the burden of assessing compliance with the rules should remain with the Fiscal Policy Council" because "indicators, especially those based on estimates of the cycle, are prone to flaws." - Policy implication: rely on an independent council assessment rather than multiple quantitative cycle-based indicators to judge compliance. ### Key findings on Swedish financial sector globalization and systemic risk - Banking and financial sector size: - "The assets of the banking system amount to over 350 percent of GDP." - "All financial institutions―banking, insurance, mortgage, asset management, and other non-bank financial businesses ―comprise more than 550 percent of GDP." - Cross-border expansion: - "Swedish banks’ total foreign assets more than doubled over the last decade, reaching 150 percent of GDP." - Entry of foreign banks into Sweden is limited: "only three subsidiaries (Danske Bank, DnB NOR Bank, and Dexia) and 27 branches (as of end-2009)" and "the total of their assets amounts to less than 10 percent of the total banking system or 28 percent of GDP in Sweden." - Geographic exposures: - By end-2009, Swedish banks’ foreign claims in the Nordic region "reached more than a half of their total foreign claims (less than 30 percent in 2002)." - Claims in the Baltic economies reached "nearly 10 percent (up from merely 3 percent in 2002)." - Risks from Baltic exposures: - "Loan claims on their Baltic subsidiaries at end 2008 represented 35–45 percent of bank capital" for affected banks. - Operating-profit reliance on Baltic operations is "extensive," so deterioration there could present "material risks to their capital." ### Systemic contingency claims analysis (CCA) and risk metrics - Simple aggregation of individual banks’ expected losses "amounted to SEK 600 billion (19¼ percent of GDP) in the spring of 2009." - Accounting for mutual dependence via systemic CCA: - 50th percent Value-at-Risk (VaR) estimate: "SEK 120 billion (4 percent of GDP)." - 95th percent VaR estimate: "SEK 210 billion (6½ percent of GDP)." - Attribution and evolution: - "The increase in the expected losses of the banking system was mostly attributed by Swedbank and SEB." - As market perceptions improved, "the total expected losses of the banking system" declined; "Currently, the expected losses stood at SEK 40 billion (1¼ percent of GDP)." - Guarantee-fee implications: systemic CCA can be used "to estimate a guarantee fee for an individual bank"—the "fair value of a risk-based guarantee fee" varies across banks and was higher for Swedbank and SEB during the sample periods. ### Joint-probability and systemic-relevance measures (Segoviano and Goodhart methodology) - Joint probability of default (JPoD) for a sample including four major Swedish banks and two other Nordic banks "rose to one percent in the spring of 2009." - The JPoD "has remained much lower than the average of banks’ individual default probabilities," consistent with systemic CCA findings. - The "systemic relevance" measure (probability at least one bank becomes distressed when one other specific bank becomes distressed) "rose sharply towards the Spring of 2009." - Notable systemic importance: "Handelsbanken and Nordea" became the most systemically important banks despite lower Baltic exposures, owing to Nordea's size and Handelsbanken's dominant domestic market share. ### Identified contagion channels and supervisory considerations - Contagion channels: - Direct financial linkages between banks. - Financial contagion between banks and between banks and sovereigns. - Dependence on wholesale funding. - Observations from market indicators: - Moody’s KMV EDF indicators and CDS spreads showed "sharp increases in credit risks starting late 2008," notably for Swedbank and SEB. - Sovereign credit risks in Nordic economies affected bank credit-risk indicators; Granger-causality tests indicate close associations between Swedish bank CDS spreads and those for the Baltics and Nordic economies. *Source: Excerpt from IMF staff report content unit _cr10220.* ### 13. This analysis can be extended to incorporate sovereign risks. The Distress ### 13. This analysis can be extended to incorporate sovereign risks. The Distress ### Distress Dependence Matrix: market perceptions over time - Matrices estimated for three dates: August 1, 2008 (pre-crisis), April 1, 2009 (peak crisis), and April 1, 2010 (recent). - Sample includes: four Swedish banks; three Nordic economies (Denmark, Norway, Sweden); three Baltic economies (Estonia, Latvia, and Lithuania); Germany; and GIIPS (Greece, Italy, Ireland, Portugal, and Spain). - The matrices show probability of distress of the bank or economy in the row, conditional on distress of the bank or economy in the column. - Main findings: - Pre-crisis date (August, 2008): Swedish banks’ risk profile was dominated by Sweden’s and Nordics’ sovereign risks mostly (Area A in the Table 1). - Peak-crisis date (April 1, 2009): Swedish banks’ risks were perceived to be affected by sovereign CDS spreads in the Baltics (Area B) and to become increasingly dependent on other Nordic sovereign risks (Area C). The average conditional probability of distress for each Swedish bank also rose, notably for SEB and Swedbank which have large exposures to the Baltics (Area D). The inter-linkages among Swedish banks also rose (Area E). - Recent date (April 1, 2010): The pattern of distress dependence looks quite similar to that of the pre-crisis date. Swedish banks are most vulnerable to Sweden sovereign risks, followed by other Nordic risks. Risks associated with the Baltic economies are now much smaller. - Systemic inter-linkages within banks and across banks and sovereigns evolve over time. - Swedish banks and GIIPS (Table 2): Swedish banks’ risks with GIIPS rose on April 2009, apparently on account of deterioration in Swedish banks’ own creditworthiness, but remain lower than their risks with the Nordics on the same date. Most recently, despite heightened strains in GIIPS, Swedish banks’ risks with GIIPS are perceived to be small. ### Wholesale funding, liquidity mismatches, and foreign currency funding - Banks’ reliance on wholesale funding increased significantly since the early 2000s, with a half of their lending funded by non-deposit sources. - Foreign currency funding ratio defined as foreign currency funding as a percent of total funding is high for some banks. - Some banks present extensive liquidity mismatches, defined as short-term assets minus liabilities as a percent of total assets (short-term defined as maturity less than 3 months). - While net foreign exchange positions are small through hedging, in extreme market circumstances banks are exposed to roll-over and counterparty risks. ### Network analysis and hypothetical tail-risk scenarios (BIS data, simplified network) - Asset-side exposures: Swedish banks exposed largely to other Nordic economies and Germany, followed by the United States, the United Kingdom, and Baltic economies. - Liability-side top five lenders to Sweden: Denmark, Germany, the United State, the United Kingdom, and France. - Sweden’s exposures to GIIPS are very small on both sides, suggesting direct linkage is small. - Three hypothetical tail-risk scenarios (assumptions: no country uses international reserves; countries reduce foreign assets to hoard liquidity; only direct and first round direct effects taken into account): - Scenario 1: Top five lenders for Sweden, facing liquidity constraint, cut their foreign assets by 10 percent across the board. - Scenario 2: Italy, Ireland, Portugal, and Spain cut their foreign assets by 50 percent. - Scenario 3: Greece does not fulfill its obligations on foreign liabilities. - Key results and interpretations: - Sweden is very sensitive to shocks originating from large economies because those economies hold large amounts of foreign assets. - Direct impact from Ireland, Italy, and Portugal is very small; however, indirect impacts can be substantial because major lenders to Sweden (e.g., Germany, France, United Kingdom) have large exposures to those economies. - Greece’s direct effect on Sweden is small, but its indirect impact in the Greece scenario would be significant, equivalent to 60 percent of Sweden’s international reserves. - Extracted scenario figures (as presented): - 10 percent cut of foreign claims by the following economies - United States20.814.735.476.2 - Denmark2.21.53.77.9 - France16.922.139.083.9 - Germany27.519.647.1101.4 - United Kingdom15.821.337.179.9 - 50 percent cut of foreign claims by the following economies - Ireland3.612.516.134.7 - Italy2.716.919.642.2 - Portugal1.13.34.59.6 - Spain3.122.525.655.1 - Greece scenario0.727.428.060.3 - Memorandum item: - Sweden's international res e46.5 - (In billions of US dollars) ### Existing supervisory arrangements for cross-border banking - Under the EU framework, Swedish authorities regulate and supervise Swedish banking groups, including branches abroad. Stress tests at banks’ and authorities’ levels must include consolidated risk assessments; banks’ Internal Risk Based approach should incorporate cross-border banking risks. - Sweden has intensified oversight of cross-border operations in cooperation with relevant authorities abroad. - Supervisory arrangements for each banking group are set up via bank-specific Memorandum of Understandings (MOUs) addressing responsibilities, supervision plans, exchange of information, and notification requirements. - The Swedish Ministry of Finance, the Riksbank, and the FSA have begun formulating a Nordic-Baltic stability group and new MOUs (including some broad parameters on burden sharing rules). ### Challenges in cross-border risk assessment and MOUs - Proper risk assessment of cross-border banking is challenging; MOUs generally lack specific arrangements regarding crisis management and resolution. - MOUs lack specifics in critical areas, e.g., modality of early intervention and trigger of coordinated intervention. ### Key challenges of cross-border operations - Diversified operational environments (from wealthy to emerging Eastern European economies) create challenges for consistent cross-border regulatory and supervisory frameworks. - Under the home country principle, coordination of supervisors across jurisdictions is key, but national mandates may lead authorities to act in national interest rather than joint best interest. - Specific issues: - Conflicts of interest: Swedish banks’ operations in Nordics amount to 30–40 percent of Nordic and Swedish GDP; activities in Baltic economies account for 5–6 percent of Swedish GDP but range from 60 to 140 percent of GDP in Baltic host economies, creating asymmetries in attention and incentives. - Lack of harmonization in crisis prevention frameworks: supervisory powers and remedial tools diverge widely across EU supervisors. - Differential crisis management capacity: host authorities in emerging economies may lack credible deposit insurance, emergency liquidity assistance, or debt guarantees comparable to home authorities; fixed exchange rate regimes further constrain central bank liquidity provision. - Lack of agreement on basic principles and procedures for crisis resolution and insolvency frameworks: EU directives give home authorities sole power to initiate and implement resolution measures (with exceptions for subsidiaries), but many economies lack a legal framework for special bank resolution distinct from non-bank corporates; cross-border operational separability is often limited. ### Discussion: EU reform and need for further measures - EU regulatory reform trends toward centralization in supervision: 2008 amendments to the Capital Requirements Directive aimed to strengthen consolidating supervisors via supervisory colleges and improve host supervisors’ information rights. The EU’s new supervisory framework (agreed December 2009) including a European Systemic Risk Board and a European System of Financial Supervisors is expected to strengthen cross-border supervision. - However, more measures may be needed to manage crises effectively due to mismatch between cross-jurisdictional banking activities and national responsibility for supervision and resolution. - Creating an integrated EU-level framework for crisis prevention and management, crisis resolution, and depositor protection will be difficult due to heterogeneous sizes, development levels, and fiscal capacities across economies; issues include adverse selection, moral hazard, free rider problems, and incentive incompatibility. ### Interim policy options to strengthen cross-border banking regulation - More capital and liquidity requirements: - Major changes under consideration by the Basel Committee. - Tighter capital and liquidity requirements (for both local and foreign currencies) expected to strengthen resilience. - Updated Basel II guidelines (July 2009) support higher capital requirements under Pillar II to account for firm-wide risk management, risk concentrations, reputation risk and implicit support, and liquidity risks. - Stronger supervisory capacity and powers: - Swedish FSA resources could be strengthened. - Enhance FSA powers for early intervention; currently lacks power to (i) appoint a person with specific or general powers at a problem bank; (ii) coordinate a rescue plan before insolvency is declared; (iii) control or play a role in reorganization or winding-up; (iv) initiate insolvency proceedings leading to reorganization or winding-up. - Clarify division of labor on macro prudential oversight between the Riksbank and the FSA. - More contributions by systemically important banks to financial stability: - Sweden has established a stabilization fund; banks currently pay a flat rate fee. - Government planning to introduce risk based fees from 2011 to limit moral hazard. - Better alignment of banks’ structure and crisis management/insolvency frameworks: - Supervisors should pay attention to legal structure of banking groups and have power to direct wind down of subsidiaries and discontinuation of activities. - Stronger public finance and more international reserves: - Sweden maintains strong public finance positions; Riksbank has extensive capacity to provide emergency liquidity support in krona but limited foreign currency liquidity capacity. - As of end-April 2010, Sweden’s international reserves stood at $49.1 billion, equivalent to less than 19 percent of financial sector’s external debt. - Note: reciprocal currency swap arrangements as of end-May 2010: the Riksbank has reciprocal currency swap arrangements with the ECB but not with the U.S. Federal Reserve. *Source: _cr10220 - 13. This analysis can be extended to incorporate sovereign risks. The Distress* ### 25. How much more of each of the above-measures is needed is a difficult question. This ### _cr10220 - 25. How much more of each of the above-measures is needed is a difficult question. This ### Key point - How much additional strengthening of international reserves, public finance buffers, bank capital, liquidity positions, and supervision frameworks is needed is a difficult question and will partly depend on where a future crisis would originate and how it evolves under what macroeconomic circumstances. - It is likely that the resource needs for the authorities (i.e., international reserves and public finance buffer) would be smaller if banks’ capital and liquidity positions, as well as the supervision frameworks, are stronger. ### Credit risk indicators used in this attachment - The attachment employs various risk analytical tools, mostly developed by the IMF Monetary and Capital Markets Department. - Box 1 Figure 1 illustrates the relationship among these various risk models. Individual credit risk indicators - Distance to Default (DtoD). - A market based default risk indicator, which measures the number of standard deviations of asset (return) volatility from the default barrier for a specific time horizon (one year is used in this attachment). - Contingent Claims Approach (CCA). - Based on Merton’s CCA (Merton, 1974) and using balance sheet information on debt payments, as well as market data for equity and equity volatility, the value of bank assets and asset volatility can be inferred, and risk measures, such as default probabilities and expected default losses, can be estimated. - Moody’s KMV follows this approach and provides expected default frequency. ### Systemic risk models - Systemic CCA (Gray and Jobst, 2010 a. b., and c.). - Because banks’ CDS spreads are depressed due to government implicit and explicit guarantees, the difference between equity market implied losses and CDS implied losses provides a measure of the government’s contingent liabilities. - Systemic CCA ― risk-adjusted balance sheets for the system of financial institutions ― can provide estimates for total systemic losses, systemic contingent liabilities, and tail risks. - Consistent Information Multivariate Density Optimizing (CIMDO) Approach (Segoviano, 2006, and Segoviano and Goodhart, 2009). - It uses CDS spreads to get default probabilities and bank equity prices to calculate correlations. - Risk measures include Joint Probability of Default ― the probability that all the banks in the sample portfolio default jointly ― and the Systemic Relevance ― the probability that all banks in the sample default, conditional on the default of a specific bank. - Note that CDS implied default probabilities are net of the effect of government guarantees. ### Balance sheet models - Network Approach. - It simulates domino effects of the default of a specific bank or economy on others. - Construct a matrix of inter-bank accounting exposures that include gross financial exposures among them (e.g., BIS data), then simulate shocks to a specific bank and track the domino effect on other banks. ### Relationships among various risk models (as presented) - Balance sheet based models - Network approach - Equity price based models - CIMDO approach - DtoD - CCA - Moody’s KMV - Systemic CCA - Note: Figure footnote: 1/ Author’s simplified presentation based on Gray and Jobst (2010 c. forthcoming). ### Box 2 — Cross-Border Banking Regulatory Framework in the EU - The home country principle characterizes the EU’s overall cross-border banking system stability architecture. - Banks are licensed, regulated, and supervised by their home country supervisory authorities, and covered by the home country’s crisis management, crisis resolution, deposit insurance, and insolvency frameworks. - A subsidiary of the banking group should be supervised by the country in which it is registered as a corporate entity and licensed. - The home country for the parent bank should be responsible for a consolidated supervision of a banking group as a whole. - Crisis management arrangements in the EU are based on cooperation and information exchanges between partially harmonized national systems with cross-border powers. - A framework for such cooperation and information exchanges is established through largely non-binding Memorandum of Understandings, including central banks and often Finance Ministries. - There are neither formal frameworks for agreements on early intervention nor crisis resolution, including burden sharing of potential fiscal costs. ### Division of labor between home and host (foreign) authorities (as presented) - Licensing - Parents (Domestic operations): Home - Subsidiary (Domestic operations): Home - Branch (Foreign operations): Home - Subsidiary (Foreign operations): Foreign - Prudential regulation and supervision - Domestic parents: Home - Domestic subsidiary: Home - Foreign branch/subsidiary: Home / Foreign (as indicated in source layout) - Crisis prevention and management - Domestic parents: Home - Domestic subsidiary: Home - Foreign operations: Home / Foreign (as indicated in source layout) - Crisis resolution - Domestic parents: Home - Domestic subsidiary: Home - Foreign operations: Home / Foreign (as indicated in source layout) - Emergency liquidity assistance - Domestic parents and subsidiary: Home - Foreign operations: Foreign - Deposit insurance - Domestic parents and subsidiary: Home - Foreign operations: Home and foreign (“top up”)1/ - Footnote 1/: A foreign bank branch can apply for an additional deposit protection to the host (foreign) deposit guarantee scheme if the protection is higher in the foreign country than it is in the home country. *Source: _cr10220 - 25. How much more of each of the above-measures is needed is a difficult question. This* ### REFERENCES ### _cr10220 - REFERENCES ### References - Čihák, M. and E. Nier, 2009, “The Need for Special Resolution Regimes for Financial Institutions—The Case of the European Union,” IMF Working Paper, September, WP/09/200. - European Central Bank, 2007, “EU Banking Structure October 2007” Frankfurt: European Central Bank). - Espinosa-Vega, M., and J. Sole, 2010, “Cross-Border Financial Surveillance: A Network Perspective,” IMF Working Paper, April , WP/10/105. - Gray, D. F., and A. A. Jobst, 2010a, “New Directions in Financial Sector and Sovereign Risk Management,” Journal of Investment Management, Vol. 8, No.1. - Gray, D. F., and A. A. Jobst, 2010b, “Using the Systemic CCA Model of Expected Losses and Implicit Guarantees in the Swedish Banking Sector,” Mimeo. - Gray, D.F. and A. A. Jobst, 2010c, “Systemic Contingent Claims Analysis (Systemic CCA) – Estimating Potential Losses and Implicit Government Guarantees to Banks,” IMF Working Paper (Washington: International Monetary Fund), forthcoming. - Ingves, S., 2010, “The Importance of Being Savvy―Lessons on European Crisis Management,” Speech at Fundación Rafael del Pino on April 15, 2010, http://www.riksbank.com/templates/Page.aspx?id=43861 - International Monetary Fund, 2010, “Global Financial Stability Report: Meeting New Challenges to Stability and Building a Safer System,” World Economic and Financial Surveys (Washington DC, April). - Segoviano, M. A., 2006, “The Consistent Information Multivariate Density Optimizing Methodology,” Financial Markets Group, London School of Economics, Discussion Paper 557. - Segoviano, M. A. and C. Goodhart, 2009, “Banking Stability Measures,” IMF Working Paper, January, WP/09/4. - Sy A.N.R., and J.A. Chan-Lau, 2006, “Distance-to-default in Banking: A Bridge Too Far?” IMF Working Paper, WP/06/215. - González-Páramo J. M., 2006, “Cross-Border Banking in the EU: Developments and Emerging Policy Issues,” speech in Hong Kong on February 24, 2006, http://www.ecb.int/press/key/date/2006/html/sp060224.en.html ### Distress Dependence and Bank Risk (Selected quantitative findings) - Table 1 (Major Nordic Banks: Distress Dependence Matrices) - 1-Aug-08: Given the distress of Sweden, the probability of distress of Swedbank was 57 percent. - 1-Apr-09 raw average (excluding own effects): Swedbank 0.41, Handelsbanken 0.68, Nordea 0.68, SEB 0.46. Colum average (excluding own effects) across countries: 0.41, 0.68, 0.68, 0.46, 0.66, 0.75, 0.83, 0.78, 0.20, 0.13, 0.18; overall raw average 0.52. - 1-Apr-10 column average (excluding own effects): Swedbank 0.33, Handelsbanken 0.55, Nordea 0.46, SEB 0.31; Baltic columns: Estonia 0.11, Latvia 0.04, Lithuania 0.07; overall raw average 0.39. - Table 2 (Major Nordic Banks and GIIPS: Distress Dependence Matrix) - 1-Aug-08 example: given the distress of Greece, the probability of distress of Swedbank was 10 percent. - 1-Aug-08 row raw averages (excluding own effects): Swedbank 0.19, Handelsbanken 0.25, Nordea 0.21, SEB 0.41; column averages (excluding own effects) 0.31, 0.36, 0.40, 0.20, 0.13, 0.17, 0.36, 0.23, 0.34, 0.27. - 1-Apr-09 row raw averages (excluding own effects): Swedbank 0.69, Handelsbanken 0.45, Nordea 0.45, SEB 0.67; column averages (excluding own effects) 0.42, 0.69, 0.70, 0.48, 0.41, 0.45, 0.64, 0.60, 0.68, 0.56. - 1-Apr-10 column averages (excluding own effects): Swedbank 0.27, Handelsbanken 0.44, Nordea 0.37, SEB 0.26; GIIPS columns Greece 0.09, Ireland 0.16, Italy 0.25, Portugal 0.19, Spain 0.26; overall raw average 0.24. - 18-May-10 column averages (excluding own effects): Swedbank 0.27, Handelsbanken 0.38, Nordea 0.32, SEB 0.21; GIIPS columns Greece 0.07, Ireland 0.13, Italy 0.21, Portugal 0.13, Spain 0.18; overall raw average 0.20. - Table 3 (Operating Environments for Swedish Banks — Most recent year) - Global competitiveness index (rank out of 133 economies): Sweden 44, Denmark 31, Finland 24, Norway 43, Germany 3, Estonia 19, Latvia 24, Lithuania 35. - "of which: Institutions" values: Sweden 4, Denmark 4, Finland 4, Norway 3, Germany 3, Estonia 1, Latvia 1, Lithuania 1. - "Macro economic stability" values: Sweden 3, Denmark 5, Finland 4, Norway 3, Germany 3, Estonia 4, Latvia 1, Lithuania 1. - "Number of banks per supervisor": Sweden 229, Denmark 154, Finland 114, Norway 240, Germany 1,416, Estonia 9, Latvia 9, Lithuania 13. - "Total assets of banks per supervisor": Sweden 42,150, Denmark 53,143, Finland 64,120, Norway 14,770, Germany 716,300, Estonia 353, Latvia 686, Lithuania 535. - "Total assets of banks per one euro budget for supervisors (in thousands of euro)": Sweden 0.23.0? (source table formatting preserved as: 0.23.030.5 for Sweden; Denmark 43.69.056.4; Finland 20.11.311.0; Norway 70.10.78.6; Germany 65.819.8; Estonia 470.30.66.1; Latvia 5991.00.64.9; Lithuania 570.20.2n.a.) - Fiscal revenues, Per capita GDP, and Nominal GDP columns present but specific numeric entries not clearly delimited in source table. - Table 4 (Comparisons of Supervisory Power — selected entries preserved verbatim) - Taking-up of business / licensing of credit institutions: - To enforce that entities do not provide banking services in your jurisdiction without authorisation/due notification? Sweden Yes; Denmark Yes; Germany Yes; Finland Yes; Estonia Not fully; Latvia Yes; Lithuania No. - To grant initial authorisations? Sweden Yes; Denmark Yes; Germany Yes; Finland Yes; Estonia Yes; Latvia Yes; Lithuania Yes. - To verify if the persons who effectively direct the business are fit and proper? Sweden Yes; Denmark Yes; Germany Yes; Finland Yes; Estonia Yes; Latvia Yes; Lithuania Yes. - Ongoing activity, including crisis management (examples): - To submit supervised institutions to (regular or special) on-site inspection? All: Yes. - To submit entities performing outsourced functions for supervised institutions to on-site inspection? Sweden Yes; Denmark No; Germany Yes; Finland Yes; Estonia Yes; Latvia Yes; Lithuania Not fully. - To require supervised institutions to provide information on demand (e.g. in times of crisis)? All: Yes. - To require an institution to meet supervisory requirements that are stricter than the legal requirements (capital, liquidity or other : please specify in the last column)? Sweden Yes; Denmark No; Germany Yes; Finland Yes; Estonia Yes; Latvia Yes; Lithuania Yes. - Administrative measures and sanctions (selected): - To issue a public warning or reprimand against a bank? Sweden Yes; Denmark Yes; Germany No; Finland Yes; Estonia Yes; Latvia Yes; Lithuania Yes. - To withdraw all or part of the license? All: Yes. - To appoint a person or body who has general or specific powers to authorize acts or take? Sweden No; Denmark No; Germany Not fully; Finland Yes; Estonia No; Latvia Yes; Lithuania Yes. - To require commitments/actions from shareholder to support the institution if needed with cash (equity)? Sweden No; Denmark No; Germany No; Finland No; Estonia Yes; Latvia Yes; Lithuania Yes. - To prohibit or limit principal or interest payments on subordinated debt? Sweden Yes; Denmark Yes; Germany Yes; Finland Yes; Estonia Yes; Latvia No; Lithuania Yes. - To convert subordinated debt into preferential or new equity? Sweden Yes; Denmark No; Germany Yes; Finland No; Estonia No; Latvia No; Lithuania Not fully. - To initiate an insolvency proceeding (either reorganisation or winding-up)? Sweden No; Denmark Yes; Germany Not fully; Finland No; Estonia Not fully; Latvia Yes; Lithuania Yes. - Sources: Committee of European Banking Supervisors, http://www.c-ebs.org/Review-Panel/Other-Surveys/supervisory-powers.aspx. - Figure 1 (Swedish Banks Cross Border Banking Operations) - Swedish Banks' Foreign Claims (Average annual growth rate from 2002 to 2009): - Denmark 19% - Finland 15% - Norway 19% - Germany 10% - UK 5% - Other advanced Europe 8% - Estonia 4% - Latvia 3% - Lithuania 3% - Others 14% - Major Swedish Banks: Lending By Country (percent shares, as of end 2009) — country categories shown: Sweden, Denmark, Finland, Norway, Baltic, Germany, Others. - Major Swedish Banks: Operating Income By Country (percent share, as of end 2009) — country categories shown: Sweden, Denmark, Finland, Norway, Baltic, Others. - Figure 2 (Swedish Banks’ Exposure to Baltics, As Of End-2008) - SEB and Swedbank: Exposures to Baltic Countries: - Estonia: Loans market share 78; Estonian GDP percent 82; Deposits market share 84; Estonian GDP percent 42. - Latvia: Loans market share 40; Latvian GDP percent 41; Deposits market share 29; Latvian GDP percent 17. - Lithuania: Loans market share 58; Lithuanian GDP percent 37; Deposits market share 57; Lithuanian GDP percent 19. - Sweden: Swedish GDP percent: 2; Percent of bank capital: 36. - Sweden: Swedish GDP percent: 3; Percent of bank capital: 44. - Sweden: Swedish GDP percent: 3; Percent of bank capital: 40. - Figure 3 (Credit Risk Indicators) - Swedish banks: 1 year Expected Default Frequency (In percent) displayed time series Jun-07 through Mar-10 for Handelsbanken, Nordea, Swedbank, SEB. - 5 year credit default swap spreads (In basis points) time series May-07 through Feb-10 for Swedbank, SEB, Handelsbanken, Nordea; Baltic sovereign average and EU banks shown for comparison. - Figure 4 (Gray and Jobst's Systemic CCA, 2007–10) - Sample institutions: Nordea, Swedbank, Handelsbanken, and SEB. - Systemic CCA outputs shown as Total Expected Losses (sum of individual expected losses), Total Expected Losses (VaR, 95%), Total Expected Losses (VaR, 90%) in billions of SEK; expected losses by bank (Median, 50th percentile) and Systemic CCA implied government guarantee fees (In basis points) plotted over July 1, 2007 - May 7, 2010 and subperiods. - Figure 5 (Nordic Banks: Segoviano and Goodhart's Default Dependency Analysis, 2007–10) - Nordic banks: Joint probability of default (Percent) time series May-07 through May-10. - Nordic banks: the probability that at least one bank becomes distressed given that a specific bank becomes distressed (In percent) time series May-07 through May-10 for Swedbank, SEB, Handelsbanken, Nordea, Danske, DNB. *Sources: References and tables/figures as presented in the provided content unit.* ### 1. Employment was unexpectedly resilient during the recession. Does this imply the rise ### _cr10220 - 1. Employment was unexpectedly resilient during the recession. Does this imply the rise ### A. What Explains Recent Developments in the Labor Market? - Recent developments - The unemployment rate rose from about 6 percent to above 9 percent but by much less than the 11 percent in 2010 initially expected by the Riksbank. - There was an (over 6 percent decline in output from peak to trough) during the downturn. - Employment decline was concentrated in manufacturing; services largely held up. - Working hours, productivity, and real wages declined. - Cross-country patterns - Many European countries (including Sweden) experienced decreases in labor productivity and average working hours, while the decline in permanent employment has been modest. - The United States saw large declines in employment and real wages and a rise in labor productivity relative to trend. - Swedish relative labor costs remained highly competitive; cost pressures from recent central wage agreements appear to be low. - Comparison with the early 1990s recession - The current labor market has fared better than in the early 1990s: jobless rates are relatively modest; labor productivity and average working hours fell; labor participation held up; permanent employment has recently leveled off. - Factors explaining resilience - Structural reforms since the mid-1990s improved labor market flexibility, supporting strong labor force participation, more flexible wage negotiations, and improved search and matching flows. - The recession was driven largely by external shocks; many firms hoarded labor given flexibility to release it later, contributing to falling productivity. - Public sector employment remained robust (unlike the sharp decline during the previous crisis). - Exchange rate flexibility mitigated part of the external shock. - Labor market policy changes (selected actions) - Reduce marginal taxes on labor income: Lower threshold for state income tax was raised in 2009; employer social security contributions were reduced and in-work tax credit expanded through 2011. - Reform sickness and disability benefit schemes: Tighten administration, time limits on eligibility and measures for rehabilitation lowered sickness absence rates. - Reform employment protection legislation: No significant action on permanent contracts but trial periods and duration of temporary contracts were extended. ### B. Is the Labor Market Flexible? - Measurement and methodology - Flexibility measured by turnover rates into and out of unemployment (inflow and outflow hazard rates), estimated using methodology proposed by Shimer (2007) and Elsby et. al., (2008). - Cross-country evidence - Anglo-Saxon and Nordic (including Sweden) countries have the highest flow rates; continental European countries scored low on both inflow and outflow rates. - Youth unemployment hazard flows are much higher than total unemployment hazard flows across all countries. - Dynamics and causality - A rise in unemployment is generally preceded by an increase of inflow hazard; persistence of unemployment changes is usually driven by outflow hazard. - Granger causality tests and pair-wise correlations show this close relationship in many countries (including Sweden). - In countries with high hazard rates, changes in unemployment rates are largely driven by changes in high outflow rates. - Counterfactual scenarios for Sweden - If labor market conditions at the start of the recession had been similar to those in the recession in early 1990s, unemployment rate would have risen to over 10 percent and continued deteriorating until mid-2011, before declining. - If conditions had been similar to those in Germany, unemployment rate would have risen more slowly but more persistently. - Alternatively, unemployment would have continued rising until end-2010 if today’s labor market conditions were the same as those in the early 1990s. If conditions today were similar to Germany, the unemployment rate would remain at high levels (over 8 percent) in the medium term. ### C. Implications for the Outlook and Policies - Uncertainty and risks - Deterioration in Europe could force firms to release hoarded labor, causing unemployment to rise again. - Past experience from countries with procyclical labor productivity and working hours suggests the upturn could be weak or remain negative for some years as hours and productivity return to trend before rehiring. - Youth employment vulnerability - Youth unemployment rate rose to about 30 percent, more than three times that of adults and at the high-end of the OECD average. - Estimates using Okun’s Law suggest changes of youth unemployment rate are about twice as responsive as those for adults over business cycles. - Many young workers were on temporary contracts and were among the first released in lay-offs. - Existing policy infrastructure - About 2 percent of GDP was spent on labor market policies, over half of which was on ALMPs, one of the highest among OECD countries. - ALMPs focus on elements that cross-country evidence suggests are most effective; however, evidence on their effectiveness during and after recessions is mixed. - Evidence on program effectiveness (findings from regression analysis) - The effects of ALMPs and PLMPs tend to be stronger in the case of Sweden than elsewhere; coefficients on interacting terms for Sweden are significant, indicating stronger effects on total and private employment. - Selected regression numbers from the full sample (1970–2009, unbalanced panel): - Lagged employment: 0.70 0.68 0.95 0.77 0.73 0.80 - Passive labor market programs (PLMPs): -1.75 -1.23 -0.41 -1.15 -1.03 -0.67 - ALMPs*SWE: 1.55 1.41 - PLMPs*SWE: -0.89 - Lagged real GDP growth: 0.44 0.22 0.79 0.40 0.21 0.25 - Observations: 300 300 300 300 300 280 - Notes on regressions: Numbers in bold indicate significance at 5 percent; persistent dummy variable equals '1' if output growth at year t was less than negative one percent and lasted more than one year; dummy 'SWE' equals 1 for Sweden and 0 otherwise. - Policy implications - Reinforce labor market flexibility to secure strong employment during recovery. - Maintain and target ALMPs given evidence of stronger effects in Sweden, while monitoring their effectiveness during and after recessions. - Pay particular attention to youth labor market programs given high youth unemployment and their greater responsiveness to output gaps. *Source: IMF staff analytical note contained in the provided content unit.* ### 14. Expenditures on ALMPs in Sweden are mostly related to job search assistance, ### _cr10220 - 14. Expenditures on ALMPs in Sweden are mostly related to job search assistance, ### Main findings on ALMP effectiveness - Expenditures on ALMPs in Sweden are mostly related to job search assistance, employment incentives, and job training, which also appear to be those types of spending that contribute to employment. - Job search assistance and start-up incentives - Results suggest broad significance of PES and start-up incentives on total and private sector employment. - Results are in line with evaluations on other country studies, especially programs on investment in active placements and active monitoring on unemployed job search efforts. - Caveat: much of this could reflect the fixed cost of running the PES services as the data do not distinguish between these two spending categories. - Training - Estimates find some positive impact of training on total employment, but it is uncertain whether the positive benefit outweighs the cost. - Training accounts for about 20 percent of total ALMPs spending. - Employment incentives to private-sector employment - Estimation suggests strongly significant impact of subsidies in creating employment in the private sector. - These subsidies form a major share of total ALMPs in Sweden. - Other studies suggest large displacement effects and potentially small net employment gains from these subsidies. - Direct job creation - Estimation results are ambiguous; coefficients are not significant, possibly due to displacement effects on a net basis. ### Estimation details and key coefficients / sample information - Full sample: 1970 - 2009 (unbalanced panel) 2/ - Dependent variable: lagged employment - Selected reported coefficients (as presented in the source table): - Lagged employment: 0.71 0.68 0.71 - Public employment service (PES) administration and start-up incentives: ... 4.38 4.75 - Labor market training: ... 1.35 ... - Subsidized employment: ... 1.24 2.47 - Rehabilitation measures for disabled: -10.50 -4.20 -4.94 - Passive labor market policies: -2.40 -1.70 -1.47 - Employment protection: -1.24 -0.56 -0.50 - Lagged real GDP growth: 0.53 0.24 0.29 - Notes from table: - Number of observations: 276 300 300 - 1/ Numbers in bold indicates significant level at 5 percent. - 2/ Cells denoted as '...' indicate variables included in the regression but not significant at 5 percent level. - Summary interpretation from methodology section: - In general, spending on ALMPs has contributed to an increase of total employment rate; coefficients on ALMPs are significant at 5 percent level at about 0.36 on total employment. - Effects of ALMPs on youth and private sector employment tend to be muted. - PLMPs have a consistent significant negative effect on all employment rates (reverse causality suggested). - Difference in protection between regular and temporary employment has a negative significant effect. - Effects of ALMPs do not appear asymmetric over economic cycles; PLMPs have stronger negative impact during persistent downturns, but ALMPs show no notable differences during protracted recessions. ### Robustness and identification - Robustness checks: - Two-step estimation to control for possible interaction between ALMPs and PLMPs: first obtain residuals from regressing each type of ALMPs on PLMPs, then use them in the benchmark estimation. - Controlling for interaction: negative coefficients on PLMPs tend to be smaller but remain significant. - Instrumental variables techniques (using lagged spending) applied to address potential endogeneity problems; results do not materially change. ### Uses of estimates and projection insight - The estimates can be used to evaluate the evolution of employment. - Estimated results appear to follow closely to the actual employment rate. - Using budgeted spending on labor market policies and under certain assumptions on structural variables, the evolution of employment shows some improvements in the medium-term (figure referenced: Projection and Estimated Errors on Employment Rate (in percent of working population)). ### Policy recommendations (lessons for the recession) - Evaluating effectiveness of active measures - A large share of public spending on active measures is already in areas generally found to be more effective. - Further expansion of direct measures (e.g., tax incentives or discretionary subsidies for firms to hoard labor) may only contribute marginally while they could compromise efficiency. - Unwinding of temporary crisis measures - Temporary crisis measures introduced during the recession would need to be timely unwound to avoid attenuating job-search incentives and trapping workers in reduced hours (e.g., marginal increase in the level and/or duration of unemployment benefits). - Rebalancing of employment protection - Recommendations from the OECD on rebalancing employment protection between regular and temporary workers would help improve labor market structure. - Addressing youth unemployment - Policies could ensure better integration between employment services and education system, including apprenticeship training, referrals to PES from schools, and access to job-search assistance, in line with OECD recommendations. ### Fiscal sustainability and risk scenarios (Attachment IV highlights) - Baseline medium-term projection: - Public debt-to-GDP ratio will decline from a high of 42.7 percent of GDP in 2010 to 32.7 percent of GDP in 2014. - With a primary surplus of about 3 percent of GDP and a declining public debt ratio in 2014, Sweden’s fiscal position is expected to remain strong. - Alternative scenarios / risks (selected exact figures): - External risks - The impact of a permanent ½ standard-deviation shock to the interest rate—a 0.6 percentage point increase from the baseline—would increase public debt by 2 percentage points to 51 percent of GDP in 2014. - A one-time 30 percent depreciation in the REER (in 2011) would increase public debt immediately, but only marginally—about 4 percentage points to 46 percent of GDP. Debt would subsequently fall to 36 percent of GDP in 2014. - A one-time 10 percent of GDP shock to contingent liabilities (in 2011) would increase public debt to 51 percent of GDP; assuming baseline speed of debt reduction thereafter, public debt would lower to 41 percent of GDP in 2014 (about 10 percent of GDP higher than the baseline). - Domestic risks - A ½ standard deviation shock to primary balance, which lowers primary balance by nearly 1 percent of GDP each year during the forecast period, would raise debt in 2014 by 4½ percentage points of GDP (to 36 percent of GDP) relative to the baseline. - A ½ standard deviation shock to growth would bring average projected annual growth down by 0.8 percent and raise public debt to 39 percent of GDP in 2014. - One-quarter standard deviation shocks to growth, real interest rate, and primary balance (lowering output growth by 0.4 percent a year, raising real interest rate by 0.35 percent a year, and reducing the primary balance by ½ percent of GDP a year) would bring public debt to 35 percent of GDP in 2014—an increase of 3 percentage points of GDP from the baseline. - Long-run public sector balance sheet - Projected increase in spending with aging: 2.6 percent of GDP (compared to 5.2 percent in the euro area). - Public sector balance sheet approach suggests the net worth constraint continues to be met by 2060, albeit with a smaller margin to absorb upside risks to aging costs. *Source: Statistics Sweden and IMF staff estimates.* ### 1. This supplement provides an update on economic and policy developments in recent ### _cr10220 - 1. This supplement provides an update on economic and policy developments in recent ### Update and staff position - This supplement provides an update on economic and policy developments in recent weeks. Staff projections and the thrust of the staff appraisal remain unchanged. - Parliamentary and local elections will be held on 19 September 2010. ### Monetary policy developments - The Riksbank raised its policy rate by 0.25 percentage points to 0.5 percent on July 1, the first increase since the global crisis. - Decision rationale: - Strong domestic growth—particularly the resumption of export growth and rising household consumption. - Concerns about rising household indebtedness. - Decision was balanced by: - A postponement of projected further tightening. - Projections of a subsequent relaxation in the event of further European strains. - Dissent by two Monetary Policy Committee members who called for the initial increase to be postponed. - Directors' view: the recent policy rate increase by 25 basis points still leaves the stance of monetary policy appropriately accommodative; the tightening cycle should be gradual and cautious given the large output gap and recent krona strength. ### Growth forecasts and confidence intervals - Riksbank revised baseline forecast published in April: - Projects a 3.8 percent increase in real GDP in 2010—about 1½ percentage points stronger than in April. - 90 percent confidence interval around the 2010 growth projection: 2.1 percent to 5.4 percent (previously -1 percent to 5 percent). - Projects 2011 real GDP growth at 3.6 percent with a 90 percent confidence interval ranging from 1 percent to 6.1 percent. - Ministry of Finance revised its growth forecast for 2010: - From 2½ percent (Spring Policy Bill on May 15) to 3.3 percent. - IMF staff projection: the economy to grow by 3 percent in 2010. - Authorities’ forecasts: - Around 3½ percent GDP growth in 2010 (recently updated). - Authorities expect higher domestic demand and stronger outcomes for 2011 than staff; staff projects 1.9 percent for 2011 while authorities are almost 2 percentage points higher. ### Labor market and unemployment projections - Ministry of Finance revised period average unemployment rate: - From 9.2 percent and 8.8 percent respectively in 2010 and 2011, to 8.9 percent and 8.4 percent. - Selected labor observations: - Unemployment rose to over 9 percent during the downturn (highest since 1998). - Employment is increasing steadily and unemployment has started to decline from an elevated level. - Staff slightly more pessimistic on labor market than authorities; staff expects lower private consumption and lower investments in 2011 relative to authorities. ### Fiscal policy and public finances - 2009 fiscal relaxation: fiscal policy focused on supporting labor market participation, resulting in a fiscal relaxation of 3 percentage points of gross domestic product (GDP) in 2009. - Directors welcomed additional fiscal support to activity in the 2010 budget and envisaged for 2011, via full operation of large automatic stabilizers and planned discretionary stimulus. - Directors encouraged authorities to stand ready to reconsider fiscal stance for 2011 if growth outlook is stronger than expected, and noted the central role of the Council for Fiscal Policy in ensuring fiscal framework credibility. ### Balance of risks and external environment - Near-term prospects remain uncertain and depend on: - Global demand for Sweden’s output bundle—investment and intermediate goods and consumer durables—which may lag in the recovery. - Market stress in Europe, which has dented growth prospects in a key export market and reversed much of earlier krona depreciation. - Directors supported keeping domestic policies supportive and encouraged flexible responses to evolving economic circumstances. - Directors noted risks to financial sector stability from banking operations abroad and liquidity operations in euro and dollar markets; recommended reflecting risks in capital and liquidity requirements in line with forthcoming global agreements. ### Financial sector policies and supervision - Exit from financial sector support measures has begun; recent stress tests indicated regulatory capital requirements are comfortably met by all institutions. - Financial Supervisory Authority proposal: cap loan-to-value ratios to help address vulnerabilities. - Recommended actions: - Strengthen cross-border resolution frameworks in line with EU proposals. - Review current toolkit of supervisory intervention as part of contingency planning, addressing: - Verifying adequacy of international reserves. - Establishing a special resolution regime to manage troubled institutions. - Increasing the Financial Supervisory Agency’s capacity. - Authorities’ measures and intent: - Prolongation of the Debt Guarantee Program with stricter conditions: increased pricing and requirements to establish viability reviews. - Riksbank ceased to offer loans at maturities of both three and six months; loans with one-month maturity will be offered until October as part of phase-out. - Authorities plan a Swedish public inquiry commission to evaluate financial sector functioning and public safety net; aim to establish a coherent and effective regulatory framework and address division of roles between authorities and regulation for distressed institutions. ### Key quantitative indicators (as reported) - Real economy (in percent change): - Real GDP: 2009 -5.1; 2010 3.0; 2011 1.9. - Domestic Demand: 2009 -5.0; 2010 2.2; 2011 1.8. - CPI inflation: 2009 2.0; 2010 2.2; 2011 2.0. - Unemployment rate (in percent): 2009 8.3; 2010 9.3; 2011 8.8. - Potential Real GDP: 2009 -0.3; 2010 0.2; 2011 0.6. - Output Gap (as a percent of potential): 2009 -4.8; 2010 -2.0; 2011 -0.8. - Public finance (in percent of GDP): - General government balance: 2009 -0.8; 2010 -2.2; 2011 -1.5. - Total Revenues: 2009 52.7; 2010 51.5; 2011 52.0. - Total Expenditures: 2009 53.5; 2010 53.7; 2011 53.5. - Structural balance (as a percent of potential GDP): 2009 1.7; 2010 0.1; 2011 0.6. - General government gross debt: 2009 38.3; 2010 42.3; 2011 42.7; 2011 (alternative) 42.4 (table shows 2010 42.3, 2011 42.7 42.4—preserve as in source). - Money and credit (12-month, percent change): - M0: 2009 0.7. - M3: 2009 -2.7. - Credit to non-financial corporations and households: 2009 6.2. - Interest rates (year average): - Repo rate: 2009 0.7. - Three-month treasury bill rate: 2009 0.4. - Ten-year government bond yield: 2009 3.3. - Balance of payments (in percent of GDP): - Current account: 2009 7.2; 2010 5.9; 2011 6.6. - Trade balance: 2009 6.7; 2010 6.8; 2011 7.0. - Foreign Direct Investment, net: 2009 -5.1; 2010 -2.0; 2011 -0.4. - International reserves (in billions of US dollars): 2009 41.6; 2010 48.0; 2011 45.0. - Reserve cover (months of imports of goods and services): 2009 3.2; 2010 3.2; 2011 2.8. - Exchange rate: - Skr per U.S. dollar (June 17, 2010): 7.84. - Nominal effective rate (2000=100): 2009 91.0. - Real effective rate (2000=100): 2009 87.0. - Fund Position (May 31, 2010): - Holdings of currency (in percent of quota): 80.68. - Holdings of SDRs (in percent of allocation): 101.73. - Quota (in millions of SDRs): 2395.50. - Social indicators: - GDP per capita (in current PPP US dollars, 2007): 36,603. - Income Distribution (ratio of income received by top and bottom quintiles, 2008): 3.5. - Life expectancy at birth (2009): 79.4 (males) and 83.4 (female). - Automobile ownership (2007): 465 per thousand. - CO2 Emissions (tonnes per capita, 2006): 5.6. - Population Density (inhabitants per sq. km., 2008): 22.5. - Poverty Rate (share of the population below the established risk-of-poverty line, 2005): 9%. *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10220.pdf* ### 12. Likewise, many adjustments are already ongoing at an EU-level. In accordance with ### _cr10220 - 12. Likewise, many adjustments are already ongoing at an EU-level. In accordance with ### Cross Border crisis preparedness - In accordance with the 2008 EU MoU, Sweden, together with the Nordic and Baltic countries, is currently setting up a Cross Border Stability Group to enhance preparedness for managing a crisis in any of the common international banking groups. - The group has agreed on a number of crisis management procedures and prepared for a clear division of roles and responsibilities between the authorities and ministries. ### Fiscal policy and framework - The government broadly agrees with staff’s view of the Swedish fiscal position and the fiscal policy stance in the current economic situation. - Sweden experienced output falling more than 6 percent in real terms from peak to trough during the international downturn. - A strong fiscal starting position permitted: - letting the automatic stabilizers operate fully; - a series of discretionary measures without putting sustainable fiscal policy at risk. - Discretionary measures cited include structural tax cuts, increased municipality grants (preventing municipalities from acting pro-cyclically), and increased resources to the labor market (preventing long-term unemployment and improving conditions for those most detached from the labor market). - Even after these measures, public finances remain strong. - The government welcomes staff’s favorable assessment of the Swedish fiscal framework and emphasizes that in a severe recession an important policy principle is keeping public finances in good order to ensure that the deficits are temporary and manageable. - The government shares staff’s view on the important role of the Fiscal Policy Council in assessing policy and compliance with the framework; there are no plans at present to change the role of the Council. - Sweden’s path forward for exit from the crisis involves nurturing the recovery, reinforcing the jobs policy, and safeguarding public finances. - With a rapid return to surplus in the public finances in line with budget policy objectives, Sweden will be able to face new crises and long run challenges like an ageing population from a position of strength. - As a result of the improved economic outlook, public finances are expected to move into surplus in 2012. - The government acknowledges the risk that developments could be worse than expected and considers the envisaged discretionary stimulus planned for 2010–11 to appropriately balance the risks; the government is following developments carefully and is prepared to take further measures as necessary. ### Monetary policy and framework - The authorities welcome staff’s conclusion that earlier considerable disinflation concerns have been successfully headed off. - According to the Riksbank’s latest forecast: - inflation will initially be held back due to higher productivity growth and a stronger krona; - as unit labor costs rise more quickly and economic activity strengthens, inflation will rise; - during the Riksbank’s forecast period until mid-2013, CPI inflation will be slightly higher than 2 percent, while underlying (CPIF) inflation will be slightly lower than 2 percent. - Inflation expectations remain steady around the target in the long run. - The authorities agree with staff that inflation pressures are low at the moment, but inflation is expected to increase as economic activity strengthens. - The Executive Board of the Riksbank decided on June 30 to raise the repo rate by 0.25 percentage points to 0.5 percent. - The Riksbank agrees with staff that the tightening cycle should be gradual; the published repo rate path shows a gradual normalization of the repo rate to attain the inflation target and keep the real economy stable. - Monetary policy is set to remain supportive of growth, in line with staff’s appraisal. - Regarding extraordinary measures, the Riksbank has followed two basic principles: - they should not replace effectively functioning markets; and - loans should be granted against collateral and at the repo rate with a surcharge. - The Riksbank’s exit is therefore fairly uncomplicated compared with the unwinding of large-scale asset purchases necessary in several other countries. - The first of the three fixed-interest rate loans granted to the banks in 2009 matured on June 30, also contributing to normalization of monetary policy. ### Contingency planning and reserves - Staff notes the need to update "war games" to verify contingency plans and states it would be useful to confirm that international reserves are at appropriate levels. - Should a more negative growth scenario materialize, the Riksbank stands ready to reintroduce extra-ordinary measures. - The Riksbank welcomes staff’s conclusion that abolishing the +/-1 percent tolerance interval around the inflation target in June was consistent with accountability. *Source: _cr10220 - 12. Likewise, many adjustments are already ongoing at an EU-level. In accordance with* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10220.pdf_