## _cr11171

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### Competitiveness and the Equilibrium Real Exchange Rate
- Since the March 2009 trough, the krona appreciated by 23 percent in real effective terms.
- Staff assessment: following the 23 percent real effective appreciation from its mid-2009 trough, the krona remains competitive, with qualitative caveats.
- Qualitative caveats noted:
  - Population ageing calls for a medium-term strengthening of the net external position.
  - MB and ES measures are qualified by risks that staff medium term macro projections may fail to appropriately reflect a possible drop in consumer durables and investment goods demand that might have resulted from the recent crisis.
  - Alongside other indicators, the staff assessment is that the currency is competitive.
- CGER entries (as presented): Macro Balance-10-4; Equilibrium RER-21-5; External Stability-24-14 (Source: CGER 1/ April 2011).

### A strong recovery: key outcomes and short-run statistics
- Real GDP growth: Sweden grew 5½ percent in 2010.
- Recovery drivers:
  - Exports rose by 20 percent since early-2009.
  - Investment rose by 14 percent since early-2009.
  - Total consumption rose by 5½ percent since early-2009.
- Output gap:
  - Nearly -6 percent in 2009 (staff estimate).
  - Narrowed to -3 percent in 2010 (staff estimate).
- Labor market:
  - Total employment has regained pre-crisis levels.
  - Unemployment rate close to 8 percent in April 2011.
  - Long-term unemployed: more than doubled during the crisis and remains one and a half times the pre-crisis level.
- Short-run activity (2011Q1):
  - GDP rose 0.8 percent quarter-on-quarter.
  - Consumption slowed; inventories continued strong increases.
- Financial system and markets:
  - Stock market indices approaching pre-crisis peaks.
  - Money market spreads remain above pre-crisis levels following withdrawal of emergency liquidity support.
  - Bank capital adequacy ratios strengthened; bank CDS spreads well below average of other European banks.

### Outlook and projections (staff and authorities)
- Staff central case projections:
  - Growth projected at 4.4 percent in 2011.
  - Growth projected at 3.8 percent in 2012.
  - Output gap projected to close early in 2012; gap around 1–2 percent in 2011 under the central case.
- Riksbank forecast:
  - Real GDP growth of 4.6 percent in 2011, with 90 percent confidence intervals ranging from 2.5 percent to 7.6 percent.
- Quarter-by-quarter (percent change, quarter-over-quarter, seasonally-adjusted) projections (selected series):
  - Real GDP 2011: Q1 0.8, Q2 0.6, Q3 0.6, Q4 0.6; Annual 4.4. 2012: Q1 1.2, Q2 1.2, Q3 1.2, Q4 1.1; Annual 3.8.
  - Private Consumption 2011: Q1 0.4, Q2 0.7, Q3 0.7, Q4 0.5; Annual 2.5. 2012: Q1 0.6, Q2 0.6, Q3 0.5, Q4 0.5; Annual 2.4.
  - Gross Fixed Capital Formation 2011: Q1 1.6, Q2 3.1, Q3 1.8, Q4 1.0; Annual 8.9. 2012: Q1 2.9, Q2 2.9, Q3 2.9, Q4 2.9; Annual 10.0.
  - Exports 2011: Q1 2.3, Q2 2.2, Q3 1.1, Q4 0.9; Annual 9.4. 2012: Q1 1.7, Q2 1.7, Q3 1.7, Q4 1.7; Annual 6.2.
  - CPI 2011: Q1 0.8, Q2 0.8, Q3 0.8, Q4 0.8; Annual 3.0. 2012: Q1 0.5, Q2 0.5, Q3 0.5, Q4 0.5; Annual 2.5.

### Risks to the outlook
- External risks:
  - Euro area sovereign and banking strains: on WEO estimates, if these strains spill over into the core, euro area growth could be lowered by 3 percentage points and global output by 1 percentage point relative to the baseline WEO forecast.
  - Oil price shock scenario from WEO: temporary surge to $150 per barrel in 2011—40 percent higher than the baseline—lowers global growth in 2012 by two-thirds of a percentage point; permanent shocks imply much larger output losses.
- Domestic risks:
  - Housing market concerns: large house price falls could lower consumption growth markedly.
  - Structural unemployment: persistence could lower potential growth.
- Exchange rate pressures:
  - Krona remains under upward pressure, reflecting market stress in Europe, a “search for strong sovereigns”, and monetary tightening by the Riksbank.

### Housing market: assessment, vulnerabilities, and measures (Box 2)
- Common features with boom-bust cases:
  - House prices and private debt have risen substantially.
  - Price-to-income and price-to-rent ratios are above historical norms.
- Important differences from major bust cases:
  - Since the 1980s, Swedish house price inflation has fallen short of major European bust cases.
  - No surge in residential investment—partly due to strict rent control in main cities.
  - Pre-crisis lending growth more tempered and targeted at households rather than property developers.
- Valuation and studies:
  - Swedish National Housing Credit Guarantee Board suggests house prices are overvalued by some 20–25 percent.
  - Riksbank study attributes recent price movements to “fundamentals”, such as low nominal interest rates, and is skeptical of large downside risk.
- Mortgage and prudential arrangements:
  - Mortgages predominantly financed through covered bonds; issuing banks remain permanently liable.
  - Micro- and macro-prudential measures taken: Riksbank policy rate increases; supervisor imposed interest rate penalties on mortgages with LTV >85 percent from October 2010.
- Riksbank factors attenuating bank losses:
  - (i) Borrowers subject to direct and life-long personal liability after default.
  - (ii) Well developed public insurance system cushions income shocks.
  - (iii) No buy-to-let market.
- Overall risk assessment:
  - Significant risk of a decline in house prices in coming years, with rising nominal interest rates likely the catalyst.
  - Decline unlikely to cause significant macroeconomic disruption unless adjustment is disorderly; a “perfect storm” including euro area spillovers would pose material risk.

### Financial sector stability and regulation
- System scale and structure:
  - Financial system assets equivalent to 5½ times GDP.
  - Four major banking groups dominate the system (65 percent market share) with extensive cross-border operations and substantial reliance on wholesale funding.
- Capital and liquidity:
  - Common equity Tier 1 capital ratio for major banks ranging from 7½–10 percent (11–15 percent with full Basel II rules).
  - Authorities indicate major banks have sufficient resources to meet forthcoming Basel III requirements, including capital conservation and counter-cyclical buffers.
- Covered bonds and household indebtedness:
  - Outstanding stock of covered bonds stands at over 50 percent of GDP (up from below 20 percent in the mid-2000s).
  - Loans cannot exceed fixed percentages of collateral value—75, 70, and 60 percent for residential, agricultural and commercial mortgages respectively.
  - Covered bond issuance as a share of total mortgage lending doubled to 80 percent since 2006.
  - A sustained drop in house prices of some 40 percent would be required to reduce the value of collateral pools below the face value of outstanding covered bonds.
  - Household debt-to-income ratio has more than doubled since mid-1990s; mortgages explain most of the increase.
- FSAP findings:
  - Sweden’s financial system generally sound.
  - Under adverse macroeconomic scenario (prolonged low growth and domestic housing crash), all major banks would maintain the 7 percent common equity Tier 1 capital ratios required under Basel III.
  - Liquidity assessment: in stress scenarios banks could face difficulties given reliance on wholesale funding; Riksbank structural liquidity measure improved but Swedish banks remain behind other European banks.
- Recommendations and planned actions:
  - Authorities intend to go further and faster than the Basel III timeline; FSA and MOF indicated common equity Tier 1 capital requirements would be at least 10–12 percentage points in a few years.
  - Effective discretionary supervision and active use of Pillar II and capital/liquidity surcharges for systemically important banks emphasized.
  - New liquidity governance regulation (FFFS 2010:7) adopted in December 2010.
  - New comprehensive liquidity reporting framework to commence in July 2011, comparable with Basel III liquidity coverage measures, to be progressively upgraded to binding prudential requirements.

### Termination of crisis liquidity support and collateral framework (paragraph 44)
- Most unconventional liquidity support measures have been terminated.
- Remaining measures (government debt guarantee and recapitalization programs) expected to be terminated by end-June 2011.
- Riksbank reviewing the collateral policy framework expanded during the crisis.

### Reserve adequacy and liquidity-gap approach (reserve analysis)
- Traditional metrics (Sweden, end-2010):
  - Foreign exchange reserves amounted to 10 percent of GDP.
  - 18 percent of broad money.
  - 2 percent of imports of goods and services.
  - 18 percent of bank short-term debts.
- Liquidity-gap approach:
  - Apply LCR and NSFR by currency to benchmark maximum foreign exchange reserve needs.
  - Illustration for four major banks: US dollar NSFR funding gaps substantial; euro gaps small or zero under specified assumptions.
  - US dollar funding gap for the four major banks ranges from $30 billion to $70 billion depending on assumptions.
- Probability-adjusted reserve needs (illustrative dates and entries):
  - September 2008: examples include Swed, Nordea, and Handel (All banks): Funding gap 47.2; bank(s) distress probability 0.30.
  - March 2009: examples include All banks: Funding gap 60.2; bank(s) distress probability 0.28.
  - March 2010 and March 2011: illustrated funding gaps and lower distress probabilities.
- Conclusion:
  - Foreign exchange reserve needs rose sharply in 2008–09; authorities raised reserves to over $50 billion by mid-2009.
  - Analysis suggests current level of foreign exchange reserves ($50 billion referenced in text) is enough to meet foreign liquidity needs under the unlikely event of distress in the selected European sovereign, given favorable market perceptions.
  - Recommendation to frequently review possible external stress events and to review governance framework on foreign exchange reserve management urgently.

### Output gap, potential output, and methods (Attachment analysis)
- Staff summary estimate of the output gap (overall):
  - Staff estimate the output gap at 2½–3½ percent of potential GDP in 2010.
- Cross-method findings (preserved quantitatively):
  - Univariate filters (excluding CF) estimate:
    - Output gap in the order of negative 5–6 percent in 2009.
    - Output gap of negative 2½–3½ percent in 2010.
  - Production-function (growth accounting) approach:
    - Trough at negative 5–6 percent in 2009.
    - Recovered to negative 3–3½ percent in 2010.
  - Multivariate (MV) filter:
    - Output gap trough about minus 7 percent in 2009Q3.
    - MV central estimate minus 2 percent in 2010Q4.
    - Potential growth: declined from 2 percent in 2008 to 1.3 percent; historical average 3 percent (1997–2007); rose by 1½ percent in 2010.
  - Staff prior and parameters:
    - Parameter governing speed to steady state set at 0.4 (range considered 0.1 to 1).
    - Labor share of income: 67 percent; fixed labor share used in calculations: 0.63.
    - Two NAIRU scenarios: policy success equilibrium unemployment lowered to 5 percent; alternative steady-state unemployment at 6 percent.
- Policy implications highlighted:
  - Riksbank needs accurate, model-informed assessment of the output gap to calibrate the policy rate path and avoid sharper later rate increases.
  - Multivariate model approaches that incorporate unemployment, inflation, and capacity utilization provide more policy-relevant output gap measures than univariate filters alone.
  - Monitor labor market indicators (vacancies, unemployment composition, long-term unemployment, matching efficiency) to assess whether rises in unemployment reflect cyclical slack or a higher NAIRU.

### Fiscal developments, stance, and framework
- Fiscal outcome and composition:
  - Fiscal deficit narrowed from 0.9 percent of GDP in 2009 to 0.3 percent of GDP in 2010.
  - Fiscal outcome was broadly neutral and about 1½ a percentage point of GDP smaller-than-projected.
  - For 2009–10, discretionary measures summing to some 4 percentage points of GDP were planned, of which 0.7 percent of GDP are crisis-related spending stimulus measures; execution incomplete, particularly at the local level.
  - 2010 general government overall balance outturn was -0.3 percent of GDP, almost 2 percentage points of GDP stronger than authorities anticipated in Spring 2010.
  - Structural surplus in 2010 was 1.4 percent of GDP.
  - Crisis-related stimulus measures on the spending side amounted to 0.1 percent of GDP.
  - Discretionary deficit-increasing measures totaled 2.3 percentage points of GDP (roughly two-thirds focused on tax measures).
- 2011 budget and medium-term:
  - Supply-side spending initiatives by 0.4 percent of GDP in 2011 to encourage long term employment and labor supply.
  - Projected long-term impact: 250,000 new jobs by 2015 and reduction of equilibrium unemployment from 6½ in 2006 to 5 percent by 2015 (authorities’ projection).
  - Planned tax reductions in 2012 up to 0.7 percent of GDP, conditional on reforms.
  - Appropriated expenditures to 2014 set below the expenditure ceiling by 1 percentage point of GDP annually as a “safety margin”.
- Estimates of cyclically adjusted balances (2009–10):
  - Authorities’ estimates of the cyclically adjusted balance in 2009–10: 3 and 1.8 percent of GDP.
  - Staff’s estimates: 1.3 and 1.4 percent of GDP.
- Recommended fiscal stance:
  - Underlying fiscal stance should remain unchanged in 2011–12; shift to tightening only in unlikely event of significant sustained krona overvaluation.
  - Emphasis on measures to strengthen labor market performance; expansion of earned income tax credit recommended.
- Fiscal framework elements:
  - (i) unlegislated surplus target at 1 percent of GDP over the business cycle;
  - (ii) rolling central government nominal expenditure ceiling established for three years ahead (2011 budget extends to four years);
  - (iii) balanced budget requirement for local governments.
- Fiscal Policy Council:
  - Tasks include evaluation of extent medium-term fiscal goals are achieved and quality of forecasts; needs adequate resourcing and a narrower mandate focused on fiscal stance and conformity with stability/sustainability goals.

### Contingent liabilities, PPPs, and fiscal risks (shock scenarios)
- Three kinds of shocks considered: macroeconomic assumptions, contingent liabilities, and policy deviations from baseline.
- Alternative shock scenarios summarized:
  - Permanent ½ standard-deviation shock to growth, interest rate and primary balance independently.
  - ¼ standard deviation shock to the three combined.
  - One-time 30 percent depreciation of the REER.
  - One-time 10 percent of GDP shock to contingent liabilities.
- Under these scenarios public debt trajectory remains negative and increase in level of debt is moderate; worst case: gross debt would reach 35 percent of GDP in 2015.
- Contingent liabilities sources spotlighted: central government, local governments, PPPs, financial system.
- Recommendations for PPPs and contingent liabilities:
  - Integrate PPP projects with government investment strategy and medium-term fiscal framework.
  - Ensure robust legal framework and clear allocation of oversight/responsibility.
  - Empower Ministry of Finance to stop or suspend PPP projects and require final approval before contract signature.
  - Transparently discuss fiscal impact of PPPs and integrate contingent liabilities into budget documents and debt sustainability analysis.

### Institutional and macroprudential recommendations (FSAP and staff)
- FSAP key recommendations:
  - Increase the FSA’s budgetary resources to match the size of the supervised financial sector.
  - Focus the FSA’s mandate more closely on core stability.
  - Enhance coordination mechanisms among Riksbank, FSA, NDO, and MOF—proposed creation of a Systemic Financial Stability Council (SFSC) with specified mandate.
  - Commence routine quarterly meetings among Riksbank, FSA, NDO, and MOF to review macroprudential risks ahead of Committee on Review of Regulatory Framework recommendations due in August 2012.
  - Review stability fund framework (merge stability and deposit insurance funds; introduce risk-based fees).
  - Introduce a special bank resolution framework.
- Staff view: authorities’ intention to go further and faster than Basel III appropriate given unique characteristics and risks; no need for Basel III phase-in if banks maintain current capital levels.

### Monetary policy, inflation, and guidance
- Policy actions and stance:
  - Riksbank stopped offering 3 and 6 month loans, replaced by 28 day loans with a penal rate.
  - Riksbank began a tightening cycle in July 2010.
  - Policy rate raised by 150 basis points to 1¾ percent.
  - By end-2010, Riksbank terminated all crisis-time liquidity measures and its balance sheet contracted markedly.
- Inflation and expectations:
  - Headline inflation returned to 2 percent target.
  - Inflation excluding mortgage interest costs around 1½ percent.
  - Real policy rate currently negative; stance expected to remain accommodative in coming months even as activity closes the output gap.
  - Further interest rate acceleration required if output gap, wage settlements, commodity prices, and house prices signal higher-than-expected inflationary pressures.
  - If krona continues to appreciate strongly and offsets headline effects of rising global commodity prices, a partial retreat from the anticipated path would be appropriate.
- Regime assessment:
  - Free floating exchange rate arrangement and flexible inflation targeting remain appropriate.
  - Monetary policy should remain focused on inflation target; coordination with financial stability agencies needed.

### Labor market issues and reforms
- Medium-term objective: drive unemployment down to 5 percent on a sustained basis.
- Recent/projected outcomes:
  - Total employment back to pre-crisis levels but some lost manufacturing jobs unlikely to be replaced.
  - Authorities project equilibrium unemployment at 5 percent in the medium-term (¶24).
- Policy measures recommended:
  - Continue to reduce unemployment without lowering adult participation rates.
  - Reduce labor market frictions and impediments to matching.
  - Achieving projection requires moderate wage increases in 2011–12 and permanent concessionary wage determination arrangements for new entrants.
- OECD-related measures taken:
  - Reduce marginal taxes on labor income (lower threshold for state income tax raised in 2009; employer social security contributions reduced; in-work tax credit expanded through 2011).
  - Reform sickness and disability benefit schemes (tightening administration, time limits, rehabilitation measures).
  - Reform employment protection legislation: trial periods and duration of temporary contracts extended; no significant action on permanent contracts.

### Selected macro and fiscal time-series (staff tables and aggregates, selected entries)
- Real GDP (2005–12): 3.2, 4.3, 3.3, -0.6, -5.3, 5.5, 4.4, 3.8
- CPI inflation (2005–12): 0.8, 1.5, 1.7, 3.3, 2.0, 1.9, 3.0, 2.5
- Unemployment rate (percent) (2005–12): 7.6, 7.0, 6.1, 6.2, 8.3, 8.4, 7.4, 6.6
- Output Gap (as percent of potential) (2005–12): 4.2, 5.6, 5.4, 1.5, -5.9, -3.1, -1.6, -0.9
- Structural balance (staff estimates, 2005–12): 3.0, 1.9, 1.0, 0.9, 1.3, 1.4, 1.3, 1.2
- General government gross debt (percent of GDP) (2005–12): 50.4, 45.3, 40.2, 38.8, 42.8, 39.8, 36.1, 32.7
- International reserves (in billions of US dollars, selected): 2008 35.4; 2009 44.2; 2010 46.6; 2011 53.9; 2012 55.8.

### Recommendation on surveillance cycle
- Sweden should remain on the standard 12-month consultation cycle.

*Source: IMF staff report content unit _cr11171 (selected excerpts from the provided PDF).*

### 1.     Competitiveness and the Equilibrium Real Exchange Rate ..............................................4

### Competitiveness and the Equilibrium Real Exchange Rate

### A strong recovery: key outcomes and statistics
- Real GDP growth: Sweden grew 5½ percent in 2010.
- Recovery drivers:
  - Exports rose by 20 percent since early-2009.
  - Investment rose by 14 percent since early-2009.
  - Total consumption rose by 5½ percent since early-2009.
- Output gap:
  - Nearly -6 percent in 2009 (staff estimate).
  - Narrowed to -3 percent in 2010 (staff estimate).
- Labor market:
  - Total employment has regained pre-crisis levels.
  - Unemployment rate close to 8 percent in April 2011.
  - Significant increase in long-term unemployed: more than doubled during the crisis and remains one and a half times the pre-crisis level.
- Short-run activity (2011Q1):
  - GDP rose 0.8 percent quarter-on-quarter.
  - Consumption slowed more markedly; inventories continued strong increases.
- Financial system and markets:
  - Stock market indices approaching pre-crisis peaks.
  - Money market spreads remain above pre-crisis levels following withdrawal of emergency liquidity support.
  - Bank capital adequacy ratios strengthened; bank CDS spreads well below average of other European banks.

### Competitiveness and the equilibrium real exchange rate (Box 1)
- Since the March 2009 trough, the krona appreciated by 23 percent in real effective terms.
- Staff assessment: following the 23 percent real effective appreciation from its mid-2009 trough, the krona remains competitive, with qualitative caveats.
- Qualitative caveats noted in the staff assessment:
  - Population ageing calls for a medium-term strengthening of the net external position.
  - MB and ES measures are qualified by risks that staff medium term macro projections may fail to appropriately reflect a possible drop in consumer durables and investment goods demand that might have resulted from the recent crisis.
  - Alongside other indicators, the staff assessment is that the currency is competitive.
- CGER table entries (as presented):
  - 2010 2011
  - Macro Balance-10-4
  - Equilibrium RER-21-5
  - External Stability-24-14
  - Source: CGER 1/ April 2011

### Policy responses and fiscal/monetary stance
- Monetary policy exit and tightening:
  - Riksbank stopped offering 3 and 6 month loans, replaced by 28 day loans with a penal rate.
  - Riksbank began a tightening cycle in July 2010.
  - Policy rate raised by 150 basis points to 1¾ percent.
  - By end-2010, Riksbank terminated all crisis-time liquidity measures and its balance sheet had contracted markedly.
  - Government kept the bank debt guarantee and bank recapitalization programs open but there was no use of these programs at that time.
- Fiscal developments:
  - Fiscal deficit narrowed from 0.9 percent of GDP in 2009 to 0.3 percent of GDP in 2010.
  - Fiscal outcome was broadly neutral and about 1½ a percentage point of GDP smaller-than-projected.
  - For 2009–10, discretionary measures summing to some 4 percentage points of GDP were planned, of which 0.7 percent of GDP are crisis-related spending stimulus measures; execution was incomplete, particularly at the local level.
- Guidance on fiscal policy:
  - Given Sweden’s sovereign credentials, fiscal policy has the latitude to continue to support output in the short term as the output gap closes.
  - External tail risks call for the maintenance of sizeable buffers relative to the fiscal rules.

### Outlook and projections
- Staff central case projections:
  - Growth projected at 4.4 percent in 2011.
  - Growth projected at 3.8 percent in 2012.
  - Output gap projected to close early in 2012; gap around 1–2 percent in 2011 under the central case.
- Riksbank forecast:
  - Riksbank forecasts real GDP growth of 4.6 percent in 2011, with 90 percent confidence intervals ranging from 2.5 percent to 7.6 percent.
- Near-term quarter-by-quarter projections (2011–12, percent change, quarter-over-quarter, seasonally-adjusted) as reported in the text figure and table:
  - Real GDP: Q1 0.8, Q2 0.6, Q3 0.6, Q4 0.6; Annual 4.4 (2011). Q1 1.2, Q2 1.2, Q3 1.2, Q4 1.1; Annual 3.8 (2012).
  - Private Consumption: Q1 0.4, Q2 0.7, Q3 0.7, Q4 0.5; Annual 2.5 (2011). Q1 0.6, Q2 0.6, Q3 0.5, Q4 0.5; Annual 2.4 (2012).
  - Gross Fixed Capital Formation: Q1 1.6, Q2 3.1, Q3 1.8, Q4 1.0; Annual 8.9 (2011). Q1 2.9, Q2 2.9, Q3 2.9, Q4 2.9; Annual 10.0 (2012).
  - Exports: Q1 2.3, Q2 2.2, Q3 1.1, Q4 0.9; Annual 9.4 (2011). Q1 1.7, Q2 1.7, Q3 1.7, Q4 1.7; Annual 6.2 (2012).
  - CPI: Q1 0.8, Q2 0.8, Q3 0.8, Q4 0.8; Annual 3.0 (2011). Q1 0.5, Q2 0.5, Q3 0.5, Q4 0.5; Annual 2.5 (2012).
  - (Other series presented in the table include Public Consumption, Imports, GDP Deflator, Nominal GDP with quarter-by-quarter entries.)
- Medium-term and structural points:
  - Staff estimates point to a decline in the growth rate of potential real GDP of -0.5 percent in 2008–09 compared to 3 percent on average in 1997–2007, reflecting declines in productivity growth, the capital stock and an increase in structural unemployment.
  - Potential GDP is estimated to have risen by 1 percent during the recovery.

### Risks to the outlook
- External risks:
  - Euro area sovereign and banking strains: on WEO estimates, if these strains spill over into the core, euro area growth could be lowered by 3 percentage points and global output by 1 percentage point relative to the baseline WEO forecast.
  - Oil price shock scenario from WEO: a temporary surge in oil prices to $150 per barrel in 2011—40 percent higher than the baseline—lowers global growth in 2012 by two-thirds of a percentage point; permanent shocks imply much larger output losses.
- Domestic risks:
  - Housing market concerns: large house price falls could lower consumption growth markedly.
  - Structural unemployment: estimates suggest the structural unemployment rate has risen somewhat; unemployment peaked close to 10 percent in early-2010 and the persistence of unemployment could lower potential growth.
- Exchange rate pressures:
  - Krona remains under upward pressure, reflecting market stress in Europe, a “search for strong sovereigns”, and monetary tightening by the Riksbank.

### Housing market: features and vulnerabilities (Box 2 summary)
- Comparable features with other boom-bust cases:
  - House prices and private debt have risen substantially.
  - Price-to-income and price-to-rent ratios are above historical norms.
- Important differences from major bust cases:
  - Since the 1980s, house price inflation in Sweden has fallen well short of major European bust cases.
  - No surge in residential investment, partly due to strict rent control in main cities.
  - Pre-crisis lending growth was more tempered and targeted at households rather than property developers.
- Indicators shown:
  - Real house prices series (1980=100) and cross-country comparisons of price-to-income and price-to-rent deviations from historical norms.
  - Household debt as a share of disposable income and private sector credit growth comparisons (2004–06 vs 2010).

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11171.pdf*

### Box 2: Sweden’s Housing Market:  “Doomed” or “Different”? (Continued)

### Box 2: Sweden’s Housing Market: “Doomed” or “Different”? (Continued)

### Housing market assessment and risks
- Mortgages are predominantly financed through covered bonds, and the issuing banks remain permanently liable for the quality of the underlying mortgages.  
- Denmark, with similar arrangements, saw negligible mortgage losses resulting from the recent 20 percent housing market correction.  
- The Swedish National Housing Credit Guarantee Board suggests house prices are overvalued by some 20–25 percent.  
- An extensive recent Riksbank study is skeptical of the risk of house price declines, noting that even recent price movements can be explained by “fundamentals”, such as low nominal interest rates.  
- Micro- and macro-prudential measures already taken:
  - The nominal policy rate of the Riksbank has been raised and further increases are expected.
  - The financial supervisor imposed interest rate penalties on mortgages with loan-to-value ratios exceeding 85 percent from October 2010.
- Riksbank identifies factors that attenuate financial stability risks if prices fall:
  - (i) Borrowers are subject to direct and life-long personal liability even after default and foreclosure procedures, which limits banks’ mortgage losses.
  - (ii) The well developed public insurance system cushions borrowers’ income during downturns.
  - (iii) There is no buy-to-let market.
- Overall risk assessment:
  - There is significant risk of a decline in house prices in coming years, even in a relatively benign global economic scenario.
  - Rising nominal interest rates are likely to be the catalyst, supported by micro-prudential measures.
  - Such a decline is not likely to cause significant macroeconomic disruption—unless the adjustment is disorderly, in which case consumption could be significantly affected.
  - Limited evidence that house price declines—even of significant magnitude—pose significant financial stability risks.
  - Only a “perfect storm” with multiple shocks, including euro area strains transmitting to the core, poses risk of significant difficulties in the Swedish housing market.

### Mortgage credit distribution and data limitations
- Assessment is corroborated by data on the distribution of mortgage credit by risk class, but these data are only partial and a broader perspective on this breakdown is needed.
- Note on SBAB data: Data are only for SBAB, the state owned mortgage finance company, the fifth largest mortgage issuer.

### Fiscal outturns and medium-term outlook
- The 2010 general government overall balance outturn was -0.3 percent of GDP, almost 2 percentage points of GDP stronger than the authorities anticipated in the Spring of 2010.  
- The structural surplus in 2010 was 1.4 percent of GDP.  
- Crisis-related stimulus measures on the spending side amounted to 0.1 percent of GDP.  
- Discretionary deficit-increasing measures totaled 2.3 percentage points of GDP, with roughly two-thirds focused on tax measures—permanent cuts in personal tax and social contributions.  
- The 2011 budget:
  - Focuses on strengthening the supply side spending initiatives by 0.4 percent of GDP in 2011 to further encourage long term employment and labor supply, strengthen welfare and improve the environment.
  - Projects long-term impact of labor market related measures at 250,000 new jobs by 2015 and a reduction of the equilibrium rate of unemployment from 6½ in 2006 to 5 percent by 2015.
- Planned tax reductions in 2012 up to 0.7 percent of GDP, conditional on structural education and welfare reforms being approved.
- Authorities have set appropriated expenditures to 2014 below the expenditure ceiling by 1 percentage point of GDP annually as a “safety margin”.
- Staff view: The underlying fiscal stance should remain unchanged in 2011–12; only in the unlikely event of significant sustained krona overvaluation would a 2012 tightening be needed.

### Fiscal framework and governance
- Key elements of the fiscal framework:
  - (i) an unlegislated surplus target established at 1 percent of GDP over the business cycle;
  - (ii) a rolling central government nominal expenditure ceiling established for three years ahead, with a new “third year ceiling added each year;
  - (iii) a balanced budget requirement for local governments.
- During the crisis, of the five indicators used by the authorities to assess compliance with the framework, only the backward looking 10 year net lending average is marginally below the 1 percent surplus target in 2010 and is projected to remain below in 2011. All other indicators are above the fiscal target.
- The 2011 budget adds three features:
  - Extends the horizon for the expenditure ceiling from three to four years ahead.
  - Appropriated expenditures to 2014 set below the expenditure ceiling by 1 percentage point of GDP annually.
  - Postpones ambitions for tax reductions to 2012.
- The Fiscal Policy Council:
  - Tasks include evaluation of the extent to which medium-term fiscal policy goals are being achieved and the quality of forecasts.
  - Needs adequate resourcing and a narrower mandate focused on assessing the fiscal stance and conformity with medium-term stability and sustainability goals.

### Monetary policy, inflation, and exchange rate considerations
- Inflation:
  - Headline inflation has risen back to the target of 2 percent.
  - Inflation excluding mortgage interest costs has remained somewhat lower at 1½ percent.
- Policy rate and stance:
  - Since July 2010, the near-zero policy interest rate has been raised to 1¾ percent in a series of 25bp steps.
  - The Riksbank has published projections showing further rises of some 25bp at every monetary policy meeting over the next 12 months; markets anticipate a broadly similar path.
  - The real policy rate is currently negative, so the stance is expected to remain accommodative in coming months even as activity closes the output gap.
- Inflation expectations:
  - Measures based on break-even rates for indexed government bonds and surveys have broadly been anchored near the target.
- Policy guidance:
  - Further interest rate acceleration would be required if output gap, wage settlements, commodity prices, and house prices signal higher-than-expected inflationary pressures.
  - If the krona continues to appreciate strongly and offsets the headline effects of rising global commodity prices, a partial retreat from the anticipated path would be appropriate.
- Regime assessment:
  - The free floating exchange rate arrangement and flexible inflation targeting regimes remain appropriate and their credibility was reinforced during the global crisis.
  - Monetary policy should remain focused on the inflation target; asset and house prices and financial stability have not been explicit objectives of monetary policy. Strengthened coordination with other agencies responsible for financial stability is needed.

### Labor market issues and reforms
- Over the medium term, further efforts are needed to drive unemployment down to 5 percent on a sustained basis.
- Recent and projected outcomes:
  - Total employment is back to pre-crisis levels, but some jobs lost—especially in manufacturing—are not likely to be replaced.
  - Authorities project equilibrium unemployment at 5 percent in the medium-term (¶24).
- Policy measures and recommendations:
  - Continue to reduce unemployment without lowering adult participation rates.
  - Reduce labor market frictions and impediments to matching.
  - Achieving the projection will require moderate wage increases in 2011–12 and permanent concessionary wage determination arrangements for new entrants.
- OECD recommendations and actions taken (selected):
  - 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: tightening administration, time limits, and rehabilitation measures have lowered sickness absence rates.
  - Reform employment protection legislation: trial periods and duration of temporary contracts were extended, no significant action on permanent contracts.

### Financial sector stability
- System scale and structure:
  - Financial system assets are equivalent to 5½ times GDP.
  - Four major banking groups dominate the system (65 percent of market share) and have extensive cross-border operations and non-banking activities, with substantial reliance on wholesale funding markets.
- Resilience improvements:
  - Major banks have raised capital to well above minimum regulatory requirements, with the common equity Tier 1 capital ratio ranging from 7½–10 percent (11–15 percent with full Basel II rules).
  - Exposures to peripheral European economies are small, and loan losses in the Baltics have fallen.
  - Authorities indicate each major bank has sufficient resources to meet forthcoming Basel III requirements, including the capital conservation and counter-cyclical capital buffers.
  - The financial strength of the non-bank financial sector, such as insurance and pensions, has also improved.
- Policy implication:
  - Resilience to external tail risks requires decisive further steps to strengthen banking stability, given the system’s size, concentration, and complexity.

*Source: IMF staff analysis, Box 2 (continued) from the provided PDF content.*

### 44.      The authorities have terminated most of their unconventional liquidity support

### _cr11171 - 44.      The authorities have terminated most of their unconventional liquidity support measures

### Termination of unconventional liquidity support and collateral framework
- Most unconventional liquidity support measures have been terminated.
- Remaining measures (government debt guarantee and recapitalization programs) are expected to be terminated by end-June 2011.
- The Riksbank is reviewing the collateral policy framework, which was expanded during the crisis.

### Strengthening regulations and capital requirements
- The authorities intend to go further and faster than the Basel III timeline.
- The FSA and MOF have indicated that common equity Tier 1 capital requirements would be at least 10–12 percentage points in a few years.
- With bank capital already strong relative to final Basel III goals, staff note there is no need for the phase-in period provided banks maintain current capital levels.
- Effective discretionary supervision—including active use of the Pillar II framework and application of capital and liquidity surcharges to systemically important banks—will be an essential complement to Basel III and EU capital directives.

### Liquidity governance, reporting, and transition to binding requirements
- In December 2010, the FSA adopted a new regulation on the governance of banks’ liquidity risk management (FFFS 2010:7).
- A new comprehensive liquidity reporting framework will commence in July 2011, including quantitative liquidity risk measures by currency comparable with a liquidity coverage ratio proposed by Basel III.
- These measures will become subject to disclosure requirements, and thereafter will be upgraded to binding prudential requirements; specific timeline and detailed metrics have yet to be developed.

### FSAP findings: credit, liquidity, and stress scenarios
- The FSAP finds Sweden’s financial system is generally sound.
- Credit assessment is based on an adverse macroeconomic scenario—prolonged low growth and a domestic housing market crash—not predicated on euro area tail risks.
- Under that scenario, all major banks would maintain the 7 percent common equity Tier 1 capital ratios required under Basel III.
- The liquidity assessment finds in stress scenarios banks could face difficulties given reliance on wholesale funding.
- The Riksbank’s structural liquidity measure—an indicator similar to Basel III net stable funding ratio—improved for most major banks, although Swedish banks remain behind other European banks.

### Housing, covered bonds, and household indebtedness
- A sustained drop in house prices of some 40 percent would be required to reduce the value of collateral pools below the face value of the outstanding covered bonds.
- The household debt-to-income ratio has more than doubled since the mid-1990s, with mortgages explaining most of this increase.
- High net worth households account for the bulk of Swedish household debt (data available to 2007).
- Additional data recommended: historical data on mortgage service by vintage of house purchase, and detailed bank lending activities to households—to strengthen stress tests and supervisory assessment of capital risk weights.
- If significant financial stability or consumer risks are identified, possible policy options include:
  - Lower mortgage interest deductions and loan-to-value ratios,
  - Introduction of debt-to-income regulations,
  - Adjustments to risk weight assets.

Box 5 (covered bonds) — key points:
- Outstanding stock of covered bonds stands at over 50 percent of GDP, up from below 20 percent of GDP in the mid-2000s.
- Loans cannot exceed fixed percentages of collateral value—75, 70, and 60 percent for residential, agricultural and commercial mortgages respectively.
- The amount of covered bond issuance as a share of total mortgage lending has doubled to 80 percent since 2006.
- During late 2008–early 2009, covered bond spreads widened and investor demand fell; the Riksbank accepted a wider range of covered bonds as collateral, the NDO purchased covered bonds in exchange for treasury securities, and the government introduced a bank debt guarantee program.
- Covered bonds and their originators would not be immune to shocks; a fall in house prices could reduce investor appetite, leading to higher rates or refinancing risks.

### Financial system size, oversight, and policy recommendations
- Strengthening liquidity regulations is expected to curb banking sector growth by limiting scope to free-ride on public liquidity backstops.
- Sweden’s strong fiscal credentials support its ability to sustain risks associated with an oversized financial sector, but ongoing regulatory and supervisory oversight is essential.
- FSAP key recommendations:
  - Increase the FSA’s budgetary resources to ensure ongoing effectiveness given the size of the financial sector supervised.
  - Focus the FSA’s mandate more closely on core stability rather than broader social concerns.
  - Enhance mechanisms to coordinate authorities with financial stability mandates—proposed creation of a Systemic Financial Stability Council (SFSC) with representation from the Riksbank, FSA, NDO, and MOF to coordinate preemptive and reactive stability policies; its mandate should specify limits on powers, handling of confidential information, and internal decision-making mechanisms.
  - Given external vulnerabilities, commence routine quarterly meetings among Riksbank, FSA, NDO, and MOF to review macroprudential risks without awaiting the Committee on the Review of the Regulatory Framework’s recommendations due in August 2012.
  - Review the stability fund framework, including options to merge the stability and deposit insurance funds and to introduce risk-based fees.
  - Introduce a special bank resolution framework.

### AML/CFT and authorities’ views
- Sweden has made significant progress on AML/CFT deficiencies identified by FATF in 2006; strengthened FSA regulations on customer due diligence and suspicious transaction reporting contributed to FATF removing Sweden from the list of regular follow up members in October 2010.
- Authorities’ overall assessment:
  - Sweden has recovered decisively from the global financial crisis; policy stance—especially monetary—should tighten in measured fashion as expected developments materialize.
  - Buffers should be reinforced on fiscal and financial sector sides to address external risks.
  - Continued moderation of wage growth in the negotiation round commencing in the Fall is essential.
  - Need for special arrangements to address long term unemployment and labor market entrants.
- Differences in nuance:
  - Riksbank estimates output gap narrowed to roughly negative ½ percent in 2011; Ministry of Finance and staff estimate up to negative 2 percent in 2011.
  - Riksbank views potential GDP growth at just above 2 percent; staff long run estimate is 2½ percent.
  - Riksbank and staff project long run equilibrium unemployment on current policies to be around 1 percentage point higher than MOF’s anticipation.
  - Authorities expect further dampening of house prices as policy rates rise but judge this unlikely to be destabilizing; additional prudential measures would be taken in case of a resurgence in house prices.

*Source: _cr11171 - 44.      The authorities have terminated most of their unconventional liquidity support measures.*

### 66.      Third, in the context of agreement with staff that the fiscal position was strong, and

### _cr11171 - 66.      Third, in the context of agreement with staff that the fiscal position was strong, and

### Fiscal assessment and cyclically adjusted balances
- Authorities and staff agree the fiscal position was strong and that buffers should be strengthened further.
- Difference between authorities’ and staff’s estimates of the underlying fiscal position reflects:
  - Estimates of the size of the output gap.
  - Authorities’ more aggregated methodology using the OECD aggregate elasticity of 0.55.
  - Staff’s disaggregated adjustments using both output and employment gaps.
- Authorities’ estimates of the cyclically adjusted balance in 2009–10: 3 and 1.8 percent of GDP.
- Staff’s estimates of the cyclically adjusted balance in 2009–10: 1.3 and 1.4 percent of GDP.

### Fiscal policy stance and recommendations
- Staff agree with authorities on scope for further fiscal initiatives in 2012 and beyond, focusing on improving functioning and flexibility of the labor market.
- Authorities propose as an option a reduction of the rate of VAT on restaurants to boost employment in that sector.
- Recommended underlying fiscal stance:
  - Remain unchanged in 2011–12 given remaining output gap and a structural balance in 2010 considerably stronger than required to meet medium-term targets.
  - Maintain a neutral stance in 2011–12 despite buoyant growth; the 2011 budget is judged to deliver this by increasing “safety margins” and postponing planned tax reductions to 2012.
  - Underlying budget stance should remain for 2012 for the same reasons; shift to tightening only if significant sustained krona overvaluation occurs.
- With the underlying fiscal stance unchanged, a mix of expenditure and tax initiatives will be feasible in 2012; emphasis recommended on steps to strengthen labor market performance—expansion of the earned income tax credit is recommended.
- Fiscal Policy Council:
  - Remains a key element of the fiscal framework.
  - Could be made directly accountable to Parliament, resourcing should be enhanced.
  - Its mandate could be even more narrowly focused on medium-term fiscal sustainability.

### Macroeconomic overview and priorities
- Sweden’s exit from the global crisis described as uniquely successful compared to others in the European Union, reflecting strong global and domestic policies.
- 2010 output rose 5½ percent and momentum maintained into 2011.
- Unemployment is down from its mid-crisis peak; core inflation has remained close to target throughout.
- Financial sector strains contained; bank capital and liquidity strengthened; most emergency stabilization measures withdrawn.
- Government budget is heading decisively back to its customary surplus; public debt remains some 40 percent of GDP and falling.
- A cautious monetary tightening cycle is under way, together with macrofinancial measures to cool housing; the krona remains competitive.
- Laggards in recovery: long-term and youth unemployment, and fixed investment (still below 2006–08 levels relative to output).
- Concerns that although house prices have recently dipped, they may still be overvalued.
- Challenge: sustain success through continued close coordination of policies.

### Monetary policy and exchange rate
- Monetary stance should continue to tighten in 2011 as indicated.
- If assessments of the output gap, wage developments, and commodity and house prices signal stronger inflationary pressures, the policy rate should be raised more rapidly than indicated.
- If the krona continues to appreciate strongly, the path for the policy rate rises may need to be delayed to offset its disinflationary effects.
- Sweden will retain its free floating exchange rate regime.
- Within this framework, judgment of reserve adequacy should remain under active review given euro area strains and the financial sector’s exposures; international reserves considered sufficient to address risks.

### Labor market and wages
- Sustained falls in unemployment remain a priority.
- Moderate settlements in the 2011–12 wage round—in the neighborhood of 3 percent—will be key.
- Significant permanent concessionary arrangements for labor market entrants in the negotiated wage agreements would be highly desirable.

### Financial stability, macroprudential policy, and regulation
- Authorities assessed financial stability as strong; staff support initiatives to sustain or raise buffers in light of external risks.
- Authorities concerned EU-level negotiations might constrain member states’ ability to differentiate regulatory requirements to account for idiosyncratic vulnerabilities (such as the size of the sector) and noted consequent risks.
- Authorities will consider feasibility of collecting data by vintage of house purchase, but do not expect it to change their overall assessment of robustness.
- As part of efforts to strengthen buffers, authorities want ability to impose stronger liquidity requirements than Basel III.
- FSAP assessment provided initial reassurance on credit risks; recommended collecting historical data on mortgage service by vintage of house purchase to:
  - Confirm credit risk assessments.
  - Inform adjustments to capital risk weights and technical parameters used in stress tests.
- If significant financial stability or consumer risks are identified, further macroprudential measures will be needed to prevent deterioration of credit risks.
- Authorities’ intention to go further and faster than Basel III regulations is judged appropriate given unique characteristics and risks of the Swedish financial system.
  - With bank capital already strong relative to ultimate Basel III goals, there is no need for the phase-in period.
  - Early introduction of strong liquidity regulations encouraged, taking particular account of risks in foreign currencies.
  - Systemic capital and liquidity surcharges to internalize risks posed to the system will also be appropriate.
  - Effects on credit growth from these actions should be factored into decisions on the policy rate.
- FSAP institutional reform recommendations include:
  - Reviewing options to merge the stability and deposit insurance funds.
  - Introducing a special bank resolution framework.
  - Establishing all key macroprudential institutions to strengthen coordination.
- Establishment of the Committee on the Review of the Regulatory Framework to consider such institutional arrangements is welcomed.
- FSAP confirmed IMF calls to increase further resources allocated to banking supervision; effective discretionary supervision will be essential to complement new regulatory frameworks, especially if international frameworks constrain country-level discretion above floors.

*Source: IMF staff appraisal text in the provided content unit.*

### 87.      Sweden should remain on the standard 12-month consultation cycle.

### _cr11171 - 87.      Sweden should remain on the standard 12-month consultation cycle.

### Recommendation
- Sweden should remain on the standard 12-month consultation cycle.

### Real economy: historical outcomes and IMF staff projections (selected indicators)
- Real GDP (2005–12): 3.2, 4.3, 3.3, -0.6, -5.3, 5.5, 4.4, 3.8
- Domestic Demand (2005–12): 3.0, 3.9, 4.7, 0.0, -4.9, 6.1, 2.9, 3.3
- CPI inflation (2005–12): 0.8, 1.5, 1.7, 3.3, 2.0, 1.9, 3.0, 2.5
- Unemployment rate (in percent) (2005–12): 7.6, 7.0, 6.1, 6.2, 8.3, 8.4, 7.4, 6.6
- Gross national saving (percent of GDP) (2005–12): 24.5, 27.2, 29.6, 28.9, 23.4, 25.0, 26.0, 27.0
- Gross domestic investment (percent of GDP) (2005–12): 17.7, 18.7, 20.3, 20.2, 16.3, 18.5, 20.0, 21.4
- Output Gap (as a percent of potential) (2005–12): 4.2, 5.6, 5.4, 1.5, -5.9, -3.1, -1.6, -0.9

### Public finance: key aggregates and fiscal stance (selected data)
- Total Revenues (percent of GDP) (2005–12): 53.8, 53.0, 52.5, 51.9, 52.1, 50.7, 49.3, 48.6
- Total Expenditures (percent of GDP) (2005–12): 51.8, 50.8, 46.1, 46.6, 49.7, 47.8, 45.2, 44.2
- Overall balance (percent of GDP) (2005–12): 1.9, 2.2, 3.6, 2.2, -0.9, -0.3, 0.8, 1.3
- Structural balance (as a percent of potential GDP) (staff estimates, 2005–12): 3.0, 1.9, 1.0, 0.9, 1.3, 1.4, 1.3, 1.2
- General government gross debt, official statistics (percent of GDP) (2005–12): 50.4, 45.3, 40.2, 38.8, 42.8, 39.8, 36.1, 32.7
- From Table 5 (nominal SEK and fiscal accounts, selected years):
  - Total Revenue (in billions SEK): 1,643 (2007), 1,662 (2008), 1,610 (2009), 1,605 (2010), 1,675 (2011), 1,731 (2012), 1,751 (2013), 1,836 (2014)
  - Total Expense (in billions SEK): 1,441 (2007), 1,494 (2008), 1,536 (2009), 1,603 (2010), 1,578 (2011), 1,605 (2012), 1,605 (2013), 1,672 (2014)
  - Net lending (in percent of GDP) (2007–14): 3.6, 2.2, -0.9, -3.4, -0.3, 0.3, 0.8, 1.3
  - Structural Balance (staff measure) (2007–14): 1.0, 0.9, 1.3, 0.2, 1.4, 1.4, 1.3, 1.2
  - Gross Public Debt (percent of GDP) (2007–14): 40.2, 38.8, 42.8, 45.5, 39.8, 36.8, 36.1, 32.7
- Fiscal impulse (expansionary +) (2007–14): 0.9, 0.2, -0.4, -1.2, -0.2, 0.4, 0.2, 0.0

### Financial system structure (2002–10; selected aggregates)
- Total financial system assets (2002, 2007, 2009, 2010) (in millions of SEK and percent of GDP):
  - 2002: 9,186,817 (100.0), 375.9 percent of GDP
  - 2007: 14,764,633 (100.0), 472.3 percent of GDP
  - 2009: 17,199,559 (100.0), 536.8 percent of GDP
  - 2010: 17,865,864 (100.0), 557.6 percent of GDP
- Top four banks (consolidated) total assets (millions of SEK; percent of total assets; percent of GDP):
  - 2002: 5,760,842; 62.7; 235.7
  - 2007: 9,491,189; 64.3; 303.6
  - 2009: 11,438,287; 66.5; 357.0
  - 2010: 11,779,660; 65.9; 367.6
- Total banking sector (2002–10) (in millions of SEK; percent of financial system assets; percent of GDP):
  - 2002: 6,838,534; 74.4; 279.9
  - 2007: 10,946,958; 74.1; 350.2
  - 2009: 13,312,469; 77.4; 415.5
  - 2010: 13,725,841; 76.8; 428.4
- Memorandum: Nominal GDP (in millions of SEK) (2002–10): 2,443,630 (2002), 3,126,018 (2007), 3,089,181 (2009), 3,301,072 (2010)

### Financial soundness indicators: banks (selected ratios, 2003–2011 Q1)
- Regulatory capital to risk-weighted assets (2003–2011 Q1): 10.5, 10.6, 10.5, 10.5, 10.2, 10.7, 13.0, 12.6, 12.4
- Regulatory Tier I capital to risk-weighted assets (2003–2011 Q1): 8.0, 8.3, 7.7, 7.8, 7.5, 8.1, 10.9, 11.0, 11.1
- Capital as percent of assets (leverage ratio) (2003–2011 Q1): 5.1, 4.8, 4.8, 4.8, 4.7, 4.6, 5.0, 4.7, 4.6
- Nonperforming loans to total gross loans (2003–2011 Q1): 2.0, 1.2, 0.9, 0.8, 0.6, 1.1, 2.0, 1.9, 1.7
- Loan-loss provisions to nonperforming loans (2003–2011 Q1): 49.4, 66.2, 69.7, 56.1, 58.3, 49.1, 55.4, 44.3, 43.9
- Return on assets (2003–2010): 0.6, 0.7, 0.8, 0.8, 0.8, 0.5, 0.3, 0.4 (four major banks comparable series also reported)
- Liquidity: Liquid assets as percent of total assets (2003–2010): 4.4, 5.2, 5.0, 5.0, 5.0, 4.0, 6.3, 4.8, 5.1
- Customer deposits as a percent of total (non-interbank) loans (2003–2010): 50.6, 52.6, 50.2, 53.8, 51.4, 46.1, 47.1, 47.8, 47.7
- Noninterbank loans to noninterbank deposits (2003–2010): 142.6, 130.8, 137.4, 135.7, 139.8, 139.6, 144.8, 154.9, 155.8

### Non-bank financial sector and household sector (selected indicators)
- Household debt as percent of GDP (2003–10): 57.1, 60.4, 64.3, 66.9, 69.0, 72.8, 81.9, 82.9 (table lists through 2010)
- Household interest expense as percent of disposable income (2003–10): 5.6, 5.2, 4.9, 5.2, 6.2, 7.3, 4.9, 4.7
- Solvency ratio (margin/required margin), life insurance companies (2003–10): 9.0, 8.4, 11.2, 13.8, 14.9, 8.4, 7.8, 11.7
- OM Stockholm Stock Exchange Index (annual percent change) (2003–10): -39.7, 43.2, 10.6, 34.9, 12.9, -24.0, -25.1, 54.4

### Balance of payments and external position (selected figures and projections)
- Current account (in percent of GDP) (2006–15 projections): 8.7, 7.0, 6.3, 6.0, 5.7, 5.5, 5.4, 5.3
- Trade balance (in percent of GDP) (2006–15): 7.2, 7.8, 7.2, 6.6, 6.6, 6.0, 5.8, 5.4
- Exports of goods & services (in SEK billions, 2006–15): 1,471, 1,585, 1,670, 1,473, 1,618, 1,684, 1,725, 1,791, 1,807, 1,840
- Imports of goods & services (in SEK billions, 2006–15): 1,241, 1,360, 1,459, 1,268, 1,421, 1,478, 1,521, 1,584, 1,595, 1,628
- Swedish Assets Abroad and Liabilities Abroad (in billions of krona, 2006–15): Assets Abroad: 6,451; 7,511; 7,917; 8,031; 7,975; 8,969; 9,595; 10,326; 11,117; 11,822. Liabilities Abroad: 6,807; 7,559; 8,324; 8,436; 8,703; 9,522; 10,093; 10,707; 11,317; 11,841
- International Investment Position (in percent of GDP, 2006–15): -12.1, -1.5, -13.9, -13.1, -22.1, -15.6, -13.2, -9.6, -4.8, -0.4

### Medium-term scenario (2008–16 projections, selected)
- Real GDP (2008–16): -0.6, -5.3, 5.5, 4.4, 3.8, 3.5, 3.0, 2.5, 2.5
- Final domestic demand (2008–16): 0.6, -3.3, 3.8, 2.8, 3.6, 2.9, 2.9, 2.8, 2.8
- Exports (2008–16): 1.7, -13.4, 10.7, 9.4, 6.2, 6.2, 3.5, 4.3, 4.3
- Inflation (HICP annual average, percent) (2008–16): 3.3, 2.0, 1.9, 3.0, 2.5, 2.0, 2.0, 2.0, 2.0
- Unemployment rate (HICP annual average, percent) (2008–16): 6.2, 8.3, 8.4, 7.4, 6.6, 5.8, 5.5, 5.5, 5.5
- Potential output (2008–16): 3.2, 2.1, 2.5, 2.8, 3.1, 2.7, 2.8, 2.4, 2.4
- Output gap (percent of potential) (2008–16): 1.5, -5.9, -3.1, -1.6, -0.9, -0.1, 0.1, 0.2, 0.3

### Monetary policy and inflation dynamics (key messages)
- CPI and HICP series show inflation “around the target” with market inflation expectations that “crept up but are returning to the target.”
- Riksbank policy actions: “The Riksbank is expected to further raise the policy interest rate.” Repo rate (year average historical series included in source).
- Wage growth: described as moderate; business surveys point to tighter labor market conditions.

### Banking-system performance and risks (selected messages)
- Recovery in bank performance: banks have boosted liquidity buffers and strengthened capital positions; regulatory Tier 1 capital to RWAs for all banks rose above European peers.
- Nonperforming loan ratios: rose during the crisis but have stopped rising and loan losses have declined.
- Reliance on market funding: continued to be substantial; wholesale funding to total funding indicators for major banks reported.
- Household sector: household indebtedness reached unprecedented levels and household debt as percent of GDP is high relative to non-Scandinavian peers.

### Social and other indicators (selected)
- GDP per capita (current PPP US dollars, 2009): 35,805
- Income distribution (ratio of income received by top and bottom quintiles, 2005): 3.3
- Life expectancy at birth (2009): 79.3 (males) and 83.3 (female)
- Automobile ownership (2004): 456 per thousand
- CO2 Emissions (tonnes per capita, 2007): 5.4
- Population Density (inhabitants per sq. km., 2008): 22
- Poverty Rate (share below established risk-of-poverty line, 2005): 9%

*IMF staff report: Table and figure data as presented in the source document.*

### 1.      The Swedish economy has rebounded strongly; real GDP and manufacturing capacity

### 1.      The Swedish economy has rebounded strongly; real GDP and manufacturing capacity utilization levels were back to pre-crisis levels at end-2010

### Macroeconomic context and policy concern
- The economy rebounded strongly: real GDP and manufacturing capacity utilization levels were back to pre-crisis levels at end-2010.
- Asset prices have remained buoyant, largely reflecting monetary expansion during the crisis. Reflecting these gains, the authorities have begun tightening monetary policy.
- Unemployment remains high, and fixed investment as a share of GDP remains below pre-crisis levels. Assessment of the output gap and the rate at which it is closing is key for the Riksbank’s ability to calibrate the policy rate path; failure to sufficiently adjust in advance could require sharper interest rate increases, potentially undermining the recovery.

### Staff summary estimate of the output gap (overall)
- Staff estimate the output gap at 2½–3½ percent of potential GDP in 2010.
- The recent crisis does not appear to have affected the level of potential output substantially, but:
  - There is some evidence that in the short-term the equilibrium rate of unemployment may have risen somewhat.
  - The pace of capital formation has slowed.
  - As a result the rate of potential growth has likely slowed, although these effects are unlikely to be permanent.
- The output gap is likely to close somewhat gradually.

### Earlier staff 2006–07 estimates (context)
- 2006 estimates anticipated a slowdown in the growth rate of potential output (from 3 percent in 2007 to 1½ percent in 2012) given the economy was reaching full capacity in 2006–07. Extrapolating the 2006 peak growth rate would have implied a negative output gap close to 3 percent in 2010, with the gap closing substantially from 2009–10.

### A. Univariate filter results (HP, CF, Kalman)
- Methods used: Hodrick-Prescott (HP) filter; Christiano-Fitzgerald band-pass filter (CF); Kalman filter.
- Excluding the CF filter, univariate filters estimate:
  - Output gap in the order of negative 5–6 percent in 2009.
  - Output gap of negative 2½–3½ percent in 2010.
- Caveats on univariate filters:
  - During crises and large structural changes they are prone to bias because they rely on historical patterns.
  - Standard smoothing parameters may incorrectly attribute structural decreases in potential output to cyclical movements, overstating the output gap during downturns.
  - The HP and CF suffer from end-point bias and may not be suitable for forward-looking policy decisions without reliable GDP forecasts incorporated.

### B. Growth accounting — Production function approach
- Approach: Cobb-Douglas production function using potential employment, potential capital, and TFP (TFP derived as the residual).
- Key drivers of the crisis output decline:
  - Contraction in hours worked and total factor productivity (TFP). The decline in productivity and hours worked were unprecedented in recent history.
  - Employment and labor force participation played a moderate role due to labor hoarding, labor market reforms, and active labor market policies.
- Debate on TFP trend:
  - The Riksbank argues TFP will not return to its pre-crisis growth trend, viewing the pre-crisis increase as partly cyclical (one-off dot-com related improvements).
- Estimation details:
  - Trend TFP and equilibrium labor-input variables derived via HP and Kalman filters, with corrections for end-point bias by including projections to the series to be filtered.
  - Adjustments made for capacity utilization.
  - Two sets of projections for inputs: (i) extrapolating data series on constant growth rates; (ii) assuming a decline in growth rates. Output projections based on staff’s central case.
- Output gap estimates from production function approach:
  - Trough at negative 5–6 percent in 2009.
  - Recovered to negative 3–3½ percent in 2010.
- Bias considerations:
  - Labor hoarding could cause adjusted TFP to be underestimated, thus underestimating potential output and the size of the negative output gap.
  - If nonmanufacturing capacity utilization is less volatile than manufacturing, adjusted TFP could be overestimated, leading to overestimation of the output gap.

### C. Multivariate (MV) modeling approach
- MV filter incorporates empirical relationships between actual and potential output, unemployment, core inflation, and manufacturing capacity utilization within a small macro model.
- Estimation via regularized maximum likelihood on quarterly data for Sweden from 1996Q2–2010Q4.
- Priors and key parameters:
  - Important priors: speed at which potential growth returns to steady state after shocks; relative variance of demand vs supply shocks.
  - Staff prior: demand shocks are the primary source of real GDP fluctuations in Sweden (consistent with Sweden's export orientation and historically external-demand-driven fluctuations).
  - Parameter governing speed to steady state set at a moderate 0.4 (range considered was 0.1 (fast) to 1 (slow)), reflecting some hysteresis effects from the recession.
  - Labor share of income noted as 67 percent; fixed labor share used in some calculations is 0.63.
- Two main scenarios considered:
  - Authorities’ labor market reforms succeed: equilibrium unemployment lowers to 5 percent.
  - “No policy” scenario: equilibrium unemployment remains at 6 percent.
- MV filter central results and dynamics:
  - Output gap and inflation:
    - Estimated output gap dropped sharply during the 2008–09 recession to a trough of about minus 7 percent in 2009Q3.
    - By 2010Q4, the MV central estimate of the output gap had swung back to minus 2 percent.
    - Core inflation declined during 2003Q1–2004Q3 and 2008Q4–2010Q4, dipping below the 2 percent target.
  - Potential output:
    - Potential growth declined from 2 percent in 2008 to 1.3 percent, from a historical average of 3 percent (1997–2007).
    - Potential growth rose by 1½ percent in 2010.
    - Estimated potential is relatively smooth and lags actual GDP peaks and troughs; the gap accounts for most short-term GDP fluctuations.
  - Unemployment and NAIRU:
    - MV estimates show a slight increase in the NAIRU from 2002–06, followed by a slight decline before the crisis.
    - The model indicates a small rise in the NAIRU in 2008–10 (of some ½ of a percentage point) in the main scenario—perhaps reflecting lagged labor-market effects of the steep increase in actual unemployment in 2008–09.
    - In the alternative (no policy) scenario with steady-state unemployment at 6 percent, the equilibrium unemployment rate rises by about 1 percentage point.
  - Illustrative quarterly point estimates (selected):
    - 1997–2004: 3.2, 3.0, -0.3 (table-like figures in source)
    - 2004–07: 3.7, 2.8, 1.2
    - 2008: 0.5, 2.0, -0.1
    - 2009: -5.3, 1.3, -6.8
    - 2010: 5.4, 1.5, -3.0
    (These reflect sequences of Actual GDP, Potential Output, Output gap as presented in the source.)

### D. Corroborative evidence on equilibrium unemployment — Beveridge Curve
- The Beveridge Curve (vacancies vs unemployment) is used to assess labor market matching efficiency; an outward shift signals deterioration in matching efficiency and possible rise in equilibrium unemployment.
- Historical puzzle: Beveridge curve shifted outward from 2001–07 despite labor market reforms that would intuitively lower equilibrium unemployment. Possible explanations:
  - Reforms temporarily increased matching problems by introducing lower-skilled workers (from sickness benefits) who lack requisite skills.
  - A cyclical effect whereby the curve shifts out during upswing periods (as after the dot-com crash).
- During the crisis:
  - Movements along the Beveridge Curve occurred as unemployment rose and vacancy rates fell (January 2007 to January 2009).
  - The curve appears to have shifted outwards during the crisis, consistent with MV filter evidence of a slight increase in NAIRU in 2008–10—suggesting the labor market could have temporarily moved to a new equilibrium.

### Key quantitative points (preserved exactly)
- Staff estimate the output gap at 2½–3½ percent of potential GDP in 2010.
- Univariate filters (excluding CF) estimate negative 5–6 percent in 2009 and negative 2½–3½ percent in 2010.
- Production-function adjusted estimates: trough negative 5–6 percent in 2009; recovered to negative 3–3½ percent in 2010.
- MV filter: output gap trough about minus 7 percent in 2009Q3; central estimate minus 2 percent in 2010Q4.
- Potential growth: declined from 2 percent in 2008 to 1.3 percent; historical average 3 percent (1997–2007); rose by 1½ percent in 2010.
- Parameter governing speed to steady state set at 0.4 (range 0.1 to 1).
- Two NAIRU scenarios: equilibrium unemployment lowered to 5 percent (policy success) vs steady state at 6 percent (no policy).
- Labor share of income: 67 percent; fixed labor share used in calculations: 0.63.

### Policy-relevant implications and recommendations (implicit in analysis)
- Riksbank needs accurate, model-informed assessment of the output gap to calibrate the policy rate path and avoid having to raise interest rates more sharply later, which could undermine the recovery.
- Multivariate, model-based approaches that incorporate unemployment, inflation, and capacity utilization provide more policy-relevant and robust output gap measures than univariate filters alone, especially during and after large shocks.
- Monitor labor market developments closely (vacancies, unemployment, long-term unemployment, matching efficiency) to assess whether increases in unemployment reflect cyclical factors or a shift in equilibrium unemployment (NAIRU).
- Consider uncertainty around potential growth and possible hysteresis (captured by moderate speed-to-steady-state parameter 0.4); policy should account for potential gradual closure of the output gap rather than an abrupt return to pre-crisis potential.

*Prepared by Rita Babihuga (EUR) — source content from IMF staff analysis as presented in the supplied chapter.*

### 27.      The empirical approaches considered in this attachment consistently point to a

### _cr11171 - 27.      The empirical approaches considered in this attachment consistently point to a

### Output gap and cyclical slack (2010–11)
- Empirical approaches consistently point to a negative output gap in 2010–11, but differ on the extent of slack.
- The three standard methodologies suggest significant spare capacity at end-2010:
  - The output gap in 2010 is estimated to have been within the range of negative 2½ –3½ percent.
  - Methodologies differ on speed of adjustment since end-2010; the output gap is within the range of negative ½–2 percent in 2011.
- The model-based multivariate filter suggests an increase in the equilibrium rate of unemployment, with cyclical unemployment spilling over into the underlying rate of unemployment:
  - This increase is in the range of ½ to 1 percent depending on the effectiveness of ongoing labor market reforms.

### Univariate and multivariate filter findings
- Univariate filters discussed:
  - HP filter: explanation of lambda; standard values for an advanced economy like Sweden’s are 1600 (quarterly) and 100 (annual).
  - Christiano-Fitzgerald (CF) band pass filter: non-stationary, asymmetric; applied to stationary (I(1) differenced) Swedish GDP.
  - Kalman filter: unobserved components model; output as AR1/ARMA, potential output as random walk with drift; tends to suggest a larger output gap than the HP filter because it treats potential output growth as time-varying.
- Multivariate filter (Benes et. al., 2010) built around three gaps: output gap, unemployment gap, capacity utilization gap, with three identifying equations linking inflation, unemployment (Okun’s law), and capacity utilization to the output gap.
- Role of capacity utilization: model assumes capacity utilization contains important information to improve estimates of potential output and the output gap.

### Production function approach and adjusted TFP
- Main empirical problem: capital and labor utilization are unobserved; TFP residual may be polluted by utilization changes.
- Solution: adjust capital stock using capacity utilization to proxy flow of capital services; labor utilization assumed constant.
- Adjusted production function specification (as in text, equation (2)) uses capacity utilization (cu) to derive adjusted TFP (ε is adjusted TFP).
- Empirical patterns:
  - Adjusted TFP falls less than unadjusted TFP during 2008–09.
  - Decline in adjusted TFP likely reflects lasting factors even when adjusted TFP resumes trend growth (e.g., higher cost of capital during the global financial crisis, permanent shift of demand away from high-productivity growth sectors such as manufacturing).
  - Evidence of resource shift away from tradable to non-tradable sector; manufacturing suffered the bulk of job losses during the crisis and has lagged in the recovery.
- Components indicate:
  - A decline in potential output growth during 2008–09 and a slight increase in 2010.
  - After rising by 0.9 percent per year on average during 2000–08, the equilibrium labor participation rate declined during the recession (though not as severely as in the 1990s).
  - Equilibrium hours worked per employee fell during the recession; the Kalman filter shows a larger decline in equilibrium hours due to time-varying trend treatment.
- By construction, adjusted TFP should not be affected by cyclical factors; a smoothed adjusted TFP series is a representation of trend TFP for potential output.

### Multivariate model structure and estimation
- Core identifying equations (as presented):
  - Inflation equation relating core inflation with level and change in the output gap (equation (1) in text).
  - Dynamic unemployment equation linking unemployment gap to the output gap with lagged effects (Okun’s law) (equation (2)).
  - Capacity utilization equation specified similarly to Okun’s law (equation (3)).
- NAIRU (equilibrium unemployment) evolves with transitory, level shocks and persistent shocks; NAIRU dynamics specified (equation (4)) with persistent shocks following an autoregressive process.
- Potential output modeled as a function of trend growth and changes in the NAIRU (equation (5)). Trend growth of potential output is time-varying (not constant).
- Trend capacity utilization modeled with autoregressive growth processes (equation (6)).
- Estimation approach:
  - Maximum likelihood estimation infeasible due to many unidentified parameters; model estimated using regularized maximum likelihood (interpreted as a simple Bayesian technique requiring prior distributions).
  - Choice of priors can have non-negligible impact because data are uninformative about some parameters.

### Key parameter choices and steady-state values used in the multivariate model
- Values provided for key steady-state parameters:
  - Labor share θ = 0.63
  - Steady state unemployment: 5.1 and 6 percent (policy and alternative scenario)
  - Potential GDP steady-state growth = 2½ percent
- Note: While steady-state values matter conceptually (endogenous estimates converge to these exogenously given values long-term), dynamics over the time horizon of interest are relatively little affected by the choice of steady-state values.

### Sweden fiscal and labor-market context relevant to potential/output-gap analysis
- During the early 1990s Nordic crisis fiscal position deteriorated sharply (overall fiscal balance deteriorated by 16 percentage points of GDP over 1990–93), with only half attributed to cyclical factors.
- In the 2008–09 global crisis Sweden’s experience differed from other advanced countries:
  - The cyclically adjusted primary balance did not deteriorate.
  - Financing needs remained low.
  - Public debt increased marginally in 2009 and returned to a negative trend in 2010.
  - Welfare and pension reforms have helped address some long-term fiscal pressures.
- Long-term indicators: Sweden performs better than group averages and the median in health spending and fertility rate metrics.
- Output and employment gaps (memorandum items in text table):
  - Output gap (in percent): 5.4, 1.5, -5.9, -3.1 (for years shown in the table)
  - Employment gap (in percent): 3.6, 3.0, -3.4, -2.0 (for years shown in the table)

### Structural fiscal balance and cyclical adjustment
- Structural fiscal balance estimates sensitive to methodology for estimating cyclical components (output gap vs employment gap) and treatment of stimulus measures.
- During the recent crisis, labor market performance was stronger than anticipated: employment gap smaller and less volatile than output gap.
- Using only the output gap for cyclical adjustment overestimates the underlying structural fiscal position; failure to account for temporary stimulus measures underestimates it if treated as permanent.
- Staff preferred measure:
  - Uses the employment gap to account for cyclical impact on personal income tax, social security contributions, consumption-related taxes and transfers.
  - All other fiscal variables adjusted using the output gap.
  - Cyclical adjustments made on a disaggregated basis using OECD elasticities.
- Range of underlying fiscal position estimates widened in 2009 (range from 1.8 to 3.1 percent of GDP) due to divergence between employment and output gaps and treatment of stimulus measures.
- Structural balance record:
  - Structural balance has been at or exceeded the target of 1 percent of GDP over the cycle, even during the crisis.
  - Despite crisis-related deterioration of the overall fiscal position by over 3 percentage points of GDP in 2009 (mostly automatic stabilizers), the underlying structural fiscal position remained strong.
- Selected figures from Text Table 1 (Sweden: Estimates of the Underlying Structural Fiscal Position 2004－2010, in percent of GDP):
  - CAB - output gap: 1.1, 1.7, 2.3, 1.3 (for 2007, 2008, 2009, 2010)
  - CAB - output gap + employment gap: 1.8, 1.1, 1.1, 0.8
  - SB - output gap (ignoring stimulus measures): 0.4, 1.5, 2.3, 1.4
  - SB - output gap + employment gap (ignoring stimulus measures): 1.0, 0.9, 1.1, 0.9
  - SB - output gap (subtracting stimulus measures): 0.4, 1.5, 2.4, 1.9
  - SB - output gap + employment gap (subtracting stimulus measures): 1.0, 0.9, 1.3, 1.4

*Source: Staff Estimates*

### 15.      Three kinds of shocks are considered: macroeconomic assumptions, contingent

### _cr11171 - 15.      Three kinds of shocks are considered: macroeconomic assumptions, contingent

### Macroeconomic assumptions and shock scenarios
- Three kinds of shocks considered: macroeconomic assumptions, contingent liabilities of the government, and the possibility that policies deviate from those underlying the baseline.
- External dependence and risks:
  - Sweden’s exports depend critically on global demand for consumer durables, capital goods and inventories.
  - Continued strains in euro area periphery’s sovereigns and banking systems, including potential spillovers to the core, could translate into significantly lower growth in Europe and the rest of the world.
  - Higher oil prices could result in lower global growth.
- World growth projections and uncertainty:
  - The central projection for world growth in 2011–12 is roughly unchanged since fall 2010 WEO; the 90 percent confidence interval around these global projections has narrowed (see table 3).
  - Lower growth would result in a deterioration of the overall fiscal position.
- Nature of growth shocks:
  - Transitory shock: automatic stabilizers activate, fiscal position deteriorates transitorily, public debt increases somewhat but underlying structural fiscal position would not deteriorate.
  - Permanent component shock (likely if euro area periphery strains are fully realized): underlying fiscal position will deteriorate; structural fiscal reform (particularly on the revenue side) should be postponed until the new structural fiscal position is determined with reasonable certainty.
- Alternative shock scenarios summarized:
  - Permanent ½ standard-deviation shock to growth, interest rate and primary balance independently.
  - ¼ standard deviation shock to the three combined.
  - One-time 30 percent depreciation of the REER.
  - One-time 10 percent of GDP shock to contingent liabilities.
  - Under these scenarios public debt trajectory remains negative and the increase in the level of debt is moderate in all cases; under the worst case scenario, gross debt would reach 35 percent of GDP in 2015.

### Contingent liabilities (central government, local governments, PPPs, financial system)
- National Debt Office responsibilities:
  - Produce an annual report analyzing the risk for the State from its portfolio of formal and explicit loans and guarantees.
  - Analysis covers medium- and long-term potential losses and short-term liquidity risks (size of payments necessary in very negative scenarios).
- Broader fiscal-risk sources to include for comprehensive analysis:
  - Financial system, public-private partnerships (PPPs), and local governments.
- Local governments:
  - As of 2006, total borrowing by local governments amounted to SEK 350 billion or 10 percent of GDP with almost two thirds corresponding to companies owned by local governments.
  - Kommuninvest i Sverige AB comprising 83 percent of municipalities and with SEK 123.6 billion of outstanding credit in 2009 has top credit ratings.
  - Local governments must, at least, run balanced budgets; debt servicing costs are included in the balanced budget requirement.
- Public-private partnerships (PPPs):
  - Historically limited contingent liabilities; examples:
    - Arlandabanan railway (late 1990s) cost around SEK 4.5 billion; private partner reimbursed through ticket proceeds.
    - Karolinska Teaching hospital project approved end-2010: more than SEK 13 billion (largest hospital project built with PPP funding).
  - Government commission (2007 Budget Bill) recommended a Swedish-specific PPP model, legal framework, and list of suitable projects.
  - Recommended safeguards to manage PPP risks:
    - Integrate PPP projects with government investment strategy and medium-term fiscal framework.
    - Ensure a robust legal framework.
    - Establish clear allocation of responsibilities within government for oversight and risk assessment.
    - Empower Ministry of Finance to stop or suspend PPP projects and have final approval before contract signature.
    - Transparently discuss fiscal impact of PPP projects, including contingent liabilities, in budget documents and integrate in debt sustainability analysis.
- Financial system contingent liabilities:
  - Private debt level: 280 percent of GDP (one of the highest in the world).
  - Financial system size: above 500 percent of GDP.
  - Market concentration: four major banks hold 65 percent of the market share.
  - System features: extensive cross-border operations and non-banking activities with substantial reliance on wholesale funding markets.
  - Post-crisis resilience improvements: major banks raised capital to well above regulatory requirements; small exposure to peripheral European economies; loan losses in the Baltics have fallen.
  - Remaining risks: Euro area tail risks, housing market, and the size of the financial system.
  - Assessment: FSAP finds financial system generally sound based on adverse macroeconomic scenario (prolonged low growth and a domestic housing market crash); this assessment is not predicated on Euro area tail risks.

### Fiscal framework, current stance, and public sector balance sheet
- Key elements of Sweden’s fiscal framework:
  - Unlegislated surplus target: 1 percent of GDP over the business cycle.
  - Rolling central government expenditure ceiling: established for three years ahead (2011 budget extended from three to four years ahead).
  - Balanced budget requirement for local governments.
  - Riksdag sets total expenditure allocations first; appropriations within that ceiling determined separately and later.
  - Fiscal Policy Council (FPC) acts as a watchdog; recommendation: a narrower mandate focusing on short-term fiscal stance and long-term sustainability would enhance effectiveness.
- Current fiscal stance (consistent with 2011 Spring Bill):
  - Significantly over-performs relative to fiscal framework requirements, particularly regarding the 1 percent of GDP surplus target.
  - Reflects cyclical improvements from strong recovery and impact of reforms to reduce welfare expenditures combined with moderate long-term age related spending.
  - Public debt to GDP ratio increased in 2009 by 4 percentage points of GDP to 43 percent of GDP and will gradually fall to around 20 percent of GDP in 2015.
- Public sector balance sheet highlights (Text Table 4 excerpts; all figures in percent of GDP):
  - Assets: 104 106 105 104 104 106 105 104 (columns correspond to Baseline/Alternative and years 2008–2011 as in table).
  - Financial assets: 63 65 64 62 63 65 64 62
    - Cash & ST securities: 55 54 55 54
    - Equity and mutual funds: 28 28 28 28
    - Other: 31 32 31 30
  - Capital stock net of depreciation: 41 41 41 41 41 41 41 41
  - Liabilities: 50 54 51 48 50 54 51 48
    - Financial liabilities: 50 54 51 48 50 54 51 48
    - Gross debt: 39 43 40 37 39 43 40 37
    - Other: 11 11 11 11
  - Current net worth: 55 53 54 55 55 53 54 55
  - NPV of future fiscal policies (50 years) 3/: 193 214 208 202 101 61 28
  - Intertemporal net worth: 247 266 262 258 65 68 66 64
  - Intertemporal financial net worth 4/: 206 225 221 217 24 27 25 23
  - Notes from table:
    - 1/ Refers to the baseline medium-term fiscal in the 2011 Spring Bill (without tax reductions) with a fiscal position stronger than that required under the fiscal rule.
    - 2/ Alternative scenario assumes fiscal balances over the medium- and long-term consistent with the 1 percent of GDP surplus rule.
    - 3/ Stream of discounted projected future primary fiscal balances under current policies and with the indicated aging costs. Discount rate is the average cost of government funding.
    - 4/ Considers only financial assets and liabilities (i.e. excludes capital stock). This measure is a liquidity indicator whereas the comprehensive net worth is a solvency indicator.

### Fiscal shock simulations and debt dynamics
- Under alternative scenarios (permanent ½ standard-deviation shocks, combined ¼ shocks, one-time REER depreciation, one-time contingent liability shock of 10 percent of GDP), public debt trajectories:
  - Debt increase is moderate in all cases.
  - Worst case: gross debt would reach 35 percent of GDP in 2015.
- Twin deficits and crisis likelihood:
  - Evidence suggests countries with ‘twin’ deficits more likely to suffer speculative attacks leading to government liquidity crises.
  - Sweden: except for small fiscal deficits in 2009 and 2010, current account and fiscal positions projected to be in surplus over the medium-term.

### Capacity to react to realized fiscal risks (fiscal space)
- Fiscal space assessment (based on Ostry et. al., 2010 methodology):
  - Estimated fiscal space abstracting from short-term liquidity risks: large on average globally, 60 percent of GDP (80 percent for European countries).
  - Sweden: fiscal space almost three times as large as the average (170 percent of GDP); more than twice relative to European countries.
  - Drivers: low initial public debt projected by end-2015 to be 38 percent of GDP. Only Australia, Korea and New Zealand projected to have lower debt levels in sample.
  - Caveat: feasibility to use entire buffer depends critically on short-term liquidity considerations not triggering a rollover crisis.
  - 2008–10 financial crisis underscores the need for large fiscal space for advanced economies to absorb extraordinary shocks.

### Policy recommendations and risk mitigation priorities
- For contingent liabilities and PPPs:
  - Integrate PPP projects with government investment strategy and medium-term fiscal framework.
  - Ensure robust legal framework and clear government responsibility allocation for oversight and risk assessment.
  - Empower Ministry of Finance to stop or suspend PPP projects under certain conditions and require final approval before contract signature.
  - Transparently discuss fiscal impact of PPPs and integrate contingent liabilities into budget documents and debt sustainability analysis.
- For financial sector-related fiscal risks:
  - Reduce fiscal risks by front-running Basel III’s capital and liquidity requirements (making them even stronger).
  - Further develop the macro-prudential framework.
  - Adequately fund prudential supervision.
  - Aggressively implement steps to strengthen macro prudential and regulatory institutions and policies.
- For fiscal policy and framework:
  - Preserve and enhance credibility of the fiscal framework (1 percent of GDP surplus target, rolling expenditure ceiling, balanced budget requirement for local governments).
  - Consider narrowing the FPC mandate to focus on short-term fiscal stance and long-term sustainability to enhance effectiveness.
  - Postpone structural fiscal reforms (particularly on the revenue side) when a permanent negative growth shock is realized until the new structural fiscal position is determined with reasonable certainty.

### Conclusions and overall assessment
- Sweden fiscal risks appear moderate and fiscal buffers to deal with these risks are adequate.
- Basic fiscal variables, long-term fiscal indicators, sovereign asset and liability composition and financing requirements indicate the probability of fiscal distress is small.
- Key task: ensure potential risks from the financial sector are contained.
- Financial sector risks could be aggravated by euro area tail risks and high domestic private debt; if peripheral European economies’ risks materialize, impacts on Sweden could be significant and more persistent.
- Associated fiscal risks and contingent liabilities should be reduced by:
  - Continued progress to build fiscal buffers.
  - Aggressive implementation of steps to strengthen macro prudential and regulatory institutions and policies.

*Source: IMF staff analysis in _cr11171 (selected excerpts).*

### References

### References

### Major cited works
- Baldacci, Emanuele, James McHugh and Iva Petrova, 2011, “Measuring Fiscal Vulnerabilityand Fiscal Stress: A Proposed Set of Indicators,” IMF Working Paper 11/94 (Washington: International Monetary Fund).
- Baldacci, Emanuele, Iva Petrova, Nazim Belhocine, Gabriela Dobrescu, and Samah Mazraani, 2011, “Assessing Fiscal Stress,” IMF Working Paper 11/100 (Washington: International Monetary Fund).
- Cottarelli, Carlo, 2011, “The Risk Octagon: A Comprehensive Framework for Assessing Sovereign Risks” presented in University of Rome “La Sapienza,” January.
- Girouard, Nathalie and Christophe André, 2005, “Measuring Cyclically-adjusted Budget Balances for OECD Countries,” OECD Economic Department Working Paper No. 434 (Paris: Organization for Economic Co-operation and Development).
- IMF, 2010, Fiscal Monitor, November (Washington: International Monetary Fund).
- IMF, 2011, Fiscal Monitor, April (Washington: International Monetary Fund).
- Ostry, Jonathan D., Atish R. Ghosh, Jun I. Kim, and Mahvash S. Qureshi, “Fiscal Space,” IMF Staff Position Note 10/11 (Washington: International Monetary Fund).
- Swedish Fiscal Policy Council, 2011, Swedish Fiscal Policy 2011, May.

### Indicators of fiscal vulnerability and fiscal stress — framework and interpretation
- Framework groups indicators into three categories:
  - Basic fiscal variables
  - Long-term fiscal indicators
  - Asset and liability management indicators
- Purpose: measure fiscal sustainability risks under the medium-term scenario of the World Economic Outlook baseline projections, including solvency risks based on current deficit and debt levels, projected growth-adjusted interest rate on public debt, long-term budget pressures from demographic aging (projected change in health care and pension expenditures), and sovereign asset/liability composition and financing requirements.
- Rationale for excluding financial market indicators:
  - Financial market indicators already incorporate an assessment of risk to the baseline (including rollover risks and shocks to the baseline).
  - They incorporate perceived probability of government access to non-market financing to avoid insolvency.
  - They tend to lag rather than lead deterioration in fiscal fundamentals.
- Risk threshold definition:
  - Threshold indicates higher risk of fiscal stress, defined as a crisis episode that encompasses public debt default as well as near-default events and severe deterioration in solvency risk outlook.
  - Thresholds estimated in Baldacci et. al., (2011b) using a univariate procedure that maximizes the likelihood of predicting a fiscal crisis.
  - Each of the nine variables has predicted power defined as one minus the total error and is expressed as signaling power in index form so that the total sum is 100.

### Thresholds and signaling weights (Advanced Economies)
- Indicator — Threshold — Signaling weight
  - r - g (5-year average) — 3.6 — 14.9
  - Cyclically adjusted primary balance — 72.2 — 7.3
  - General government gross/net debt — -4.2 — 9.4
  - Total fertility rate — 0.6 — 42.4
  - Old age dependency ratio — 36.0 — 4.5
  - Long-term projections of the change in public pension expenditure — 6.2 — 9.6
  - Long-term projections of the change in public health expenditure — 4.5 — 9.4
  - Current gross financing need — 17.2 — 24.6
  - Share of short-term debt as a ratio of total debt — 9.1 — 2.8
  - Debt held by non-residents as a proportion of total debt — 83.6 — 10.1
  - Weighted average maturity of general government debt — 3.9 — 5.0

### Data sources and variable definitions (as used in the indicator framework)
- r - g (5-year average): Imputed interest rate on general government debt, deflated by the GDP deflator, minus real GDP growth rate; five year forward moving average — Source: WEO.
- Cyclically adjusted primary balance: Expressed as a percent of potential GDP — Source: WEO.
- General government gross/net debt: Expressed in percent of GDP. Net debt used for Japan and Canada, gross debt for all other countries — Source: WEO.
- Total fertility rate: The average number of children per woman — Source: UN.
- Old age dependency ratio: 30 years ahead projections of the ratio of the population over 65, divided by the number of adults — Source: UN.
- Long-term projections of the change in public pension expenditure: Expressed in percent of GDP; change in projected expenditures 40 years ahead relative to the base year — Source: Staff estimates.
- Long-term projections of the change in public health expenditure: Expressed in percent of GDP; change in projected expenditures 40 years ahead relative to the base year — Source: staff estimates.
- Current gross financing need: Projected general government overall balance plus general government debt with a maturity of one year or less; expressed in percent of GDP — Sources: WEO, Bloomberg.
- Share of short-term debt as a ratio of total debt: Short-term debt defined as general government debt with a maturity of one year or less; total debt is general government gross debt — Sources: WEO, Bloomberg.
- Debt held by non-residents as a proportion of total debt: Includes both domestic and foreign currency issued debt; expressed as a proportion of total debt — Source: BIS.
- Weighted average maturity of general government debt: Historical data calculated by staff; current data available from Bloomberg — Sources: Bloomberg, Dealogic.

### Sweden: Public debt sustainability insights and reserve adequacy lessons (Attachment III)
- Lessons from the global crisis (summary of key points):
  - Pre-crisis assumption: Swedish authorities, like others in advanced countries, assumed little rationale for holding precautionary foreign exchange reserves because they expected market access under adverse conditions.
  - Crisis revelation: The global financial crisis showed the need to rethink foreign exchange reserve adequacy.
- Crisis effects on Swedish banks:
  - Swedish banks relied substantially on wholesale dollar and euro funding via commercial paper, covered bonds, other debt instruments, and extensive use of the foreign exchange swap market.
  - After the collapse of Lehman Brothers in September 2008, counterparty risk increased; funding and currency swap markets were impaired; Swedish banks faced constraints in funding and hedging.
- Policy response and reserve operations:
  - The Riksbank introduced a US dollar lending facility to ease liquidity strains.
  - To finance this, authorities boosted foreign exchange reserves mid-crisis.
  - The Riksbank arranged reciprocal swap facilities with the Federal Reserve.
  - The National Debt Office (NDO) borrowed externally SEK 100 billion (US$ 15 billion) to finance reserve operations.
  - At its peak (April 2009), the Riksbank’s US dollar lending amounted to $30 billion, most financed by the swap.
  - If the swap had not been in place, total US dollar lending would have exceeded the stock of foreign exchange reserves at that time ($28 billion).
- Outcome:
  - By summer 2009, funding market strains started easing and demand for the Riksbank’s dollar lending facility declined.
  - The Riksbank terminated the US dollar lending facility at end-2009.
  - The Riksbank maintains a high level of foreign exchange reserves following these events.

*Source: _cr11171 - References (selected content provided)*

### 5.      This crisis experience has reopened the issue of foreign exchange reserve adequacy,

### 5.      This crisis experience has reopened the issue of foreign exchange reserve adequacy,

### B. Traditional Metrics of Reserve Adequacy
- No consensus on defining foreign exchange reserve adequacy; common rules of thumb: GDP; import cover; broad money; and short-term external debt.
- Sweden’s metrics at end-2010:
  - foreign exchange reserves amounted to 10 percent of GDP
  - 18 percent of broad money
  - 2 percent of imports of goods and services
  - 18 percent of bank short-term debts
- These all exceeded the median of advanced economies.
- Limitations of traditional metrics in advanced countries:
  - GDP metric has little theoretical or empirical grounding.
  - Import cover metric less relevant for a large capital account surplus country like Sweden.
  - Broad money metric has limited traction with strong institutions and sound macroeconomic policy framework.
- Debt metric (short-term external debt) is most useful among traditional metrics for advanced countries but qualified:
  - Greenspan-Guidotti 100 percent rule applied to bank short-term debts would imply required reserves of $266 billion (58 percent of GDP), compared to $ 47billion at end-2010 — i.e., 5.6 times Sweden’s current holding.
  - If all advanced economies pursued such a strategy, it would cause considerable global over-insurance.

### C. A Liquidity Gap Approach
- Riksbank motives for holding foreign exchange reserves:
  - providing emergency liquidity assistance to banks
  - covering Sweden’s share of international lending by the IMF
  - intervening in foreign exchange markets
- Mid-crisis Riksbank ability to serve as lender of last resort in foreign currencies was constrained by foreign exchange reserves and government’s external borrowing ability.
- Proposed intuition for assessing adequate reserves:
  - determine maximum banks’ foreign exchange reserve needs under stress;
  - estimate probability of stress events on these banks;
  - extend probability estimates to joint probability of bank liquidity needs and inability of the sovereign to borrow mid-crisis.
- Basel III liquidity standards relevant:
  - Liquidity Coverage Ratio (LCR): ensure banks have sufficient high quality liquid assets to survive 30 days of stress, to be met in a single currency and by each currency.
  - Net Stable Funding Ratio (NSFR): ensure long-term assets funded with stable liabilities and banks can survive one year under market stress circumstances.
- Applying LCR and NSFR by currency gives a benchmark for maximum foreign exchange reserve needs; difference between actual and required liquidity gaps by currency estimates maximum reserve needs.
- Illustration using NSFR estimates for four major Swedish banks (US dollar and euro balance sheets):
  - US dollar balance sheets: substantial reliance on debt securities for funding and large amount of non-US dollar assets converted through foreign exchange swaps; anecdotal evidence suggests a large portion of debt securities are short-term and non-US dollar assets longer-term — implying maturity mismatch.
  - Euro balance sheets: rely less on debt securities, more on deposits and equity; hold more securities in assets; degree of maturity mismatch could be considered moderate.
  - NSFR definition used:
    - NSFR = Available amount of stable funding / Required amount of stable funding
    - = ∑ Funding ஐ factor / ∑ Assets ஐ factor
  - Assumption: in stress, banks will not be able to raise funding in foreign currencies (extreme stress scenario).
  - Results:
    - Substantial funding gaps in US dollar balance sheets, not significant gaps in euro balance sheets.
    - US dollar funding gap narrowed over last three years but remains substantial, ranging from $30 billion to $70 billion for the total of four major banks, depending on assumptions on the stability of funds and the liquidness of assets.
    - Upper estimates significantly exceed the current level of foreign exchange reserves ($50 billon).
    - By bank, Nordea estimated to have large NSFR gaps due to extensive Nordic operations.
    - Euro funding gap estimated small or zero under Table 1 discount factors, partly because more than a half of euro-denominated debt securities have maturity of over one year.
- Probability of loss of access by banks to foreign currency funding:
  - No consensus on measuring probability of liquidity crisis; analysis uses probability of default by a bank as proxy for being shut out from funding markets.
  - Illustration assumes a stressed European sovereign becomes distressed, leading to distress in Swedish banks and shut out from funding markets.
  - Probability measurement follows Segoviano and Goodhart (2009) methodology using CDS spreads and equity prices for the four major Swedish banks, Sweden, and the selected European sovereign.
  - Distress dependence matrix shows Swedish banks’ risks with the European sovereign rose sharply in spring 2009 but later declined; probability that all Swedish banks become distressed given stress in the European sovereign reached highs at 0.4 in mid 2009 but is now low.
- Combining liquidity gaps with probabilities (decision tree illustration):
  - September 2008 example:
    - Probability that Swedbank faces liquidity risk estimated at 0.56.
    - Swedbank’s NSFR gap in US dollar suggests funding gap of $10 billion.
    - To prevent Swedbank US dollar funding shortage, central bank needs to hold $10 billion in foreign exchange reserves with probability 0.56.
  - Probability both Swedbank and Nordea become distressed estimated at 0.36; given their funding gaps of $33 billion in total, central bank needs to hold $33 billion with probability 0.36.
  - Calculations performed for September 2008, March 2009, March 2010, and March 2011 and summarized in Figure 5.
- Key illustrative statistics and outcomes:
  - Foreign exchange reserve needs rose sharply in 2008–09.
  - Example: in September 2008 foreign exchange reserve needs were $18 billion with probability 0.5; increased to $50 billion in March 2009, exceeding foreign exchange reserve holding at that time ($27 billion).
  - In mid-2009 authorities raised foreign exchange reserves to over $50 billion, which aligns with the analysis’ suggested needs.
- Incorporating Sweden’s sovereign risk:
  - Central bank need not hold precautionary reserves if government can maintain market access to borrow foreign currencies anytime.
  - Large bank distress can raise market concern about government’s ability to resolve banking problems; government funding costs could increase.
  - When accounting for sovereign risk, probability of significant reserve needs is low except in March 2009.
  - In March 2009 Sweden’s sovereign probability of distress was 0.1–0.2 for a single bank stress, rising to 0.3–0.4 if two or three banks became stressed.
  - Example combining probabilities: in September 2008 given Swedbank distress (0.56) and probability Sweden sovereign becomes distressed of 0.1, probability both occur is 0.06 (=0.56×0.1), implying need to hold $10 billion with probability 0.06 when accounting for sovereign market access loss.

### D. Concluding Observations
- Foreign exchange reserve needs evolve over time, reflecting systemic linkages between banks and between banks and the sovereign.
- Sweden’s sovereign strength was affected at the height of stress in March 2009, indicating risk that the government itself could have been shut out of funding markets.
- Active foreign exchange reserve management using formal tools illustrated is needed.
- Analysis suggests current level of foreign exchange reserves ($50 billion) is enough to meet foreign liquidity needs even under the unlikely event of distress in the selected European sovereign considered, given current favorable market perceptions about Swedish banks and Sweden sovereign strength.
- All elements of calculations can evolve quickly:
  - banks’ liquidity positions can adjust rapidly;
  - market perceptions about impact of a foreign stress event can change quickly.
- Authorities should frequently review range of possible external stress events (including which country could be a trigger) and how they affect Sweden directly and indirectly; consider including purely domestic stress events when appropriate.
- Governance framework on foreign exchange reserve management policy should be reviewed urgently to ensure policy effectiveness.

*Source: Bank reports.*

### References

### _cr11171 - References

### References
- Basel Committee on Banking and Supervision, 2010, Basel III: International Framework for Liquidity Risk Management, Standards, and Monitoring, December.
- Berg, Claes, 2008, “Global financial crisis: Which are the consequences for FX management by Central Banks in an Insurance Perspective?” presented at Bank of Thailand ́s International Symposium “Financial Globalization and Emerging Market Economies” in Bangkok 7-8 November 2008:
- International Monetary Fund, 2011, “Assessing Reserve Adequacy,” February, http://www.imf.org/external/np/pp/eng/2011/021411b.pdf
- Jeanne, O. and R. Rancière, 2006, “The Optimal Level of International Reserves for Emerging Market Countries: Formulas and Applications,” IMF Working Paper, October, WP/06/229.
- Segoviano, M. A. and C. C. Goodhart, 2009, “Banking Stability Measures,” IMF Working Paper, January, WP/09/4.

### Table 1. Assumptions for NSFR Factors
- Notes:
  - “U” refers to factors used for estimating a NSFR upper bound, and “L” refers to factors used for estimating a NSFR lower bound.
  - Consistent with Riksbank (2010) and the BCBS (2010).
  - The stability of deposits ranges from 0.5-0.9 depending on the type of depositors, as assumed by Riksbank (2010) and BCBS (2010).
  - Based on anecdotal evidence.
  - Consist mostly of Nordea’s short-term claims on securities settlement proceeds.
  - Assumed mortgage assets, for which BCBS assume the discount ratio of 0.65.
- Funding (stability of funding) — Factors (U / L)
  - Deposits by credit institutions 2/: 0.0 / 0.0
  - Deposits from the public 3/: 0.5 / 0.9
  - Debt securities in issue 4/:
    - In US dollars: 0.2 / 0.2
    - In euro: 0.6 / 0.6
  - Securities 2/: 0.5 / 0.05
  - Subordinated and other liabilities 4/:
    - In US dollars: 0.2 / 0.2
    - In euro: 0.6 / 0.6
  - Other assets 5/: 0.2 / 0.0
  - Equity 2/: 1.0 / 1.0
- Assets (liquidness of assets) — Factors (U / L)
  - Loans to credit institutions 2/: 0.0 / 0.0
  - Loans to the public 2/: 0.85 / 0.85
  - Non-US dollar (or euro) assets covered by swaps 6/: 0.65 / 0.5

### Table 2. Swedish Banks and Selected European Sovereign Distress Dependence Matrix (In probability)
- Sources: Datastream and author's calculation following M. Segoviano and C. Goodhart (2009)'s methodology.
- 1-Aug-08 — Column average (excluding own effects): 0.44, 0.50, 0.56, 0.27, 0.12, 0.22, 0.48, 0.27, 0.43, 0.30
  - Row excerpts:
    - Swedbank: 1.00 0.37 0.41 0.32 0.10 0.19 0.41 0.23 0.35 0.25
    - Handelsbanken: 0.31 1.00 0.54 0.27 0.10 0.18 0.47 0.24 0.40 0.28
    - Nordea: 0.28 0.44 1.00 0.22 0.08 0.16 0.40 0.21 0.37 0.24
    - SEB: 0.72 0.70 0.72 1.00 0.19 0.33 0.65 0.39 0.60 0.43
- 1-Apr-09 — Column average (excluding own effects): 0.48, 0.78, 0.78, 0.54, 0.39, 0.49, 0.70, 0.62, 0.72, 0.58
  - Row excerpts:
    - Swedbank: 1.00 0.84 0.85 0.81 0.50 0.63 0.84 0.75 0.84 0.71
    - Handelsbanken: 0.36 1.00 0.63 0.41 0.29 0.36 0.58 0.50 0.60 0.47
    - Nordea: 0.37 0.64 1.00 0.41 0.29 0.37 0.58 0.50 0.62 0.47
    - SEB: 0.72 0.85 0.85 1.00 0.47 0.59 0.81 0.72 0.83 0.68
- 1-Apr-10 — Column average (excluding own effects): 0.36, 0.60, 0.51, 0.34, 0.09, 0.21, 0.33, 0.23, 0.33, 0.24
  - Row excerpts:
    - Swedbank: 1.00 0.55 0.52 0.50 0.11 0.25 0.39 0.28 0.38 0.28
    - Handelsbanken: 0.21 1.00 0.37 0.22 0.05 0.13 0.21 0.14 0.21 0.15
    - Nordea: 0.30 0.57 1.00 0.31 0.07 0.18 0.30 0.21 0.31 0.21
    - SEB: 0.58 0.67 0.62 1.00 0.13 0.28 0.44 0.31 0.44 0.32
- 1-Apr-11 — Column average (excluding own effects): 0.25, 0.36, 0.28, 0.22, 0.04, 0.06, 0.19, 0.07, 0.14, 0.10
  - Row excerpts:
    - Swedbank: 1.00 0.27 0.25 0.30 0.04 0.07 0.19 0.08 0.14 0.10
    - Handelsbanken: 0.12 1.00 0.22 0.14 0.02 0.03 0.13 0.04 0.09 0.06
    - Nordea: 0.20 0.39 1.00 0.21 0.04 0.06 0.20 0.07 0.15 0.10
    - SEB: 0.41 0.41 0.36 1.00 0.06 0.09 0.24 0.10 0.18 0.13

### Figure 1. Reserve Coverage, 2000–10
- Data sources: IMF World Economic Outlook database; and World Bank/IMF/BIS External Debt database.
- Charts report reserve coverage in:
  - In percent of GDP: time series 2000–2010 for Advanced economies, Emerging markets economies, Sweden.
  - In percent of broad money: time series 2000–2010 for Advanced economies, Emerging markets economies, Sweden.
  - In percent of imports of goods and services: time series 2000–2010 for Advanced economies, Emerging markets economies, Sweden.

### Figure 2. Advanced Economies: Foreign Exchange Reserves, End-2010
- Sources: IMF World Economic Outlook database; and World Bank/IMF/BIS External Debt database.
- Key summary statistics (as presented):
  - In percent of GDP:
    - Median of the sample : 3.7 percent
    - Sweden: 10.4 percent
  - In percent of banks' total external debt:
    - Median of the sample : 6.2 percent
    - Sweden: 9.2 percent
  - In percent of banks' short-term external debt:
    - Median of the sample: 13.9 percent
    - Sweden: 17.9 percent

### Figure 3. Swedish Major Banks: US Dollar Funding Gaps, 2008–09 (In billions of US dollars)
- Sources: Bank annual reports; Haver; and Fund staff estimates.
- Charts shown:
  - Total of all four banks — Lower bound estimates and Upper bound estimates for 2008, 2009, 2010.
  - Individual bank panels (Handelsbanken, Nordea, SEB, Swedbank) — Lower bound estimates and Upper bound estimates for 2008, 2009, 2010.

### Figure 4. Estimating the Foreign Exchange Reserve Needs by Probability (September 2008; March 2009; March 2010; March 2011)
- Source: IMF staff estimates.
- Selected numerical entries (Funding gap in billions of US dollar; bank(s) distress probability; bank(s) distress probability × sovereign distress probability):
  - (September 2008)
    - Swed, Nordea, and Handel (All banks): Funding gap 47.2; bank(s) distress probability 0.30; bank(s) distress probability × sovereign distress probability 0.45
    - Swedbank and Nordea: Funding gap 60.2; bank(s) distress probability 0.28; bank(s) distress probability × sovereign distress probability 0.42
    - Swedbank: Funding gap 32.9; bank(s) distress probability 0.36; bank(s) distress probability × sovereign distress probability 0.55
    - Nordea: Funding gap 22.6; bank(s) distress probability 0.50; bank(s) distress probability × sovereign distress probability 0.61
    - SEB: Funding gap 13.0; bank(s) distress probability 0.61; bank(s) distress probability × sovereign distress probability 0.81
  - (March 2009)
    - Swed, Nordea, and Handel (All banks): Funding gap 60.2; bank(s) distress probability 0.28; bank(s) distress probability × sovereign distress probability 0.42
    - Swedbank and Nordea: Funding gap 47.2; bank(s) distress probability 0.45; bank(s) distress probability × sovereign distress probability 0.71
    - Swedbank: Funding gap 10.3; bank(s) distress probability 0.56; bank(s) distress probability × sovereign distress probability 0.81
    - Nordea: Funding gap 22.6; bank(s) distress probability 0.61; bank(s) distress probability × sovereign distress probability 0.61
    - SEB: Funding gap 13.0; bank(s) distress probability 0.61; bank(s) distress probability × sovereign distress probability 0.81
  - (March 2010)
    - Swed, Nordea, and Handel (All banks): Funding gap 42.3; bank(s) distress probability 0.06
    - Swedbank and Nordea: Funding gap 51.3; bank(s) distress probability 0.05
    - Swedbank: Funding gap 28.9; bank(s) distress probability 0.12
    - Nordea: Funding gap 20.9; bank(s) distress probability 0.24
    - SEB: Funding gap 9.0; bank(s) distress probability 0.32
  - (March 2011)
    - Swed, Nordea, and Handel (All banks): Funding gap 49.7; bank(s) distress probability 0.11
    - Swedbank and Nordea: Funding gap 56.2; bank(s) distress probability 0.10
    - Swedbank: Funding gap 35.9; bank(s) distress probability 0.20
    - Nordea: Funding gap 25.5; bank(s) distress probability 0.30
    - SEB: Funding gap 6.5; bank(s) distress probability 0.43

### Figure 5. Estimated Foreign Exchange Reserve Needs by Probability (Without assuming Sweden sovereign risk)
- Source: IMF staff estimates.
- Plots display Probability vs. Amount of foreign exchange needs (in billions of US dollars) for:
  - (September 2008), (March 2009), (March 2010), (March 2011)
  - Probability grid: 0.0 to 1.0; Amount scale up to 80 (or 60 for March 2011).

### Figure 6. Estimated Foreign Exchange Reserve Needs by Probability (Assuming Sweden sovereign risk)
- Source: IMF staff estimates.
- Plots display Probability vs. Amount of foreign exchange needs (in billions of US dollars) for:
  - (September 2008), (March 2009), (March 2010), (March 2011)
- Note: "One," "two," "three," and "all" refer to the case that one, two, three, and all banks fails, respectively.

*International Monetary Fund — SWEDEN: Staff Report for the 2011 Article IV Consultation — Informational Annex (Prepared June 24, 2011)*

### ANNEX I. SWEDEN: FUND RELATIONS

### ANNEX I. SWEDEN: FUND RELATIONS

### I. Membership
- Status: Joined 08/31/1951
- Article VIII

### II. General Resources Account (SDR Million; Percent of Quota)
- Quota: 2,395.50 — 100.00
- Fund holdings of currency (Exchange Rate): 1,785.00 — 74.51
- Reserve tranche position: 610.50 — 25.49
- Lending to the Fund: New Arrangements to Borrow 261.35

### III. SDR Department (SDR Million; Percent of Allocation)
- Net cumulative allocation: 2,248.96 — 100.00
- Holdings: 2,252.92 — 100.18

### IV. Outstanding Purchases and Loans
- None

### V. Latest Financial Arrangements
- None

### VI. Projected Obligations to Fund (SDR Million; based on existing use of resources and present holdings of SDRs)
- Forthcoming charges/interest:
  - 2012: 0.03
  - 2013: 0.03
  - 2014: 0.03
  - 2015: 0.03
- Total (per year shown): 0.03

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

### VIII. 2011 Article IV Consultation — Mission and Outreach
- Mission dates: staff team visited Stockholm during May 19—June 1, 2011.
- Mission team: P. Doyle (head, EUR), R. Babihuga, K. Ishi (EUR), Borja Gracia (FAD); Mr. Holmberg, Advisor to Sweden’s Executive Director, also attended.
- Outreach: meetings with parliamentary finance committee, private sector representatives, labor union, manufacturing association, the four largest banks, think tanks, and the Fiscal Policy Council.
- Press conference held in the Riksbank after concluding meeting.
- Publication: the staff report will be published.
- Last Article IV Consultation: discussions held May 27—June 8, 2010; staff report issued July 2010 (IMF Country Report 10/220); concluded by Executive Board on July 14, 2010.

### IX. Technical Assistance and AML/CFT
- LEG and MCM provided technical assistance on bank resolution frameworks (Aide Memoire, March 16, 2007) in connection with the 2007 Article IV consultation.
- Sweden has made significant progress addressing FATF-identified AML/CFT deficiencies from 2006:
  - Strengthened preventive measures for financial institutions, including customer due diligence and reporting of suspicious transactions.
  - Result: in October 2010 FATF removed Sweden from its regular follow-up process.
- Suggested enhancements going forward:
  - Enable the freezing of all funds in cases of terrorism financing.
  - Improve beneficial ownership data on legal persons.

### X. Resident Representative
- None

### Public Information Notice (PIN) — Executive Board Conclusions (July 8, 2011)
- Background and macro performance:
  - 2010 output rose by 5½ percent.
  - Unemployment fell to 7¾ percent from mid-crisis peak of over 9 percent.
  - Core inflation remained close to target throughout.
  - Fiscal deficit narrowed to 0.3 percent of GDP in 2010.
  - Public debt about 40 percent of GDP and expected to fall.
  - Riksbank tightened policy by raising policy rate by 1¾ percentage points since July 2010.
  - Krona appreciated by 20 percent against the euro since its trough in mid-2009.
- 2011 momentum:
  - First quarter GDP rose by 6½ percent year-on-year.
  - Risks: long-term and youth unemployment lagging, fixed investment below 2006–08 levels relative to output, potential decline in house prices could adversely affect growth.
- Executive Directors’ assessment and recommendations:
  - Commended strong recovery and measured exit from policy stimulus.
  - Welcomed increases in policy rate and withdrawal of many financial support measures.
  - Noted challenges: youth and long-term unemployment, firm house price valuations amid elevated household indebtedness, external risks from euro area stresses.
  - Fiscal guidance: supported 2011 budget balance between supporting activity and building fiscal buffers; if scope for reductions in 2012, focus on earned income tax credit to strengthen labor market performance.
  - Labor market: recommended moderation in wage settlements and adoption of permanent concessionary arrangements for labor market entrants.
  - Monetary policy: considered anticipated further increases in the Riksbank policy rate to be appropriate; authorities should respond flexibly—raise rates more rapidly if wage settlements accelerate and delay if strong krona appreciation continues.
  - Financial sector: welcomed FSAP update findings; called for continued supervisory vigilance given house price vulnerabilities; be prepared to take further macroprudential measures if significant new risks develop.
  - Liquidity and regulatory stance: welcomed strengthened liquidity monitoring and plans for early introduction of strong liquidity regulations accounting for foreign currency risks.
  - Prudential standards: supported authorities’ intention to go faster and further than Basel III capital regulations given unique characteristics and risks of Swedish financial system.
  - FSAP institutional recommendations endorsed: merge stability and deposit insurance funds; establish a special bank resolution regime; increase Financial Supervisory Agency capacity; improve coordination among macroprudential institutions.

### Sweden: Selected Economic and Social Indicators, 2005–12 (key figures)
- Real economy (percent change):
  - Real GDP: 2005 3.2; 2006 4.3; 2007 3.3; 2008 -0.6; 2009 -5.3; 2010 5.5; 2011 4.4; 2012 3.8
  - Domestic Demand: 2005 3.0; 2006 3.9; 2007 4.7; 2008 0.0; 2009 -4.9; 2010 6.1; 2011 2.9; 2012 3.3
  - CPI inflation: 2005 0.8; 2006 1.5; 2007 1.7; 2008 3.3; 2009 2.0; 2010 1.9; 2011 3.0; 2012 2.5
  - Unemployment rate (in percent): 2005 7.6; 2006 7.0; 2007 6.1; 2008 6.2; 2009 8.3; 2010 8.4; 2011 7.4; 2012 6.6
  - Gross national saving (percent of GDP): 2005 24.5; 2006 27.2; 2007 29.6; 2008 28.9; 2009 23.4; 2010 25.0; 2011 26.0; 2012 27.0
  - Gross domestic investment (percent of GDP): 2005 17.7; 2006 18.7; 2007 20.3; 2008 20.2; 2009 16.3; 2010 18.5; 2011 20.0; 2012 21.4
  - Output Gap (as a percent of potential): 2005 4.2; 2006 5.6; 2007 5.4; 2008 1.5; 2009 -5.9; 2010 -3.1; 2011 -1.6; 2012 -0.9
- Public finance (percent of GDP):
  - Total Revenues: 2005 53.8; 2006 53.0; 2007 52.5; 2008 51.9; 2009 52.1; 2010 50.7; 2011 49.3; 2012 48.6
  - Total Expenditures: 2005 51.8; 2006 50.8; 2007 46.1; 2008 46.6; 2009 49.7; 2010 47.8; 2011 45.2; 2012 44.2
  - Overall balance: 2005 1.9; 2006 2.2; 2007 3.6; 2008 2.2; 2009 -0.9; 2010 -0.3; 2011 0.8; 2012 1.3
  - Structural balance (as a percent of potential GDP)1/: 2005 3.0; 2006 1.9; 2007 1.0; 2008 0.9; 2009 1.3; 2010 1.4; 2011 1.3; 2012 1.2
  - General government gross debt, official statistics: 2005 50.4; 2006 45.3; 2007 40.2; 2008 38.8; 2009 42.8; 2010 39.8; 2011 36.1; 2012 32.7
  - Gross public debt, Maastricht criterion: 2005 50.2; 2006 45.0; 2007 40.0; 2008 38.3; 2009 42.1; 2010 ...; 2011 ...; 2012 ...
- Money and credit (12-month, percent change):
  - M1: 2005 9.4; 2006 11.1; 2007 9.9; 2008 4.9; 2009 8.0; 2010 7.1
  - M3: 2005 7.5; 2006 10.6; 2007 12.5; 2008 10.4; 2009 8.2; 2010 4.5
  - Credit to non-bank public: 2005 10.8; 2006 11.2; 2007 14.3; 2008 7.7
- Interest rates (year average):
  - Repo rate: 2005 1.5; 2006 3.0; 2007 4.0; 2008 2.0; 2009 0.3; 2010 1.3
  - Three-month treasury bill rate: 2005 1.7; 2006 2.3; 2007 3.5; 2008 3.8; 2009 0.4; 2010 0.5
  - Ten-year government bond yield: 2005 3.4; 2006 3.7; 2007 4.2; 2008 3.9; 2009 3.3; 2010 2.9
- Balance of payments (percent of GDP):
  - Current account: 2005 6.8; 2006 8.4; 2007 9.2; 2008 8.7; 2009 7.0; 2010 6.3; 2011 6.0; 2012 5.7
  - Trade balance: 2005 7.2; 2006 7.8; 2007 7.2; 2008 6.6; 2009 6.6; 2010 6.0; 2011 5.8; 2012 5.4
  - Foreign Direct Investment, net: 2005 -4.5; 2006 0.7; 2007 -2.3; 2008 1.2; 2009 -5.2; 2010 -2.1; 2011 -2.1; 2012 -2.1
  - International reserves (in billions of US dollars): 2005 26.4; 2006 26.0; 2007 29.7; 2008 35.4; 2009 44.2; 2010 46.6; 2011 53.9; 2012 55.8
  - Reserve cover (months of imports of goods and services): 2005 2.1; 2006 2.0; 2007 1.8; 2008 1.7; 2009 3.0; 2010 3.3; 2011 2.9; 2012 2.9
- Exchange rate and related:
  - Exchange rate regime: Free Floating Exchange Rate
  - Skr per U.S. dollar (June 1, 2011): 6.15
  - Nominal effective rate (2000=100): 2005 99.2; 2006 99.5; 2007 101.3; 2008 99.5; 2009 90.7; 2010 97.8
  - Real effective rate (2000=100)2/: 2005 84.4; 2006 80.2; 2007 84.2; 2008 84.4; 2009 80.0; 2010 81.8
- Fund Position (April 30, 2011):
  - Holdings of currency (in percent of quota): 74.51
  - Holdings of SDRs (in percent of allocation): 100.74
  - Quota (in millions of SDRs): 2395.50
- Social Indicators (reference year):
  - GDP per capita (in current PPP US dollars, 2009): 35,805
  - Income Distribution (ratio of income received by top and bottom quintiles, 2005): 3.3
  - Life expectancy at birth (2009): 79.3 (males) and 83.3 (female)
  - Automobile ownership (2004): 456 per thousand
  - CO2 Emissions (tonnes per capita, 2007): 5.4
  - Population Density (inhabitants per sq. km., 2008): 22
  - Poverty Rate (share of the population below the established risk-of-poverty line, 2005): 9%
- Sources: Statistics Sweden; Riksbank; Ministry of Finance; Datastream; INS; and IMF staff estimates.
- Notes:
  - 1/ IMF Staff Estimates
  - 2/ Based on relative unit labor costs in manufacturing.

### Statement by Swedish Authorities (Benny Andersen and Martin Holmberg; July 8, 2011)
- Authorities’ assessment:
  - Appreciate comprehensive analysis; broadly agree with main findings of the AIV and FSSA reports.
  - Short-term outlook and risks: agree with staff assessment; 2010 growth reported at 5.7 percent; 2011 growth expected around 4.5 percent; GDP production volumes returned to pre-crisis levels; recovery and structural reforms have increased employment and reduced unemployment.
  - Expectation of higher wage increases as labor demand rises; upcoming wage bargaining rounds occur in stronger cyclical phase.
  - Agree considerable uncertainties remain: external public finance developments could heighten market stress and reduce external demand; housing market inflation noteworthy and monitored closely; more data on housing market needed.
- Fiscal policy and framework:
  - Government broadly agrees with staff on fiscal position and stance; sound public finances permit short-term support without jeopardizing long-run sustainability.
  - Returning to a surplus is highest priority and expected to be achieved already this year.
  - Surplus expected to gradually rise in coming years; some scope for reform may emerge in 2012 compatible with broadly neutral fiscal stance.
  - Reform efforts to focus on structural measures to increase employment, decrease unemployment, and improve functioning of the economy.
  - Reform ambitions conditional on sustainable scope for new measures; reforms proposed only when surplus target will be met and expenditure ceiling not exceeded.
  - Government prefers correcting an overshooting of the surplus target afterward rather than committing to uncertain reforms in advance.
  - Government agrees on important role of the Fiscal Policy Council; a recent remit review was made and no significant changes to mandate or resources are expected in the near term.
- Monetary policy:
  - Note that the Executive Board of the Riksbank decided on July 5 to raise the repo rate by [text ends in source].

*Source: ANNEX I. SWEDEN: FUND RELATIONS (As of May 31, 2011) and Public Information Notice No. 11/88 (July 13, 2011).*

### 0.25 percentage points to 2.0 percent. The published repo rate path shows a gradual

### _cr11171 - 0.25 percentage points to 2.0 percent. The published repo rate path shows a gradual

### Monetary policy and inflation
- Repo rate path: "0.25 percentage points to 2.0 percent." The published repo rate path shows a gradual normalization of the repo rate to attain the inflation target and keep the real economy stable.
- Divergence in inflation measures:
  - HICP (internationally comparable, excludes mortgage costs): "1.7 percent."
  - CPI inflation: "3.3 percent in May," expected to remain high above the inflation target of "2 percent" during 2011.
- Interpretation:
  - Underlying inflation is low; higher CPI inflation is attributed to rising mortgage rates and considered a transitory effect.
  - In periods with large interest rate adjustments, greater weight is given to measures of underlying inflation when formulating monetary policy.
- Risks and scenarios:
  - If high CPI inflation affects long-term inflation expectations and wage formation, monetary policy may need to be tightened more than in the main scenario.
  - If the international economic situation weakens (for example, if fiscal problems in the euro area worsen), the repo rate may need to be raised at a slower pace.

### Financial sector policy and framework — Financial Stability Assessment
- Authorities' stance: broadly agree with the overall thrust of staff’s financial stability assessment.
- Main risks:
  - Developments outside Sweden pose the main risks to financial stability.
  - Swedish banks’ direct exposure to peripheral euro-area countries is small.
  - Heavy reliance on short-term wholesale funding, in particular in US dollars, makes Swedish banks vulnerable to market disruptions and liquidity risks.
  - Indirect channels from a worsening euro-area sovereign debt crisis and a renewed global recession could affect financial stability and bank asset quality.
- Strengths and policy actions:
  - Swedish banks are currently well capitalized from an international perspective.
  - Authorities intend to accelerate implementation of Basel III capital requirements and impose higher than minimum capital requirements on the largest and systemically important banks.
  - Authorities will ensure Basel III liquidity standards are implemented in an "adequate, appropriate and proportionate manner."
- Staff view: staff welcomes the authorities’ stance given the nature of Swedish banks’ exposures and prevailing risks.

### Macroprudential and Financial Stability Framework
- Coordination proposal:
  - Staff suggested strengthening coordination by establishing a high-level Systemic Financial Stability Council.
  - Authorities note a Committee has been established to look into this issue and "will present recommendations by August 2012."
- Institutional and legal considerations:
  - Some macroprudential policies relate to crisis management and resolution; others do not.
  - Legal differences in data-sharing possibilities among authorities need resolution.
  - Proposal to include independent members in a macroprudential body could raise confidentiality concerns; tasks and composition require considerable thought.
- Implementation priority:
  - Regardless of establishing a macroprudential function, institutional infrastructure and mandates of involved authorities need clarification.

### Sectoral Regulation and Supervision
- Financial Supervisory Authority (Finansinspektionen, FI):
  - Government intends to act on recommendations concerning FI’s resources and legal responsibilities.
  - In the Budget Bill for 2012, the government intends to propose to parliament "a substantial increase in FI’s appropriations over a three-year period" to strengthen supervisory and oversight functions.
  - To further safeguard FI’s independence, FI’s policy documents will be amended with a provision clearly stating operational and budgetary independence.
  - Government will propose legislative amendments clarifying FI’s sole responsibility for licensing regulated entities.
- Appeals and enforcement:
  - Clarification on appeals: FI would generally decide that a revocation of a license should have immediate effect even if subject to appeal; for suspension, the credit institution must request the court to stay execution and courts do not grant such requests routinely.
  - FI maintains it is not efficient to establish a separate enforcement department; current provisions and practices are considered adequate to safeguard interests and fundamental rights of addressees.
  - Addressees are invited to comment on findings before Board decisions on sanctions, in accordance with general administrative law.
- Cross-border supervision:
  - Continued effort to develop cross-border supervision at FI and collaboration in supervisory colleges, in line with staff recommendations in the FSSA report.
- Insurance sector and Solvency II:
  - Several issues raised by staff will be dealt with once Solvency II is implemented.
  - Sweden participates in IAIS work on Internationally Active Insurance Groups.
  - Regulation regarding transfer of policies and other life insurance related issues is under national review.
  - FI is reviewing the model for baseline supervision; a pilot review of a number of small insurance companies was performed during the first half of 2011.
- Securities markets and market infrastructures:
  - Authorities broadly agree with staff’s assessment of compliance with IOSCO principles; see independence and resources comments above.
  - Authorities welcome IMF assessments of NASDAQ OMX Derivatives Markets and of the RIX system and have initiated work in response to many views expressed.
  - On staff’s suggestion to ring-fence NOMX DM in a separate legal entity, authorities consider whether legal separation is necessary and note risk reduction may be achieved by other means; such a measure should be taken only if benefits outweigh costs.
- Anti-Money Laundering and Anti-Terrorist Financing:
  - Authorities agree with the assessment; significant resources have been devoted to improving compliance, including creation of a dedicated unit at FI, and the framework will be developed further.

*Source: IMF content unit _cr11171 - 0.25 percentage points to 2.0 percent. The published repo rate path shows a gradual*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11171.pdf_