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### The Setting
- Sweden’s macrofinancial performance over two decades: robust growth, low inflation, declining trend unemployment, rising incomes, low government bond yields, and strong external positions.
- Sweden is small and open; Europe purchases some 70 percent of its exports of goods and services.
- Financial sector large—some 5½ times GDP—and liabilities are dominated by wholesale funding.
- Fiscal rules target a 1 percent of GDP surplus across the cycle, with multi-year nominal expenditure ceilings and an independent fiscal council.
- Recent krona appreciation has been driven in part by fiscal credibility and capital inflows.

### Risks to the Outlook (Risk Assessment Matrix highlights)
- Downside risks dominate:
  - Strong intensification of euro area crisis → Impact: ↓ MH; Policy response: Revisit pace of fiscal consolidation if domestic growth prospects weaken; Use monetary policy supportively.
  - Disorderly default in one or several EA economies → Impact: ↓ LH; Policy response: Support activity via fiscal and monetary stimuli; Provide liquidity and public backstop for bank recapitalization.
  - Oil price hike → Impact: ↓ MM; Policy response: Set monetary conditions to head off second round effects only.
  - Sharp fall in Swedish house prices → Impact: ↓ LM; Policy response: Ease monetary conditions; Inject liquidity if needed.
  - Exposure to and contagion from further escalation of financial stress in the euro area → Impact: ↓ HH; Policy response: Reduce vulnerabilities of the financial sector; provide public backstop.

(Note: L, M, H denote low, medium and high.)

### Recent Macrofinancial Developments
- GDP and activity:
  - Sweden grew by 6.1 percent in 2010 and 4 percent in 2011.
  - Q4 2011 GDP contracted 1.0 percent; Q1 2012 GDP grew 0.8 percent.
  - After growing by a cumulative 2.1 in the first three quarters of 2011, Q4 2011 surprised on the downside.
- Demand components and labor:
  - Exports surged in 2010 but softened through 2011; fixed investment eased from 2010.
  - Household credit growth slowed by over 3 percentage points from a year earlier to 5½ percent.
  - Unemployment around 7½ percent—some 1½ percentage points above 2008 levels.
  - Household saving rates increased amid declining wealth and low confidence.
- Inflation and monetary policy:
  - 2011 inflation averaged around 3 percent; underlying inflation measured by the CPIF was 1.4 percent.
  - CPIF excluding energy averaged around 1 over 2011; CPIF annual increase amounted to only ½ percent in December 2011.
  - The Riksbank raised the repo rate from 1.25 to 2 percent between January and July 2011, paused in Aug-Sep, then lowered by 25 basis points in December 2011 and February 2012.
  - Core inflation (CPIF excl. energy) averaged 1.1 percent Jan–Mar 2012.
- Public finances:
  - Overall balance strengthened by 0.2 of a percentage point of GDP in 2011, to a small surplus of 0.1 percent from a deficit of 0.1 percent in 2010.
  - Expenditure fell by 1.1 percentage points of GDP reflecting phase-out of temporary stimulus and prior reforms.
  - Staff calculations suggest the 2011 outcome fell short of the 1 percent structural surplus target by 0.8 percentage points.
  - Q1 2012 data show a slowdown in central government tax revenue relative to the previous year.
- Financial sector:
  - Swedish banks’ risk-weighted capital ratios remain relatively high; exposures to strained EA countries negligible.
  - Earnings increased and loan losses fell; access to international capital markets remained secure.
  - As stresses mounted in Europe, CDS spreads and expected default frequency measures rose—most notably for Nordea.
  - In May 2012 Moody’s downgraded long-term debt ratings for Nordea and Handelsbanken by one notch to Aa3, in part reflecting reliance on wholesale funding.
  - Average solvency ratio of life insurance firms fell sharply since mid-2011 but remains around 8 times minimum requirements.
- External sector and capital flows:
  - Trade surplus shrank with weakening global demand; current account remained positive (2011 Q4 at 7.2 percent of GDP).
  - Capital inflows concentrated in portfolio investment in government and corporate securities, offsetting large but falling outflows through FDI and other investments.
  - Portfolio inflows and confidence in Sweden’s policies contributed to krona strength; krona strengthened 1.6 percent in 2011 and was little changed vis-à-vis the euro in the first four months of 2012.

### Outlook and Projections
- Short-term projection:
  - Staff projects GDP growth to drop from 4 percent in 2011 to 1 percent in 2012, then rebound to 2 ⅓percent in 2013.
  - These projections broadly track activity in Advanced Europe and are somewhat more optimistic than the Riksbank and consensus (both around ½ percentage point less at the time of the projections).
- 2012 drivers and gaps:
  - 2012 activity expected to be sustained by steady personal consumption, accommodative fiscal conditions, continued non-residential property investment, and strong international non-oil commodity prices.
  - Net exports and business investment expected to remain sources of weakness.
  - Output gap estimated around zero in 2011 Q4; projected to open to -0.4 percent in 2012, subduing core inflation.
- 2013 and potential growth:
  - For 2013, stronger European and global growth and continued consumption are projected to lift growth and close the output gap by end-2013.
  - Potential growth projected to recover gradually to around 2½ percent after falling an estimated ¾ of a percentage point from the pre-crisis trend.

### Key Vulnerabilities Identified
- Housing market:
  - Price-to-income ratios indicate overvaluation in the region of 10 percent.
  - Elevated household debt: 170 percent of disposable income.
  - High share of interest-only mortgages and softening house prices increase risk.
- Financial sector structure and funding:
  - System is large, concentrated, complex, and reliant on short-term wholesale funding.
  - Significant domestic and regional exposure to real estate.
  - Recent curbs in welfare insurance may make mortgage lending less secure.
  - These fragilities raise prospects of increased credit losses in a sustained regional recession.

### Policy Implications and Stance
- Policy dilemma:
  - Whether to pre-empt downside tail risks by aggressively accrual of buffers in fiscal and financial sector policies or to adopt a more accommodative stance under the central slow-growth EA scenario.
- Current stance as of the report:
  - Financial sector: various steps taken to bolster resilience, with more underway.
  - Fiscal policy: government budget guided by medium-term rules, allowing automatic stabilizers to operate.
  - Monetary policy: accommodative with the policy rate negative in real terms and medium-term inflation expectations anchored at the target.
  - Both fiscal and monetary instruments retain room to make decisive adjustments should tail risks materialize.

### Financial Sector Role, Resilience, and Vulnerabilities
- Systemic exposure and strengths:
  - Financial sector is a key contingent fiscal risk because of European tail risks.
  - Strengths: historically low mortgage losses, limited buy-to-let markets, open-ended personal liability, well-developed welfare and social security systems.
  - As of end March 2012, under the Basel II definition, core Tier 1 capital ratios range between 12 and 16 percent.
  - Under the Basel III definition, common equity Tier 1 capital ratios are estimated to be between 11 and 15 percent.
  - Banks have strengthened liquidity; a stability fund established in 2008; Deposit Insurance System reformed in July 2011.
- Stress tests and remaining vulnerabilities:
  - Stress tests suggest banks could maintain a 10 percent core Tier 1 capital ratio under severe EA recession scenarios (Basel II), though one bank’s common equity Tier 1 could fall under 10 percent (Basel III).
  - Remaining concerns: raw common equity ratios as low as 4 percent for some banks; risk weighted assets around 25 percent of total assets; substantial liquidity risks due to short-term funding, including US dollar books; household debt at 1.7 times disposable income.

### Financial Sector Policy Recommendations
- Strengthen bank capitalization and risk-weight calibration:
  - Review appropriateness of risk-weight calibration under IRB models; consider imposing a regulatory floor on risk weights on residential mortgages.
  - Enhance disclosure of IRB methodology and assumptions; maintain constant supervisor scrutiny.
- Strengthen liquidity requirements:
  - Introduce the Liquidity Coverage Ratio (LCR) in January 2013 and prepare to introduce a Basel III net stable funding ratio (NSFR)-type measure in the medium term.
  - Banks should raise their NSFRs towards 100 percent and publish them.
  - Review adequacy of Basel III liquidity standards for Sweden.
- Regional coordination:
  - Continue consultation and coordination with Nordic-Baltic authorities to minimize regulatory arbitrage and anticipate cross-jurisdictional consequences.
- Supervision intensity and crisis management:
  - Remove legal impediments to the FI’s authority to use Pillar II if any.
  - Establish a special resolution framework for non-systemic financial institutions.
  - Increase FI resources and accountability; formalize Domestic Standing Committee crisis procedures and conduct “war games” on burden-sharing.
  - Extend resolution and recovery planning to other major banks.

### Fiscal Policy: Stance, Measures, and Guidance
- Appropriate 2012 setting:
  - Given output near potential, strong sovereign market access, downside external risks, and modest deviation from structural surplus target, a mildly supportive stance in 2012 is appropriate with phased return to structural surplus thereafter.
  - Automatic stabilizers to operate; scope to reset structural fiscal trajectory if global economy deviates markedly.
- 2012 specifics:
  - Budget balance expected to remain at -0.3 percent of GDP in 2012 due to deceleration of growth and new discretionary measures.
  - Authorities’ estimate: structural balance would fall to 1.2 percent of GDP implying a stimulus of 0.2 percent of GDP.
  - Fund staff estimate: structural balance falls to -0.3 percent of potential GDP, implying a stimulus of 0.5 percent of potential GDP.
  - Authorities increased the expenditure ceiling between 2014–15 by SEK 20 billion.
  - With this, the expenditure ceiling is expected to increase by 1½ percent in nominal terms over the next four years, leaving a budgetary margin of about 1 ½ percent of GDP.
  - Budget Bill measures about 0.4 percent of GDP for 2012, main expansionary measures include lowering the VAT rate for restaurant and catering services, extra funding for infrastructure investment, and active labor market measures.
- Medium-term and structural reform suggestions:
  - Authorities plan revenues as percent of GDP to remain largely unchanged; overall balance would exceed 1 percent of GDP by 2014 and strengthen thereafter.
  - Contingent measures focus on increasing labor supply: strengthen “in-work” tax credit, raise lower threshold for state income tax, review corporate taxation, tax cuts for pensioners.
  - Tax structure: multiple VAT rates curb collections despite a high standard VAT rate; with a Gini coefficient of 0.23, restructuring VAT could improve efficiency and reduce labor cost wedges.
  - Targeting: measures for vulnerable groups should be better targeted.
  - Local governments: consider allowing greater flexibility to establish rainy-day contingency funds.
- Fiscal framework guidance:
  - Adherence to the 1 percent of GDP surplus target over the medium term remains appropriate to build buffers.
  - Fiscal Policy Council should increase resources and focus on sustainability.

### Monetary Policy Stance and Recommendations
- Current stance and conditionality:
  - Repo rate appropriately set at 1½ percent under the baseline scenario, given benign inflation outlook, modest cost pressures, and temporary demand slowdown.
  - Monetary policy should continue to be set according to the baseline scenario while slack persists.
- Communication and forecasting:
  - Riksbank could publish macroeconomic forecasts conditioned on market-implied domestic and foreign forward rates, in addition to forecasts conditioned on its preferred policy path.
  - Keep commitment to publish expected policy rate path under review.
  - Seek consensus on Riksbank’s mandate with regard to asset prices and financial stability.
  - Riksbank should raise research efforts on equilibrium unemployment composition and macrofinancial linkages.
- Macroprudential interaction:
  - Macroprudential instruments (e.g., tightening LTV rules, adjusting risk-weighted assets, limiting loan terms) should be deployed further if the housing market reflates.
  - Monetary policy should take into account potential slowing of credit supply from macroprudential tightening and be prepared to offset drag while slack remains.

### Exchange Rate, Reserves, and Liquidity
- Exchange rate framework:
  - Monetary and free floating exchange rate frameworks remain credible; krona likely to depreciate in adverse tail risk scenarios.
- Gross international reserves:
  - 50.4 USD or 344.7 SEK billion; equivalent to 23 percent of imports and 14.8 percent of short term external debt.
- Staff liquidity-gap analysis:
  - Suggests a case to increase foreign exchange reserves now, given a higher probability that reserves might be exhausted in a tail-risk event; authorities should raise reserve cover further should this probability rise.

### Structural Reform Priorities
- Labor market:
  - Reforms since early 1990s boosted trend growth and employment; recent reductions in scope/resources for active labor market policies warrant better targeting.
  - Target reforms to groups with weak labor-market attachment; evaluate payroll tax reductions’ targeting.
- Housing and rental market:
  - Rental and sub-let markets remain substantially unreformed and highly regulated.
  - Fast urbanization in Stockholm, Gothenburg and Malmo and lack of rental property availability have driven house price surges.
  - Recommendations: deregulate rental markets; raise investment in residential property; increase land available for construction.

### External Spillovers, Trade Exposure, and Regional Claims
- Direct trade exposure:
  - 70 percent of Swedish total exports go to the EU.
  - Sweden: Exports to Europe (Percent of GDP, merchandise exports): European Union 19.3; Euro area 13.1; Greece 0.1; Ireland 0.2; Italy 0.9; Portugal 0.2; Spain 0.6; United Kingdom 2.4.
- Banks’ claims on Nordic-Baltic region, 2011 (Billions of USD / Percent of total assets):
  - Nordics: Denmark 180.9 15.2; Finland 146.2 12.2; Norway 129.9 10.9.
  - Baltics: Latvia 16.0 1.3; Lithuania 15.7 1.3; Estonia 17.5 1.5.
- Assessment: So far Europe’s sovereign debt turmoil had modest effects on Sweden, but increased financial market stress could trigger larger effects via trade and global demand channels.

### Fiscal Buffers and Stress Scenarios (select findings)
- Simulated outcomes:
  - United Kingdom / United States–like shock: fiscal deficit would deteriorate by about 3 percentage points of GDP; debt to GDP would rise to about 50 percent of GDP, including banking sector support.
  - Iceland–like shock: fiscal balance would deteriorate by about 8½ percent of GDP; debt to GDP would rise above 80 percent of GDP, including financial sector support (assumed half of Iceland’s in proportion to Sweden’s financial sector size).
- Market-access threshold:
  - Sweden’s 1990s experience suggests sovereign could retain market access with debt to GDP ratios close to 75 percent but at a high cost; debt ratios beyond this could result in market pressures.
- Policy implication:
  - Authorities’ preference to continue building buffers is cautious and appropriate given scale of potential European tail risks.

### How Strong is the Pass-through from Repo Rates to Mortgage Rates? (Box 3)
- Measurement:
  - Pass-through measured as simple correlation coefficient between the repo rate and the effective interest rate on housing loans to households and NIPSHs.
- Quantitative findings:
  - Prior to the crisis: Sweden 0.99; United Kingdom 0.82; United States 0.67; Germany 0.65.
  - Since 2008Q1: Sweden 0.96.
- Interpretation:
  - Pass-through dropped marginally (0.99 → 0.96) but remains higher than comparators’ pre-crisis correlations.

### Key Measures in the 2012 Budget Bill (Box 6)
- Estimated total impact: about 0.4 percent of GDP for 2012 and 2013.
- Major measures:
  - Lowering the VAT rate for restaurant and catering services from 25 percent to 12 percent.
  - Temporary augmentation of funds for infrastructure maintenance and investments on road and railway networks.
  - Structural labor market measures: more places in labor market programs, temporary increases in vocational education places, and monitoring/job-seeking measures.
  - Tax measures: simplification for foreign experts, changes in 3:12 rules, introduction of investment savings account, changes to taxation of endowment insurance, increase the deduction for research and development expenditure.

### Medium-Term Public Debt (ANNEX I) — Baseline and Scenarios
- Baseline result:
  - Overall balance would remain at a strong surplus of about 2½ percent of GDP over the medium term, bringing debt to GDP to 22 percent in 2017.
- Historical and projected public sector gross debt (percent of GDP): 2007 40.2; 2008 38.8; 2009 42.6; 2010 39.4; 2011 38.4; 2012 37.5; 2013 35.3; 2014 32.0; 2015 28.4; 2016 24.5; 2017 20.6.
- Change in public sector debt (percent of GDP): 2007 -5.0; 2008 -1.4; 2009 3.8; 2010 -3.1; 2011 -1.0; 2012 -0.9; 2013 -2.2; 2014 -3.3; 2015 -3.7; 2016 -3.8; 2017 -4.0.
- Gross financing need (percent of GDP / billions USD, 2007–2017): percent of GDP 15.3; 13.9; 15.5; 15.5; 13.6; 13.0; 11.7; 10.0; 8.3; 6.7; 5.1. In billions USD 70.6; 67.7; 62.9; 71.7; 73.0; 69.3; 65.5; 59.0; 51.5; 43.2; 34.6.
- Scenario outcomes:
  - Worst-case growth shock: gross debt would reach 35 percent of GDP in 2017, still below 38.4 percent of GDP observed in 2011.
- IMF staff observation:
  - Even under less favorable stress tests, public debt projected to continue downward and remain below past peaks; importance of monitoring external euro area risks and preserving fiscal buffers.

### Additional Economic Outlook Fragments
- Short-run numeric outlook and expectations:
  - Growth in the near term: "0.8 percent."
  - Consumption and investment growth expected to continue to rise "at a somewhat lower rate than normal."
  - Labor market: expected to weaken temporarily; resource utilization lower than normal.
  - Inflation: "Inflation is projected to increase gradually to 2 percent in the next few years."
  - Monetary stance: "The repo rate remains at 1.5 percent" and Riksbank’s repo rate path indicates it will remain at this low level "for around a year."
- Housing and liquidity recommendations reiterated:
  - Introduction of LCR in all currencies and separately for euro and USD by 2013.
  - Banks urged to reduce structural liquidity risks and approach minimum NSFR; improve transparency on liquidity metrics.

### Final Staff Recommendations and Follow-up
- Continue to set monetary policy according to the baseline while slack persists, offsetting drag from prudential actions.
- Deploy macroprudential instruments further if the housing market reflates.
- Publish forecasts conditioned on market-implied forward rates and review policy rate path publication.
- Seek consensus on Riksbank’s role regarding asset prices and financial stability.
- Proceed with planned increases in bank capital for major banks (2013 and 2015), higher mortgage risk weights, tighter liquidity rules, strengthened supervisory/resolution frameworks, deregulate rental markets, and increase land supply to moderate housing shortages.
- Remain on the standard 12-month Article IV consultation cycle.

*SWEDEN 2012 ARTICLE IV REPORT — INTERNATIONAL MONETARY FUND*

### 1. Selected Economic Indicators, 2009–13________________________________________________________ 29

### 1. Selected Economic Indicators, 2009–13

### The Setting
- Sweden’s macrofinancial performance over two decades: robust growth, low inflation, declining trend unemployment, rising incomes, low government bond yields, and strong external positions.  
- Sweden is small and open; Europe purchases some 70 percent of its exports of goods and services.  
- Sweden’s financial sector is large—some 5½ times GDP—and liabilities are dominated by wholesale funding.  
- Fiscal rules target a 1 percent of GDP surplus across the cycle, with multi-year nominal expenditure ceilings and an independent fiscal council.  
- Recent krona appreciation has been driven in part by fiscal credibility and capital inflows.

### Risks to the Outlook (Risk Assessment Matrix highlights)
- Downside risks dominate, including:
  - Strong intensification of euro area crisis → Impact: ↓ MH; Policy response: Revisit pace of fiscal consolidation if domestic growth prospects weaken; Use monetary policy supportively.
  - Disorderly default in one or several EA economies → Impact: ↓ LH; Policy response: Support activity via fiscal and monetary stimuli; Provide liquidity and public backstop for bank recapitalization.
  - Oil price hike → Impact: ↓ MM; Policy response: Set monetary conditions to head off second round effects only.
  - Sharp fall in Swedish house prices → Impact: ↓ LM; Policy response: Ease monetary conditions; Inject liquidity if needed.
  - Exposure to and contagion from further escalation of financial stress in the euro area → Impact: ↓ HH; Policy response: Reduce vulnerabilities of the financial sector; provide public backstop.

(Note: L, M, H denote low, medium and high.)

### Recent Macrofinancial Developments
- GDP and activity
  - Sweden grew by 6.1 percent in 2010 and 4 percent in 2011.
  - Q4 2011 GDP contracted 1.0 percent; Q1 2012 GDP grew 0.8 percent.
  - After growing by a cumulative 2.1 in the first three quarters of 2011, Q4 2011 surprised on the downside.
- Demand components and labor
  - Exports surged in 2010 but softened through 2011; fixed investment eased from 2010.
  - Household credit growth slowed by over 3 percentage points from a year earlier to 5½ percent.
  - Unemployment around 7½ percent—some 1½ percentage points above 2008 levels.
  - Household saving rates increased amid declining wealth and low confidence.
- Inflation and monetary policy
  - 2011 inflation averaged around 3 percent; underlying inflation measured by the CPIF was 1.4 percent.
  - CPIF excluding energy averaged around 1 over 2011; CPIF annual increase amounted to only ½ percent in December 2011.
  - The Riksbank raised the repo rate from 1.25 to 2 percent between January and July 2011, paused in Aug-Sep, then lowered by 25 basis points in December 2011 and February 2012.
  - Pass-through from policy rates to mortgage rates has been less than complete.
  - Core inflation (CPIF excl. energy) averaged 1.1 percent Jan–Mar 2012.
- Public finances
  - Overall balance strengthened by 0.2 of a percentage point of GDP in 2011, to a small surplus of 0.1 percent from a deficit of 0.1 percent in 2010.
  - Expenditure fell by 1.1 percentage points of GDP reflecting phase-out of temporary stimulus and prior reforms.
  - Staff calculations suggest the 2011 outcome fell short of the 1 percent structural surplus target by 0.8 percentage points.
  - Q1 2012 data show a slowdown in central government tax revenue relative to the previous year.
- Financial sector
  - Swedish banks’ risk-weighted capital ratios remain relatively high; exposures to strained EA countries negligible.
  - Earnings increased and loan losses fell; access to international capital markets remained secure.
  - As stresses mounted in Europe, CDS spreads and expected default frequency measures rose—most notably for Nordea.
  - In May 2012 Moody’s downgraded long-term debt ratings for Nordea and Handelsbanken by one notch to Aa3, in part reflecting reliance on wholesale funding.
  - Average solvency ratio of life insurance firms fell sharply since mid-2011 but remains around 8 times minimum requirements.
- External sector and capital flows
  - Sweden’s trade surplus shrank with weakening global demand; current account remained positive (2011 Q4 at 7.2 percent of GDP).
  - Capital inflows concentrated in portfolio investment in government and corporate securities, offsetting large but falling outflows through FDI and other investments.
  - Portfolio inflows and confidence in Sweden’s policies contributed to krona strength; krona strengthened 1.6 percent in 2011 and was little changed vis-à-vis the euro in the first four months of 2012.

### Outlook and Projections
- Short-term projection:
  - Staff projects GDP growth to drop from 4 percent in 2011 to 1 percent in 2012, then rebound to 2 ⅓percent in 2013.
  - These projections broadly track activity in Advanced Europe and are somewhat more optimistic than the Riksbank and consensus (both around ½ percentage point less at the time of the projections).
- 2012 drivers and gaps:
  - 2012 activity expected to be sustained by steady personal consumption, accommodative fiscal conditions, continued non-residential property investment, and strong international non-oil commodity prices.
  - Net exports and business investment expected to remain sources of weakness.
  - Output gap estimated around zero in 2011 Q4; projected to open to -0.4 percent in 2012, subduing core inflation.
- 2013 and potential growth:
  - For 2013, stronger European and global growth and continued consumption are projected to lift growth and close the output gap by end-2013.
  - Potential growth projected to recover gradually to around 2½ percent after falling an estimated ¾ of a percentage point from the pre-crisis trend.

### Key Vulnerabilities Identified
- Housing market:
  - Staff estimates suggest price-to-income ratios indicate overvaluation in the region of 10 percent.
  - Elevated household debt: 170 percent of disposable income.
  - High share of interest-only mortgages and softening house prices increase risk.
  - Domestic housing fragilities could amplify external slowdown effects.
- Financial sector structure and funding:
  - System is large, concentrated, complex, and reliant on short-term wholesale funding.
  - Significant domestic and regional exposure to real estate.
  - Recent curbs in welfare insurance may make mortgage lending less secure.
  - These fragilities raise prospects of increased credit losses in a sustained regional recession.

### Policy Implications and Stance
- Policy dilemma:
  - Whether to pre-empt downside tail risks by aggressively accrual of buffers in fiscal and financial sector policies or to adopt a more accommodative stance under the central slow-growth EA scenario.
- Current stance as of the report:
  - Financial sector: various steps taken to bolster resilience, with more underway.
  - Fiscal policy: government budget guided by medium-term rules, allowing automatic stabilizers to operate.
  - Monetary policy: accommodative with the policy rate negative in real terms and medium-term inflation expectations anchored at the target.
  - Both fiscal and monetary instruments retain room to make decisive adjustments should tail risks materialize.

*SWEDEN 2012 ARTICLE IV REPORT — INTERNATIONAL MONETARY FUND*

### 27.      Given the large size of the sector and its direct exposure to core EA countries, the financial

### 27.      Given the large size of the sector and its direct exposure to core EA countries, the financial

### Financial sector role and systemic exposure
- The financial sector represents a key contingent fiscal risk, given European tail risks.
- Efforts to contain these risks are nested within Basel III and broader EU initiatives, including CRD IV, while acknowledging Swedish financial sector contingent risks may not be fully reflected in EU-wide prescriptions.
- Strengths:
  - In domestic markets: historically low mortgage losses, limited buy-to-let markets, open-ended personal liability, and well-developed welfare and social security systems (albeit some erosion in recent years) curtail risks of major credit losses.
  - Externally: direct exposures to the most vulnerable peripheral countries are small; market indicators suggest small spillover risks from these countries.
  - Banks increased capital ratios through rights issues, retained earnings, and reductions of higher risk assets. As of end March 2012, under the Basel II definition, core Tier 1 capital ratios range between 12 and 16 percent.
  - Under the new Basel III definition, common equity Tier 1 capital ratios are estimated to be between 11 and 15 percent.
  - Banks have strengthened overall liquidity, including as indicated by the Riksbank’s short-term liquidity measure, by increasing longer-term funding and liquid assets.
  - A stability fund was established in 2008, and the Deposit Insurance System was reformed in July 2011 to be fully consistent with the revised EU Deposit Insurance Directive.
  - The 2008–09 crisis confirmed that the authorities’ crisis readiness is high.

### Recent regulatory and supervisory measures
- Authorities moved ahead of European norms in some areas given heightened European tail risks and lack of a common European backstop:
  - In November 2011, the financial regulator (FI) proposed common equity Tier 1 capital requirements for four major banks of at least 10 percent from the beginning of 2013, and 12 percent from the beginning of 2015. The move preceded the recent CRD IV consensus.
  - Since July 2011, banks have been subject to new liquidity reporting requirements to enable monitoring of Basel III-type liquidity indicators.
  - Planned introduction of the Liquidity Coverage Ratio (LCR) requirements in total currency position and for euro and US dollar currency positions separately in January 2013.
  - Resources of the FI are being raised over the next few years; legislative amendments have been made to clarify FI autonomy.
  - The Council for Cooperation on Macroprudential Policy (CCMP), comprising the Riksbank and the FI, was established and held its first meeting in February 2012; one CCMP task is coordinating Sweden’s response to recommendations made by the ESRB and Basel committees.

### Stress tests, resilience, and remaining vulnerabilities
- Authorities’ recent stress tests suggest that even under severe EA recession scenarios, banks would be able to maintain a 10 percent core Tier 1 capital ratio under the Basel II definition—although one bank’s common equity Tier 1 capital ratio could go under 10 percent under the Basel III definition.
- This assessment coincides with the broadly reassuring assessment provided by the 2011 FSAP Update.
- Remaining qualifications and vulnerabilities:
  - Shock beyond historical experience cannot be disregarded given current European circumstances.
  - Raw common equity ratios are as low as 4 percent for some banks.
  - Risk weighted assets continue to fall to around 25 percent of total assets—among the lowest in Europe.
  - Direct and indirect exposures to the core EA and associated tail risks are significant.
  - Banks’ liquidity risks remain substantial, due in part to reliance on short-term funding, including on their US dollar books.
  - Household debt continues to rise and is now 1.7 times disposable income, as highlighted in the 2012 EC Alert Mechanism Report.

### Policy recommendations to bolster financial system resilience
- Strengthen bank capitalization further, specifically by raising risk weights:
  - High risk-weighted capital ratios in part reflect low risk weights for residential mortgages under IRB models; these may overlook tail risks outside of historical experience and exaggerate resilience.
  - Joint efforts by regulators and the private sector to review appropriateness of risk-weight calibration are underway.
  - As a potential measure, imposing a regulatory floor on risk weights on residential mortgages can be considered.
  - The appropriate use of IRB models should be under constant supervisor scrutiny; disclosure of methodology and assumptions can be further enhanced.
- Strengthen liquidity requirements:
  - After the planned 2013 LCR introduction, prepare to introduce a Basel III net stable funding ratio (NSFR)-type measure in the medium term.
  - Meanwhile, banks should continue to raise their NSFRs towards 100 percent and publish them.
  - The pace of balance sheet adjustments to meet the NSFR should consider short-term impacts on banks’ ability to collect deposits, issue longer debts, and on availability of “safe” assets under regulatory rules.
  - Review adequacy of Basel III liquidity standards for Sweden, addressing issues in the context of ongoing international review of Basel III standards.
  - Consider reformulating the stability fund to introduce a risk-based contribution so that a bank taking a higher risk bears appropriately higher contributions; coordinate this with EU-level initiatives.
- Coordinate regulatory reforms regionally:
  - All major Swedish banks operate extensively in the Nordic-Baltic region with Swedish authorities as home supervisor; Sweden’s approach to regulatory reform is most advanced regionally.
  - Continue extensive prior consultation and coordination with other authorities, especially when regulatory standards are set beyond ex-ante agreed margins, to minimize unintended regulatory arbitrage and anticipate consequences to other jurisdictions.
- Upgrade supervision intensity and crisis management:
  - Remove legal impediments to the FI’s authority to use Pillar II, if any.
  - Resolve legal certainty related to the FI’s power to take corrective and remedial actions against a weak bank; establish a special resolution framework for non-systemic financial institutions (as recommended in the 2011 FSAP Update).
  - With increased resources, the FI should further increase its accountability on resource uses; a common understanding is needed that additional resources should maybe be used for FI’s financial stability mandate rather than into other areas including the international regulatory reform agenda.
  - Formalize meeting procedures of the Domestic Standing Committee for crisis management, including by regularizing meeting schedule.
  - On cross-border cooperation, existing bilateral and regional Memoranda of Understanding (MOU) and EU-wide arrangements provide a basis for cooperation; the 2010 Nordic-Baltic MOU provides principles of burden sharing, but this has not been tested.
  - Authorities are developing a framework to assess how burden-sharing principles work, taking account of fiscal positions of each country; “war games” could be conducted.
  - Given most cross-border arrangements are not legally binding, more assurance is needed; ongoing efforts to establish “a resolution and recovery plan” for the largest Swedish banks can be extended to other major banks.
- Extend and formalize macroprudential institution (CCMP):
  - Next steps include establishing a formal macroprudential authority with a clear financial stability mandate, a set of authorized tools, and accountability obligations.
  - Consider merits of including a mechanism to reflect regional perspectives.
  - Recognize that these initiatives may slow credit supply and growth; monetary policy should take this into account in setting the repo rate and fiscal policy should accommodate it via automatic stabilizers.

### Fiscal policy framework and stance
- Given output is close to potential, strong sovereign access to markets, downside external risks, and modest deviation of the fiscal balance from its structural surplus target, the appropriate setting for 2012 would be a mildly supportive stance anticipating a phased return to the structural surplus target thereafter.
- Automatic stabilizers would operate in case of moderately weaker/stronger than anticipated activity, with scope to reset the structural fiscal trajectory as well if the global economy deviates markedly from projections.
- Rationale: This fiscal stance supports near-term activity while boosting fiscal buffers by further lowering the public debt-to-GDP ratio in the central case, increasing capacity to cope with a sharp and sustained shock and the likelihood of maintaining market access under severe adverse scenarios.
- Authorities’ planned trajectory and 2012 specifics:
  - For 2012, the budget balance is expected to remain at -0.3 percent of GDP in 2012 due to deceleration of growth and new discretionary measures in the 2012 Budget Bill.
  - Authorities’ estimate: structural balance would fall to 1.2 percent of GDP implying a stimulus of 0.2 percent of GDP.
  - Fund staff estimate: structural balance falls to -0.3 percent of potential GDP, implying a stimulus of 0.5 percent of potential GDP.
  - The difference reflects different output gap estimates and methodologies to calculate the structural balance.
  - The authorities increased the expenditure ceiling between 2014–15 by SEK 20 billion.
  - With this, the expenditure ceiling is expected to increase by 1½ percent in nominal terms over the next four years, leaving a budgetary margin of about 1 ½ percent of GDP, based on the authorities’ assumptions.
  - Overall, the Budget Bill contains measures of about 0.4 percent of GDP, partly offset as some previous measures expire; main expansionary measures for 2012 include lowering the VAT rate for restaurant and catering services, extra funding for infrastructure investment, and a package of active labor market measures.
- Medium-term plans and structural reform suggestions:
  - Authorities plan for revenues as a percentage of GDP to remain largely unchanged, with the fiscal balance strengthening to target due to a declining expenditure ratio in line with 4-year nominal spending ceilings.
  - The overall balance would exceed 1 percent of GDP by 2014, and continue to strengthen further over the medium term.
  - Additional contingent measures focus on increasing labor supply: further strengthening the “in-work” tax credit, further raising the lower threshold for the state income tax, reviewing corporate taxation, and tax cuts for pensioners.
  - Tax structure improvements:
    - Tax expenditures are considerable, including multiple VAT rates which curb VAT collections despite a high standard VAT rate.
    - With distributional concerns attenuated by a Gini coefficient of 0.23 and possibility of targeted support to low-income households, restructuring the VAT could improve tax efficiency and create room to reduce the wedge between employers’ gross pre tax labor costs and real take-home pay.
  - Targeting of tax and expenditure measures:
    - Measures aimed at supporting employment of vulnerable groups should be better targeted; more specifically designed measures for workers with greater difficulties entering the labor market would likely be more effective.
  - Reduce procyclicality of local government fiscal positions:
    - Consider allowing greater flexibility for local governments to establish and manage rainy-day contingency funds, particularly if the central government structural surplus target rule is procyclical ex-post.
- Fiscal framework guidance:
  - Adherence to the fiscal surplus target rule over the medium term remains fully appropriate to build buffers against tail risks.
  - The Fiscal Policy Council continues to play an effective role; further increases in its resources and focus on sustainability would reinforce credibility.
  - These fiscal settings would allow monetary policy to respond to external developments—easing if capital inflows continue alongside weak external demand, and tightening if activity and domestic inflationary pressures surge.

### Monetary policy stance
- With the repo rate above the lower effective bound and a fully flexible exchange rate (and the krona likely to depreciate in an adverse tail risk scenario), monetary policy instruments have room to make decisive adjustments should tail risks materialize.
- Monetary policy should continue to be set according to the baseline scenario.

*SWEDEN 2012 ARTICLE IV REPORT INTERNATIONAL MONETARY FUND*

### 45.      Under that baseline scenario, for now, given the benign inflation outlook, modest cost

### _cr12154 - 45. Under that baseline scenario, for now, given the benign inflation outlook, modest cost

### Monetary policy stance and recommendations
- Current policy: repo rate is appropriately set at 1½ percent under the baseline scenario given the benign inflation outlook, modest cost pressures and the prospect of a temporary slowdown in demand.
- Rate path adjustments: should reflect the potential impact of stricter banking regulation and fiscal withdrawal as long as economic slack persists.
- Macroprudential deployment: macroprudential instruments—e.g. tightening LTV rules further, adjusting risk-weighted assets, limiting loans’ length—should be deployed further if the housing market reflates once again.
- Communication and forecasts:
  - Persistent deviations of market forward rates (and survey expectations) from the projected official rate have occurred and could impair monetary transmission if disbelief persists.
  - Recommendation: the Riksbank could start publishing macroeconomic forecasts conditioned on market-implied domestic and foreign forward rates, in addition to forecasts conditioned on its preferred path for the policy rate, and keep the commitment to publish its expected policy rate path under review.
  - Consensus is recommended on the Riksbank’s mandate with regard to asset prices and financial stability.
  - The Riksbank should raise research efforts on equilibrium unemployment composition and macrofinancial linkages to inform policy-rate setting.

### Exchange rate and reserves
- The monetary and free floating exchange rate frameworks remain credible, as indicated by inflation expectations and recent reviews.
- Gross international reserves: 50.4 USD or 344.7 SEK billion; equivalent to 23 percent of imports and 14.8 percent of short term external debt.
- Staff liquidity-gap analysis: suggests a case to increase foreign exchange reserves now, given a higher probability that reserves might be exhausted in a tail-risk event (such as default by one of the European sovereigns now under market pressure) relative to a year ago. Authorities should raise reserve cover further should this probability rise.

### Financial sector policies and vulnerabilities
- Strengths and vulnerabilities:
  - Direct exposures to strained Euro Area economies are negligible and risk-weighted bank capital is high.
  - The financial system is large, directly exposed to Europe, highly concentrated, and reliant on wholesale funding, with low raw capital ratios.
  - Vulnerabilities: elevated household debt, soft housing market, employment and income uncertainties.
- Regulatory and supervisory recommendations:
  - EU Fourth Capital Requirements Directive will be key; use of national flexibility to implement country-specific macroprudential policies is recommended.
  - Authorities plan to raise capital requirements for the four major banks in steps in 2013 and 2015, increase risk weights for mortgages, tighten liquidity regulations, and strengthen supervisory resources and coordination.
  - Additional steps needed: effective use of "Pillar 2"; appropriate application of additional regulatory resources; strengthen early intervention and resolution powers; assess adequacy of international liquidity standards for Sweden; extend resolution planning to all major banks; deepen regional supervisory coordination under Nordic-Baltic arrangements.
  - Establishment of a macroprudential authority under consideration; clarity needed on stability mandate, decision-making, tools, and accountability while respecting Riksbank and supervisor independence.

### Structural reform priorities
- Past reforms since the early 1990s boosted trend growth and employment and strengthened shock resilience; participation rates held up through 2008–09.
- Areas of concern:
  - Reforms could be better targeted to groups with weak labor market attachment (example: payroll tax reduction for new entrants applies to entire young population though only a fraction need help).
  - Recent reforms reduced scope and resources for active labor market policies; design matters—better-focused reforms (e.g., Denmark) have been more effective.
- Housing and rental market:
  - The rental and sub-let markets remain substantially unreformed and subject to severe regulations.
  - Sweden’s fast urbanization (greater cities: Stockholm, Gothenburg and Malmo) and lack of rental property availability have been key determinants of house price surges and resilience.
  - Recommendations:
    - Deregulation of rental markets to reduce shortages, improve employment prospects and address skill shortages, particularly in main cities.
    - Raise investment in residential property (Sweden scores amongst the lowest in the EU) by initiatives at local and central government level to increase land available for construction so supply rises with fundamentals and prevents further price acceleration.

### Authorities' views (summary of differences with staff)
- Macrofinancial concerns: authorities agreed on concerns about high household debt and sought early strengthening of bank capital and macroprudential architecture improvements.
- Fiscal stance:
  - Authorities estimate a stronger underlying fiscal position than staff for 2011–12:
    - Authorities’ cyclically adjusted balance estimates for 2011–12: 0.7 and 1.2 percent of potential GDP, respectively.
    - Staff’s estimates: 0.1 percent of potential GDP for 2011 and -0.4 percent of potential GDP for 2012.
  - Authorities see scope to implement discretionary measures in 2013, specifically greater investment spending, partly reflecting their estimate of the structural surplus; staff favors contingency on weaker-than-expected activity.
  - Authorities view recent measures addressing youth unemployment (reduction in employer social security contributions, reduction of VAT rate on restaurants) as increasing young workers’ opportunities; staff prefers better targeted measures.
- Monetary policy and framework:
  - Authorities acknowledge the large and persistent wedge between projected official rate and market-implied expectations but consider inflation expectations anchored and intend to continue publishing preferred policy paths as a communication tool.
  - Majority of the MPC currently takes financial stability issues into consideration; this stance will be reviewed in the context of establishing a macroprudential council.
  - Monetary authorities will continue analysis of the long-run sustainable rate of unemployment despite modest perceived returns for rate setting.

### Staff appraisal and overall policy stance
- Macroeconomic outlook:
  - Sweden has secured strong growth, low inflation, declining government debt, rising incomes, and a strong external position, but prospects are closely tied to Europe; underlying growth momentum has declined since mid-2011.
  - With exports likely soft, projected muted annual GDP growth in 2012 with activity regaining steam from mid-year; European fragilities imply significant tail risks.
- Policy evaluation:
  - Monetary and fiscal policies responded well—tightening during recovery in 2010–11 and easing in late 2011.
  - Government budget remains guided by medium-term rules allowing automatic stabilizers to operate; inflation expectations are anchored.
  - Fiscal stance: modest relaxation of the fiscal deficit in 2012 is acceptable and leaves public debt on a downward trajectory; framework targets 1 percent of GDP surplus over the cycle and nominal expenditure ceilings.
  - Monetary policy: appropriately accommodative given benign inflation outlook, modest cost pressures, and temporary demand slowdown; set to offset any drag from prudential actions while slack remains and can be adjusted rapidly if tail risks materialize.

### External spillovers and trade exposure (Box 1)
- Direct trade exposure:
  - 70 percent of Swedish total exports go to the EU.
- Sweden: Exports to Europe (Percent of GDP, merchandise exports):
  - European Union 19.3
  - Euro area 13.1
  - Greece 0.1
  - Ireland 0.2
  - Italy 0.9
  - Portugal 0.2
  - Spain 0.6
  - United Kingdom 2.4
- Sweden’s banks’ total financial claims on the Nordic-Baltic region, 2011 (Billions of USD / Percent of total assets):
  - Nordics:
    - Denmark 180.9 15.2
    - Finland 146.2 12.2
    - Norway 129.9 10.9
  - Baltics:
    - Latvia 16.0 1.3
    - Lithuania 15.7 1.3
    - Estonia 17.5 1.5
- Assessment: So far Europe’s sovereign debt turmoil had modest financial and trade effects on Sweden, but a scenario of increased financial market stress in Europe could trigger larger effects via trade and global demand channels.

### Fiscal buffers and stress scenarios (Box 2)
- Objective: assess whether Sweden’s fiscal buffers are adequate to maintain market access through and after a “large” shock by replicating experiences of the United Kingdom, the United States, and Iceland since 2008 within Sweden’s fiscal framework.
- Key simulated outcomes:
  - United Kingdom / United States–like shock:
    - Fiscal deficit would deteriorate by about 3 percentage points of GDP.
    - Debt to GDP would rise to about 50 percent of GDP, including the cost of banking sector support.
  - Iceland–like shock:
    - Fiscal balance would deteriorate by about 8½ percent of GDP.
    - Debt to GDP would rise above 80 percent of GDP, including financial sector support (assumed half of Iceland’s in proportion to Sweden’s financial sector size).
- Market-access threshold consideration:
  - Sweden’s 1990s experience suggests sovereign could retain market access with debt to GDP ratios close to 75 percent but at a high cost; debt ratios beyond this level could result in market pressures.
  - Under adverse tail scenarios affecting Europe, this threshold could be optimistic as many countries would simultaneously seek large financing in disorderly markets.
- Policy implication: authorities’ preference to continue building buffers is cautious and appropriate given scale of potential European tail risks.

### Final recommendations and follow-up
- Continue to set monetary policy according to the baseline scenario while slack persists, offsetting drag from prudential actions.
- Deploy macroprudential instruments further if the housing market reflates.
- Publish forecasts conditioned on market-implied forward rates and review publication commitment on expected policy rate path.
- Seek consensus on Riksbank’s role regarding asset prices and financial stability.
- Proceed with planned increases in bank capital for major banks (2013 and 2015), higher mortgage risk weights, tighter liquidity rules, and strengthened supervisory/resolution frameworks.
- Deregulate rental markets and increase land supply to moderate housing shortages and support employment and medium-term potential output growth.
- Remain on the standard 12-month Article IV consultation cycle.

*International Monetary Fund. Sweden: 2012 Article IV Report (excerpts).*

### Box 3. How Strong is the Pass-through from Repo Rates to Mortgage Rates in Sweden?

### Box 3. How Strong is the Pass-through from Repo Rates to Mortgage Rates in Sweden?

### Summary
- The Riksbank (February 2012 Monetary Policy Report) emphasizes that the pass-through of monetary policy impulses from the policy rate to mortgage rates has weakened according to various measurements over the past year.
- Relative to before the crisis this weakening is milder, but Sweden’s pass-through is still not equaled in peer countries, with the exception of the United Kingdom.

### Measurement
- Pass-through is measured as the simple correlation coefficient between the repo rate and the effective interest rate on housing loans to households and NIPSHs.
- Calculated as the correlation coefficient of the effective interest rate on housing loans to households and repo rates.

### Quantitative findings
- Prior to the crisis:
  - Sweden: 0.99
  - United Kingdom: 0.82
  - United States: 0.67
  - Germany: 0.65
- Since 2008Q1 (post-2008):
  - Sweden: 0.96
  - According to this metric, Sweden’s pass-through has dropped marginally (0.99 → 0.96) but remains higher than that of any of the comparators.

### Comparative context
- Before the crisis Sweden exhibited a very strong transmission to long-term rates in housing lending, with a correlation coefficient of 0.99 comparing favorably to peers cited above.
- The post-2008 marginal decline to 0.96 still leaves Sweden’s pass-through stronger than the reported pre-crisis correlations for the United Kingdom (0.82), United States (0.67), and Germany (0.65).

*Sources: Haver Analytics and Fund staff calculations.*

### Box 6. Key Measures in the 2012 Budget Bill

### Box 6. Key Measures in the 2012 Budget Bill

### Overview
- With ongoing global uncertainty, the 2012 Budget Bill announced the implementation of temporary measures that balance the need to address the slowdown in economic activity while keeping public finances in good order.
- These measures, some of which are temporary, are estimated at about 0.4 percent of GDP for 2012 and 2013.

### Fiscal impact
- Estimated total impact: about 0.4 percent of GDP for 2012 and 2013.

### Major measures
- Lowering of VAT rate of restaurant and catering services:
  - Reduction of the VAT rate from 25 percent to 12 percent.
  - This would bring it in line with the VAT rate on food and hotel services.
- Infrastructure investment:
  - Temporary augmentation of funds for infrastructure maintenance and investments on road and railway networks.
  - Priority given to the most economically important routes.
- Labor market measures:
  - Structural measures to improve employment services and monitoring of job seeking activities.
  - More places in labor market programs for people at risk of long-term unemployment.
  - Temporary increases in the number of employment training and work experience places, and in the number of places in vocational education.
- Tax measures for business and savings:
  - Simplification of taxation of foreign experts.
  - Changes in the rules of closely held companies (3:12 rules).
  - Introduction of investment savings account.
  - Changes to the taxation of endowment insurance.
  - Increase the deduction for research and development expenditure.

*International Monetary Fund. SWEDEN 2012 ARTICLE IV REPORT — Box 6: Key Measures in the 2012 Budget Bill.*

### ANNEX I. SWEDEN: MEDIUM-TERM PUBLIC DEBT

### ANNEX I. SWEDEN: MEDIUM-TERM PUBLIC DEBT

### Baseline outlook and main finding
- Sweden’s fiscal position is expected to remain strong in the baseline scenario as economic activity strengthens over the medium term.
- As consumption and employment recover fully, tax collections are expected to rise, increasing the revenue to GDP ratio, although remaining below the pre-crisis level due to interim tax cuts.
- Expenditures to GDP are projected to decline gradually over the medium term, in part as a result of previous reforms.
- Result: Sweden’s overall balance would remain at a strong surplus of about 2½ percent of GDP over the medium term, bringing debt to GDP to 22 percent in 2017.

### Macroeconomic risks
- Main risks emanate from ongoing uncertainty regarding global growth and developments in the euro area.
- Sweden’s exports are highly sensitive to global demand for consumer durables, capital goods and inventories.
- Continued strains in some euro area countries and banking systems, with potential spillovers to the core, could translate into significantly lower growth in Europe and the rest of the world, weakening activity in Sweden and deteriorating its fiscal position.

### Scenario and stress-test results
- Standard scenarios examined:
  - 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 (real effective exchange rate).
  - One-time 10 percent of GDP shock to contingent liabilities.
- Under all scenarios, public debt remains on a downward trend and the increase in the level of debt compared to the baseline is moderate.
- Worst-case scenario highlighted:
  - Based on a shock to growth, gross debt would reach 35 percent of GDP in 2017, which would still be below the 38.4 percent of GDP observed in 2011.

### Key historical and projected public sector debt (public sector gross debt, in percent of GDP)
- 2007: 40.2
- 2008: 38.8
- 2009: 42.6
- 2010: 39.4
- 2011: 38.4
- 2012: 37.5
- 2013: 35.3
- 2014: 32.0
- 2015: 28.4
- 2016: 24.5
- 2017: 20.6

### Change in public sector debt (in percent of GDP)
- 2007: -5.0
- 2008: -1.4
- 2009: 3.8
- 2010: -3.1
- 2011: -1.0
- 2012: -0.9
- 2013: -2.2
- 2014: -3.3
- 2015: -3.7
- 2016: -3.8
- 2017: -4.0

### Identified debt-creating flows (in percent of GDP)
- Identified debt-creating flows (4+7+12), 2007–2017: -6.4; -2.3; 1.9; -3.0; -2.4; -0.9; -2.2; -3.3; -3.7; -3.8; -4.0
- Primary deficit (2007–2017): -5.3; -3.8; -0.2; -1.1; -1.3; -1.0; -1.8; -2.6; -3.0; -3.5; -3.6
- Revenue and grants (percent of GDP, 2007–2017): 52.5; 51.9; 51.9; 50.6; 49.7; 49.5; 49.8; 49.9; 49.7; 49.8; 49.9
- Primary (noninterest) expenditure (percent of GDP, 2007–2017): 47.2; 48.0; 51.6; 49.5; 48.4; 48.5; 48.0; 47.3; 46.7; 46.4; 46.3

### Automatic debt dynamics and contributions (selected)
- Automatic debt dynamics (2007–2017): -1.1; 1.5; 2.1; -1.9; -1.1; 0.1; -0.4; -0.7; -0.7; -0.4; -0.4
- Contribution from interest rate/growth differential (2007–2017): -0.9; 0.7; 2.5; -1.8; -0.6; 0.1; -0.4; -0.7; -0.7; -0.4; -0.4
  - Of which contribution from real interest rate (2007–2017): 0.6; 0.4; 0.5; 0.6; 0.9; 0.5; 0.4; 0.4; 0.2; 0.3; 0.2
  - Of which contribution from real GDP growth (2007–2017): -1.5; 0.3; 2.0; -2.3; -1.5; -0.4; -0.8; -1.1; -0.9; -0.7; -0.6
- Contribution from exchange rate depreciation (2007–2017): -0.2; 0.9; -0.3; -0.2; -0.5; ... (table continues)

### Gross financing need (in percent of GDP and in billions of U.S. dollars)
- Gross financing need (percent of GDP, 2007–2017): 15.3; 13.9; 15.5; 15.5; 13.6; 13.0; 11.7; 10.0; 8.3; 6.7; 5.1
- Gross financing need (in billions of U.S. dollars, 2007–2017): 70.6; 67.7; 62.9; 71.7; 73.0; 69.3; 65.5; 59.0; 51.5; 43.2; 34.6

### Scenario benchmarks (selected)
- Scenario with key variables at their historical averages (2012–2017): 37.5; 35.0; 32.5; 30.0; 27.5; 25.0; -0.1
- Scenario with no policy change (constant primary balance) in 2012-2017: 37.5; 36.0; 34.3; 32.6; 31.1; 29.7; -0.4

### Key macroeconomic and fiscal assumptions underlying baseline (selected)
- Real GDP growth (in percent, 2007–2017): 3.4; -0.8; -5.0; 5.9; 4.0; 1.0; 2.3; 3.2; 3.0; 2.4; 2.4
- Average nominal interest rate on public debt (in percent, 2007–2017): 4.1; 4.2; 3.1; 2.8; 3.2; 3.1; 3.2; 3.2; 2.8; 3.1; 2.9
- Average real interest rate (nominal rate minus change in GDP deflator, 2007–2017): 1.5; 0.9; 1.1; 1.5; 2.3; 1.2; 1.2; 1.2; 0.8; 1.1; 0.9
- Inflation rate (GDP deflator, in percent, 2007–2017): 2.6; 3.3; 2.0; 1.3; 0.9; 1.9; 2.0; 2.0; 2.0; 2.0; 2.0
- Growth of real primary spending (deflated by GDP deflator, in percent, 2007–2017): -0.4; 1.0; 2.2; 1.5; 1.6; 1.3; 1.3; 1.6; 1.6; 1.7; 2.2

### Additional fiscal metrics (selected)
- Public sector debt-to-revenue ratio (2007–2017): 76.6; 74.8; 82.0; 78.0; 77.3; 75.7; 70.9; 64.3; 57.1; 49.2; 41.2
- Residual, including asset changes (2-3) (2007–2017): 1.4; 0.9; 1.9; -0.1; 1.4; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0

### IMF staff observations and implications for policy (from Annex and surrounding text)
- Even under less favorable conditions reflected in the stress tests, public debt is projected to continue on a downward path and remain below past observed peaks.
- The analysis highlights the importance of monitoring external risks—particularly those arising from the euro area—and preserving fiscal buffers given the sensitivity of Sweden’s external sector to global demand.

*Source: ANNEX I. SWEDEN: MEDIUM-TERM PUBLIC DEBT (Public Sector Debt Sustainability Framework, 2007–2017), IMF 2012 Article IV report.*

### 0.8 percent. Consumption and investment growth are expected to continue to rise in the

### _cr12154 - 0.8 percent. Consumption and investment growth are expected to continue to rise in the

### Economic outlook
- Growth in the near term: "0.8 percent."
- Consumption and investment growth are expected to continue to rise in the coming periods, but "at a somewhat lower rate than normal."
- Labor market: expected to weaken temporarily; resource utilization is lower than normal.
- Inflation: underlying inflation is currently low; "Inflation is projected to increase gradually to 2 percent in the next few years."
- Monetary stance: "The repo rate remains at 1.5 percent" and the Riksbank’s repo rate path indicates it will remain at this low level "for around a year."
- Uncertainty scenarios:
  - Downside: Worsening sovereign debt problems in the euro area could negatively impact Sweden and may require lowering the repo-rate path.
  - Upside: Faster return of confidence among households, companies, and financial markets could raise domestic demand and inflationary pressures, calling for a higher repo-rate path.

### Financial stability
- Main risks: developments in the euro area; indirect channels matter despite small direct exposures of Swedish banks to fiscally weak euro-area countries.
- Funding and liquidity vulnerability: Swedish banks' large usage of short-term wholesale funding, "in particular in US dollars," increases vulnerability to market disruptions and liquidity risks.
- Capitalization and resilience:
  - Swedish banks are currently well capitalized from an international perspective.
  - Riksbank stress tests indicate banks would suffer "only a limited decline in capital ratios" under a severe recession scenario.
- Regulatory developments and recommendations:
  - Accelerated implementation of Basel III capital requirements and a proposal for "higher capital requirements on the four largest banks."
  - Sequencing of further macroprudential measures should take due account of economic conditions.
  - Authorities reviewing the capital adequacy requirement for mortgages; this "will probably lead to higher risk weights for Swedish mortgages, and consequently lower capital ratios, all else being equal," but capital ratios are still expected to be adequate and meet required levels.
  - Introduction of LCR in all currencies, in aggregate, as well as in "euro and USD separately, by 2013."
  - Riksbank recommends banks reduce structural liquidity risks, approach the minimum level of NSFR, and improve transparency on comparable key figures for public reporting on liquidity risks.
  - The Pillar 2 mandate for the Swedish FSA (Finansinspektionen, FI) to be widened through the introduction of CRR/CRD IV ("article 99a"), allowing FI to require higher capital charges for system risks as well as idiosyncratic risks; FI is developing a more transparent process for Pillar 2 with publicly available information.
- Housing-related measures and measurement cautions:
  - The argument that high house price-to-income levels present downward pressure needs further backing; being above historical average does not itself imply a long-term equilibrium below current levels.
  - Price-to-rent ratio may be inappropriate as a measure of fundamentals due to rent control regulation in Sweden.
- Cross-border cooperation:
  - Process initiated to enhance cross-border cooperation; work on a cross-border cooperation agreement on crisis management for Nordea (the only Swedish G-SIFI) has been initiated involving Denmark, Finland, Norway, Sweden, Estonia, Latvia, Lithuania, and Poland.
  - Further enhancement expected with implementation of the forthcoming EU Directive on recovery and resolution of credit institutions and investment firms.

### Fiscal policy and framework
- Assessment: Sweden’s public finances are sound; fiscal position is strong, allowing short-term support to output without jeopardizing long-run sustainability or crisis response capacity.
- Fiscal strategy:
  - Emphasis on retaining strong safety margins in public finances in light of the sovereign debt crisis in Europe.
  - Maintain the surplus target and the expenditure ceiling, while allowing automatic stabilizers to operate freely.
  - Priority to maintain adequate safety margins to have sufficient resources to manage a possible intensified crisis.
- Reform outlook:
  - Government assessment: some scope for reform will likely emerge in 2013, compatible with a "mildly supportive fiscal stance."
  - Future reforms to focus on structurally warranted measures to increase employment, decrease unemployment, and improve economic functioning; reform ambition conditional on sustainable scope for new measures.
- Tax and employment measures:
  - Importance of a tax system that supports employment and growth; full employment is a prerequisite for long-term sustainable growth.
  - Recent measures: introduction of an in-work tax credit and reduction in social security contributions for young people.
  - Reduction of the rate of VAT on restaurants viewed as a way to increase opportunities for young workers; reform will be closely evaluated from tax and employment perspectives and has shown "promising effects on both prices and sales in the restaurant sector."
- Local government finances:
  - Proposal to reduce pro-cyclicality risk: local governments will be allowed to build balancing reserves to use a portion of their surplus from good times to cover deficits in a recession.

### Monetary policy and framework
- Credibility: Monetary and exchange rate framework remain credible.
- Market expectations: Deviation of interest expectations embedded in some asset prices from the Riksbank’s published interest path noted; measuring markets’ interest rate expectations is difficult and estimates are imprecise, especially during turbulence.
- Inflation expectations: "remain firmly anchored at around 2 percent"; difference between asset-price-implied expectations and Riksbank path not viewed as harming credibility.
- Communication: Publishing the interest rate path has served as an effective communication tool; Riksbank strives for communication that is open, factual, comprehensible and up-to-date.
- Monetary policy and financial stability:
  - In each decision the Executive Board assesses the repo-rate path needed for a well-balanced monetary policy—balancing stabilizing inflation around target and stabilizing the real economy.
  - Sveriges Riksbank Act includes promoting a safe and efficient payment system; risks linked to financial markets are taken into account in repo rate decisions.
  - Prevention of asset price imbalances and indebtedness: main tools are effective regulation and supervision; monetary policy acts as a complement.
  - Expectation that monetary policy will still have a role in addressing financial stability issues going forward, regardless of the outcome of the Government Investigation on Financial Crisis Prevention and Management Issues.
- Research: Staff proposes the Riksbank should raise research efforts on equilibrium unemployment; continued and enhanced analysis will be conducted as part of regular analysis.

### Structural reform policy
- Assessment: Structural reforms undertaken have boosted trend growth and employment.
- Targeting and scope:
  - Staff noted concerns about targeting reforms towards groups with weak labor-market attachment; Government emphasizes broad and general reforms to increase incentives to work as most effective, while also undertaking directed reforms for vulnerable groups (youth, immigrants, disabled, long-term unemployed).
  - Trade-off acknowledged between simplicity and pinpoint targeting.
  - Government view: reduction in pay-roll taxes for youth increases employment among this group.
- Active labor market policies (ALMPs):
  - Focus on job-search early in unemployment spell, with access to training, education and subsidized jobs when necessary.
  - Recent implementation of a profiling system to identify individuals needing training early in the unemployment spell.
  - Extra funds allocated during the crisis and recently to maintain quality and effectiveness of ALMPs.

### Housing policy
- Spring Budget 2012 measures:
  - Changes in the sub-let market for owner-occupied dwellings expected to increase the volume of rental apartments and flexibility in the housing market, improving situations in large cities and fast growing regions.
  - Measures to increase housing production include prolongation of the time when rental apartments cannot be subject to a review of rent in the "Rent and Tenancies Tribunal," and an exemption from real estate tax for newly built houses during the first "15 years."
  - Two ongoing investigations into municipal land designation policy to improve availability of land for housing.
- Household and housing indicators:
  - Growth in household indebtedness has continued to dampen due to the slow-down in the housing market, the rise in mortgage rates, and introduction of loan-to-value regulation.
  - Household debt now expected to increase at a moderate rate in the coming period, "albeit still slightly faster than households’ disposable incomes."
  - Average number of persons in each apartment in Sweden is about "2.1 (slightly higher in for example Stockholm)," which is quite low compared to peer economies.

*Source: _cr12154 - 0.8 percent. Consumption and investment growth are expected to continue to rise in the*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12154.pdf_