## _cr1225 — Selected Economic Indicators and Policy Assessment (Norway, 2004–12) ## Source details **Canonical URL:** [_cr1225 — Selected Economic Indicators and Policy Assessment (Norway, 2004–12)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1225.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1225.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1225.pdf.json) --- ### A. Macroeconomic setting — growth, labor market, and inflation - Growth and output gap - Mainland economy growth: 2.1 percent in 2010 and estimated around 2½ percent in 2011. - Real mainland GDP: nearly 3 percent above its pre-crisis level; output gap nearly closed (Annex I). - Growth led by private consumption and a recovery in construction; oil-sector investment rebounded after a sharp contraction in 2010. - Labor market - Unemployment: 2¼ percent (Q1 2008 low); increased by 1¼ percentage points during the downturn; 3¼ percent (October 2011). - Real wage growth: below 1 percent in late 2009; 2½ percent by mid-2011. - Employment and private-sector hiring intentions strengthened; labor constraints increasing in manufacturing. - Inflation - Headline CPI inflation: 0.2 percent (December 2011). - CPI excluding energy products and tax changes (CPI-ATE): 1 percent. - Norway’s CPI-ATE is among the lowest core inflation rates in advanced economies despite solid wage growth and a small output gap. ### B. Policy support and adjustments — fiscal, monetary, financial sector - Fiscal policy - Fiscal stimulus measured by change in structural non-oil budget deficit: 2 percent of trend mainland GDP in 2009. - Fiscal policy broadly neutral in 2010 and 2011. - Structural non-oil deficit returned below 4 percent of the Government Pension Fund–Global (GPF-G)’s capital (benchmark under fiscal guidelines). - Central government expected overall surplus of 10½ percent of trend mainland GDP in 2012. - Gross government debt will remain around 60 percent of mainland GDP; government net asset position (including GPF-G) will rise to 225 percent of mainland GDP. - Monetary policy - Policy rate reduced by 4½ percentage points from October 2008 to June 2009 to 1¼ percent; quarter-point hikes in Oct 2009, Dec 2009, May 2010, May 2011; cut of 50 basis points in Dec 2011 to 1¾ percent. - Current policy rate: 1¾ percent. - Estimated steady state policy rate: 4½ percent. - Calibrated Taylor rule coefficients: 1.5 on inflation deviation; 0.5 on output gap. - Financial sector policy (crisis measures and normalization) - Reforms included easier collateral for central bank liquidity, covered-bond exchange program, corporate bond purchases, and bank capital injections. - Reliance on exceptional measures gradually reduced as recovery progressed. ### C. Exchange rate, external sector, and competitiveness - Exchange rate and imports - Norwegian krone rebounded to around pre-crisis rates; REER moderately above its 10 year average. - Imported goods constitute 30 percent of Norway’s consumption basket. - Exchange rate appreciation contributed materially to low core inflation via lower import price growth. - External balances and terms of trade - Non-oil trade balance remained broadly stable at around -7 percent of mainland GDP due to improving terms of trade. - Current account balance described as fairly stable. - Energy exports: decline in quantities offset by higher prices; non-energy exports fully recovered in real terms relative to the recession. - Exchange rate valuation signals - ULC-based REER appreciated by 35 percent over the last decade and stands significantly above its 30-year average. - Current-account-norm based assessments (CGER-style) point to overvaluation around 12 percent (Annex II). - MB methodology: implied real exchange rate overvaluation = 12.6 percent (current account norm = 13.5 percent of GDP; staff projection = 9.2 percent of GDP). - ES methodology options imply overvaluation ranging from 6.0 percent to 33.3 percent depending on consumption-of-hydrocarbon-revenues assumption. ### D. House prices, household debt, and housing vulnerabilities - House price dynamics and valuations - House prices grew at an annual rate of 11 percent during 2004–07 (OECD average 5½ percent). - House prices are now 20 percent higher than at end-2007. - House price-to-income ratio: 28 percent above its historical average. - Price-to-rent ratio deviation: nearly 70 percent above historical average (highest among OECD economies). - IMF EWE model-based estimates: residential property prices may be misaligned by 15-20 percent (high uncertainty). - Household debt and loan characteristics - Household debt reached 200 percent of disposable income by early 2008 (twice euro area average of 102 percent). - Total household mortgage debt as fraction of disposable income: 195 percent by end-2010; Norges Bank projects further rise over next four years (as of report). - About 95 percent of mortgages are adjustable-rate. - As of Autumn 2011, loans with LTVs exceeding 90 percent accounted for 38 percent of mortgages for home purchases and 26 percent of all new mortgages. - Mortgages rose from 30 percent of GDP in 2000 to 60 percent in 2010. - Vulnerability channels and quantitative evidence - Econometric evidence (panel regression across 20 OECD countries): a 10 percent drop in real house prices in Norway is associated with roughly 1 percentage point lower GDP growth (Annex III). - Norway-specific ratios (end-2009): residential investment to GDP = 3 percent; mortgage debt to GDP = 70 percent. ### E. Financial sector balance sheets, funding, and resilience - Credit growth and composition - Credit growth currently at annual rate of 6½ percent (driven by households and corporates). - Banks and mortgage companies provide about 80 percent of total domestic financing. - Growth of mortgage companies: nearly 50 percent of new mortgages originated by mortgage companies (post-2007 covered bond legislation). - Capitalization and asset quality - Average tier 1 capital ratios increased during recovery; average tier 1 capital ratio over 11 percent. - DNB accounts for about a third of lending; must raise core tier 1 ratio from 7.9 percent to 9 percent by June 2012 to meet EBA requirements (intends to use internal resources). - Non-performing loans stabilized at 1½ percent of total loans. - Loan loss rate particularly high in shipping sector. - Funding and liquidity risks - Norwegian banks finance almost 20 percent of their assets with short-term foreign wholesale funds. - Shortage of adequate liquid assets and low deposit-to-loan ratio make meeting proposed Liquidity Coverage Ratio and Net Stable Funding Ratio challenging. - Covered bond financing increases reliance on market funding versus deposits. - Key financial indicators - Banks’ nonperforming loans to total loans: 1.5 percent. - Customer deposits share (selected years): 44.2 percent → 47.1 percent (trend shown). - Covered bond companies: gross lending and bond debt shares increased markedly in recent years. ### F. Outlook, central scenario, and risks - Staff central scenario and projections - Mainland GDP growth likely to ease in 2012 to 2.2 percent (staff) / around 2¼ percent (staff projections elsewhere). - Mainland GDP projected to plateau near potential growth of 2¾ percent over medium term. - Potential growth estimate components: - labor productivity growth = 1.6 percent per year (average over last two decades); - working-age population growth = 1.1 percent per year (driven by high net immigration). - Total GDP growth expected to be about ¾ percentage points below mainland growth over forecast horizon due to declining oil and gas production. - Composition and medium-term rebalancing - Near term: domestic demand-led growth (solid wage growth, housing momentum, sluggish external demand); non-oil trade deficit expected to deteriorate slightly. - Medium term: rebalancing as macro policies tighten, housing valuations normalize, and external demand improves. - Key downside risks (Risk Assessment Matrix, Annex IV) - Collapse in property markets: 10 percent drop in house prices associated with ~1 percentage point lower GDP growth; high LTVs could raise defaults and stress bank balance sheets. - Intensification of eurozone crisis: global growth deceleration would reduce non-oil exports (60 percent of non-oil exports to Europe), weaken consumer confidence, and could heighten international interbank market stress; prolonged oil price fall below US$70/barrel would depress oil investment. - Inability of banks to meet refinancing needs on foreign wholesale markets: Norwegian banks finance almost 20 percent of assets with short-term foreign wholesale funds—high overall concern and high likelihood. - Substantial and prolonged reduction in oil prices: low likelihood but high impact if realized. - Safe-haven inflows causing rapid appreciation: low likelihood; medium impact if realized. ### G. Macroprudential, fiscal, and structural policy recommendations - Sequencing and stance - Macroprudential tightening is the more pressing near-term priority; fiscal tightening should commence starting in 2013 under central scenario to avoid reopening a negative output gap. - Macroprudential and fiscal tightening should be sequenced carefully to avoid excessive contraction; monetary policy can remain looser for longer if macroprudential and fiscal policies tighten. - Monetary policy should be prepared to respond nimbly to shocks; it is the first line of defense if risks materialize. - Macroprudential measures (specific recommendations) - Make LTV and LTI limits more binding with less scope for banks to exceed them based on subjective judgment. - Raise minimum risk weights on mortgages in coordination with other Nordic countries to limit cross-border regulatory arbitrage. - Reduce tax-code incentives that encourage households and corporations to increase leverage (e.g., reconsider mortgage interest deductibility, increase property tax valuations). - Phase in measures gradually and consider joint effects to avoid excessive housing market disruption. - Capital and liquidity actions - Some banks, especially large banks, need to build further capital to ensure Basel III core tier 1 equity requirements are safely met; DNB to raise core tier 1 ratio from 7.9 percent to 9 percent by June 2012. - Encourage restraint on dividends and remuneration to support capital building. - Reduce reliance on short-term foreign wholesale funding; extend tenor of wholesale funding gradually. - Fiscal and entitlement reforms to address long-run pressures - Gradual structural fiscal adjustment to rebuild precautionary buffers and address the possibility that real return on GPF-G may be less than 4 percent over extended periods. - Policy options to reduce long-run fiscal pressures include: - require employers to contribute to longer-term sick leave benefits (offset by cuts in employer payroll taxes or reduced employer-paid days); - increase use of social security physicians in disability eligibility assessments; - reform public sector pensions to increase incentives to remain in the labor force; - change annual pension indexation from wage growth minus 0.75 percent to CPI inflation; - reduce tax subsidies for owner-occupied housing (e.g., fixed nominal cap on mortgage interest deduction; bring property tax valuations closer to market values); - promote equity finance via Allowance for Corporate Equity (ACE) to reduce tax bias toward debt (noting authorities' concerns and preference to observe other countries’ experience). - Institutional framework for macroprudential policy - Clarify assignment of responsibilities among Norges Bank, Ministry of Finance, and Financial Supervisory Authority (FSA); promote operational independence, accountability, information-sharing, and a strong role for the central bank. - FCC proposal: give Norges Bank main responsibility for assessing macroprudential risks and recommending policy changes; FSA to “comply or explain” if not implementing recommendations. - Establish robust collaboration mechanisms to avoid information-sharing frictions if responsibilities are separated. ### H. Implementation actions and supervisory guidance (authorities’ steps) - FSA mortgage lending guidelines - March 2010 guidelines: LTV on mortgages generally not exceed 90 percent; LTV on home equity loans not exceed 75 percent; LTI on mortgages generally not exceed 300 percent. - December 2011 tightening: lower maximum LTV on mortgages to 85 percent; lower maximum LTV on home equity loans to 70 percent; recommend banks allow for a 5 percentage point interest rate increase when assessing debt-service ability. - Guidelines are not hard caps; FSA survey Autumn 2011 found loans with LTVs exceeding 90 percent accounted for 38 percent of mortgages for home purchases and 26 percent of all new mortgages. - FSA indicated breach of guidelines may compel higher capital requirements under Basel II Pillar 2. - Prudential and regulatory coordination - Authorities decided on December 20, 2011 to keep in force the Basel I floor (80 percent of Basel I limits as transitional floor) until further notice. - Authorities noted potential need to coordinate risk-weight increases with Nordic neighbors due to EEA rules and cross-border branches. ### I. Annex findings — output gap estimation and house price analysis - Output gap (Annex I; summary) - Broad conclusion: "All approaches point to an output gap that has nearly closed." - Average across measures: output gap trough of -1¼ percent in 2010Q2; returned very close to zero by 2011Q2. - Output gap methodologies and results (annex) - HP filter (λ = 1600): output gap about zero as of 2011Q2. - Okun’s law: output gap troughed at -1 percent during recession; Okun-based estimate indicates output ½ percent above trend as of 2011Q2. - Multivariate filter: similar to HP filter; output gap essentially closed as of 2011Q2. - Production function approach (labor share θ = 0.55): output gap -0.4 percent in 2011Q2, reflecting underutilized labor inputs. - Immigration increased labour force and potential output; production function accounts for this effect. - House prices (Annex III; summary) - House price-to-income ratio: 28 percent above historical average. - House price-to-rent ratio deviation: nearly 70 percent above historical average. - Mortgages as share of GDP rose from 30 percent in 2000 to 60 percent in 2010. - Total household mortgage debt to disposable income: 195 percent by end-2010; household debt-to-disposable income reached more than 200 percent (general series). - Econometric evidence: a 10 percent drop in real house prices associated with roughly 1 percentage point lower GDP growth in Norway. *Source: 2011 ARTICLE IV REPORT — NORWAY (selected sections).* ### 1. Selected Economic Indicators, 2004–12 _______________________________________________________ 33 ### _cr1225 - 1. Selected Economic Indicators, 2004–12 ### A. Macroeconomic setting — growth and labor market - Growth and output gap - Norway experienced a steady, domestic demand-led recovery. - Mainland economy growth: 2.1 percent in 2010 and estimated around 2½ percent in 2011. - Real mainland GDP was nearly 3 percent above its pre-crisis level and nearly closing the output gap (Annex I). - Growth led by private consumption and a recovery in construction; oil-sector investment rebounded after a sharp contraction in 2010. - Labor market - Unemployment reached a low of 2¼ percent in Q1 2008. - During the downturn the unemployment rate increased by 1¼ percentage points. - Unemployment moderated to a low 3¼ percent as of October 2011. - Real wage growth: below 1 percent in late 2009, accelerating to 2½ percent by mid-2011. - Employment and private-sector hiring intentions strengthened; labor constraints gradually increasing in manufacturing. ### B. Policy support and adjustments - Fiscal policy - Fiscal stimulus measured by change in structural non-oil budget deficit: 2 percent of trend mainland GDP in 2009. - Fiscal policy broadly neutral in 2010 and 2011. - Structural non-oil deficit returned below 4 percent of the Government Pension Fund–Global (GPF-G)’s capital, the benchmark target under Norway’s fiscal guidelines. - Monetary policy - Key policy rate reduced by 4½ percentage points from October 2008 to June 2009, to 1¼ percent. - Subsequent quarter-point hikes in October 2009, December 2009, May 2010, and May 2011. - Norges Bank cut the policy rate by 50 basis points in December 2011, bringing it to 1¾ percent. - Financial sector policy - Measures during the recession included easier collateral requirements for central bank liquidity, a program exchanging less-liquid covered bonds for government securities, purchases of corporate bonds, and bank capital injections. - Reliance on exceptional measures was gradually reduced as the economy recovered. ### C. Inflation, exchange rate, and external sector - Inflation and core measures - Headline CPI inflation: 0.2 percent as of December 2011. - CPI excluding energy products and tax changes (CPI-ATE): 1 percent. - Norway’s CPI-ATE is among the lowest rates of core inflation in advanced economies despite solid wage growth and a relatively small output gap. - Exchange rate and import prices - The Norwegian krone rebounded after depreciation in early global financial crisis and is around pre-crisis rates. - Imported goods constitute 30 percent of Norway’s consumption basket. - Exchange rate appreciation contributed materially to low core inflation through lower import price growth. - Real effective exchange rate (REER) is moderately above its 10 year average. - External balances and terms of trade - Import volumes rebounded strongly with domestic demand; non-oil export volumes also recovered but more slowly. - Non-oil net export volumes fell, but the non-oil trade balance remained broadly stable at around -7 percent of mainland GDP due to improving terms of trade. - Current account balance described as fairly stable. - Energy exports: decline in energy export quantities offset by higher prices; energy exports and production data show recovery in values. - Non-energy exports have fully recovered in real terms relative to the recession. ### Key statistics (as presented) - Mainland GDP growth: 2.1 percent (2010); around 2½ percent (2011, estimate). - Real mainland GDP: nearly 3 percent above pre-crisis level. - Unemployment: 2¼ percent (Q1 2008 low); increased by 1¼ percentage points during downturn; 3¼ percent (October 2011). - Real wage growth: below 1 percent (late 2009); 2½ percent (mid-2011). - Fiscal stimulus: 2 percent of trend mainland GDP (2009). - Structural non-oil deficit: back below 4 percent of GPF-G capital (post-crisis). - Policy rate path: reduction of 4½ percentage points to 1¼ percent (Oct 2008–Jun 2009); later hikes; cut of 50 basis points in Dec 2011 to 1¾ percent. - Headline CPI inflation: 0.2 percent (December 2011). - CPI-ATE: 1 percent. - Imported goods share of consumption basket: 30 percent. - Non-oil trade balance: around -7 percent of mainland GDP. *2011 ARTICLE IV REPORT NORWAY, INTERNATIONAL MONETARY FUND.* ### 7. Standard metrics suggest the krone ### _cr1225 - 7. Standard metrics suggest the krone ### Exchange rate valuation and competitiveness - Several rule-of-thumb measures point to some krone overvaluation: - Purchasing power parity measures indicate Norway’s price level is high relative to countries with similar income levels. - CPI-based REER has been relatively stable, but rapid wage growth has caused strong appreciation of the ULC-based REER, leaving it substantially higher than its historical average. - More refined measures based on current account norms that account for changes in the value of oil wealth over time point to overvaluation of around 12 percent (Annex II). - Despite these signals of overvaluation, Norway’s non-oil sector remains internationally competitive: - Market shares for Norway’s main non-oil exports have remained stable, if not slightly increasing, over the last decade. - Risks to competitiveness: - Further appreciation of the krone, continued high wage growth, or a turnaround in the terms of trade would likely strain profitability of the non-oil export and import-competing sectors. ### House prices and private-sector debt - Household debt and distributional concentration: - Household debt rose rapidly in the run-up to the recession, reaching 200 percent of disposable income by early 2008, twice the euro area average of 102 percent. - About 95 percent of mortgages are at variable rates. - Since the recession, the household debt-to-income ratio has stabilized, but remains high and masks a growing share of households with debt-to-income ratios in excess of 500 percent. - Housing valuation dynamics: - House prices grew at an annual rate of 11 percent during 2004–07, versus the OECD average of 5½ percent. - Prices dipped briefly during the recession, then resumed an upward trend; house prices are now 20 percent higher than they were at end-2007. - Standard metrics (price-to-rent and price-to-income) indicate a risk of overvaluation; Norway’s deviation of the price-to-rent ratio from its historical average is the highest among all OECD economies. - Model-based estimates suggest price overvaluation could be in the range of 15-20 percent (Annex III), with high uncertainty. - Vulnerabilities: - High LTV ratios imply limited equity buffers for many households. - Econometric evidence suggests a 10 percentage point drop in house prices is associated with lower GDP growth of roughly 1 percentage point in Norway (Annex III). ### Financial sector balance sheets and vulnerabilities - Credit growth and demand: - Credit growth has accelerated during the recovery and is currently growing at an annual rate of 6½ percent, driven by demand from households and corporates. - Banks and mortgage companies provide about 80 percent of total domestic financing. - Capitalization and asset quality: - Tier-1 capital ratios have increased during the recovery due to higher retained profits from strong earnings. - The largest bank, DNB, accounts for about a third of lending and must raise its core tier 1 ratio from 7.9 percent to 9 percent by June 2012 to meet EBA requirements; DNB intends to achieve this via internal resources. - Non-performing loans increased during the recession but have stabilized at 1½ percent of total loans. - The loan loss rate has been particularly high for the shipping sector. - Funding and liquidity risks: - Norwegian banks finance almost 20 percent of their assets with short-term foreign wholesale funds, exposing them to disruptions in global interbank markets. - Shortage of adequate liquid assets and a low deposit-to-loan ratio will make it difficult for Norwegian banks to meet the proposed Liquidity Coverage Ratio and Net Stable Funding Ratio as currently tabled by the Basel Committee. - The growth of mortgage companies (enabled by 2007 legislation allowing covered bond issuance) means nearly half of new mortgages are originated by these institutions, increasing reliance on covered bond financing relative to deposits. - Other indicators: - Banks’ nonperforming loans to total loans: 1.5 percent. - Deposit-to-loan ratios and liquidity metrics have weakened in part due to transferring mortgages to mortgage companies. ### Outlook, risks, and spillovers - Staff central scenario and projections: - Mainland GDP growth is likely to ease in 2012 to 2.2 percent, reflecting global weakness. - Mainland GDP is projected to plateau over the medium term near the potential growth rate of 2¾ percent. - The potential growth estimate is based on: - labor productivity growth of 1.6 percent per year (the average over the last two decades), and - working-age population growth of 1.1 percent per year (driven by high net immigration). - The growth rate of total GDP is expected to be about ¾ percentage points below mainland growth over the forecast horizon due to declining oil and gas production. - Composition of growth: - Near term: growth remains domestic demand-led because of solid wage growth, continued housing market momentum, and sluggish growth in major trading partners; non-oil trade deficit expected to deteriorate slightly. - Medium term: growth expected to rebalance as macroeconomic policies gradually tighten, housing valuations return toward normal levels, and external demand improves; non-oil trade deficit stabilizes. - Key downside risks noted in the Risk Assessment Matrix (Annex IV): - Collapse in property markets: - Elevated housing valuations create risk of a large price reversal, which would depress residential investment and consumption via wealth effects. - High LTV ratios could lead to higher default rates and stress bank balance sheets. - Commercial property price corrections pose risks because lending to this sector accounts for the bulk of corporate lending. - Intensification of the eurozone crisis: - Direct trade and financial linkages to the most vulnerable eurozone countries are limited, but global growth deceleration would reduce non-oil exports (60 percent of which are to Europe) and weaken consumer confidence. - Severe eurozone turmoil could heighten stress in international interbank markets, hampering Norwegian banks’ access to funding and possibly leading to fire sales that threaten bank profitability—though such liquidity stresses could be mitigated by official liquidity support, as during the Lehman crisis. - Severe eurozone turmoil could also lower oil prices; a prolonged fall below US$70/barrel—roughly the cost of production in Norway’s most expensive oil fields—would depress oil investment. *Source: NORWAY 2011 ARTICLE IV REPORT (selected sections).* ### 17. The authorities broadly share these ### _cr1225 - 17. The authorities broadly share these ### Central scenario and key risks - The proposed government budget projects 3 percent growth for 2012, somewhat higher than staff’s latest projection; the budget forecast was made in early October and did not reflect the significant deterioration in the international growth outlook since then. - IMF staff and the authorities broadly share views on the central scenario and key risks. ### Policy mix: overview and sequencing - Macroprudential tightening is needed to reduce financial stability risks associated with high household debt and elevated house prices and to continue moving to a safer financial system, in line with global and European reforms. - Structural fiscal adjustment is necessary to reduce projected long-run fiscal gaps. - Macroprudential and fiscal tightening should be sequenced carefully to avoid re-opening a negative output gap, especially given heightened global risks. - Of the two, macroprudential tightening is the more pressing near-term priority. - The neutral stance envisaged in the 2012 budget is appropriate; fiscal tightening should commence starting in 2013 under the central scenario. - If macroprudential and fiscal policies tighten over the medium term, monetary policy can remain loose for longer to help keep output at potential and reduce risks of excessive exchange rate appreciation and competitiveness problems. - Policies should adjust from these paths if shocks cause substantial deviations from the central scenario. ### Fiscal policy: stance and medium-/long-term challenges - 2012 budget aims for a broadly neutral stance. - The budget targets a structural deficit approximately equal to 4 percent of the GPF-G’s capital—the target under Norway’s fiscal guidelines. - With the GPF-G’s capital growing, the structural non-oil deficit as a percent of trend mainland GDP will increase, but only by 0.3 percent of mainland GDP—implying a broadly neutral fiscal impulse. - No major discretionary policy changes are planned. Key fiscal metrics and projections: - Central government expected to register an overall surplus of 10½ percent of trend mainland GDP in 2012. - Gross government debt will remain around 60 percent of mainland GDP. - Government’s net asset position (including the GPF-G) will rise to 225 percent of mainland GDP. - The GPF-G will start declining as a share of mainland GDP as new oil revenues slow and its real return is spent each year; returns available for budgetary use will fall as a percent of mainland GDP starting in the mid-2020s. - Spending on age and disability pensions will rise steadily as a percent of mainland GDP due to population aging; healthcare spending will also rise due to aging and technological change. Rationale for spending less than 4 percent of GPF-G capital over the medium term: - With the output gap closing, some overperformance against the 4 percent rule will be necessary during the expansion to rebuild a buffer for the next downturn, ensuring the 4 percent target is at least met on average over the cycle. - Real yields on long-term government bonds in major advanced countries have fallen sharply over the last decade, suggesting maintaining a 4 percent real return on the GPF-G’s assets may be challenging; spending out of GPF-G assets may need to be less than 4 percent if the goal of limiting spending to the real return is to be met. - Given the looming long-run fiscal gap, gradual tightening now will help smooth the path of eventual adjustment. Entitlement and tax reform options to reduce long-run fiscal pressures: - Require employers to contribute to longer-term sick leave benefits (they currently contribute only for the first 16 days) to improve incentives to accept returning workers and monitor use of longer-term sick leave; this would need to be offset by cuts in employer payroll taxes or a reduction in the days for which employers pay 100 percent of benefits to keep overall employment costs unchanged. - Increase use of social security physicians in assessing eligibility for disability benefits to promote uniform assessments and limit abuse. - Reform public sector pensions in line with recent reforms of the National Insurance Scheme to increase incentives to remain in the labor force. - Change the annual increase in pensions from wage growth minus 0.75 percent to CPI inflation to yield fiscal savings while preserving the real value of pensions during retirement. - Reduce tax subsidies for owner-occupied housing—e.g., introduce a fixed nominal cap on the amount of a mortgage eligible for interest deduction and bring property tax valuations closer to market valuations—to free resources for productivity-enhancing tax cuts, improve progressivity, and bolster financial stability by reducing excessive mortgage debt risks. - Promote increased use of equity finance by reducing the tax bias toward debt (interest is tax-deductible while equity is not); one option is an Allowance for Corporate Equity (ACE) as used in some countries. Fiscal space for such reforms could be created by housing tax reforms, other corporate/personal tax reforms, or restraint on spending growth. Authorities’ fiscal views: - Authorities reiterated commitment to fiscal discipline and adherence to fiscal guidelines. - They agreed with staff’s recommendation for a somewhat tighter structural deficit over the medium term to ensure guidelines are met on average over the cycle, though they consider 4 percent to remain an appropriate estimate of the likely real return on the GPF-G over time. - Authorities acknowledged long-run fiscal challenges and need to address high enrollment rates in sickness and disability benefits; noted recent reforms requiring employers and physicians to monitor sick leave earlier and more closely. - Regarding ACE introduction, authorities expressed concerns about possible fiscal losses and prefer to observe other countries’ experiences before adopting it. ### Monetary policy - Inflation is expected to rise back to the 2½ percent target only gradually. - Headline inflation currently 0.2 percent and is expected to slowly rise to the 2½ percent target by 2013. - Survey respondents expect inflation of 2.4 percent two years hence. - Solid wage growth, the closing of the output gap, and stabilization of exchange rate appreciation are expected to increase inflation; moderation of global commodity prices should be disinflationary. - The current monetary stance remains appropriate given this outlook. - The current policy rate is broadly in line with both calibrated and estimated Taylor rules; below-target inflation and a closed output gap imply the current policy rate should remain below its steady state level, which is estimated to be 4½ percent. - The calibrated Taylor rule uses coefficients of 1.5 on the deviation of inflation from target and 0.5 on the output gap. - The slight gap between the Taylor rule and the current policy rate can be explained by the standard Taylor rule's failure to take into account financial sector stress conditions, which are currently elevated and justify a policy rate slightly below the standard Taylor rule level. Policy flexibility and conditional responses: - Norges Bank should be prepared to respond nimbly if the outlook changes. - If macroprudential tightening does not occur or is not sufficiently rapid to arrest rising risks associated with elevated house prices and household debt, monetary policy may need to tighten. - A sharper-than-expected deterioration in external conditions (e.g., intensified eurozone turmoil) could necessitate monetary easing. - Authorities agreed monetary policy should be the first line of defense if risks materialize; measures could include policy rate changes and liquidity measures (as during the Lehman crisis). - Authorities concurred with staff’s recommendation for tighter macroprudential policy to allow monetary policy to stay accommodative longer, though they noted uncertainty regarding the effectiveness of macroprudential policies. ### Financial sector issues and institutional framework - Responsibility for financial stability and macroprudential policy is fragmented among Norges Bank, the Ministry of Finance, and the Financial Supervisory Authority (FSA), an independent agency reporting to the Ministry of Finance; coordination and accountability could be enhanced by clearer assignment of responsibilities aligned with institutional strengths. - The Norwegian government has set up a working group expected to make recommendations on a new macroprudential framework in early 2012. - IMF staff analysis suggests guiding principles for strong macroprudential frameworks, including: promoting operational independence to shield policy from political cycles; establishing clear lines of accountability; facilitating information-sharing across policymaking institutions; and bolstering the role of the central bank to harness macroeconomic expertise and promote coordination with liquidity management, payment systems oversight, and monetary policy. Financial Crisis Commission (FCC) proposal: - FCC recommends giving Norges Bank main responsibility for assessing macroprudential risks and recommending changes in macroprudential policies. - Under this proposal, the FSA would need to either implement Norges Bank’s recommendations or publicly explain why it has not—creating a “comply or explain” mechanism that promotes independence, accountability, and central bank expertise. - A potential drawback is that institutional separation could inhibit information-sharing and timely risk identification; appropriate fora and protocols could mitigate this concern. - Alternative proposals include giving a key role to the Ministry of Finance, though that would be less successful in shielding macroprudential policy from the political cycle. *Source: 2011 ARTICLE IV REPORT NORWAY (excerpt).* ### 34. The authorities are taking steps to ### _cr1225 - 34. The authorities are taking steps to ### Financial-stability measures on household debt and housing - In March 2010, the Financial Supervisory Authority (FSA) instituted new guidelines for residential mortgage lending recommending that: - LTV ratios on mortgages should generally not exceed 90 percent; - LTVs on home equity loans should generally not exceed 75 percent; and - loan-to-income (LTI) ratios on mortgages should generally not exceed 300 percent. - In December 2011, the FSA tightened these guidelines by: - lowering the maximum LTV on mortgages to 85 percent; - lowering the maximum LTV on home equity loans to 70 percent; and - recommending that banks allow for an interest rate increase of 5 percentage points when assessing a borrower’s debt-service ability. ### Effectiveness and enforcement concerns - The guidelines are not hard caps and can be exceeded if banks undertake a special prudential assessment. - An FSA survey in Autumn 2011 found: - loans with LTVs exceeding the recommended 90 percent accounted for 38 percent of mortgages for home purchases; and - such loans accounted for 26 percent of all new mortgages. - Conclusion: More binding guidelines and tighter enforcement are necessary to achieve the desired reduction in high-risk loans. ### Regulatory risk weights and cross-border arbitrage - Regulatory risk weights on residential mortgages are relatively low and could be raised. - A risk: increased lending by Norwegian branches of banks based elsewhere in the European Economic Area (EEA), since Norwegian regulation does not apply to these branches under EEA rules. - Possible responses: - Seek agreement from foreign regulators to apply Norwegian risk weights on mortgage loans extended by foreign banks to Norwegian households (jurisdictional reciprocity). - Coordinate with Nordic countries to raise risk weights on mortgages. - Rationale for Nordic coordination: Almost all major foreign banks operating in Norway are based in a few nearby Nordic countries; the Nordic-Baltic Stability Group should help facilitate cooperation. ### Liquidity and capital buffers - Basel III liquidity requirements will be challenging for Norwegian banks because of: - dependence on short-term wholesale funding; and - the limited amount of Norwegian sovereign bonds that can serve as liquid assets. - Recommendation: banks should be encouraged to gradually extend the term of their wholesale funding. - Capital position: - Norwegian banks have an average tier 1 capital ratio over 11 percent. - Continued efforts to encourage banks to restrain dividend payments and remuneration are appropriate given elevated risks. ### Cross-border resolution and institutional progress - Norway’s financial system is closely interlinked with neighboring countries; DNB has significant operations in other Nordic countries and foreign-owned banks account for about a third of lending in Norway. - Progress: creation in August 2010 of the Nordic-Baltic Stability Group, including a preliminary ex ante burden-sharing formula and a regional forum to discuss financial stability issues. - Caveat: the burden-sharing formula is not legally binding and could be re-opened in a crisis. ### Authorities’ views - Authorities reiterated commitment to financial stability and agreed on the need to bolster capital levels, especially for the largest Norwegian banks. - Authorities’ concerns: - that the upcoming European Union Capital Requirements Directive could unduly impede flexibility with regards to exceeding Basel III regulatory minima. - On macroprudential policy: - agreed in principle on the need to tighten macroprudential policies but advocated moving cautiously due to uncertainties about objectives, targets, institutional structure, and tools. - On mortgage risk weights and transition rules: - concurred with staff on considering increased risk weights for mortgages in coordination with regional partners; - noted that transition rules to Basel III, wherein 80 percent of Basel I limits serve as a transitional floor and which the authorities decided on December 20, 2011, to keep in force until further notice, also indirectly raise the risk weights for mortgages. - Considered the FSA’s establishment and tightening of recommended limits on LTV and LTI ratios to be suitable tools. ### Staff appraisal — macro outlook and risks - Recent performance: Norway’s economy continues to perform well amid global turbulence, aided by robust consumer spending, improving terms of trade, a rebounding housing market, and supportive policies including low interest rates and temporary fiscal stimulus. - Growth projections and inflation: - Mainland GDP is projected to grow by around 2¼ percent in 2012. - Inflation is expected to slowly move toward the 2½ percent target over the next two years. - Over the medium term, growth is expected to stay near its potential rate of 2¾ percent. - Key risks: - Intensified turmoil in the eurozone could affect Norway via shaken consumer confidence, lower non-oil exports and oil prices, and strains in international interbank markets. - Domestic risk: buoyant house prices may eventually reverse, adversely affecting consumption, residential investment, and financial stability given very high levels of household debt. ### Policy mix and sequencing - Recommended approach: - Tighter macroprudential policies are needed to reduce risks associated with high household debt and elevated house prices. - Over the medium term, fiscal adjustment is necessary to (i) rebuild precautionary fiscal buffers and ensure that the fiscal guidelines are met on average over the cycle and (ii) address the possibility that the real return on the GPF-G may fall short of the assumed 4 percent for an extended period. - Macroprudential tightening should proceed first; fiscal tightening would be appropriate starting in 2013 under the central scenario. - Monetary policy can offset contractionary effects: keep monetary policy looser than otherwise while implementing relatively tight fiscal policy to reduce risks of excessive exchange rate appreciation and competitiveness problems. - Monetary policy role: - Monetary policy should be the first line of defense if shocks deviate from the central scenario; monetary easing may be needed if external conditions deteriorate sharply. - Conversely, if macroprudential tightening does not occur or is ineffective, monetary tightening may be necessary. ### Specific macroprudential and regulatory recommendations - Considerations for macroprudential tightening: - Make LTV and LTI limits more binding with less scope for banks to exceed them based on subjective judgment. - Raise minimum risk weights on mortgages in coordination with other Nordic countries to limit cross-border regulatory arbitrage. - Reduce tax-code incentives that encourage households and corporations to increase leverage. - Phase in measures gradually and take into account their joint effect to avoid excessive disruptions to housing markets. - Capital and liquidity actions: - Some banks, especially large banks, need to build further capital to ensure Basel III core tier 1 equity requirements are safely met. - Encourage restraint of dividends and remuneration to help achieve capital goals. - Lower liquidity risks by reducing reliance on short-term wholesale funding. ### Institutional framework for macroprudential policy - Benefits of a formal countercyclical macroprudential framework: - establish clear lines of accountability; - shield macroprudential policy from the political cycle; - facilitate information-sharing across policymaking institutions; - bolster the role of the central bank to harness macroeconomic expertise and promote coordination with liquidity management, payment systems oversight, and monetary policy. - Possible institutional arrangements include the one proposed by Norway’s FCC, provided mechanisms ensure robust collaboration between the FSA and the central bank for risk identification and information sharing. ### Entitlement reform and long-run fiscal challenges - Context: oil revenue is expected to decline while pension and healthcare spending will rise, creating a large long-run fiscal gap. - Policy priority: build broad public consensus for entitlement reforms to reduce costs, increase efficiency, and bolster employment while maintaining a strong safety net. - Specific areas for further reform: - reduce growth in spending on sick leave and disability benefits, where enrollment rates are very high by international standards; - improve incentives for longer working lives in public-service old-age pension schemes; - contain growth of old-age pensions by indexing them to CPI inflation. *Source: 2011 Article IV Report — Norway* ### 49. It is recommended that the next ### _cr1225 - 49. It is recommended that the next ### Real economy (change in percent) — key historical and projected figures - Real GDP: 4.0 2.6 2.4 2.7 0.0 -1.6 0.7 1.7 1.7 (2004–2012 series as listed) - Real mainland GDP: 4.1 3.8 4.6 6.8 1.4 -1.6 1.8 2.6 2.2 - Domestic demand: 7.1 5.4 6.4 5.9 1.3 -4.1 3.2 3.0 2.9 - Private consumption: 5.2 4.9 5.1 5.4 1.7 0.0 3.6 3.1 3.0 - Private mainland fixed investment: 12.7 15.1 10.7 14.6 -2.4 -18.4 -1.0 6.1 5.4 - Government consumption: 0.7 1.9 1.9 2.7 2.6 4.3 1.7 2.5 2.5 - Unemployment rate (percent of labor force): 4.5 4.6 3.4 2.5 2.6 3.2 3.6 3.6 3.6 - Output gap (mainland economy, - implies output below potential): -0.9 -0.6 0.7 2.4 1.5 -0.7 -1.0 0.0 -0.2 - CPI (average): 0.5 1.5 2.3 0.7 3.8 2.2 2.4 1.4 2.0 - CPI (end of period): 1.1 1.8 2.2 2.8 2.1 2.0 2.8 1.6 2.2 ### Public finance — central and general government key metrics - Central government (fiscal accounts basis) - Overall balance (percent of mainland GDP) 1/: 9.2 14.5 19.7 18.3 22.3 10.0 8.9 11.5 10.8 - Structural nonoil balance (percent of mainland trend GDP) 2/: -3.4 -3.4 -2.9 -2.8 -3.3 -5.3 -5.4 -5.2 -5.5 - in percent of Pension Fund Global capital 3/: -5.6 -4.9 -3.4 -2.7 -3.0 -4.4 -4.1 -3.5 -3.9 - General government (national accounts basis, percent of GDP) - Overall balance: 11.1 15.0 18.2 17.2 18.8 10.6 10.5 13.2 11.6 - Net financial assets: 103.7 120.6 133.8 139.2 123.8 157.0 164.0 168.1 175.1 - of which: capital of Government Pension Fund Global: 57.9 71.4 81.7 87.4 88.8 111.9 121.8 128.6 137.0 - Table 4 highlights (central government, percent of mainland GDP) - Revenue: 54.7 58.8 62.1 58.6 63.5 56.1 53.6 57.3 56.8 - Oil revenue: 16.3 20.3 23.5 19.2 23.5 16.2 14.9 17.5 17.3 - Nonoil revenue: 38.4 38.5 38.6 39.4 40.0 39.8 38.7 39.9 39.5 - Expenditure: 45.6 44.4 42.6 40.7 41.8 46.3 45.0 46.0 46.2 - Balance: 9.1 14.4 19.4 17.9 21.7 9.8 8.7 11.3 10.6 - Structural nonoil balance 2/: -3.5 -3.4 -2.9 -2.8 -3.2 -5.3 -5.5 -5.2 -5.5 - Fiscal impulse 5/: 3.4 -0.1 -0.4 -0.1 0.4 2.0 0.1 -0.2 0.3 ### External sector and balance of payments — selected figures - Current account balance (percent of mainland GDP): 16.2 21.6 23.2 18.2 23.8 14.7 14.6 17.8 15.9 - Balance of goods and services (percent of mainland GDP): 17.2 21.7 23.4 17.9 23.7 14.3 15.7 18.3 16.2 - Mainland trade balance of goods: -8.0 -7.9 -8.1 -8.4 -8.0 -6.9 -6.7 -6.5 -6.8 - Offshore trade balance of goods: 24.1 28.5 30.5 26.2 31.6 20.8 22.2 24.5 22.8 - Exports of goods and services (volume change in percent): 1.1 0.4 -0.9 1.4 0.7 -4.6 1.1 0.4 0.3 - Imports of goods and services (volume change in percent): 9.7 7.8 9.2 10.1 4.1 -12.7 9.3 4.0 3.7 - Terms of trade (change in percent): 7.7 15.6 11.9 -2.5 13.1 -13.9 6.2 ...... - International reserves (end of period, in billions of US dollars): 44.3 47.0 56.8 60.8 50.9 48.9 52.9 ...... - External indicators (Table 3, percent of mainland GDP projections) - Current account balance (percent of GDP) (2008–16 series): 17.3 11.7 11.5 13.7 12.4 11.2 10.2 9.7 9.2 - Mainland balance of goods 1/: -8.0 -6.9 -6.7 -6.5 -6.8 -7.0 -6.8 -6.6 -6.2 ### Financial sector and government balance-sheet highlights - Three-month interbank rate (year average, in percent): 2.0 2.2 3.1 5.0 6.2 2.5 2.5 2.8 ... - Ten-year government bond yield (year average, in percent): 4.4 3.7 4.1 4.8 4.5 4.0 3.5 3.8 ... - Assets of all financial institutions (billions of NOK, select years): 4,236 5,004 6,112 6,174 6,424 6,391 (2006–Q3 2011 series as listed) - Share of assets owned by Banks: 62.0 62.4 62.5 59.9 56.7 60.2 - Banks excluding foreign subsidiaries — key balance sheet shares (percent of assets) - Lending to households, municip. and non-finan. firms: 72.9 68.6 59.5 53.7 53.7 52.0 - Customer deposits: 44.2 43.2 43.2 43.1 46.6 47.1 - Bond debt: 20.7 18.3 19.0 15.5 14.7 13.1 - Covered bond companies (selected shares): Gross lending ... 94.7 87.5 93.6 94.7 94.6; Bond debt ... 44.7 59.0 66.6 70.0 73.0 ### Annex I — Estimating the size of Norway’s output gap: summary findings - Broad conclusion: - "All approaches point to an output gap that has nearly closed." - "The average across all measures indicates that the output gap reached a trough of -1¼ percent in the second quarter of 2010 and has since returned very close to zero." - Context and interpretation: - Norway experienced a relatively mild recession during the recent global financial crisis; the recession was relatively shallow compared to regional peers. - Factors cited: substantial macroeconomic stimulus, high public sector employment, and limited dependence on the hardest-hit segments of global manufacturing. - The quick rebound in output and low unemployment suggest the output gap narrowed substantially. - Several measures point to a substantial boom in the period leading up to the recession; this boom "could potentially be related to the surge in net immigration during this period." - Methodological note: - Several approaches are considered, ranging from single-variable methods (output or unemployment) to multivariate methods that incorporate a variety of indicators. - Hodrick-Prescott (HP) filter approach: - The HP filter estimates trend output by minimizing variation in the cyclical component while penalizing volatility in trend growth. - In this exercise, the penalty parameter, λ, is set equal to 1600. - Limitations noted: HP filter does not incorporate information from other macro variables (e.g., inflation or unemployment) and faces end-point estimation issues due to its two-sided nature. *Sources: Ministry of Finance; Norges Bank; Statistics Norway; International Financial Statistics; IMF staff estimates and projections; IMF staff projections as of December 2011; Projections based on authorities' 2012 budget; Projections from the 2012 National Budget.* ### annex by adding output forecasts to the end of the ### _cr1225 - annex by adding output forecasts to the end of the ### A. HP-filter estimates and headline findings - The HP-filter approach estimates Norway’s output gap to be about zero as of 2011Q2. - The output gap during the recent recession is estimated to be smaller than that experienced during the previous recession in the early 2000s. - The HP filter marks the period leading up to the recent recession as being associated with a substantial cyclical boom. ### B. Estimating the output gap using Okun’s law - Okun’s law formulation used: (U-U*) = β(Y-Y*), where U is the unemployment rate, Y is output, and U* and Y* are steady-state levels. - Two estimates of U* used: - Average unemployment rate over the last 15 years → U* = 3.5 percent. - OECD’s estimate of the NAIRU for Norway (time-varying). - The coefficient β is estimated using a dynamic specification similar to Balakrishnan, Das, and Kannan (2010). - Key quantitative findings: - Okun’s law estimates indicate the output gap was slightly positive in 2011Q2. - Okun’s law shows the output gap troughed at only -1 percent during the recession. - Based on Okun’s law, the level of output is estimated to be ½ percent above trend as at 2011Q2. - Interpretation: - Because the unemployment rate only increased slightly during the recession, Okun-based estimates imply a shallower output contraction than the HP filter. ### C. Multivariate filter approach - Model structure: - Three gaps: output gap, unemployment gap, capacity utilization gap. - Three identifying relationships: Phillips-curve (output gap → inflation), dynamic Okun’s law (unemployment gap ↔ output gap), capacity utilization equation (capacity utilization ↔ output gap). - Laws of motion for equilibrium values and Bayesian estimation with a multivariate Kalman filter applied. - Findings: - Multivariate-filter output gap estimates are similar to HP filter results. - Both approaches indicate a significant boom before the recent recession and an output gap essentially closed as of 2011Q2. - The embedded Okun’s relationship pushes estimates upward, while low inflation pushes them downward, yielding a near-zero gap. ### D. Production function approach - Production function used (modified to account for capacity utilization): - ))1(ln()ln(HuPRPY···· … with specification including Y (output), P (working age population), PR (labor participation rate), u (unemployment rate), H (hours worked per worker), cu (capacity utilization rate), K (capital stock), and ε (TFP residual). - The parameter α is the average labor share over the sample period, assumed to be 55 percent for Norway. - Advantages and caveats: - TFP captures efficiency and any mismeasurement/omitted inputs. - Estimation relies on total capital stock; variation in capacity utilization affects TFP residuals unless explicitly controlled for. - Key quantitative findings: - Accounting for varying capacity utilization, the production function approach indicates the output gap was -0.4 percent in 2011Q2. - The negative output gap primarily reflects less-than-full utilization of the existing stock of labor: labor force participation rates below trend and total hours below trend (though shrinking). - Capacity utilization has been increasing since 2009 but remains below the pre-recession average. ### E. Impact of immigration on potential output - Recent surge in net immigration in Norway has boosted the labor force and thus potential output. - Of the methods used, only the production function directly incorporates changes in labor force size; this helps explain why the production function approach does not show a large positive output gap in the run-up to the recent recession. ### F. Appendix — model details and calibration - Model gap equations: - Inflation equation (relates level and change of output gap to core inflation): π_t = ... + Ω(y_t - y_{t-1}) + ... - Dynamic Okun’s law (unemployment gap linked to output gap): u_t = φ_1 u_{t-1} + φ_2 y_t + ε_t - Capacity utilization equation: c_t = κ_1 c_{t-1} + κ_2 y_t + ε_t - Equilibrium dynamics: - NAIRU (U_t) follows a stochastic process with transitory and persistent components; persistent shocks to the NAIRU (U_t^G) follow an autoregressive process. - Potential output (Y_t) is modeled as a function of trend growth G_t^Y and changes in the NAIRU, allowing short- and medium-term growth of potential to differ from trend growth. - Estimation method: - Full model estimated by regularized maximum likelihood (Bayesian methodology) requiring prior distributions and values for some steady-state parameters. - Calibration values used in estimation: - θ (labor share) = 0.55 - U_SS (steady-state unemployment rate) = 4 percent - G_SS_Y (potential GDP growth rate, steady-state) = 2.7 percent - Note on priors: choice of priors can materially affect estimates when data are uninformative about some parameters. ### G. Exchange rate valuation, competitiveness, and external assessments - Competitiveness context: - Norway’s ULC-based REER appreciated by 35 percent over the last decade and stands significantly above its 30-year average. - Despite higher costs, Norway’s non-oil exports have maintained a relatively constant market share over the last decade; ratio of non-oil exports to GDP has remained roughly 30 percent. - Exports supported by stronger global demand and improved non-oil terms of trade (index, 2000Q1=100). - Price level and PPP comparison: - Norway’s price level vis-à-vis the U.S. is 46 percent higher than what would be implied by the empirical fit of the relationship between relative price levels and income per capita. - Exchange rate assessment adjusted for oil wealth (CGER-style MB and ES approaches for oil-exporting countries): - MB methodology: - Current account norm = 13.5 percent of GDP - Staff medium-term projection = 9.2 percent of GDP - Implied real exchange rate overvaluation = 12.6 percent - ES methodology (options shown): - To keep consumption of hydrocarbon revenues constant in real terms: - Current account norm = 11.3 percent; Staff projection = 9.2 percent; Implied overvaluation = 6.0 percent - To keep consumption of hydrocarbon revenues constant in real per capita terms: - Current account norm = 13.3 percent; Staff projection = 9.2 percent; Implied overvaluation = 11.6 percent - To keep consumption of hydrocarbon revenues constant as share of mainland GDP: - Current account norm = 20.5 percent; Staff projection = 9.2 percent; Implied overvaluation = 33.3 percent - Sensitivities and additional quantitative notes: - ES results sensitive to real interest rate and size of oil reserves. - Calculations use a 4 percent real return on foreign assets (consistent with the fiscal rule). - A reduction in the rate of return by one percentage point would increase the overvaluation assessment by about 7 percent. - For every 1 billion increase in standard cubic meters of oil equivalent, the assessed overvaluation would be reduced by about 3.5 percent. - Long-run paths: - Adjusted ES approach presents implied equilibrium current account and net foreign assets paths required to keep constant real per capita consumption of hydrocarbon revenues. *Source: IMF staff estimates.* ### ANNEX III. HOUSE PRICES IN NORWAY ### ANNEX III. HOUSE PRICES IN NORWAY ### Overview and key findings - Norwegian house prices have been on a long boom; prices dipped during the global financial crisis but "quickly resumed their upward trend in 2010." - Over the last two years (relative to the report), Norway experienced one of the most rapid paces of real house price appreciation in the OECD. - The house price-to-income ratio is "28 percent above its historical average—higher than the peak reached before the last major house price bust in Norway two decades ago." - House price appreciation has been broad-based across major cities, with higher appreciation in Stavanger, suggesting large common national drivers. - IMF Early Warning Exercise (EWE) model-based estimates suggest Norwegian residential property prices "may be misaligned by 15-20 percent," with high uncertainty around this estimate. ### Factors behind the boom - Supply and population - Real house price growth has persistently exceeded growth of construction costs over the last decade, indicating land availability and/or regulatory constraints on supply responsiveness. - Over the last decade, population growth (partly from robust net immigration) led to total increase in households since 2001 that "has exceeded the increase in dwellings, but only slightly." - Growth of dwellings exceeded growth of households during 2002-2007 when prices grew most rapidly—so supply/population mismatch does not fully explain the boom. - The ratio of house prices to rents has risen sharply and is "nearly 70 percent above its historical average—the highest such deviation in any OECD country," indicating additional demand-side factors beyond supply-population mismatch. - Interest rates and credit conditions - Interest rates have declined considerably in the last decade in both nominal and real terms; mortgage loan rates fell, aided by increased competition among mortgage lenders. - About "95 percent of mortgages loans are adjustable-rate" and interest payments are front-loaded; lower rates have made mortgages cheaper and homes more affordable. - Mortgages rose from "30 percent of GDP in 2000 to 60 percent in 2010." - Total household mortgage debt as a fraction of disposable income increased to "195 percent by end-2010," higher than the previous peak in 1990. Norges Bank estimates this ratio will continue to rise over the next four years (as of the report). - Despite rising household debt, lower interest rates have kept households’ interest burden "broadly constant as a percent of disposable income." - Loan-to-value (LTV) ratios: as of Autumn 2011, "38 percent of mortgages for home purchase and 26 percent of all new mortgages (including refinancing) have LTVs exceeding 90 percent." - The share of mortgages with LTVs over 90 percent has increased since 2010 despite FSA guidelines recommending against allowing LTVs to exceed this level except in exceptional circumstances. - Non-bank mortgage lenders and covered bonds: since 2007, covered bonds allowed specialized mortgage credit institutions to issue covered bonds, improving funding terms; the volume of secured loans by mortgage companies picked up considerably since 2008. In 2011, loans from mortgage companies represented "nearly 50 percent of new mortgages." - Expectations and market behavior - Survey evidence from the FSA shows rising optimism: the percent of households expecting high house price appreciation was "as low as 10 percent in 2008" and "70 percent of the survey respondents expect prices to increase over the next 12 months" at the time of the report. - Sales volumes and the rising velocity of real estate transactions (aside from the 2008 drop) have remained at all-time highs during the last 2 years, signaling speculative motives. - Taxation and incentives - Income tax on imputed rents for owner-occupied housing was abolished in 2005, while rents from rental units remain taxed as income—creating an implicit tax subsidy for owner-occupied housing. - Mortgage interest payments are "fully tax-deductible." - Property taxes are relatively low: "1.2 percent of GDP in 2008 against 1.8 percent of GDP in the average OECD country"; valuations of dwellings for wealth tax purposes are only about a quarter of true market value. - Financial assets and financial debts are valued at true value for wealth tax purposes; this asymmetry creates incentives to hold wealth in housing assets and to leverage balance sheets (more mortgage debt and housing assets) until wealth tax liability is extinguished. - Capital gains on owner-occupied houses and second homes are tax-free if held for minimum periods (one and five years, respectively). - The 2005 abolition of the tax on imputed rents likely increased housing demand substantially; subsequent efforts (including steps in 2010 to raise property valuations for tax purposes) are likely small relative to the 2005 change. - The tax system’s promotion of high household leverage may have amplified the boom’s effect on household balance sheets. ### Summation of drivers - Fundamentals explaining part, but not all, of the boom: - Higher income, population growth, and tax changes have boosted demand. - Slow supply adjustment exerted additional pressure. - Non-fundamental factors: - Optimistic price expectations and favorable financing conditions (low interest rates, loose credit) have likely contributed and may not be sustainable. ### Consequences of a house price decline and vulnerability channels - General concern: the boom and rising household indebtedness make Norway vulnerable to an interest rate hike, slowing income growth, or a house price burst. - Historical context: housing booms fueled by credit expansions have led to major economic and financial disruptions (Nordic crisis of early 1990s; 2007-09 global crisis). - Three main channels through which housing affects the real economy: - Residential investment - Though residential investment is a relatively small share of GDP, it has an outsized impact on Norwegian growth due to volatility. - Housing construction is labor-intensive; fluctuations can lead to large labor reallocation and first-order employment effects. - During the expansion until 2007, housing investment had a sizeable contribution to employment growth. - Private consumption - House prices affect consumption via wealth and liquidity effects; a decline weakens aggregate consumption through negative wealth effects and reduced borrowing capacity when housing is used as collateral. - There is a strong correlation between private consumption and house prices in Norway. - Financial sector - Banks are highly exposed to housing: mortgages account for "40 percent of banks’ assets (including mortgage companies)." - Falling house prices reduce household equity and increase banks’ loss-given-default; this can lead to tighter credit, further price drops, and weaker growth and employment. - In the early 1990s bust, NPL ratio on household lending reached "10 percent." - Mortgage full recourse provides households incentive to avoid default, but the Debt Settlement Act (early 90s) mitigates this by giving debt-distressed persons a route to regain control. - Vulnerabilities: historically high household debt, large fraction of loans with high LTVs, predominance of adjustable-rate mortgages, and a high percentage of financial assets in illiquid forms (insurance reserves account for "over a third of gross financial wealth"). - Indirect effects: - Lower consumption in a bust can cause business loan deterioration (commercial real estate, other business loans), amplifying financial sector stress—as observed in the early 1990s. ### Quantitative vulnerability assessment and econometric evidence - Panel regression model (20 OECD countries, 1980-2011) modeled real GDP growth as a function of change in real house prices and interactions with residential investment/GDP and mortgage debt/GDP; country and year fixed effects included. - Key regression output (as reported): - House price growth coefficient: -0.018 (0.058) - House price growth * residential INV/GDP: 2.515** (0.978) - House price growth * Mortgage credit/GDP: 0.024 (0.048) - Constant: 0.017*** (0.006) - Observations: 427 - Countries: 20 - R-squared: 0.753 - F-test (p-values): 0.000 - Total effect in Norway: 0.0786*** (0.0269) - Interpretation and illustrative scenarios: - The estimates suggest that a "10 per cent drop in real house prices in Norway is associated with roughly 1 percentage point lower GDP growth than otherwise." - A correction of "30 percent in house prices—as occurred during the crisis in the 90s—would exert a non-negligible effect to the real economy." - Norway's exposure: reduced vulnerability from a relatively small residential investment sector is offset by higher vulnerability from high mortgage debt; the overall effect on GDP growth is comparable to the average country in the sample. - Country-specific reference ratios (end-2009 data point used in notes): - Norway: residential investment to GDP ratio = "3 percent" and mortgage debt to GDP ratio = "70 percent." - Mean country in sample: residential investment to GDP ratio = "5" and mortgage debt to GDP ratio = "40 percent." *Source: NORWAY 2011 ARTICLE IV REPORT — INTERNATIONAL MONETARY FUND* ### ANNEX IV. NORWAY: RISK ASSESSMENT MATRIX ### ANNEX IV. NORWAY: RISK ASSESSMENT MATRIX ### 1. Significant reduction in house prices - Overall Level of Concern: Medium - Likelihood of Severe Realization of Threat in the Next 1-3 Years: Medium - Expected Impact if Threat is Realized: High - Key findings and channels: - Norway has the highest house price-to-rent ratio relative to its historical average amongst all OECD economies. - Although this can be partly explained by fundamentals, there is a risk of significant overvaluation. Nonetheless, prices may not necessarily adjust within the next 3 years. - A fall in house prices would dampen private consumption and reduce residential investment. - A 10 percent fall in real house prices is estimated to lower GDP growth by 1 percentage point in Norway (Annex III). - The high level of household debt may imply a considerable increase in default rates that would severely hurt banks’ balance sheets. ### 2. Intensification of the eurozone crisis and global double-dip - Overall Level of Concern: Medium - Likelihood of Severe Realization of Threat in the Next 1-3 Years: Medium - Expected Impact if Threat is Realized: High - Key findings and channels: - The eurozone sovereign debt crisis remains a key global risk, and its intensification could precipitate a global double-dip recession. - Norwegian banks have little direct exposure to the most vulnerable eurozone countries. - Severe eurozone stress and an associated global recession would significantly affect Norway via shaken consumer confidence, lower non-oil exports, falling oil prices, and strains in international interbank markets. ### 3. Inability of banks to meet refinancing needs on foreign wholesale markets - Overall Level of Concern: High - Likelihood of Severe Realization of Threat in the Next 1-3 Years: High - Expected Impact if Threat is Realized: Medium - Key findings and channels: - Due to the recent tensions in the international financial markets, Norwegian banks are facing increasing borrowing costs on foreign wholesale markets. - Norwegian banks finance almost 20 percent of their assets with short-term foreign wholesale funds. - Without prompt support by public authorities, the freezing of foreign wholesale markets could compromise financial stability by triggering rapid deleveraging. ### 4. Substantial and prolonged reduction in oil prices - Overall Level of Concern: Low - Likelihood of Severe Realization of Threat in the Next 1-3 Years: Low - Expected Impact if Threat is Realized: High - Key findings and channels: - The deteriorating outlook in advanced economies could put some mild downward pressure on oil prices. - However, a considerable and prolonged reduction in oil prices could occur if downside risks to the global growth outlook were to materialize. - A mild and temporary decline in oil prices would mainly result only in smaller inflows into the Government Pension Fund. - A substantial and prolonged reduction in oil prices would have a much more severe impact by weakening the offshore sector’s investment demand. ### 5. Safe-haven inflows cause rapid appreciation - Overall Level of Concern: Low - Likelihood of Severe Realization of Threat in the Next 1-3 Years: Low - Expected Impact if Threat is Realized: Medium - Key findings and channels: - Given its strong sovereign position, Norway could achieve safe-haven status and attract large capital inflows. - This possibility is, however, unlikely, as the small outstanding stock of government bonds limits liquidity and Norway’s attractiveness as a safe-haven destination. - Exchange rate appreciation would hurt the export sector, which already faces relatively high labor costs. - Large inflows would also reduce lending rates, which could stimulate even larger household and corporate borrowing, leading to an unsustainable private-sector credit boom that would ultimately burst. *2011 ARTICLE IV REPORT NORWAY 58 INTERNATIONAL MONETARY FUND* ### ANNEX V. EXPOSURE TO THE EUROZONE AND OTHER INTERNATIONAL LINKAGES ### ANNEX V. EXPOSURE TO THE EUROZONE AND OTHER INTERNATIONAL LINKAGES ### International trade and integration - Gross exports exceeded 40 percent of GDP in 2010. - Oil and natural gas constituted 64 percent of exports of goods (2010). - Imports were around 25 percent of GDP in 2010. - Non-oil export destinations (2010): - DEU, NLD: 17% - ITA, ESP: 4% - GRC, IRE, PRT: 2% - Other Euro: 10% - DNK, GBR, SWE: 22% - USA, CAN, JPN, KOR: 16% - BRIC: 10% - ROW: 19% - Assessment: Norwegian exporters unlikely to be heavily affected by further eurozone turmoil so long as it is limited mainly to the periphery; however, a generalized global downturn would depress global oil prices and demand for Norway’s non-oil exports. ### Financial linkages and portfolio composition - Gross foreign assets: 284 percent of GDP (2010). - Gross foreign liabilities: 186 percent of GDP (2010). - Portfolio investment in equity and fixed-income securities accounts for 62 percent of gross foreign assets. - Gross foreign assets composition (2010): - FDI: 16% - Securities in Pension Fund: 45% - Other Securities: 17% - Loans and deposits: 17% - Reserves: 5% - Allocation of securities (2010): - DEU, NLD: 11% - ITA, ESP: 8% - GRC, IRL, PRT: 6% - Other Euro: 11% - DNK, GBR, SWE: 20% - USA, CAN, JPN, KOR: 32% - BRIC: 3% - ROW: 9% - The large majority of securities are held within the Government Pension Fund—Global (GPF-G), which has an explicit mandate to invest between 50 and 60 percent of its portfolio in Europe and can invest abroad only in publicly traded stocks, fixed-income securities, and in real estate up to 5 percent of the total portfolio. ### Banking sector exposures and vulnerabilities - Banks finance almost 20 percent of their assets with short-term foreign wholesale funds. - DNB (largest Norwegian bank) holds no sovereign bonds of Greece, Ireland, Portugal, Belgium, Italy, or Spain. - NIBOR and TED rates (2004–2011): the NIBOR spread is highly correlated with the TED spread, reflecting sensitivity to international funding tensions. - Econometric result: a 1 standard deviation shock to an index of European financial stress reduces Norway’s mainland GDP growth by 0.5 percentage points after three quarters (2009 Norway Article IV Staff Report, Annex III). - Banking-sector recommendations in the source: bolster capital and liquidity buffers; exercise restraint on dividends and remuneration; reduce reliance on short-term foreign wholesale funding; closely monitor mortgage companies relying heavily on covered bond financing. ### Macroeconomic outlook, risks, and monetary/fiscal context - Near-term projection: mainland GDP is projected to grow by around 2¼ percent in 2012. - Medium-term: growth expected to stay near potential rate of 2¾ percent. - Policy rate (at time of report): 1¾ percent. - Unemployment remains low at around 3¼ percent. - Inflation target: 2½ percent; inflation expected to move toward 2½ percent over the next two years from low current rates. - Identified risks: intensified eurozone turmoil (transmits via consumer confidence, lower oil prices, lower non-oil exports, strains in international interbank markets); domestic risk from buoyant house prices and very high household debt (house price-to-rent ratio highest relative to historical average among OECD economies). - Household debt: household debt-to-disposable income ratio reached an all-time high of more than 200 percent. - Residential mortgages make up approximately 85 percent of household debt. ### Policy recommendations and Executive Board assessment - Tighten macroprudential policies, including: - tighten standards for mortgage lending (recommended limits on loan-to-value and loan-to-income ratios); - consider making these limits more binding; - raise minimum risk weights on mortgages in coordination with other Nordic countries to limit cross-border regulatory arbitrage; - reduce tax-code incentives for households and corporations to leverage. - Encourage banks to bolster capital and liquidity buffers and reduce reliance on short-term foreign wholesale funding. - Closely monitor mortgage companies that rely heavily on covered bond financing. - Strengthen institutional framework for macroprudential policy with an enhanced role for the central bank; address coordination with liquidity management, payment systems oversight, and monetary policy; adopt a framework encouraging information-sharing and establish clear lines of responsibility. - Fiscal stance: broadly neutral in the short term; fiscal tightening appropriate over the medium term to rebuild precautionary fiscal buffers and ensure fiscal guidelines are met on average over the cycle. Directors noted contractionary effects from macroprudential and medium-term fiscal tightening can be largely offset by keeping monetary policy looser than otherwise, and that monetary policy should be the first line of defense to address downside risks. - Authorities’ view: Norway’s fiscal framework phases oil income into the economy on par with the expected real return from the Government Pension Fund Global, estimated at four percent; current guidelines imply room for an annual increase in spending of oil revenues in the magnitude of ¼ per cent of GDP of Mainland-Norway over the medium term. ### Key statistics and projections (selected) - Exports (2010): gross exports exceeded 40 percent of GDP. - Oil and natural gas share of exports (2010): 64%. - Imports (2010): around 25 percent of GDP. - Gross foreign assets (2010): 284 percent of GDP. - Gross foreign liabilities (2010): 186 percent of GDP. - Portfolio investment in equity and fixed-income securities share of gross foreign assets: 62%. - Banks’ short-term foreign wholesale funding: almost 20 percent of assets. - Econometric shock effect: 1 standard deviation → -0.5 percentage points mainland GDP growth after three quarters. - Policy rate: 1¾ percent. - Unemployment: around 3¼ percent. - Household debt-to-disposable income ratio: more than 200 percent. - Residential mortgages as share of household debt: approximately 85 percent. - Mainland GDP projection for 2012: around 2¼ percent. - Medium-term potential growth: 2¾ percent. *Source: ANNEX V. EXPOSURE TO THE EUROZONE AND OTHER INTERNATIONAL LINKAGES, _cr1225 - 2011 Article IV Report (Norway).* ### introduction of new macro prudential policies based inter alia on the recommendations in ### introduction of new macro prudential policies based inter alia on the recommendations in ### Macroprudential policy actions and guidance - Introduction of new macro prudential policies based inter alia on the recommendations in Basel III and the European Commission proposal for CRD IV. - Authorities have "duly noted the advice in the staff report." - The Norwegian Financial Supervisory Authority has adopted amendments strengthening its guidelines for prudent residential mortgage lending in late 2011. - The limit for what is considered a prudent loan-to-value ratio for residential mortgages was reduced from 90 to 85 per cent of the property’s market value. - This limit applies to all loans secured by the property. - If total lending exceeds 70 per cent of the property’s market value, interest-only loans should be avoided. - Banks and other regulated lenders operating in the Norwegian market are recommended to make allowances for at least a 5 percentage point increase in interest rates when assessing a loan applicant’s debt-servicing capacity. - The FSA has indicated that breach of the guidelines may compel the FSA to impose higher capital requirements in accordance with the Basel II Pillar 2 process. - As part of general housing policy, a state agency (Husbanken) manages a designated policy towards specific and vulnerable groups in the housing market. ### Concerns regarding Basel III and CRD IV risk weights - The Basel III and the proposed CRD IV frameworks recommend certain standard regulatory risk weights for residential mortgages, and also allow for lower risk weights in banks’ own internal rating models. - Authorities are concerned that these risk weights may be too low, and lead to too low capital requirements for banks operating in the Norwegian market. - The issue will be discussed both domestically and with the Nordic neighbors. - Important factors include: - the method used for calculating minimum capital requirements, - the required minimum percentages. - In December 2011 the Ministry of Finance decided that the so-called Basel I floor, requiring a minimum level for the denominator of the capital requirement calculation, should be continued for an indefinite period for Norwegian banks. ### Tax policy and housing taxation - Authorities acknowledge that owner-occupied housing is favored both as regards the income tax and as regards the wealth tax. - Home ownership is "deeply rooted in Norway," making an increased tax burden on people’s homes a challenging political issue. - A new and fairer model for assessing the tax value of homes for the purpose of wealth taxation was implemented from 2010, implying a roughly 25 per cent increase in such values. ### Mortgage interest deductibility and alternatives - If a tax on imputed rents is not deemed feasible, limited deductibility of mortgage interest payments might be seen as a possible second best measure, but with clear disadvantages: - Housing investments would be affected only to the extent they are debt financed. - It will be difficult and costly in practice to distinguish mortgage interest payments from other interest expenses. - An inadequate distinction may cause investment distortions. - Historical precedent: "A substantial reduction in the tax value of mortgage deductions, however, followed the implementation of the dual tax system in 1992 when interest payments became deductible only against the low capital tax (with a tax rate of 28 percent)." ### Allowance for corporate equity (ACE) - Authorities "take note of staff’s recommendation to introduce an allowance for corporate equity (ACE)." - Few countries have introduced a deduction for the cost of equity in the corporate tax; most countries seem reluctant to forego their share of the source-based taxation. - Authorities do not rule out consideration of the ACE-model sometime in the future, but have no immediate plan to introduce such a substantial change to the tax system. *Source: IMF staff report excerpt.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1225.pdf_