## 1. Income Inequality in Denmark

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---

### Context
- Denmark has a longstanding track-record of sound economic and social policies and consistently scores high in international comparisons of the business climate and competitiveness.
- Education levels are high.
- Flexible labor market model and extensive active labor market policies have fostered comparatively high employment.
- Income inequality is the lowest in the OECD.

### Recent developments
- Economic growth:
  - Real GDP growth: 1.3 percent in 2014; 1.2 percent in 2015.
  - Staff estimates an output gap of about -1 percent of GDP remains (uncertainty is large).
- Inflation and labor market:
  - Headline inflation averaged 0.5 percent in 2015.
  - Core inflation at 1.2 percent in 2015.
  - Unemployment reached 6.2 percent at end 2015.
- Housing and asset prices:
  - Real house prices rose over 6 percent in 2015.
  - Flats up 11 percent in 2015; Copenhagen prices up 14 percent in 2015.
  - Continuation of the recent trend would bring prices for flats and in Copenhagen back to the peak of the previous boom in about one year’s time.
  - Stock market rose 27 percent in 2015 (over six times the gain of the EURO Stoxx index).
- External sector:
  - Current account surplus peaked at 7¾ percent in 2014 and edged down to about 7 percent in 2015.
  - Exchange rate assessed broadly consistent with fundamentals (staff used average estimates of the EBA methodologies and Denmark-specific factors).
- Fiscal position:
  - Headline fiscal balance: 2.1 percent of GDP deficit in 2015.
  - Structural balance (staff estimate): improved by about ¼ percent to -1.1 percent of potential GDP in 2015.
  - Debt-to-GDP ratio around 45 percent of GDP.
- Banking sector:
  - Banks remain liquid, well-capitalized, and profitable.
  - Higher fee income (including from mortgage refinancing) compensated for slightly reduced interest margins.
  - Ongoing reduction of impairment charges has boosted banks’ profits.

### Outlooks and risks
- Baseline forecast:
  - GDP growth: 1.3 percent in 2016 and 1.6 percent in 2017.
  - Output gap expected to close in 2019.
  - Inflation: subdued in 2016; forecast to rise steadily, reaching 2 percent in the outer years.
- Key downside risks:
  - Sharper-than-expected slowdown in Europe or in emerging markets.
  - Exceptionally high household gross debt: 260 percent of disposable income.
  - High share of adjustable rate mortgages: a spike in market interest rates could abruptly raise households’ debt service and depress consumption.
  - Disruption from a “Brexit” (trade and financial flows) and possible capital flow changes.
  - Spillovers from Nordic neighbors (e.g., a cooling Swedish housing market).
  - Unchecked continuation of rapid house price increases increasing the risk of a medium-term correction.
- Authorities’ view on risks:
  - Agreed broadly with staff’s outlook and risk assessment.
  - Noted possibility of sizable capital inflows from safe-haven flows in a Brexit scenario.
  - Attributed recent house price developments to underlying fundamentals (rising disposable incomes, urbanization, low interest rates).
  - Observed that overall household debt levels recently have not been rising.
  - Highlighted a smaller-than-estimated output gap (i.e., lower potential output) as a key risk.

### Policy discussions — overarching
- Policy objectives: sustain the recovery, contain risks, and raise potential growth.
- Fiscal policy: consolidation should be tuned to minimize short-term risks to the recovery.
- Structural policies: product market liberalization and better integration of refugees to raise potential output.
- Housing: enhance flexibility of housing supply, reduce adverse tax incentives, and deploy timely macroprudential measures to reduce medium-term housing risks.

### A. Macroeconomic policy
- Monetary policy:
  - Anchored to a peg to the euro; Danmarks Nationalbank (DN) conducts FX interventions and sets policy interest rates to maintain the peg.
  - DN certificates of deposit (CD) policy rate lowered to an unprecedented -0.75 percent following appreciation pressures in early 2015.
  - January: CD rate raised to -0.65 percent; DN left this rate unchanged when the ECB further reduced policy rates in January and March.
  - DN stated the lower bound for interest rates had not yet been reached and rates could be lowered further if needed.
  - Staff recommendation: normalization of rates should continue as exchange rate pressures allow; if further reductions are needed, DN could mitigate bank impact by raising current account limits (tiering) as done in early 2015.
- Fiscal policy:
  - Authorities’ estimates of structural balance differ substantially from staff’s (authorities: structural deficit 0.6 percent of GDP in 2015; staff: -1.1 percent; EC: 1.8 percent).
  - Government medium-term plan: eliminate the structural deficit by 2020.
  - Envisaged consolidation largely reflects lagged impact of past labor market reforms.
  - No additional discretionary measures envisaged except possible cuts in public consumption to offset refugee-related costs.
  - Authorities project a ¼ percent tightening for 2016 bringing the structural deficit to 0.4 percent of GDP; headline deficit forecast to peak at 2.3 percent in 2016.
  - Staff view: planned fiscal tightening is appropriate; fiscal policy should act as main stabilizer given limited monetary independence and moderate public debt. Allow automatic stabilizers to operate if downside risks materialize; consider short-term fiscal support (higher productive public investment or not offsetting refugee-related spending). Conversely, faster tightening may be needed if recovery accelerates.

### B. Financial sector
- System size and linkages:
  - Total system assets are over 650 percent of GDP.
  - Banking sector accounts for two-thirds of total system assets.
  - Pension assets about 140 percent of GDP.
  - Covered bonds amount to 150 percent of GDP.
  - Bank lending to households at 130 percent of GDP.
  - Important linkages with Nordic neighbors; Danske Bank a large regional player; Sweden-based Nordea the third-largest bank in Denmark.
- Bank resilience:
  - Banks are liquid, well-capitalized, and profitable.
  - Profitability supported by higher fee income and reduced impairment charges.

### Housing sector policies
- Concerns:
  - Tight conditions in segments of the housing market; early signs of overvaluation in large cities.
  - Structural impediments hold back housing supply.
  - Procyclical housing taxes and favorable credit conditions push up demand.
  - Household-level data indicate first-time home buyers take out very sizable loans relative to income.
  - High household debt could amplify the impact of a housing correction on the real economy and banks.
- Recent measures:
  - 2015 DFSA introduction of a “Supervisory Diamond” for mortgage-credit institutions (guidance to limit lending growth, large exposures, reliance on short-term funding, and borrowers’ interest rate risk; promote loan amortization).
  - Minimum down payment requirement of five percent for new mortgages.
  - Establishment of “Seven Best Practices” for lenders in areas with rapid house price increases.
- Concerns about tax measures:
  - 2016 freeze on land tax valuations for tax purposes risks amplifying the house price cycle (analogous to real estate valuation freeze since 2002); freezes imply the rate of taxation falls when property and land prices rise.
- Staff recommendations:
  - Supply policies: alleviate regional supply constraints; make zoning regulations and spatial planning more responsive to housing demand, especially in urban areas; ease strict rental market regulations to facilitate more efficient use of existing housing stock.
  - Tax policies: end the procyclical valuation freezes for land and property taxes.
  - Macroprudential policies:
    - Early preparation of an adequate macroprudential “toolbox” to implement measures without delay when needed.
    - Consider limits on the overall debt-to-income ratio to keep household debt and debt service capacity in check.
    - Recommend raising the new minimum down payment requirement to at least 10 percent to increase household buffers against adverse house price shocks.
    - Consider applying policies with different stringency across regions if regional markets continue to diverge (e.g., targeting high-risk areas such as Copenhagen).

### Housing market and household debt (authorities’ views and staff appraisal)
- Authorities:
  - View zoning regulations and planning as constraints on housing supply but stress these regulations serve multiple objectives, "including safeguarding the quality of housing and living conditions."
  - Political appetite to loosen planning and zoning restrictions was believed to be low.
  - Acknowledge the procyclical impact of housing tax freezes; "new valuations expected to be available in 2019."
  - No additional macroprudential measures were planned at the time; the Danish Systemic Risk Council urged caution regarding low interest rates and house price developments.
  - DFSA emphasized readiness and favored regional differentiation of future measures.
- IMF staff recommendations (Staff appraisal):
  - Develop an adequate macroprudential toolbox, considering "debt-to-income limits" to keep household debt and debt service capacity in check.
  - Improve zoning regulations to alleviate supply constraints.
  - Ease tight rental market regulations to facilitate more efficient use of existing housing stock.
  - End the procyclical valuation freezes for land and property taxes.
  - Note: The Supervisory Diamond for mortgage banks, the five percent cash down payment requirement, and new risk management guidance for mortgage lenders were welcomed as steps taken.

### Financial sector issues, supervision, and DFSA independence
- Progress:
  - Implementation of EU regulations related to CRD IV/CRR and Solvency II, and transposition of the European Bank Recovery and Resolution Directive.
  - DFSA will increase the frequency of on-site inspections for smaller banks and insurance companies.
  - Supervisory diamond for MCIs and the "seven best practices" address several FSAP recommendations.
- Remaining staff advice:
  - Strengthen the operational independence of the DFSA by lengthening terms of board members and introducing strict fit and proper appointment criteria.
  - Establish an internal audit function within the DFSA.
  - Ensure the DFSA has adequate resources to supervise the expanded remit, including pension and insurance sectors.
- Regional coordination:
  - Deeper cooperation with Nordic supervisors is critical.
  - Nordea plans to convert Nordic subsidiaries into branches (Nordea’s mortgage credit arm will remain a subsidiary for local issuance of covered bonds); regional supervisors and governments have started updating agreements for treatment of systemically important branches.
  - Staff underscored need for agreements on information sharing, cross-border supervision, depositor protection, and resolution arrangements.
- Authorities’ stance:
  - Agreed strong regional coordination is key and emphasized securing a level playing field for banks in national markets.
  - Argued the DFSA Board was "strong and independent" and considered it too soon to change the board setup.
  - Work on an internal audit or control function in the DFSA is underway; precise modalities not yet decided.

### Structural reforms — labor market, integration, and productivity
- Labor market reforms and measures:
  - 2010: Maximum duration of unemployment benefits shortened from four to two years and eligibility requirements tightened.
  - 2011: Large pension reform increased statutory retirement rate from 65 to 67 (effective 2019–22) and indexed the retirement age to life expectancy (effective 2025).
  - 2015: More flexible rules to re-qualify for unemployment benefits introduced.
  - 2016 reform package capped the total amount of benefits a household can receive; government plans to use related savings to lower taxes for low-income households later this year (plan supported by staff).
- Refugee integration:
  - Average employment rate for nonwestern immigrants after the first three years remains low at 30 percent; government aim is to raise this rate to 50 percent.
  - New reform package: asylum seekers with granted requests can enter the labor market on "apprentice terms" at a reduced wage for a limited two-year period, qualify for subsidized employment, and receive 20 weeks of vocational and language training.
  - Staff recommendations:
    - Closely monitor implementation of the integration reforms.
    - Consider lifting restrictions on accepting regular work while asylum requests are processed.
    - Consider starting the integration program earlier for asylum seekers whose requests have a high probability of success.
- Productivity and product market regulation:
  - Labor productivity growth has been lagging peers for an extended period; growth in total factor productivity (TFP) "has been particularly weak."
  - 2014 Productivity Commission report included over a hundred recommendations to accelerate productivity; various recommendations were adopted in the government's 2014 Growth Plan.
  - Staff firm-level evidence: closing the product market regulation gap with the European frontier in some network sectors (e.g., passenger rail and postal services) could significantly increase firm TFP.
  - Similar productivity gains from relaxing regulation of retail services, including lifting strict store size restrictions, especially for very large stores (hypermarkets).
- Authorities’ views:
  - Agreed earlier work access for asylum seekers could limit skill losses but noted uncertainty about skills composition of asylum seekers makes the 50 percent employment goal challenging.
  - Government preparing proposals to revise the Planning Act to relax store-size and location restrictions (but not for hypermarkets).
  - Government developing a new strategy to improve efficiency in selected network sectors.

### Staff appraisal and policy recommendations
- Macroeconomic outlook and risks:
  - Chronically slow growth and weak productivity represent long-term challenges despite sound policies; a moderate recovery is continuing with gradual further strengthening expected, but the baseline is subject to considerable downside risks, including house prices fueled by negative interest rates.
- Fiscal policy:
  - Envisaged fiscal tightening is appropriate, but the uncertain outlook calls for flexibility.
  - Given Denmark’s moderate level of public debt and absence of an independent monetary policy, fiscal policy should act as main stabilizer; automatic stabilizers should be allowed to operate if downside risks materialize, with short-term fiscal support if needed; conversely faster fiscal tightening may be needed if recovery accelerates.
- Monetary policy:
  - Should continue to focus on maintaining the peg; normalization of rates should continue if market conditions and exchange rate pressures allow.
- Housing and macroprudential policy:
  - Rapid price increases in segments of the housing market call for vigilance and more action beyond measures already taken.
  - IMF staff recommend consideration of debt-to-income limits and other macroprudential tools.
- Financial sector governance and regional cooperation:
  - Strengthen operational independence of the DFSA by lengthening board members' terms and introducing strict fit and proper appointment criteria.
  - Deepen regional coordination on financial stability, with strong agreements on information sharing, cross-border supervision, depositor protection, and resolution arrangements, especially given Nordea branchification plans.
- Integration and labor market activation:
  - Monitor implementation of integration package; consider lifting work restrictions during asylum processing and starting the integration program earlier for asylum seekers with high probability of success.
- Product market reform:
  - Closing the regulation gap with the European frontier in retail trade and certain network sectors would strengthen competition and raise firm productivity.
  - Government plans to devise a strategy for selected network sectors and liberalize the Planning Act are welcomed; IMF staff recommend a bold approach.
- Procedural recommendation:
  - It is recommended that the next Article IV consultation with Denmark be held on the standard 12-month cycle.

### Box: Income Inequality in Denmark — key findings
- Income inequality in Denmark is the lowest in the OECD; the commonly used Gini coefficient is "around 0.25."
- Hoover Index also indicates high income equality.
- Drivers of low inequality:
  - Wage compression resulting from the collective bargaining system and absence of statutory minimum wage leading to a high effective minimum wage.
  - Substantial income redistribution through the tax and transfer system: total tax revenues at "50 percent of GDP in 2014."
  - Expansive social safety net including free education, health care, and subsidized child care.
- Labor market and gender:
  - About "75 percent of women in Denmark work full time."
  - Gender wage gap is among the smallest in the OECD.
- Trade-offs:
  - High equality is associated with benefits (better economic performance and social outcomes in cross-country studies) and potential costs (wage compression can hamper employment at the lower-skills end and disincentivize labor mobility).
- Authorities’ stance:
  - Equality is considered an intrinsic societal value; new policy proposals are routinely tested for expected impacts on inequality, which can reduce political feasibility if impacts are sizable.
  - Authorities argue the social safety net supports Denmark’s flexicurity model and contributes to strong labor market performance.

### Box 2, Box 3, Box 4 — selected quantitative findings
- Box 2 (Market Pressures in Early 2015):
  - DN purchased foreign exchange to the tune of EUR 36 billion.
  - FX interventions and lower interest rates boosted DN’s earnings by $300 million in 2015.
- Box 3 (External Sector Assessment):
  - Denmark’s current account surplus averaged 5 percent of GDP over the past decade.
  - NIIP reached 47 percent of GDP in 2014.
  - In 2015, the krone depreciated by about 3.5 percent in real effective terms.
  - Combined EBA conclusion: the average REER gap is assessed to be less than 10 percent in 2015.
  - EBA table excerpts (2015): CA Analysis: 7.1 (Percent of GDP) and REER Gap -16.6 (Percent); REER (index) REER Gap -6.9 (Percent); REER (level) REER Gap -1.5 (Percent).
- Box 4 (Four Years Into Negative Interest Rates) — Financial soundness indicators (selected, 2010–15):
  - Regulatory capital to risk-weighted assets: 17.9 (2010) rising to 21.8 (2015).
  - Nonperforming loans to total gross loans: 7.9 (2010) falling to 6.9 (2015).
  - ROA (aggregated): 0.1 (2010) to 0.8 (2015).
  - ROE (aggregated): 1.7 (2010) to 9.1 (2015).
  - MCIs provide 65 percent of all lending to households in Denmark.
  - Overall bank lending-deposit margins have remained broadly stable at 1.5 percent since 2012.

### Annex II — Public Sector Debt Sustainability (baseline and scenarios)
- Nominal gross public debt (percent of GDP):
  - 2014: 38.9
  - 2015: 44.6
  - 2016: 45.8
  - 2017: 47.2
  - 2018: 47.5
  - 2019: 47.5
  - 2020: 47.1
  - 2021: 46.3
  - 2021 (projection alternative chart): 45.5
- Public gross financing needs (percent of GDP):
  - 2014: -2.5
  - 2015: 1.5
  - 2016: 9.3
  - 2017: 7.9
  - 2018: 6.6
  - 2019: 6.8
  - 2020: 8.0
  - 2021: 5.9
  - 2021 (projection alternative chart): 6.4
- Macroeconomic assumptions (selected, 2014–2021):
  - Real GDP growth: 0.4 (2014); 1.3 (2015); 1.2 (2016); 1.3 (2017); 1.6 (2018); 1.8 (2019); 1.8 (2020); 1.9 (2021); 2021 (alternate): 1.8
  - Inflation (GDP deflator): 2.3 (2014); 0.8 (2015); 1.0 (2016); 0.7 (2017); 1.8 (2018); 2.0 (2019); 2.3 (2020); 2.4 (2021); 2021 (alternate): 2.3
  - Nominal GDP growth: 2.7 (2014); 2.1 (2015); 2.2 (2016); 2.0 (2017); 3.4 (2018); 3.8 (2019); 4.1 (2020); 4.3 (2021); 2021 (alternate): 4.2
  - Effective interest rate: 4.8 (2014); 3.4 (2015); 3.6 (2016); 3.1 (2017); 2.8 (2018); 2.8 (2019); 2.6 (2020); 2.7 (2021); 2021 (alternate): 2.7
- Contribution to changes in public debt (percent of GDP, selected):
  - Change in gross public sector debt: -0.1 (2014); 0.0 (2015); 1.2 (2016); 1.4 (2017); 0.3 (2018); 0.0 (2019); -0.4 (2020); -0.7 (2021).
  - Primary deficit (percent of GDP): -1.2 (2014); -1.8 (2015); 1.3 (2016); 1.6 (2017); 1.3 (2018); 1.4 (2019); 1.3 (2020); 1.0 (2021).
- Baseline projections (2016–2021) — key assumptions:
  - Real GDP growth: 1.3 (2016); 1.6 (2017); 1.8 (2018); 1.8 (2019); 1.9 (2020); 1.8 (2021).
  - Inflation: 0.7 (2016); 1.8 (2017); 2.0 (2018); 2.3 (2019); 2.4 (2020); 2.3 (2021).
  - Primary Balance: -1.6 (2016); -1.3 (2017); -1.4 (2018); -1.3 (2019); -1.0 (2020); -0.8 (2021).
  - Effective interest rate: 3.1 (2016); 2.9 (2017); 2.9 (2018); 2.7 (2019); 2.7 (2020); 2.8 (2021).
- Alternative scenarios included Historical scenario, Constant Primary Balance scenario, and Contingent Liability Shock scenario with detailed year-by-year assumptions.

*International Monetary Fund staff summary based on the Denmark country chapter provided.*

### 1. Income Inequality in Denmark _________________________________________________________________ 15

### 1. Income Inequality in Denmark

### Context
- Denmark has a longstanding track-record of sound economic and social policies.
- Consistently scores high in international comparisons of the business climate and competitiveness.
- Education levels are high.
- Flexible labor market model and extensive active labor market policies have fostered comparatively high employment.
- Income inequality is the lowest in the OECD.

### Recent developments
- Economic growth:
  - Real GDP growth: 1.3 percent in 2014; 1.2 percent in 2015.
  - Staff estimates an output gap of about -1 percent of GDP remains (uncertainty is large).
- Inflation and labor market:
  - Headline inflation averaged 0.5 percent in 2015.
  - Core inflation at 1.2 percent in 2015.
  - Unemployment reached 6.2 percent at end 2015.
- Housing and asset prices:
  - Real house prices rose over 6 percent in 2015.
  - Flats up 11 percent in 2015; Copenhagen prices up 14 percent in 2015.
  - Continuation of the recent trend would bring prices for flats and in Copenhagen back to the peak of the previous boom in about one year’s time.
  - Stock market rose 27 percent in 2015 (over six times the gain of the EURO Stoxx index).
- External sector:
  - Current account surplus peaked at 7¾ percent in 2014 and edged down to about 7 percent in 2015.
  - Exchange rate assessed broadly consistent with fundamentals (staff used average estimates of the EBA methodologies and Denmark-specific factors).
- Fiscal position:
  - Headline fiscal balance: 2.1 percent of GDP deficit in 2015.
  - Structural balance (staff estimate): improved by about ¼ percent to -1.1 percent of potential GDP in 2015.
  - Debt-to-GDP ratio around 45 percent of GDP.
- Banking sector:
  - Banks remain liquid, well-capitalized, and profitable.
  - Higher fee income (including from mortgage refinancing) compensated for slightly reduced interest margins.
  - Ongoing reduction of impairment charges has boosted banks’ profits.

### Outlooks and risks
- Baseline forecast:
  - GDP growth: 1.3 percent in 2016 and 1.6 percent in 2017.
  - Output gap expected to close in 2019.
  - Inflation: subdued in 2016; forecast to rise steadily, reaching 2 percent in the outer years.
- Key downside risks:
  - Sharper-than-expected slowdown in Europe or in emerging markets.
  - Exceptionally high household gross debt: 260 percent of disposable income.
  - High share of adjustable rate mortgages: a spike in market interest rates could abruptly raise households’ debt service and depress consumption.
  - Disruption from a “Brexit” (trade and financial flows) and possible capital flow changes.
  - Spillovers from Nordic neighbors (e.g., a cooling Swedish housing market).
  - Unchecked continuation of rapid house price increases increasing the risk of a medium-term correction.
- Authorities’ view on risks:
  - Agreed broadly with staff’s outlook and risk assessment.
  - Noted possibility of sizable capital inflows from safe-haven flows in a Brexit scenario.
  - Attributed recent house price developments to underlying fundamentals (rising disposable incomes, urbanization, low interest rates).
  - Observed that overall household debt levels recently have not been rising.
  - Highlighted a smaller-than-estimated output gap (i.e., lower potential output) as a key risk.

### Policy discussions — overarching
- Policy objectives: sustain the recovery, contain risks, and raise potential growth.
- Fiscal policy: consolidation should be tuned to minimize short-term risks to the recovery.
- Structural policies: product market liberalization and better integration of refugees to raise potential output.
- Housing: enhance flexibility of housing supply, reduce adverse tax incentives, and deploy timely macroprudential measures to reduce medium-term housing risks.

### A. Macroeconomic policy
- Monetary policy:
  - Anchored to a peg to the euro; Danmarks Nationalbank (DN) conducts FX interventions and sets policy interest rates to maintain the peg.
  - DN certificates of deposit (CD) policy rate lowered to an unprecedented -0.75 percent following appreciation pressures in early 2015.
  - January: CD rate raised to -0.65 percent; DN left this rate unchanged when the ECB further reduced policy rates in January and March.
  - DN stated the lower bound for interest rates had not yet been reached and rates could be lowered further if needed.
  - Staff recommendation: normalization of rates should continue as exchange rate pressures allow; if further reductions are needed, DN could mitigate bank impact by raising current account limits (tiering) as done in early 2015.
- Fiscal policy:
  - Authorities’ estimates of structural balance differ substantially from staff’s (authorities: structural deficit 0.6 percent of GDP in 2015; staff: -1.1 percent; EC: 1.8 percent).
  - Government medium-term plan: eliminate the structural deficit by 2020.
  - Envisaged consolidation largely reflects lagged impact of past labor market reforms.
  - No additional discretionary measures envisaged except possible cuts in public consumption to offset refugee-related costs.
  - Authorities project a ¼ percent tightening for 2016 bringing the structural deficit to 0.4 percent of GDP; headline deficit forecast to peak at 2.3 percent in 2016.
  - Staff view: planned fiscal tightening is appropriate; fiscal policy should act as main stabilizer given limited monetary independence and moderate public debt (see Annex 2). Allow automatic stabilizers to operate if downside risks materialize; consider short-term fiscal support (higher productive public investment or not offsetting refugee-related spending). Conversely, faster tightening may be needed if recovery accelerates.

### B. Financial sector
- System size and linkages:
  - Total system assets are over 650 percent of GDP.
  - Banking sector accounts for two-thirds of total system assets.
  - Pension assets about 140 percent of GDP.
  - Covered bonds amount to 150 percent of GDP.
  - Bank lending to households at 130 percent of GDP.
  - Important linkages with Nordic neighbors; Danske Bank a large regional player; Sweden-based Nordea the third-largest bank in Denmark.
- Bank resilience:
  - Banks are liquid, well-capitalized, and profitable.
  - Profitability supported by higher fee income and reduced impairment charges.

### Housing sector policies
- Concerns:
  - Tight conditions in segments of the housing market; early signs of overvaluation in large cities.
  - Structural impediments hold back housing supply.
  - Procyclical housing taxes and favorable credit conditions push up demand.
  - Household-level data indicate first-time home buyers take out very sizable loans relative to income.
  - High household debt could amplify the impact of a housing correction on the real economy and banks.
- Recent measures:
  - 2015 DFSA introduction of a “Supervisory Diamond” for mortgage-credit institutions (guidance to limit lending growth, large exposures, reliance on short-term funding, and borrowers’ interest rate risk; promote loan amortization).
  - Minimum down payment requirement of five percent for new mortgages.
  - Establishment of “Seven Best Practices” for lenders in areas with rapid house price increases.
- Concerns about tax measures:
  - 2016 freeze on land tax valuations for tax purposes risks amplifying the house price cycle (analogous to real estate valuation freeze since 2002); freezes imply the rate of taxation falls when property and land prices rise.
- Staff recommendations:
  - Supply policies: alleviate regional supply constraints; make zoning regulations and spatial planning more responsive to housing demand, especially in urban areas; ease strict rental market regulations to facilitate more efficient use of existing housing stock.
  - Tax policies: end the procyclical valuation freezes for land and property taxes.
  - Macroprudential policies:
    - Early preparation of an adequate macroprudential “toolbox” to implement measures without delay when needed.
    - Consider limits on the overall debt-to-income ratio to keep household debt and debt service capacity in check.
    - Recommend raising the new minimum down payment requirement to at least 10 percent to increase household buffers against adverse house price shocks.
    - Consider applying policies with different stringency across regions if regional markets continue to diverge (e.g., targeting high-risk areas such as Copenhagen).

*International Monetary Fund staff summary based on the Denmark country chapter provided.*

### 22.      The authorities are monitoring the housing market and household debt closely. On the

### _cr16184 - 22.      The authorities are monitoring the housing market and household debt closely. On the

### Housing market and household debt
- Authorities view zoning regulations and planning as constraints on housing supply but stress these regulations serve multiple objectives, "including safeguarding the quality of housing and living conditions."
- Political appetite to loosen planning and zoning restrictions was believed to be low.
- Authorities acknowledged the procyclical impact of housing tax freezes; the property assessment system had "necessitated its effective suspension."
- Government working on a new valuation system; "new valuations expected to be available in 2019."
- No additional macroprudential measures were planned at the time; the Danish Systemic Risk Council urged caution regarding low interest rates and house price developments.
- DFSA emphasized readiness and the ability of the Danish political system to act swiftly when needed and favored regional differentiation of future measures—similar to its "seven best practices"—to improve acceptability and avoid criticisms that overly strict regulations stifle growth.
- IMF staff recommendations (Staff appraisal):
  - Develop an adequate macroprudential toolbox, considering "debt-to-income limits" to keep household debt and debt service capacity in check.
  - Improve zoning regulations to alleviate supply constraints.
  - Ease tight rental market regulations to facilitate more efficient use of existing housing stock.
  - End the procyclical valuation freezes for land and property taxes.
  - Note: The Supervisory Diamond for mortgage banks, the five percent cash down payment requirement, and new risk management guidance for mortgage lenders were welcomed as steps taken.

### Financial sector issues, supervision, and DFSA independence
- Progress on 2014 FSAP recommendations has been made, including implementation of EU regulations related to CRD IV/CRR and Solvency II, and transposition of the European Bank Recovery and Resolution Directive to strengthen the resolution regime.
- DFSA will increase the frequency of on-site inspections for smaller banks and insurance companies.
- The supervisory diamond for MCIs and the "seven best practices" address several FSAP recommendations.
- Remaining staff advice to follow up on:
  - Strengthen the operational independence of the DFSA by lengthening terms of board members and introducing strict fit and proper appointment criteria.
  - Establish an internal audit function within the DFSA to ensure integrity and consistency of supervisory work.
  - Ensure the DFSA has adequate resources to supervise the expanded remit, including pension and insurance sectors.
- Regional coordination:
  - Due to high interconnectedness of the Nordic banking sector, deeper cooperation with Nordic supervisors is critical.
  - Nordea plans to convert Nordic subsidiaries into branches (Nordea’s mortgage credit arm will remain a subsidiary for local issuance of covered bonds); regional supervisors and governments have started updating agreements for treatment of systemically important branches.
  - Staff underscored the need for agreements on information sharing, cross-border supervision, depositor protection, and resolution arrangements.
- Authorities’ views:
  - Authorities agreed strong regional coordination is key and emphasized securing a level playing field for banks in national markets and close coordination with host supervisors for systemically important branches.
  - Authorities argued the DFSA Board was "strong and independent" with no history of political interference and considered it too soon to change the board setup.
  - Work on an internal audit or control function in the DFSA is underway; precise modalities not yet decided.

### Structural reforms — labor market, integration, and productivity
- Recent labor market reforms and changes:
  - 2010: Maximum duration of unemployment benefits shortened from four to two years and eligibility requirements tightened.
  - 2011: Large pension reform increased statutory retirement rate from 65 to 67 (effective 2019–22) and indexed the retirement age to life expectancy (effective 2025).
  - 2015: More flexible rules to re-qualify for unemployment benefits introduced.
  - 2016 reform package capped the total amount of benefits a household can receive; government plans to use related savings to lower taxes for low-income households later this year (plan supported by staff).
- Refugee integration:
  - Denmark saw a significant uptick in asylum requests in 2015.
  - Average employment rate for nonwestern immigrants after the first three years remains low at 30 percent; government aim is to raise this rate to 50 percent.
  - New reform package: asylum seekers with granted requests can enter the labor market on "apprentice terms" at a reduced wage for a limited two-year period, qualify for subsidized employment, and receive 20 weeks of vocational and language training; package also provides incentives for companies to hire under new schemes.
  - Staff recommendations:
    - Closely monitor implementation of the integration reforms.
    - Consider lifting restrictions on accepting regular work while asylum requests are processed.
    - Consider starting the integration program earlier for asylum seekers whose requests have a high probability of success to limit skill and employability losses.
- Productivity and product market regulation:
  - Labor productivity growth has been lagging peers for an extended period; growth in total factor productivity (TFP) "has been particularly weak."
  - Despite a favorable business environment, limited competition and regulatory constraints in some sectors have held back growth.
  - 2014 Productivity Commission report included over a hundred recommendations to accelerate productivity, including strengthening competition frameworks, streamlining business regulations, and lowering corporate income taxes; various recommendations were adopted in the government's 2014 Growth Plan.
  - Staff firm-level evidence: closing the product market regulation gap with the European frontier in some network sectors (e.g., passenger rail and postal services) could significantly increase firm TFP and produce downstream gains for the broader economy.
  - Similar productivity gains from relaxing regulation of retail services, including lifting strict store size restrictions, especially for very large stores (hypermarkets).
- Authorities’ views:
  - Authorities agreed that earlier work access for asylum seekers could limit skill losses but noted uncertainty about skills composition of asylum seekers makes the 50 percent employment goal challenging.
  - Government preparing proposals to revise the Planning Act to relax store-size and location restrictions (but not for hypermarkets).
  - Government developing a new strategy to improve efficiency in selected network sectors.

### Staff appraisal and policy recommendations
- Macroeconomic outlook and risks:
  - Chronically slow growth and weak productivity represent long-term challenges despite sound policies; a moderate recovery is continuing with gradual further strengthening expected, but the baseline is subject to considerable downside risks, including house prices fueled by negative interest rates.
- Fiscal policy:
  - Envisaged fiscal tightening is appropriate, but the uncertain outlook calls for flexibility.
  - Given Denmark’s moderate level of public debt and absence of an independent monetary policy, fiscal policy should act as main stabilizer; automatic stabilizers should be allowed to operate if downside risks materialize, with short-term fiscal support if needed; conversely faster fiscal tightening may be needed if recovery accelerates.
- Monetary policy:
  - Should continue to focus on maintaining the peg; normalization of rates should continue if market conditions and exchange rate pressures allow.
- Housing and macroprudential policy:
  - Rapid price increases in segments of the housing market call for vigilance and more action beyond measures already taken.
  - IMF staff recommend consideration of debt-to-income limits and other macroprudential tools.
- Financial sector governance and regional cooperation:
  - Strengthen operational independence of the DFSA by lengthening board members' terms and introducing strict fit and proper appointment criteria.
  - Deepen regional coordination on financial stability, with strong agreements on information sharing, cross-border supervision, depositor protection, and resolution arrangements, especially given Nordea branchification plans.
- Integration and labor market activation:
  - Monitor implementation of integration package; consider lifting work restrictions during asylum processing and starting the integration program earlier for asylum seekers with high probability of success.
- Product market reform:
  - Closing the regulation gap with the European frontier in retail trade and certain network sectors would strengthen competition and raise firm productivity.
  - Government plans to devise a strategy for selected network sectors and liberalize the Planning Act are welcomed; IMF staff recommend a bold approach.
- Procedural recommendation:
  - It is recommended that the next Article IV consultation with Denmark be held on the standard 12-month cycle.

### Box: Income Inequality in Denmark — key findings
- Income inequality in Denmark is the lowest in the OECD; the commonly used Gini coefficient is "around 0.25."
- Hoover Index also indicates high income equality.
- Drivers of low inequality:
  - Wage compression resulting from the collective bargaining system and absence of statutory minimum wage leading to a high effective minimum wage.
  - Substantial income redistribution through the tax and transfer system: total tax revenues at "50 percent of GDP in 2014."
  - Expansive social safety net including free education, health care, and subsidized child care.
- Labor market and gender:
  - About "75 percent of women in Denmark work full time."
  - Gender wage gap is among the smallest in the OECD.
- Trade-offs:
  - High equality is associated with benefits (better economic performance and social outcomes in cross-country studies) and potential costs (wage compression can hamper employment at the lower-skills end and disincentivize labor mobility).
- Authorities’ stance:
  - Equality is considered an intrinsic societal value; new policy proposals are routinely tested for expected impacts on inequality, which can reduce political feasibility if impacts are sizable.
  - Authorities argue the social safety net supports Denmark’s flexicurity model and contributes to strong labor market performance.

*International Monetary Fund — Selected extracts from Article IV staff report on Denmark*

### Box 2. Market Pressures in Early 2015

### Box 2. Market Pressures in Early 2015

### Exchange rate defense and interventions
- Demand for krone rose sharply in January 2015 after Switzerland lifted its euro ceiling.
- Danmarks Nationalbank (DN) actions:
  - Cut its deposit interest rate in several steps from -0.05 percent to -0.75 percent.
  - Purchased foreign exchange to the tune of EUR 36 billion.
  - Suspended government debt issuance.
- Outcome:
  - DN’s defense of the exchange rate was successful and pressures have eased.
  - Investors speculating on krone appreciation—mostly Danish pension funds—gradually unwound their positions from March onward.
  - As pressures subsided, the issuance of government bonds resumed in October 2015 and the earlier foreign exchange purchases were fully reversed.
  - Policy rates remained deep in negative territory though DN raised the marginal deposit by 10 basis points in early 2016.
  - The FX interventions and lower interest rates boosted DN’s earnings by $300 million in 2015.

### Timing and scale indicators (as presented)
- Timeline references in the box: Jan 2014 through Jan 2016.
- International reserves presented in the charts are reported in Billions DKK (left axis) and Percent annualized GDP (right axis).

*Sources: Danmarks Nationalbank and Fund staff calculations.*

---

### Box 3. External Sector Assessment

### Current account, NIIP, and financial flows
- Denmark’s current account remains in surplus; over the past decade, the surplus has averaged 5 percent of GDP.
- Net international investment position (NIIP) reached 47 percent of GDP in 2014.
- Financial account dynamics:
  - Large net foreign investments from the banking sector (about 9 percent of GDP in 2015).
  - Portfolio investment has been volatile, but on net averages around zero in recent years.
- As appreciation pressures have eased, international reserves have returned broadly to the 2014 level.

### Staff assessment and REER movements
- Staff assesses that the external position and the krone are broadly consistent with fundamentals and desirable policies.
- The Danish krone is pegged to the euro.
- In 2015, the krone depreciated by about 3.5 percent in real effective terms to a level broadly in line with the average over the past 25 years.
- The staff’s assessment is informed by EBA estimates and Denmark-specific factors.

### External Balance Assessment (EBA) results (2015)
- EBA estimates are mixed:
  - CA model suggests the krone is substantially undervalued implied by the large current account gap.
  - REER index and level models indicate the krone is close to the norm and only moderately undervalued.
- Combined EBA conclusion: the average REER gap is assessed to be less than 10 percent in 2015.
- Table excerpts (EBA 2015 estimates, as presented):
  - CA Analysis: 7.1 (Percent of GDP) and REER Gap -16.6 (Percent)
  - REER (index) Analysis: .. and REER Gap -6.9 (Percent)
  - REER (level) Analysis: .. and REER Gap -1.5 (Percent)
  - Note: REER gaps: negative indicates undervaluation.
  - Note: Estimates are based on data available as of April 2016.

### Factors not fully captured by EBA
- Persistent current account surpluses mostly driven by large savings for retirement.
- Merchanting trade (trade in goods that do not physically cross the border of the merchant’s resident country) contributes to persistently larger current account balances.
- Specialization in sectors such as design and pharmaceuticals, which have benefited from high price increases, contributes to export performance.
- Staff assesses that these structural factors would significantly raise the current account norm in the EBA CA approach, implying a smaller CA gap.

*Sources: Fund staff calculations.*

---

### Box 4. Four Years Into Negative Interest Rates

### Timeline of negative rate policy
- Negative rates introduced in Denmark in 2012 to discourage capital inflows and hold the peg.
- July 2012: DN entered negative territory; DN’s certificates of deposit (CD) rate initially set at -0.2 percent.
- Early 2013: CD rate raised to -0.1 percent.
- April 2014: DN briefly exited negative rates.
- September 2014: DN broke through the zero bound again at -0.05 percent when the ECB introduced a negative rate on its deposit facility.
- Early 2015: DN implemented a series of deeper cuts, bringing the CD rate to a low of -0.75 percent.

### Financial sector resilience and transmission
- Credit institutions remain resilient almost four years into negative rates.
  - Bank earnings have increased since negative rates were first introduced despite subdued demand for new loans.
  - Strong profitability reflects rising fee income and historically low impairment charges, partly reflecting improved debt-servicing capacity in the low interest rate environment.
  - No evidence of cash hoarding among corporates or households.
- Differences between banks and mortgage credit institutions (MCIs):
  - MCIs provide 65 percent of all lending to households in Denmark.
  - MCIs operate under the balance principle—funding mortgage loans with issuance of covered bonds—and do not accept deposits.
  - Banks raise funding through deposits and wholesale instruments, and invest in loans and securities.
- Deposit and lending rate pass-through:
  - Deposit rates on new deposits have remained around zero since the negative rate era began, with only large corporates and institutional clients facing negative rates (deposit rates display downward stickiness).
  - Pass-through to lending rates has been incomplete.
  - Overall bank lending-deposit margins have remained broadly stable at 1.5 percent since 2012—about the historical average.
  - The impact on overall bank net interest margin was further reduced by lower costs of market funding (representing about 30 percent of bank liabilities).

*Sources: Danmarks Nationalbank and Fund staff calculations.*

*Italic: IMF staff compilation from the IMF country report content provided.*

### Box 4. Four Years Into Negative Interest Rates (continued)

### Box 4. Four Years Into Negative Interest Rates (continued)

### Impact on Mortgage Credit Institutions (MCIs) and Covered Bonds
- Finding: The impact on MCIs has been even more limited and demand for covered bonds remains strong.
- Mechanism: Because of their business model that relies on covered bond issuance to finance mortgage loans, MCIs realize a set fee over yields in the covered bond market.
- Additional factors: Additional income from raised fees and stronger refinancing activity has also contributed to solid margins.

### Mortgage Interest Rates and Policy Rate Context
- Chart note (textual): Mortgage Interest Rates, New Agreements (In percent) — series shown include Mortgage Rate, Covered Bond Yield, and Policy rate; source: Danmarks Nationalbank. (Period indicated up to 2016M03; marking “Negative rates.”)

### Key Macroeconomic Findings (selected from figures and tables)
- Growth and labor market:
  - Real GDP growth: series shown in Figure 1 (Growth of Real and Potential GDP, Percent).
  - Employment continues to increase steadily; harmonized unemployment rate noted as low compared to peers (Unemployment and Employment Rates).
- Housing sector:
  - Real house prices rising, especially for flats and in large cities such as Copenhagen (Figure 2).
  - Danish households are among the most indebted in the world (Household Debt, 2015Q3: percent of gross disposable income).
- External sector:
  - Current account surplus reached a high level as households restore balance sheets (Figure 3).
  - Real Effective Exchange Rate (Index: 2010=100) shows depreciation.
- Financial soundness (selected indicators, 2010–15):
  - Regulatory capital to risk-weighted assets: 17.9 (2010) rising to 21.8 (2015).
  - Nonperforming loans to total gross loans: 7.9 (2010) falling to 6.9 (2015).
  - ROA (aggregated data on a parent-company basis): 0.1 (2010) to 0.8 (2015).
  - ROE (aggregated data on a parent-company basis): 1.7 (2010) to 9.1 (2015).

### Risks, Likelihoods, Expected Impacts, and Policy Responses (Annex I: Risk Assessment Matrix)
- Tighter or more volatile global financial conditions
  - Relative likelihood: Medium
  - Expected impact: Medium
  - Policy response:
    - Allow automatic stabilizers to operate and delay further fiscal consolidation.
    - Reduce vulnerabilities of the financial sector by expanding the macroprudential toolkit.
- Structurally weak growth in key advanced and emerging economies
  - Relative likelihood: Medium/High
  - Expected impact: Medium
  - Policy response:
    - Allow automatic stabilizers to operate and delay further fiscal consolidation.
    - Move ahead with structural reforms to improve competitiveness.
- A drop in confidence in covered bonds
  - Relative likelihood: Low
  - Expected impact: High
  - Policy response:
    - Use regulatory policies to encourage longer bond maturities and increase buffers in loans with interest-only periods, e.g., by reducing the loan-to-value ceiling.
- Failure to effectively address housing risks
  - Relative likelihood: Medium
  - Expected impact: High
  - Policy response:
    - Continue vigilant financial supervisory oversight and use macroprudential and tax policies in a consistent manner to discourage further build-up of housing debt.
    - Address bottlenecks in rental market and zoning policies.
- British voters elect to leave the EU (Brexit)
  - Relative likelihood: High
  - Expected impact: High
  - Policy response:
    - Ensure robust contingency planning for operational risks that may arise in the event of heightened market volatility.
    - Re-double efforts to secure the benefits of economic integration and cooperation across Europe.

*Source: IMF staff, Box 4 and Annex I (Risk Assessment Matrix) in the Denmark country chapter.*

### Annex II. Public Sector Debt Sustainability Analysis— Baseline

### Annex II. Public Sector Debt Sustainability Analysis—Baseline Scenario

### Debt Levels and Financing Needs (2014–2021)
- Nominal gross public debt:
  - 2014: 38.9
  - 2015: 44.6
  - 2016: 45.8
  - 2017: 47.2
  - 2018: 47.5
  - 2019: 47.5
  - 2020: 47.1
  - 2021: 46.3
  - 2021 (projection alternative chart): 45.5
- Public gross financing needs (in percent of GDP):
  - 2014: -2.5
  - 2015: 1.5
  - 2016: 9.3
  - 2017: 7.9
  - 2018: 6.6
  - 2019: 6.8
  - 2020: 8.0
  - 2021: 5.9
  - 2021 (projection alternative chart): 6.4
- Sovereign spreads:
  - EMBIG (bp) 3/29 (label present)
  - 5Y CDS (bp)22 (label present)
  - Ratings: Moody's Aaa; S&Ps AAAAAA; Fitch AAAAAA

### Macroeconomic and Interest Rate Assumptions (2014–2021)
- Real GDP growth (in percent):
  - 2014: 0.4
  - 2015: 1.3
  - 2016: 1.2
  - 2017: 1.3
  - 2018: 1.6
  - 2019: 1.8
  - 2020: 1.8
  - 2021: 1.9
  - 2021 (alternate line): 1.8
- Inflation (GDP deflator, in percent):
  - 2014: 2.3
  - 2015: 0.8
  - 2016: 1.0
  - 2017: 0.7
  - 2018: 1.8
  - 2019: 2.0
  - 2020: 2.3
  - 2021: 2.4
  - 2021 (alternate line): 2.3
- Nominal GDP growth (in percent):
  - 2014: 2.7
  - 2015: 2.1
  - 2016: 2.2
  - 2017: 2.0
  - 2018: 3.4
  - 2019: 3.8
  - 2020: 4.1
  - 2021: 4.3
  - 2021 (alternate line): 4.2
- Effective interest rate (in percent) 4/:
  - 2014: 4.8
  - 2015: 3.4
  - 2016: 3.6
  - 2017: 3.1
  - 2018: 2.8
  - 2019: 2.8
  - 2020: 2.6
  - 2021: 2.7
  - 2021 (alternate line): 2.7

### Contribution to Changes in Public Debt (2014–2021; percent of GDP)
- Change in gross public sector debt:
  - 2014: -0.1
  - 2015: 0.0
  - 2016: 1.2
  - 2017: 1.4
  - 2018: 0.3
  - 2019: 0.0
  - 2020: -0.4
  - 2021: -0.7
  - cumulative to 2021: -0.8 (chart shows -0.3 cumulative as well)
- Identified debt-creating flows:
  - 2014: -0.3
  - 2015: -1.6
  - 2016: 0.2
  - 2017: -0.2
  - 2018: 1.2
  - 2019: 1.0
  - 2020: 0.6
  - 2021: 0.3
  - cumulative: 0.2 / 3.0 (two cumulative notes present)
- Primary deficit (percent of GDP):
  - 2014: -1.2
  - 2015: -1.8
  - 2016: 1.3
  - 2017: 1.6
  - 2018: 1.3
  - 2019: 1.4
  - 2020: 1.3
  - 2021: 1.0
  - cumulative: 0.8 / 7.4 (two cumulative notes present)
- Primary (noninterest) revenue and grants (percent of GDP):
  - 2014: 53.5
  - 2015: 56.3
  - 2016: 52.8
  - 2017: 50.4
  - 2018: 49.3
  - 2019: 48.7
  - 2020: 48.5
  - 2021: 48.4
  - cumulative: 48.4 / 48.4 / 29? (table shows 293.7 cumulative)
- Primary (noninterest) expenditure (percent of GDP):
  - 2014: 52.3
  - 2015: 54.5
  - 2016: 54.1
  - 2017: 52.1
  - 2018: 50.6
  - 2019: 50.1
  - 2020: 49.8
  - 2021: 49.4
  - cumulative: 49.2 / 301.1 (table shows 301.1 cumulative)

### Automatic Debt Dynamics and Components (2014–2021)
- Automatic debt dynamics (percent of GDP):
  - 2014: 0.8
  - 2015: 1.0
  - 2016: 1.1
  - 2017: 0.5
  - 2018: -0.2
  - 2019: -0.4
  - 2020: -0.7
  - 2021: -0.7
  - cumulative: -0.7 / -2.2 (table shows -2.2 cumulative)
- Interest rate/growth differential 6/:
  - 2014: 0.8
  - 2015: 0.6
  - 2016: 0.7
  - 2017: 0.5
  - 2018: -0.2
  - 2019: -0.4
  - 2020: -0.7
  - 2021: -0.7
  - cumulative: -0.7 / -2.2
- Real interest rate contribution:
  - 2014: 1.0
  - 2015: 1.2
  - 2016: 1.2
  - 2017: 1.1
  - 2018: 0.5
  - 2019: 0.4
  - 2020: 0.2
  - 2021: 0.1
  - cumulative: 0.1 / 2.4
- Real GDP growth contribution:
  - 2014: -0.2
  - 2015: -0.6
  - 2016: -0.5
  - 2017: -0.6
  - 2018: -0.7
  - 2019: -0.8
  - 2020: -0.8
  - 2021: -0.8
  - cumulative: -4.6
- Exchange rate depreciation contribution 7/:
  - 2014: 0.0
  - 2015: 0.4
  - 2016: 0.4
  - 2017–2021: ............................. (no further values shown)

### Other Identified Debt-Creating Flows and Residuals (2014–2021)
- Other identified debt-creating flows:
  - 2014: 0.1
  - 2015: -0.8
  - 2016: -2.2
  - 2017: -2.3
  - 2018: 0.1
  - 2019: 0.0
  - 2020: 0.0
  - 2021: 0.0
  - cumulative: -2.2
- Fiscal, General Government, Memorandum Items, Net privatization proceeds (negative):
  - 2014: 0.0
  - 2015: -1.1
  - 2016: -2.5
  - 2017: -2.6
  - 2018–2021: 0.0
  - cumulative: -2.6
- Contingent liabilities:
  - 2014–2021: 0.0 (all years)
- Please specify (2) (e.g., ESM and Euroarea loans):
  - 2014: 0.2
  - 2015: 0.3
  - 2016: 0.3
  - 2017: 0.3
  - 2018: 0.1
  - 2019–2021: 0.0
  - cumulative: 0.4
- Residual, including asset changes 8/:
  - 2014: 0.2
  - 2015: 1.6
  - 2016: 1.0
  - 2017: 1.6
  - 2018: -0.8
  - 2019: -1.0
  - 2020: -1.0
  - 2021: -1.0
  - cumulative: -3.2

### Projections and Alternative Scenarios (2016–2021)
- Baseline scenario underlying assumptions (in percent):
  - Real GDP growth: 2016: 1.3; 2017: 1.6; 2018: 1.8; 2019: 1.8; 2020: 1.9; 2021: 1.8
  - Inflation: 2016: 0.7; 2017: 1.8; 2018: 2.0; 2019: 2.3; 2020: 2.4; 2021: 2.3
  - Primary Balance: 2016: -1.6; 2017: -1.3; 2018: -1.4; 2019: -1.3; 2020: -1.0; 2021: -0.8
  - Effective interest rate: 2016: 3.1; 2017: 2.9; 2018: 2.9; 2019: 2.7; 2020: 2.7; 2021: 2.8
- Historical scenario (2016–2021):
  - Real GDP growth: 2016: 1.3; 2017: 0.4; 2018: 0.4; 2019: 0.4; 2020: 0.4; 2021: 0.4
  - Inflation: same as baseline (0.7, 1.8, 2.0, 2.3, 2.4, 2.3)
  - Primary Balance: 2016: -1.6; 2017–2021: 0.6 each year
  - Effective interest rate: 2016: 3.1; 2017: 2.9; 2018: 3.2; 2019: 3.2; 2020: 3.4; 2021: 3.7
- Constant Primary Balance Scenario (2016–2021):
  - Real GDP growth: same as baseline (1.3, 1.6, 1.8, 1.8, 1.9, 1.8)
  - Inflation: same as baseline
  - Primary Balance: constant at -1.6 each year 2016–2021
  - Effective interest rate: 2016: 3.1; 2017: 2.9; 2018: 2.9; 2019: 2.6; 2020: 2.7; 2021: 2.7
- Contingent Liability Shock scenario (2016–2021):
  - Real GDP growth: 2016: 1.3; 2017: -0.7; 2018: -0.5; 2019: 1.8; 2020: 1.9; 2021: 1.8
  - Inflation: 2016: 0.7; 2017: 1.2; 2018: 1.4; 2019: 2.3; 2020: 2.4; 2021: 2.3
  - Primary Balance: 2016: -1.6; 2017: -31.8; 2018: -1.4; 2019: -1.3; 2020: -1.0; 2021: -0.8
  - Effective interest rate: 2016: 3.1; 2017: 3.2; 2018: 5.4; 2019: 4.4; 2020: 3.7; 2021: 3.7

### Composition of Public Debt, Maturity, and Currency (charts summary)
- Gross Nominal Public Debt (percent of GDP) projected by year 2014–2021 (chart provided; values as listed above).
- Public Gross Financing Needs (percent of GDP) projected by year 2014–2021 (chart provided; values as listed above).
- By maturity (2005–2021 projection chart):
  - Medium and long-term and short-term shares shown in chart (no numeric breakdown in text).
- By currency (2005–2021 projection chart):
  - Local currency-denominated and foreign currency-denominated shares shown in chart (no numeric breakdown in text).

### Notes and Methodology
- Public sector is defined as general government.
- Based on available data (as of May 12, 2016).
- Long-term bond spread over German bonds.
- Effective interest rate defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.
- Automatic debt dynamics derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).
- Real interest rate contribution derived from numerator in footnote 5 as r - π (1+g) and real growth contribution as -g.
- Exchange rate contribution derived from numerator in footnote 5 as ae(1+r).
- Residual includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.
- Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

*Source: IMF staff.*

### Annex IV. Authorities’ Response to Past IMF Policy

### Annex IV. Authorities’ Response to Past IMF Policy Recommendations

### Fiscal policy and medium-term plans
- The Executive Board in 2014 agreed that the fiscal stance for 2015 was broadly appropriate and consistent with the medium-term goal of achieving structural budget balance.
- Authorities’ assessment and actions:
  - Structural balance improved by ¼ percent of potential GDP in 2015, in line with planned gradual consolidation.
  - Government’s medium-term fiscal plan envisages eliminating the structural deficit by 2020.
  - Planned adjustment from a structural deficit of 0.6 per cent of GDP in 2015 to a deficit of 0.4 per cent of GDP in 2016 and 2017.
  - With the planned fiscal policy for 2016, there is a small margin to the deficit limit of 0.5 percent of GDP in the Budget Law.
  - Fiscal space is described as tight in coming years due to:
    - Marked decline in oil and gas-related revenues.
    - Increased spending pressures from support, training programs, welfare services for newly-arrived refugees.
    - Public consumption and investment levels remaining higher than before the financial crisis.
  - After the summer, the Danish Government will present a new medium-term economic plan (“2025 plan”) to provide the framework for fiscal policy towards 2025.
- Policy rationale and outlook:
  - Narrowing output gap implies accommodative fiscal policy should be gradually rolled back.
  - Monetary policy expected to remain very supportive; hence fiscal tightening is needed to support sustained recovery.
  - Medium-term target: achieve at least structural balance by 2020, aligned with fiscal sustainability objectives.

### Financial sector resilience and macroprudential measures
- IMF/Board advice: financial stability risks generally contained but further efforts needed to enhance resilience given large size of financial system and mortgage risks; Board looked forward to full implementation of updated FSAP recommendations and continued regional cooperation.
- Authorities’ actions and measures:
  - Introduced supervisory diamond for MCIs (mortgage-credit institutions) and seven best practices addressing several FSAP recommendations related to mortgage finance.
  - Implemented changes to regulatory and supervisory practices with transposition of EU regulations related to CRD IV/CRR and Solvency II.
  - Transposed European Bank Recovery and Resolution Directive into Danish law, strengthening the resolution regime.
  - DFSA indicated it will increase frequency of on-site inspections for smaller banks and insurance companies.
  - Danish Financial Supervisory Authority (FSA) introduced a 5 percent down payment requirement, as well as 7 best practices for mortgaging of homes in geographical areas with high price levels and high price increases compared with the rest of the country. At present, the 7 best practices apply to the two largest cities.
  - Authorities stress the aim of recent measures is to ensure robustness of borrowers and credit institutions, not to restrain mortgage lending.
- Authorities’ stance on macroprudential toolkit:
  - Not currently planning to introduce new macroprudential measures.
  - Will monitor housing market developments closely, especially in Copenhagen.
  - Consider the IMF suggestion to prepare an adequate macroprudential "toolbox" to ensure measures can be implemented without delay when needed.
  - Acknowledge that macroprudential measures such as limits on loan-to-value and debt-to-income may contribute to dampening a build-up of systemic financial risks.

### Productivity, labor market, and structural reform
- IMF/Board advice: pursue additional reforms to enhance productivity growth and competitiveness; consider recommendations from the Productivity Commission; increase labor market participation and improve labor market functioning.
- Authorities’ actions and initiatives:
  - Growth Plan 2014 comprised measures to accelerate productivity growth: strengthening institutional framework for competition, streamlining business regulations, lowering corporate income taxes.
  - In 2015 introduced more flexible rules to re-qualify for unemployment benefits to strengthen incentives to accept work.
  - Under a 2016 reform package, the total amount of benefits that a household can receive has been capped; government plans to use related savings to lower taxes for low-income households later in the year.
  - Government has put forward a growth package with over one hundred initiatives focused on productivity and strengthening growth across Denmark, including liberalising the Planning Act and easing restrictions (increasing upper boundaries on shop sizes).
  - Ongoing work to increase productivity in the utility sector where staff identified potential.
  - Reforms since 2008 estimated to raise productive potential by more than 5 percent by 2020.
  - Example: 2011 reform raising early retirement eligibility from 60 years to 62 is increasing labor market participation for each cohort.
- Authorities’ priorities:
  - Increasing growth potential remains a clear priority; the forthcoming 2025 plan will lay out further reform proposals to increase both labor market participation and productivity.

### Economic outlook, labor market, and risks
- Recent economic developments:
  - Danish economy in its third year of recovery; GDP growth pace moderate, but employment growing strongly and nominal gross value added rising in manufacturing, business services, and construction.
  - For the first time in several years, growth in the prior year was mainly driven by domestic demand.
  - Conditions for continued growth in domestic demand supported by rising real wages, employment, and housing prices.
  - Export growth expected to accelerate in 2016 and 2017 supported by a gradually improving external environment.
  - Declining North Sea oil and gas production is a drag on GDP growth.
  - Productivity growth seems very low for this stage of the cycle, while employment growth has been robust.
  - Unemployment already low, but room for further employment increases due to a substantial increase in structural employment from recent reforms.
  - Continued robust employment growth expected to gradually close the output gap and employment gap; labor market conditions expected to tighten over the next couple of years.
- Risk assessment:
  - Risks to the growth outlook are tilted to the downside: as a small open economy, an unexpected global slowdown would lower Danish growth via weaker exports and weaker domestic spending.
  - Authorities assess risks related to global financial conditions and a possible spike in household interest-rate burden as perhaps less clear than suggested by staff:
    - Large increases in interest rates considered unlikely in the near term given expected still-accommodative monetary policy, particularly in the euro area, significant current account surplus, and increasing net international wealth.
    - Overall household debt levels have not been rising recently; household balance sheets generally assessed as robust with substantial assets.

### Housing market assessment and monitoring
- Authorities’ analysis:
  - Recent housing market developments, including rapid price increases in largest cities, seen as reflecting fundamentals: low mortgage rates, rising disposable incomes, and urbanization.
  - Price developments in the Copenhagen area require close monitoring.
  - Freeze of housing taxes since 2002 and freeze of land taxes in 2016 are acknowledged to increase procyclicality of house price fluctuations.
- Policy measures and intent:
  - Supervisory diamond benchmarks set to counteract excessive risk-taking while allowing resilient institutions to operate profitably and provide credit.
  - Aim of measures: ensure robustness of borrowers and credit institutions, not to restrain mortgage lending.
  - Authorities will monitor developments and consider preparing macroprudential tools for timely implementation when needed.

*Annex IV. Authorities’ Response to Past IMF Policy Recommendations, IMF staff report content (May 31, 2016).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16184.pdf_