Mission Concluding Statement 

Sweden: Staff Concluding Statement of the 2024 Article IV Mission

February 5, 2024

Stockholm, Sweden: After a strong post-pandemic recovery, economic activity has slowed amid sharply tighter financial conditions and a challenging external economic environment. Following a mild recession in 2023, growth is projected to remain subdued in 2024, averaging 0.2 percent. Headline inflation (HICP), which reached 10.8 percent (y/y) at end-2022 and has since been declining, is projected to average 2.6 percent in 2024 and reach target in the first half of 2025, supported by prudent policy actions and modest growth in negotiated wages. Systemic risks remain elevated against tight financial conditions, slower economic activity, weaknesses in residential real estate (RRE) and commercial real estate (CRE) markets, and high financial sector exposure to both RRE and CRE. The balance of risks to growth is tilted down, with the main risk arising from larger-than-projected effects from tight financial conditions in the context of short-term and variable-rate lending. Inflation risks are broadly balanced, with upside risks from still elevated core inflation and a slower adjustment in inflation expectations or global supply-side disruptions offset by faster disinflation from potentially weaker growth. Ensuring that inflation durably returns to target while maintaining financial stability remains the most immediate policy priority. For this, the monetary-fiscal policy mix should continue to be restrictive with macroprudential settings remaining tight to mitigate systemic risks. Strong public investment and structural reforms are instrumental to strengthen medium-term growth and support social inclusion and the green transition.

Monetary and Financial Sector Policies

The estimated contractionary monetary policy stance is appropriate and needs to be maintained for some time to ensure that inflation durably returns to target, which will contribute to high and stable output and employment in the medium term. Staff’s baseline forecast for inflation assumes that the current restrictive monetary policy stance—measured by the real rate based on expected inflation—will be in place through the first half of 2024, which would allow inflation to reach the 2 percent target in the first half of 2025. At the same time, the uncertainty about the growth and inflation outlook remains exceptionally high. This will require the Riksbank to maintain a data-dependent approach to allow for a continuous assessment of the strength of monetary policy transmission and be ready to respond to two-sided inflation risks. If inflation expectations are slower to adjust or global supply-side disruptions have stronger effects, monetary policy needs to remain contractionary for longer. Conversely, if disinflation is sharper on a protracted weakness in activity, rate cuts may be needed sooner than currently envisaged to avoid sharp increases in real rates. Given these uncertainties, it is key to continue to clearly communicate how economic developments are likely to affect the current and future monetary policy stance to ensure that inflation expectations remain anchored. Going forward, quantitative tightening should continue to play a limited role in the conduct of monetary policy.

Banking system balance sheets remain strong, though banks and supervisory authorities should remain vigilant to potential pressures in residential and commercial real estate markets and contagion risks. Analyses by staff and the authorities point to bank resilience to potential adverse shocks, but close monitoring of systemic risks is needed given heightened uncertainty. The increase in the counter-cyclical capital buffer and the extension of risk weight floors for banks’ real estate and commercial real estate loan exposures until end-2025 were timely to further enhance bank resilience. Important progress has been made in the adoption of key IMF Financial Sector Assessment Program (FSAP) recommendations, and this momentum should continue. This would require improving the collection of granular household balance sheet data and standardized disclosures for the CRE sector, continuing to improve risk analyses, increasing onsite and intrusive supervision, and continuing to strengthen crisis management strategies for potential downside scenarios. Once the current economic cycle stabilizes, higher bank capital requirements for their CRE exposures should be introduced to contain systemic risks posed by banks’ exposure to this sector. In the housing market, macroprudential measures such as amortization requirements, which address risks from high household debt, could also be raised further. Ongoing improvements to the anti-money laundering framework are timely and will continue to support financial stability.

Fiscal Policy

The planned broadly neutral fiscal policy stance in 2024 is appropriate to allow for a disinflationary macroeconomic policy mix. The 2024 budget includes well-targeted measures to address the impact of high inflation on vulnerable populations, such as income-tax reductions for lower-income households, pensions, and the elderly. If the recession deepens, available substantial fiscal space provides the room for automatic stabilizers to operate. At the same time, additional fiscal support, if needed, should be designed to avoid inflationary pressures, while being targeted towards the vulnerable.

Over the medium term, and as inflation returns to target, fiscal policy would need to address structural and demographic-related spending pressures and new investment needs to support inclusive growth and further greening the economy. Notwithstanding Sweden’s strong performance and fundamentals, higher and efficient public spending will be necessary to close education and skill gaps, improve health care, contain ageing-related costs, and invest in public infrastructure that supports the green transition. Other long-standing fiscal priorities include tax reforms to rationalize dividend taxation, lower labor income taxes, reduce interest tax deductibility and improve property taxation. Sweden's robust fiscal framework has underpinned sustainable public finances and served the economy well. The upcoming review of the framework provides an opportunity to identify additional medium-term fiscal priorities. A small deviation from the surplus target, while preserving the key elements of the framework, would allow for strong growth-enhancing public investment and social spending over the medium term.  

Structural Policies

Structural reforms in labor and housing markets and advancing the green transition are essential to raise productivity and support stronger and inclusive medium-term growth. Further strengthening active labor market policies, improving education reforms, tailored training and reskilling programs would address skill gaps and mismatches and reduce long-term unemployment. In this regard, efforts focused on upskilling and education opportunities for employed workers (such as the study grant for transition) and strengthening working incentives are welcome. A government commissioned independent review on productivity will inform policy priorities further. Addressing housing market challenges, easing restrictions on new construction, including building and permit regulations, are not only important for raising the supply of housing but also encouraging labor mobility. The government’s Climate Action Plan would require a holistic approach to meet Sweden’s ambitious climate goal targets. Fuel tax cuts in response to higher energy costs and easing of biofuel blending requirements in 2023 risk delaying carbon reduction efforts and should be reconsidered or offset by compensatory measures. Efforts to increase the supply of renewable energy and green infrastructure are welcome.

1/ An IMF mission, led by Rupa Duttagupta, and including Luisa Charry, Alexandra Fotiou, and Fuda Jiang, conducted meetings in Stockholm during January 24-February 2, 2024. The mission met with the Governor and First Deputy Governor of the Central Bank of Sweden Erik Thedéen and Anna Breman; State Secretaries Johanna Lybeck Lilja, Johan Almenberg, Jesper Ahlgren, and Carolina Lindholm; other senior officials; parliamentarians; and representatives of labor unions, business community, banking sector, and academics. The mission would like to thank the Swedish authorities for the close collaboration and candid discussions.