Sweden -- 2001 IMF Article IV Consultation -- Concluding Statement

IMF News, June 20, 2001

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Strong growth in 2000, driven by a boom in the high technology sector, reduced unemployment sharply and moved the economy closer to productive potential.
Inflation remained below the Riksbank's target.
Competitive position of the economy remained robust.
Fiscal surplus exceeded the authorities' announced aim and public debt continued to decline.
Policy achievements credited to deft macroeconomic management and reforms of the last decade.

Global slowdown (United States, Europe, Asia) expected to weigh on Sweden; high-technology sector amplifies adverse impact.
Recent indicators point to a sharper slowdown in activity than expected a few months earlier.
Unexpected surge in underlying and headline inflation in April and May and a prolonged fall in the krona raise medium-term inflation risks.
Outlook for remainder of 2001: slower growth than earlier envisaged; subdued growth into early 2002 possible due to weaker external demand and household attempts to rebuild savings.
A projected rebound in global growth and high domestic resource use could lead to return to potential output thereafter, with recovery expected at least by the latter half of 2002.

Low inflation and interest rates through early 2001 owed to the Riksbank's consistent monetary framework and non-monetary factors (deregulation, ICT-driven productivity gains).
Policy interest rate broadly steady since early 2000; Sweden enjoyed one of the lowest rates among advanced economies.
Recent months: sharp spurt in headline inflation mixed with rising indicators of underlying inflation (even excluding import prices).
Persistent krona weakness undermines assumption of gradually strengthening krona in the Riksbank's May Inflation Report.
Moderate three-year wage agreements provide some anchor for inflation expectations, but prolonged krona weakness increases probability of adverse inflation effects.
Balance of inflation risks has shifted to the upside since the May Inflation Report.
Authorities undertook signaling interventions to nudge market sentiment; monetary policy should remain focused on keeping medium-term inflation within its tolerance band.
If necessary, the Riksbank should follow through with interest rate increases to preserve credibility.

Most indicators suggest limited systemic risks; strong banking sector position should allow coping with a more marked downturn than expected.
Recent financial consolidation and risk of further share price declines warrant expanded supervision and continued vigilance.

Fiscal policy anchored by medium-term fiscal rules: target general government surplus of 2 percent of GDP over the cycle and ceilings on nominal central government spending for the subsequent three years.
Expenditure ceilings tight because:
- Room for discretionary increases largely used by measures announced in 2001-02.
- Recent unanticipated rise in inflation reduces real value of nominal ceilings.
Essential to adhere scrupulously to announced expenditure ceilings; may require offsetting mandatory inflation-induced spending increases with discretionary cuts elsewhere.
Full amount of prospective overperformance relative to the structural surplus target should be used for tax cuts.
- Estimated structural surpluses over 2002-2004 imply room for tax cuts of at least 2 percent of GDP.
- Two remaining income tax cuts in 2002 and 2003 to offset earlier increase in employees' social security contributions would use about 1¼ percentage points of GDP.
- Remaining room of three-quarters of a percent should be used in the 2002 budget to reduce the most distortionary taxes as part of a medium-term program.
Implied policy mix: tighter monetary stance if required, and a moderate fiscal expansion to help strengthen the krona and counter any unexpected slowdown.

Need to lift potential growth above recent range of 2-2½ percent through renewed structural reforms.
Reinforce efficiency of tax-benefit system while preserving social objectives.
Priority tax reforms:
- Reduce high marginal effective tax rates on labor caused by taxation of earnings and withdrawal of benefits, especially at both ends of the income scale.
- Unify the two central income tax rates at a level below the current lower rate to improve incentives and reduce transformation of labor into capital income under the dual income tax regime.
- Reform wealth tax: remove exemptions favoring the wealthiest and raise threshold to exclude moderate housing wealth.
On spending:
- Reassess rapid increase in sickness benefit payments during the upswing, including design and allocation of financing between employer and state.
Medium-term fiscal measures should aim at balanced reduction in taxation and public spending, targeted for maximum efficiency and growth while respecting distributional concerns.

Labor market improvements: marked rises in employment and participation rates since recession trough; active labor market programs better adapted; tightened duration rules for unemployment benefits.
Three-year wage agreement encouraging and consistent with inflation objective; risk that moderation could be undermined by excessive wage drift—vigilance required.
Further labor market improvements through:
- Easing employment protection regulations.
- Enhancing regional mobility by easing rent-control distortions in the housing market.
- Continuing reduced wage compression.
Local governments:
- Balanced budget rule effective last year is important.
- Risk that central government spending pressures could be deflected to local level.
- Fiscal equalization system impairs incentives for local authorities to expand tax bases or moderate tax rate increases and will need reassessment.

Authorities should continue deregulation to enhance competition and long-run efficiency and growth.
Sectors with high gains from deregulation or elimination of monopolies: rental housing, construction, pharmaceuticals, retail trade, and transportation.
Privatization of public enterprises operating in competitive markets is desirable.
Long-run demographic pressures:
- Reformed pension system includes safeguards for solvency.
- Full response to demographic transition requires measures beyond pensions, such as raising the effective retirement age.
The crisis of the early 1990s showed need for modification of some Swedish model features; strengthened macro framework and reforms place economy on stronger footing, but broadening and deepening reform agenda is necessary for continued success in a globalizing world.

International Monetary Fund—Sweden--2001 Article IV Consultation Concluding Statement (June 20, 2001).