IMF Executive Board Concludes 2023 Article IV Consultation with Denmark

IMF News, June 26, 2023

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On June 16, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Denmark and endorsed the staff appraisal without a meeting.
The Danish economy recovered strongly from the pandemic: a relatively mild contraction in 2020 was followed by growth of around 5 percent in 2021 and 3¾ percent in 2022.
Headline harmonized consumer price index inflation reached a 40-year high in October 2022 before decelerating.
Economic activity is cooling recently as inflation lowers real incomes, financial conditions tighten, and external demand weakens, while labor markets remain relatively tight.
GDP growth for 2023 is projected at 1¼ percent, with inflation expected to decelerate but stay above 2 percent in the near term.
Risks to growth are broadly balanced; risks to inflation are tilted to the upside due to possible renewed supply shocks and stronger-than-expected and persistent wage pressures.

Directors endorsed staff’s appraisal, highlighting:
- Denmark’s impressive recovery from the pandemic, with strong output and employment growth contributing to inflationary pressures.
- GDP growth expected to slow in 2023; inflation to remain elevated in the near term.
- In the medium term, lower global growth and demographic challenges point to lower economic growth.

Near-term fiscal policy should support disinflation given persistently elevated inflation.
Because of uncertainty regarding contractionary effects in the fiscal plan, positive output gaps, and high inflation, the authorities should consider:
- Keeping tight spending control.
- Saving any revenue above budget forecasts aiming to improve the structural balance by ½ percentage points of GDP.
If downside growth risks materialize and inflation eases, automatic stabilizers should be allowed to operate fully.

Medium-term fiscal policy should be recalibrated as needed to adhere to the fiscal rules.
The structural balance is expected to weaken to a deficit over the medium term mainly due to defense and demographic-related spending.
Authorities’ forward-looking efforts to contain the structural deficit within 0.5 percent of GDP by 2030 via supply-side measures are commended.
If fiscal trends suggest risk of breaching the structural deficit limit (one percent of GDP), authorities should be ready to recalibrate policy.
Any changes to indexation of statutory retirement age to life expectancy should safeguard long-term fiscal sustainability.

The financial system remains sound, but rising risks warrant continued vigilance and close monitoring.
Recommendations and observations:
- Closely monitor banks’ liquidity risk management and ensure impairment charges are continuously updated as economic prospects change.
- Commercial real estate (CRE) risks should continue to be closely watched; further efforts are needed to close data gaps.
- Consider an increase in risk weights on CRE exposures or introduction of a sectoral systemic risk buffer.
- The supervisor’s initiative to develop a pilot stress test for pension and insurance companies is welcome.
- Continue efforts to monitor cyber security risks and strengthen resilience against cyberattacks.

Consider tightening macroprudential policies to target pockets of vulnerability.
The increase of the countercyclical capital buffer was appropriate.
Consider tightening borrower-based macroprudential measures to contain riskier mortgages, especially variable-rate mortgages with deferred amortization.
Once house prices and inflation stabilize, review:
- High tax deductibility of mortgage interest expense.
- Complex rental market regulations from the financial stability perspective.
The government’s plan to link property taxes to market valuations starting in January 2024 is welcome.
Authorities are encouraged to consider reforming the institutional setting of financial sector policy making in line with the 2020 Financial Sector Assessment Program.

Denmark is exposed to money laundering and terrorist financing threats.
Progress has been made in strengthening the anti-money laundering/combatting the financing of terrorism (AML/CFT) framework.
Authorities should continue efforts to increase the use of cross-border data and technological solutions in assessment of AML/CFT risks.

Authorities’ strong focus on labor market reforms is welcome given the expected decline in the working-age population.
Policy moves noted:
- Canceling a public holiday to help increase annual hours worked.
- Proposed personal income tax reform to help improve work incentives.
- Planned reforms to early retirement schemes to increase employment.
Additional measures to explore, consistent with Denmark’s flexicurity model:
- Review the structure of marginal effective tax rates, including benefits, to minimize work disincentives, especially for lower-income households.
- Continue efforts to increase employment rates of immigrants.
- Enhance education outcomes of students with immigrant backgrounds.

Further measures are needed to achieve Denmark’s ambitious climate goals.
In addition to strengthening carbon pricing (Green Tax Reform), policy should consider complementary fiscal incentives at the sectoral level, including feebates in agriculture.

It is recommended that the next Article IV consultation be held in the standard 12-month cycle.

Output
- Real GDP growth (%): 2022: 3.8; 2023: 1.3; 2024: 1.4
Employment
- Unemployment rate (%): 2022: 4.5; 2023: 5.0
Prices
- Inflation (%, Q4 on Q4): 2022: 10.2; 2023: 3.3; 2024: 2.6
General government finances
- Revenue (% GDP): 2022: 48.6; 2023: 49.5; 2024: 49.3
- Expenditures (% GDP): 2022: 45.3; 2023: 47.5; 2024: 48.4
- Fiscal balance (% GDP): 2022: 2.0; 2023: 0.9
- Public debt (% GDP): 2022: 30.1; 2023: 30.5; 2024: 30.3
Money and credit
- Domestic credit growth (%): 2022: -4.0; 2023: …
- 3-month interbank interest rate (%): 2022: 0.3
- 10-year government bond yield (%): 2022: 1.2
Balance of payments
- Current account (% GDP): 2022: 13.1; 2023: 9.1; 2024: 7.8
- International reserves (% change): 2022: 1.9
Exchange Rate
- ULC-based REER (% change): 2022: -1.8

Source: IMF press release, June 26, 2023.