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Denmark and the IMF
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On May 8, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Denmark.1
Since 1993, Denmark has enjoyed relatively robust economic growth. Helped by cautious fiscal policies and reforms in labor markets, fiscal deficits have been turned into structural surpluses and the public debt ratio has been nearly halved. The unemployment rate has declined to a 25-year low of 5 percent. The external current account has been registering comfortable surpluses.
Growth slowed significantly during 2001 as domestic demand weakened and exports were hit by the global economic slowdown. Unemployment remained low and wage growth was somewhat faster than in euro area partner countries. However, price inflation was subdued. Monetary conditions were eased during 2001 as Danish interest rates generally followed those of the European Central Bank (ECB) downward. The 2002 budget implies a broadly neutral fiscal stance with the surplus projected to remain within the medium-term target of 1.5-2.5 percent of GDP. IMF staff project that real GDP growth in 2002 will be about 1.3 percent as recovery in Denmark's trading partners and supportive monetary conditions are expected to foster a pickup in growth during the second half of the year.
The new government intends to continue the medium-term strategy of running fiscal surpluses in order to prepare for the fiscal costs of an ageing population. To meet the fiscal target and provide some room for reducing Denmark's high tax burden, real public consumption is targeted to grow by 1 percent a year until 2006, at which point the target rate is set to fall to 0.5 percent until 2010. In addition, the government has declared a freeze on all taxes. The strategy also recognizes the need to address constraints on labor supply. Policy measures aim at increasing the participation in the labor market of older workers and immigrants.
Executive Board Assessment
Executive Directors commended the authorities for their sustained strategy of fiscal discipline and structural reforms. Unemployment is at a 25-year low, inflation is subdued, and Denmark's strong economic fundamentals have permitted the economy to weather the global slowdown reasonably well. Although growth slowed in 2001, conditions are in place for a pickup in the course of 2002.
Directors viewed the macroeconomic policy stance as appropriate at this juncture. Accommodative monetary conditions, consistent with Denmark's fixed exchange rate policy vis-à-vis the euro, are putting a protective floor under the economy in case downside risks to growth were to materialize. At the same time, strong wage growth and high capacity utilization in some industries argue against an active fiscal policy response to such risks, and it will be important to avoid public spending overruns while allowing for the operation of automatic stabilizers.
Directors judged overall competitiveness to be healthy, although the increase in unit labor costs relative to the euro area indicates that some wage moderation is needed to stem losses in market shares in continental Europe. They noted that efforts to improve the flexibility of labor markets and increase labor supply would be helpful in this regard.
Directors welcomed Denmark's progress in implementing a strong medium-term strategy to deal with the fiscal costs of an ageing population. While the goal of continuing to run fiscal surpluses is commendable, possible future pressures on the high level of taxation and the desire to maintain a comprehensive welfare system pose significant challenges for the medium term. Against this background, Directors agreed that improving public expenditure discipline, particularly at the lower levels of the government, should be a priority. They considered that a more formally binding fiscal framework would usefully support higher spending discipline, and they welcomed, in this regard, the recent agreement with the Association of Municipalities as a first step in the right direction. Directors also encouraged the authorities to pursue intentions to strengthen public management and outsource services where appropriate. While recognizing the high degree of social cohesion, a number of Directors recommended that the long-term viability of the present welfare system should be kept under close review by the Danish authorities.
Most Directors considered that high taxes might hamper efforts to increase labor supply. While welcoming the recent across-the-board tax freeze, they encouraged the authorities to aim for a more ambitious tax reform, that would focus on reducing high income tax rates and raising tax thresholds.
Directors commended Denmark's labor market reforms over the last several years, which have contributed to substantially lowering the structural unemployment rate. In view of labor supply constraints, additional reforms will, nevertheless, be needed. While Denmark's overall labor market participation rate is high by international standards, Directors saw scope to raise the participation of some groups, such as older workers and immigrants, and they welcomed, in this regard, the authorities' aim to increase the effectiveness of active labor market policies. They furthermore pointed out that problems of welfare traps and high minimum wages extend beyond these groups, and should be addressed more broadly through reform of the tax and benefit system.
Directors welcomed steps to strengthen competition policy. They encouraged the authorities to speed up the opening of the natural gas market and looked forward to the planned privatization and deregulation of network industries, supported by strong regulatory frameworks.
Directors considered that Denmark's financial sector appears sound, as evidenced by the high capitalization ratios of banks, although it was noted that the rapid increase in mortgages with adjustable interest rates should be monitored. The problems faced by some insurance companies and pension funds last year, in an environment of low interest rates and stock market returns, was also highlighted as an area requiring improved risk management. Directors commended the supervisory authorities for their attempts to improve consolidated financial sector supervision, most recently by unifying disparate financial supervisory acts and establishing cross-border memoranda of understanding. They also commended the authorities' firm stance on combating money laundering and the financing of terrorism, and looked forward to the early enactment of additional legislation in this area. Directors welcomed the authorities' interest in undertaking a Financial Sector Assessment Program.
Directors expressed their strong appreciation for Denmark's outstanding record on official development assistance, which sets an example for other industrial countries.
1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. This PIN summarizes the views of the Executive Board as expressed during the May 8, 2002 Executive Board discussion based on the staff report.
IMF EXTERNAL RELATIONS DEPARTMENT