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Public Information Notice (PIN) No. 03/34
March 18, 2003
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2002 Article IV Consultation with Norway

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2002 Article IV consultation with Norway is also available.

On March 7, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Norway.1

Background

Norway enjoyed a decade of sustained economic expansion in the 1990s, aided by consensual policies and prudent resource management centered on the strategy of investing abroad the bulk of revenues from the exploitation of petroleum resources. As government oil revenues skyrocketed in the last few years and the Government Petroleum Fund (GPF) balances began to build up rapidly, mounting political pressure for greater use of the oil revenues in the near-term led to the adoption of guidelines for a new macroeconomic policy framework in March 2001. The new fiscal guidelines implied a rise in the non-oil structural fiscal deficit by about 3 percentage points of GDP from 2001 to 2010. By linking the budgetary use of oil revenue to the real return on GPF balances, fiscal policy thus ceded more of the onus for stabilization to monetary policy. Norges Bank was assigned an explicit objective to target medium-term inflation, although output, employment, and exchange rate stability were also specified as desirable goals. Economic developments over the past two years have reflected the effects of the prospective fiscal expansion and the tighter monetary policy thus required to achieve the inflation target.

Mainland GDP growth edged up to an estimated 1.4 percent in 2002, from 1.2 percent in 2001, driven by strong consumption growth. Mainland investment and traditional exports slackened, as a result of weak external demand, high real interest rates, and an appreciation of the nominal effective exchange rate by 11.5 percent during 2002. Unemployment remained fairly stable through 2002 as the expansion of the sheltered sector offset employment losses in the exposed sector, although it rose to about 4 percent at the end of the year. Manufacturing competitiveness declined as wage increases were in excess of productivity gains and substantially higher than among the main trading partners, and the nominal exchange rate appreciated markedly.

Underlying inflation eased in 2002, aided by low inflation of imported goods. With a deterioration in the economic outlook leading to prospects for lower underlying inflation, Norges Bank cut interest rates in December 2002 and January 2003 by 50 basis points each, bringing the policy rate to 6 percent. Looking ahead, Norges Bank maintained an easing bias, reflecting the downside risks to its medium-term inflation forecast. These risks stemmed mainly from the weakening global economic outlook, rising domestic unemployment, and the sustained strength of the krone, and were likely to mitigate the adverse impact of the large settlements negotiated in the spring 2002 wage round.

Current account and general government surpluses estimated above 12 percent of GDP in 2002 reflect peak oil production and high oil prices. However, the balance on the GPF at the end of 2002 is now estimated to be around 26 percent lower than projected in the 2002 budget due to losses sustained by the Petroleum Fund in its equity holdings. Consequently, the magnitude of the fiscal expansion to 2010 implied by the fiscal guideline on the use of oil revenue has diminished by 1 percentage point and the allowable non-oil structural deficit for 2003 has similarly declined by around 0.6 percentage points of mainland GDP. The budget for 2003 implies a broadly neutral fiscal stance, with an emphasis on maintaining the growth in real underlying expenditure below the rate of mainland output growth, and a continuation of the program of tax reductions begun in the 2002 budget.

Global economic weakness, high oil prices, and the policy mix are the key influences on the outlook for 2003. Weak international demand and low profitability in manufacturing are expected to continue to hamper private investment, traditional exports, and employment, and also constitute the key downside risks. Unemployment is projected to increase as manufacturing firms adjust to the squeeze on profitability by laying off workers. High wage carryover and tax cuts are expected, however, to support disposable income and private consumption, offset only partly by rising unemployment and high electricity prices. A strong expansion in petroleum investment is also planned. On balance, mainland output is projected to grow at 1.6 percent in 2003. An international rebound starting late in the year is expected to add to the continued strength of consumption to quickly push mainland output growth up to its trend rate of about 2.3 percent in 2004. Headline inflation is projected to rise this year due to a spike in electricity prices, but core inflation should remain below the inflation target.

Executive Board Assessment

Executive Directors endorsed the thrust of the staff appraisal. They commended the authorities for the resilience of the Norwegian economy during 2002, marked by the maintenance of low inflation, virtually full employment, and sizeable fiscal and external surpluses. Directors considered that the policy strategy centered on investing abroad the bulk of petroleum revenues in the Government Petroleum Fund, the gradual phasing in of the use of oil revenues, and the commitment to low inflation had contributed to this favorable economic performance. In the long run, the process of economic restructuring resulting from the increased use of oil wealth is likely to continue.

Directors noted that the economic outlook for 2003 had deteriorated. The weak global economic environment, high real interest rates, and the strong krone were expected to hold back mainland investment and traditional exports. High wage growth would support disposable income and private consumption, but would further erode business profitability and the competitiveness of the non-oil exposed sector. Directors cautioned against the risk of high wage increases, which could lead to a continuation of high interest rate differentials and exchange rate appreciation that would exacerbate strains on the exposed sector.

Directors welcomed the recent relaxation of monetary policy, but cautioned that the scope for further easing could be undermined if social partners were to obtain another round of excessive wage increases. Directors encouraged continued efforts to promote transparency and accountability of the inflation targeting framework. They noted that improvements could include deleting the reference to exchange rate stability in the monetary policy regulation, introducing regular independent expert reviews and parliamentary hearings on the conduct of monetary policy, and appointing professionals with appropriate expertise to the Executive Board of Norges Bank.

Directors considered that the authorities had broadly adhered to the fiscal rule for the use of oil revenues in setting the budget for 2003. They cautioned, however, against asymmetric deviations from the rule in the future, especially those intended to ease the fiscal stance beyond the path implied by the rule. Caution was warranted not only to preserve the credibility of the rule, but also because the fiscal path under the rule did not provide sufficient savings to accommodate the large public pension obligations associated with the coming demographic transition. Directors therefore recommended that the authorities clarify the conditions for smoothing the budgetary effects of changes in the market value of the Government Petroleum Fund.

Directors supported the authorities' intention to reduce Norway's high tax burden, and encouraged tax reform focused on the principles of tax neutrality and efficiency. Directors considered that strong efforts would be required to modernize the public sector and curb expenditure pressures to ensure that room remained for tax reductions. Directors suggested the adoption of multiyear budgeting and expenditure ceilings as a means of establishing spending control. They advised introducing pricing and performance-based mechanisms to improve public sector efficiency.

Directors noted that the public pension system needed to be reformed to ensure the financial viability and intergenerational equity of the system. This objective could be achieved in a variety of ways, such as by indexing benefits to prices rather than wages. Directors also encouraged the authorities to address the disincentive effects of the pension and tax regimes to raise effective labor supply.

Directors encouraged the social partners to make strong efforts to restore competitiveness by containing wage demands, and by safeguarding the lead role of exposed industries in the wage bargaining system. Directors welcomed the authorities' measures to increase labor supply by reforming social benefit systems, liberalizing immigration, and easing working time regulations, but considered that economic incentives and tighter eligibility criteria would likely be required to stem the steep rise in sickness leave.

Directors welcomed efforts to foster competition in product markets, and called for further progress in privatization and deregulation. They urged the authorities to reduce Norway's budgetary support and trade protection to agriculture, by attempting to address their non-trade policy concerns through less distorting measures.

Directors commended the authorities for their ongoing efforts to monitor financial sector soundness through stress-testing. The weak economic environment called for a continuation and intensification of such supervisory vigilance. Directors also noted Norway's generally comprehensive system for anti-money laundering and combating terrorist financing.

Directors praised Norway's continued generous official development assistance, which, at about 0.9 percent of GNP, stands among the highest in the world. They warmly welcomed the authorities' intention to raise such assistance even further.

Norway's economic statistics are adequate for surveillance purposes in their coverage, quality, and timeliness.


Norway: Selected Economic Indicators


 

1999

2000

2001

2002 1/

2003 1/


           
           

Private consumption

3.3

3.5

2.5

3.1

2.9

Public consumption

3.2

1.2

2.0

2.0

2.0

Gross fixed investment

-5.6

-1.5

-4.6

-2.1

2.2

Export of goods and services

2.8

2.9

4.2

2.4

1.2

Of which: Oil and gas

-0.1

6.4

7.3

3.3

1.8

Import of goods and services

-1.8

3.2

0.0

1.6

3.0

GDP

2.1

2.4

1.4

1.6

1.8

Mainland GDP 2/

2.7

1.9

1.2

1.4

1.6

           
           

Unemployment

3.2

3.4

3.6

3.9

4.2

           
           

Consumer prices

2.3

3.1

3.0

1.3

2.7

Hourly labor cost in

         

manufacturing

5.4

4.2

4.4

4.5

4.5

           

Nominal effective exchange rate

3.1

-1.9

3.9

11.5

...

           
           

Broad money, M2

10.8

9.2

8.6

8.2

...

Domestic credit

8.3

12.4

9.8

8.9

...

           
           

Three-month interbank rate 3/

6.5

6.7

7.2

6.9

...

Ten-year government bond yield 3/

5.5

6.2

6.2

6.4

...

           
 

(In percent of GDP)

State budget, including social security

         

Revenues

40.5

43.9

50.2

46.9

45.6

Expenditures

37.9

33.5

34.2

37.5

36.0

Overall balance

2.6

10.5

16.0

9.4

9.5

           

General government financial balance

6.1

15.1

15.0

12.5

10.0

           

Current account balance

5.4

15.0

15.4

13.4

12.6

           

International reserves (in months of imports of goods and services)

4.8

5.2

4.1

4.4

...

           
           

Sources: Ministry of Finance; Norges Bank; Statistics Norway; International Financial Statistics; and IMF staff estimates.

           

1/ Staff estimates and projections as of February 2003.

2/ Excludes items related to petroleum exploitation and ocean shipping.

3/ Period average, in percent.


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. In this PIN, the main features of the Board's discussions are described.




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