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Norway and the IMF
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On June 3, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Norway.1
Norway's strong economic performance in recent years has been underpinned by a sound macroeconomic policy framework. In 2001 Norway adopted an inflation targeting framework, as well as fiscal guidelines (effective for the 2002 budget) designed to preserve petroleum revenue for future generations. This revenue, which guarantees substantial fiscal and current account surpluses for some years, is invested abroad in financial assets by the Government Petroleum Fund (GPF).
Real mainland GDP growth rebounded strongly in 2004, after a slowdown that began in late 2002. Very supportive monetary conditions-the central bank intervention rate as been 1.75 percent for over a year-high oil prices, rising house prices, strengthening consumer and business confidence, and an improved world economy all contributed to the pickup in activity. At the same time, core inflation has been well below the 2.5 percent target rate for some time, reflecting the slack that opened up during the slowdown, but also important structural factors: falling prices for some imports, because of a shift in imports toward low-cost countries, and for some domestic services, because of increased competition.
The outlook for 2005 and 2006 is promising, with most of the factors that propelled the economy forward last year expected to continue into the near future. Growth is likely to fall off somewhat
in 2006, as very high levels of petroleum investment may not be sustained and there is a widespread expectation that the central bank will begin to tighten its policy stance. With the output gap closing and the structural factors that have been holding prices down waning, inflation is set to begin to rise. Nonetheless, wage increases so far in 2005 have been moderate, as inflation continued to be low and the unemployment rate has edged down only gradually.
The non-oil fiscal deficit has widened somewhat in the past two years on a structural basis, despite strong growth, and pressures for spending more of the petroleum revenue are strong. The 2005 budget foresaw a further deviation from fiscal rule setting the central government non-oil structural deficit at 4 percent of the assets of the GPF (part of the guidelines governing fiscal policy), despite higher oil prices, and therefore a larger stock of assets, than had been expected last year.
Executive Board Assessment
Directors commended Norway's strong fiscal and monetary policy framework and the success in avoiding any adverse effects of the oil wealth. Directors welcomed the economic recovery that has taken hold since 2004. They noted that robust growth and low unemployment have been underpinned by the accommodative monetary stance, rapid credit expansion, and high world oil prices. Inflation has remained low, with core inflation well below the inflation target, reflecting the lagged effects of the 2002-03 downturn and structural factors that have lowered the prices of some imports and domestic services. Looking forward, Directors agreed that the expansion would continue into next year and beyond, barring a downturn in the world economy or a large drop in oil prices.
Directors considered that the flexible inflation targeting regime has served Norway well, and welcomed the further refinements that were implemented in the past year. Publishing the monetary policy strategy document at the beginning of the strategy period and expanding the discussion of interest rate decisions should enhance transparency. Directors noted that inflation targeting has become increasingly credible and accepted, and encouraged the authorities to continue their efforts to explain the monetary policy framework and communicate policy decisions to markets.
Against the backdrop of strong growth, and consistent with the inflation targeting framework, Directors agreed that a gradual and measured withdrawal of monetary stimulus should begin in the course of this year. They noted that slack in labor and product markets is diminishing, and that the structural factors holding prices down may be waning. They also expressed concern that labor markets could become overheated in 2006, a year when two-year wage bargains would be concluded. Directors recognized that monetary tightening could put upward pressure on the currency, but did not see this prospect as justifying continued expansionary policies in the face of the current cyclical upturn.
Directors agreed that the fiscal guidelines-which require that the non-oil central government structural budget deficit be set equal to the long-run real return on the assets of the Government Petroleum Fund, assumed to be 4 percent-have helped to sustain broadly prudent fiscal policy. They appreciated the authorities' efforts to contain the non-oil deficit by restraining spending growth. In this regard, they welcomed the revised 2005 budget, which will use extra oil revenues to reduce the non-oil deficit, thereby bringing forward the date when the fiscal guidelines are achieved to 2008. At the same time, however, Directors emphasized the need for continued fiscal restraint, especially in the run-up to the elections later this year, to deal with the projected costs of population aging. They were concerned that the further breaching of the fiscal rule might damage the credibility of fiscal policy. They therefore called on the authorities to take advantage of the current favorable economic climate to comply with the fiscal guidelines as quickly as possible. Most Directors further recommended that the guidelines be reinforced by a medium-term fiscal plan, building on existing multi-year fiscal projections and ceilings for spending growth. Directors welcomed the 2005 tax reform, which eliminates some distortions and promotes employment. However, they noted that weaknesses in the tax structure remain-particularly the bias in favor of residential investment-and that spending restraint will be needed to offset the expected adverse revenue effect.
Noting that rising pension costs are the major threat to long-term fiscal sustainability in Norway, Directors welcomed the recent decision by parliament to adopt much of the government's reform package, which should help to contain costs and improve work incentives. They urged that that the flexible retirement age provisions of the package also be adopted, and agreed that the Government Petroleum Fund-which will be linked to pensions in the government's reform-should continue to be invested abroad. Finally, Directors noted that further measures beyond the current proposal will be needed to ensure long-term sustainability.
Directors welcomed the conclusion of the Financial System Stability Assessment (FSSA) that the financial system is sound, competitive, and well-managed. They commended the authorities on the strong system of financial supervision, and on the close coordination of financial supervision among the Nordic countries in view of the important cross-border financial linkages. They recommended that the authorities implement the reforms laid out in the FSSA, to help ensure continued financial-sector strength and resilience. Directors cautioned, however, that a continuation of the rapid pace of credit expansion, and the associated rise in household debt, could, over time, pose an increasing risk, and urged the authorities to continue to monitor credit developments closely.
Directors agreed that Norwegian labor markets perform very well. However, to check the expansion of sickness and disability programs, which could undermine employment, they recommended further tightening of administrative controls and reconsideration of very high replacement rates. Directors welcomed the new competition law and the increased competition in Norwegian product markets, and urged that this momentum be sustained, including through vigorous action by the competition authority. Directors considered that further privatization would be beneficial, in view of the still-high degree of state ownership, although they recognized that policies have been put in place to help to ensure that state-owned enterprises operate on a commercial basis.
Directors commended the generous level of Norway's development assistance, which is well above the UN target. They welcomed Norway's support for multilateral trade liberalization and its own generally low trade barriers, while encouraging reduction of still-high barriers to agricultural imports.
Norway: Selected Economic Indicators
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.
IMF EXTERNAL RELATIONS DEPARTMENT