A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
Recent Developments and Outlook
The economy is slowly recovering from the shock of low oil prices. After remaining largely flat last year, mainland GDP expanded at a slow pace in the first three quarters this year, aided by supportive monetary and fiscal policies. Inflation remains above the 2.5 percent target, largely reflecting lagged effects of last year’s krone depreciation on imported consumer goods prices, whereas wage growth is very modest. Unemployment is expected to peak this year— albeit still at a low level— and is mainly concentrated in oil-dependent regions as the economy continues to adjust to declining offshore demand. The krone has strengthened somewhat this year alongside the recovery in oil prices. House price inflation accelerated again recently, particularly in Oslo and surrounding areas, and household debt remains elevated at 224 percent of disposable income.
A continued recovery is expected, but there are downside risks. We project mainland growth to remain at about 1 percent this year, but to accelerate to 1¾ percent next year, supported by a pick-up in investment and export growth and improving consumer and business sentiment. Unemployment is projected to peak this year before declining in 2017. As low capacity utilization weighs on domestic inflation and the effects of the krone depreciation dissipate, inflation is set to return gradually to target next year. However, the outlook hinges on a smooth transition away from oil and is subject to downside risks. Weaker-than-expected growth in key advanced and emerging economies could derail the non-oil export recovery and the transition. Persistently lower energy prices could compound the adverse growth impact of the ongoing decline in oil investment. Domestically, a housing market correction could result in an abrupt reduction in consumption and residential investment with ripple effects on corporate earnings and banks.
Policy Challenges — Supporting Transition and Addressing Structural Vulnerabilities
Monetary policy should stay accommodative to support the recovery. With core inflation returning to target and inflation expectation remained close thereto, monetary policy can afford to remain on hold for now. As the recovery takes on a more solid footing, a gradual return to the neutral rate will be needed over time. Given the significant slack in the economy, financial stability risks stemming from the housing market would best be tackled by targeted macroprudential and other measures (see below), including gradually phasing out the large tax subsidy for housing investment.
The expansionary 2017 budget is broadly appropriate, but fiscal measures should be pro-transition and pro-growth. The level of fiscal stimulus planned for 2017 is justified, given the significant output gap, the level of unemployment, and ample fiscal space. However, stimulus should focus on well-targeted measures that facilitate the economy’s rebalancing to a new growth model based on non-oil tradable sectors. The 2017 budget contains welcome further reductions in personal and corporate income tax rates, but other tax policy changes to promote a more efficient allocation of resources should also be considered. In particular, reducing tax preferences for housing would help channel new investment toward more productive uses and take some of the pressure off rapidly rising house prices. The temporary funding allocated to combat unemployment in oil-dependent regions should help smooth the transition. Emphasis should be put on retraining and mobility-enhancing measures, such as measures to promote housing supply and related infrastructure in job-abundant urban areas, to move unemployed workers into non-oil private tradable sectors, instead of replacing declining oil-related employment with public sector employment.
The fiscal stance should shift to neutral as the economy returns to potential. The government’s fiscal policy has generally been prudent with the non-oil structural deficit staying well below 4 percent of GPFG assets in recent years. However, the fact that GPFG has been growing much faster than the economy has allowed increased spending of oil revenues as share of mainland GDP. The new global norm of low interest rates and high equity valuations also suggest likely returns to GPFG assets to be considerably lower than 4 percent for the next decade, and we note that the Mork Commission reached a similar conclusion. In this regard, the fiscal rule’s 4 percent target is no longer appropriate as operational guidance for fiscal policy, and a target of about 2.5-3 percent of GPFG assets would be needed to conserve oil revenue to address long-run fiscal challenges even if the equity allocation of the GPFG is increased. A revised rule should also ensure non-positive fiscal impulse when the economy is at or above capacity, thereby relieving so-called “Dutch disease” pressures.
Continued structural reforms are also crucial to a successful transition to a new growth model. Low wage growth and the depreciation of the krone during 2013-15 has improved cost competitiveness, but productivity growth remains sluggish and Norway’s unit labor costs are still well above those of peer countries. In this regard, continued wage restraint on the part of social partners is important, as are reforms to reinvigorate productivity growth in the areas identified by the Productivity Commission, including education, research and innovation, mobilization of the workforce, and public sector efficiency. Such reforms would help restore Norway’s competitiveness and foster non-oil tradable sectors. More generally, further efforts are needed to increase efficiency in the labor market. While private sector pension reform has been effective in raising labor force participation among the elderly, it will be critical to complete similar reforms to the public sector retirement system and to tighten sickness and disability benefits. Additionally, relaxing constraints on new property construction, particularly in main urban areas that are less affected by low oil prices, could boost the supply of housing, thereby taking some of the pressure off elevated housing prices and facilitating labor relocation between regions.
Financial Sector Policy
The banking system is well capitalized and profitable, but important structural vulnerabilities remain. The 2015 FSAP update identified elevated household debt, overvalued house prices, and banks’ heavy reliance on external wholesale funding as the main sources of financial stability risks. Despite the housing sector-specific measures implemented so far, both house prices and household debt have been growing considerably faster than household disposable income, and have accelerated recently at an unsustainable rate, particularly in the Oslo area. Further targeted measures to contain systemic risks arising from the housing sector are thus called for, such as higher mortgage risk weights, tighter loan-to-value limits, and the introduction of debt-to-income (DTI) or debt-service-to-income ratio limits. In this regard, the mission strongly supports the recent proposals by the FSA and the Norges Bank to make permanent and tighten the current regulation on requirements for new residential mortgage loans, including reducing the speed limit and introducing a DTI ratio. The authorities should also continue to enhance stress tests for banks to take account of funding risks.
Regional cooperation on financial stability issues should be strengthened given the need to calibrate macroprudential measures to economic conditions of host countries. This is particularly important in view of the intended conversion of Nordea Bank Norge from a subsidiary into a branch. Enhanced supervisory cooperation among the Nordic finance ministries, central banks, and financial supervisors, which safeguards host country treatment and information exchange, would better ensure financial stability and a more level playing field for banks.
The mission is grateful to the Norwegian authorities and other counterparts for their warm hospitality and for the candid and high-quality discussions.
(IMF Communications Department)