Norway 2011 Article IV Consultation Staff Report

8/12/2019 Norway 2011 Article IV Consultation Staff Report

1/72

2012 International Monetary Fund February 2012IMF Country Report No. 12/25

January 13, 2012 January 27, 2012 January 29, 2001 November 22, 2011 2011 January 29, 2001

N orway: 2011 Article IV ConsultationStaff Report; Public Information N otice on theExecutive Board Discussion; and Statement by the Executive Director for N orway

Under Article IV of the IMFs Articles of Agreement, the IMF holds bilateral discussions withmembers, usually every year. In the context of the 2011 Article IV consultation with Norway, thefollowing documents have been released and are included in this package:

The staff report for the 2011 Article IV consultation, prepared by a staff team of the IMF,following discussions that ended on November 22, 2011, with the officials of Norway oneconomic developments and policies. Based on information available at the time of thesediscussions, the staff report was completed on January 13, 2012. The views expressed in thestaff report are those of the staff team and do not necessarily reflect the views of theExecutive Board of the IMF.

A Public Information Notice (PIN) summarizing the views of the Executive Board asexpressed during its January 27, 2012 discussion of the staff report that concluded theArticle IV consultation.

A statement by the Executive Director for Norway.

The policy of publication of staff reports and other documents allows for the deletion of market-sensitiveinformation.

Copies of this report are available to the public from

International Monetary Fund Publication Services700 19 th Street, N.W. Washington, D.C. 20431

Telephone: (202) 623-7430 Telefax: (202) 623-7201E-mail: [email protected] Internet: http://www.imf.org

International Monetary FundWashington, D.C.


2/72

_G

NORWAYSTAFF REPORT FOR THE 2011 ARTICLE IV CONSULTATION

KEY ISSUES

Context : Norways economy has experienced steady recovery, aided by supportive

policies, with low unemployment and the output gap nearly closed. Going forward,

moderately paced, domestic demand-led growth is projected to continue. Inflation

currently low due in part to krone appreciationis expected to rise gradually to the 2

percent target by 2013. This relatively benign central scenario is subject to significant

risks, including from possible intensification of the eurozone crisis. The major domestic

risk arises from elevated house prices and high household debt levels.

Financial sector policy : The top near-term macroeconomic priority is to reduce risks

arising from high household debt by tightening macroprudential standards for

mortgage lending while undertaking tax reforms to gradually reduce incentives for

excessive leverage. Creating a stronger institutional framework for macroprudentialpolicy would also assist risk mitigation going forward.

Fiscal policy : With the output gap closing, fiscal tightening is needed over the medium

term in the central scenario to rebuild precautionary buffers and ensure the fiscal

guidelines are met on average over the cycle. Medium-term tightening will also (i)

reduce long-run fiscal challenges, which should be further addressed through

entitlement reform, and (ii) allow Norges Bank to keep interest rates low for longer,

thus reducing risks of excessive krone appreciation and associated competitiveness

problems. For 2012, however, the budgets broadly neutral fiscal stance is appropriate,given heightened global risks and assuming macroprudential tightening.

Monetary policy : With inflation expected to return to target by the end of the policy

horizon, the current monetary stance is appropriate for now. However, monetary policy

should be the first line of defense if risks materialize.

January 13, 2012


3/72

2011 ARTICLE IV REPORT NORWAY

2 INTERNATIONAL MONETARY FUND

Approved ByJuha Khknen andDavid Marston

Discussions took place in Oslo during November 10-22, 2011. Thestaff team comprised Messrs. Fletcher (head), Kannan, Sandri (all EUR),and Favara (RES). Mr. Gronn (OED) participated in the discussions.

CONTENTS

THE MACROECONOMIC SETTING ______________________________________________________________

A. Supportive Policies Have Facilitated Steady Recovery ___________________________________________4

B. A Strong Exchange Rate Has Contributed to Low Inflation ______________________________________8

C. Improved Terms of Trade Have Boosted the External Sector __________________________________ 10

D. House Prices and Private-Sector Debt Levels Remain High ___________________________________ 12

E. Financial Sector Balance Sheets Improving, but Vulnerabilities Remain _______________________ 14

OUTLOOK, RISKS, AND SPILLOVERS ___________________________________________________________

POLICY DISCUSSIONS ________________________________________________________________________

A. The Policy Mix __________________________________________________________________________

B. Fiscal Policy ____________________________________________________________________________

C. Monetary Policy _________________________________________________________________________

D. Financial Sector Issues ____________________________________________________________________

STAFF APPRAISAL ___________________________________________________________________________

TABLES

1. Selected Economic Indicators, 200412 _______________________________________________________

2. Medium-Term Indicators, 200816 ___________________________________________________________

3. External Indicators, 200816 ________________________________________________________________

4. Key Fiscal Indicators, 200412 ______________________________________________________________

5. General Government Accounts, 200410 ______________________________________________________

6. Financial System Structure, 200611 __________________________________________________________

FIGURES

1. GDP ___________________________________________________________________________________

2. Key Activity Indicators ____________________________________________________________________

3. Labor Market ___________________________________________________________________________


4/72

NORWAY 2011 ARTICLE IV REPORT

INTERNATIONAL MONETARY FUND3

4. Price Developments __________________________________________________________________________

5. External Developments _______________________________________________________________________

6. Household and Corporate Sector ______________________________________________________________ 13

7. Credit Market Developments __________________________________________________________________

8. Credit Standards and Lending _________________________________________________________________ 19. Nordic Banks Relative Performance ___________________________________________________________ 1

10. Bank Performance __________________________________________________________________________

BOX

1. Authorities Response to Past IMF Policy Recommendations __________________________________ 26

ANNEXES

I. Estimating the Size of Norways Output Gap ___________________________________________________ 39

II. Does Norway Have a Competitiveness Problem? ______________________________________________ 45

III. House Prices in Norway ______________________________________________________________________

IV. Risk Assessment Matrix _____________________________________________________________________

V. Exposure to the Eurozone and Other International Linkages __________________________________ 58


5/72



THE MACROECONOMIC SETTING

A. Supportive Policies Have Facilitated Steady Recovery

1. Norway is experiencing a steady,domestic demand-led recovery (Figures 1and 2). Relative to its peers, Norwaysmainland economy had a relatively milddownturn during the 2008-09 global financialcrisis. It then grew by 2.1 percent in 2010 andis estimated to have grown by around 2percent in 2011, bringing real mainland GDPnearly 3 percent above its pre-crisis level andnearly closing the output gap (Annex I).

Growth has been led by private consumption

on the back of rising house prices and robustwage growth, which in turn have been buoyedby low interest rates and improving terms oftrade. 1 The recovery in the housing market hasalso spurred a strong increase in construction

1 Of these factors, a fitted consumption functionfollowing Jansen, E. (2010), Wealth Effects onConsumption in Financial Crises: The Case of Norway,Discussion Paper No. 616, Statistics Norwaysuggeststhat consumption growth during the past year wasprimarily driven by a rebound in real disposableincome, though wealth effects are also significant inNorway.

activity. Meanwhile, investment in the oilsector has rebounded following a sharpcontraction in 2010. 2

2. Steady growth has kept the labormarket strong (Figure 3). Norway entered therecession with its labor market in a robustposition, with the unemployment rate reachinga low of 2 percent in the first quarter of

2008. Given the relatively shallow recessionand high public-sector employment, theunemployment rate increased by only 1percentage points during the downturn.Employment growth in the private sector hassince strengthened, with firm surveys pointingto increasing hiring intentions. The gradualtightening of the labor market and theconsequent moderation in the unemploymentrateto a low 3 percent as of October

2011has caused real wage growth toaccelerate from below 1 percent in late 2009to 2 percent by mid-2011.

2 For simplicity, oil in this report refers to all ofNorways hydrocarbon resources. For example, oilrevenue refers to revenue from both oil and gas.

85

90

95

100

105

85

90

95

100

105

2008 2009 2010 2011

DNK EA

FIN NORNOR (mainland) SWE

GDP Dynamics Since the Crisis(Index, 2008Q2=100)

Source: Haver.

-30

-150

15

30

45

60

-30

-150

15

30

45

60

2004 2005 2006 2007 2008 2009 2010 2011

Number of dwellingsFloor space

New Building Starts(Last 12 months, percent growth over previous 12 months)

Sources : Haver Analytics; and IMF staff calculations.


6/72


7/72



Figure 2. Norway: Key Activity Indicators

Sources: Haver Analytics;and IMF staff calculations.

30

35

40

45

50

55

60

65

70

75

80

30

35

40

45

50

55

60

65

70

75

80

2004 2005 2006 2007 2008 2009 2010 2011

Overall PMINew OrdersProduction

Purchasing Manager Index(50+ = Expansion, sa)

PMI indicato rs for manufacturing recovered strongly in

2010 and the first half of 2011 before d ipping late inthe year, in line with global trends .

-60

-40

-20

0

20

40

60

80

100

-60

-40

-20

0

20

40

60

80

100

2004 2005 2006 2007 2008 2009 2010 2011

Outlook for enterprise (50+ = expansion)Industrial confidence

Business Tendency Survey forManufacturing, Mining, and Quarrying

The recovery period reflected improved confidence.

-30

-15

0

15

30

45

60

-30

-15

0

15

30

45

60

2004 2005 2006 2007 2008 2009 2010 2011

Number of dwellingsFloor space

New Building Starts(Last 12 months, percent growth over previous12 months)

Const ruction activity has expanded in line with therecovery in house p rices ...

-15

-10

-5

0

5

10

15

20

25

-15

-10

-5

0

5

10

15

20

25

2004 2005 2006 2007 2008 2009 2010 2011

Retail Sales VolumeConsumption good volume index

Retail Activity(6-month change, percent, saar)

... while reta il sales have been positive ...

-50

-40

-30

-20

-10

0

10

20

30

40

50

-50

-40

-30

-20

-10

0

10

20

30

40

50

2004 2005 2006 2007 2008 2009 2010 2011

Overall indicatorOutlook for economy next year

Consumer Confidence Indicator(>0 = optim ism, sa)

... though confidence has recently dip ped.

-6

-4

-2

0

2

4

6

8

-6

-4

-2

0

2

4

6

8

2004 2005 2006 2007 2008 2009 2010 2011

Real private consumptionGoods consumption indexRetail volume excl. cars

Real Quarterly Growth in Private Consumptionvs. Other Consumption Indicators (Percent, sa)

and matched by a recovery in overall privateconsumption ...


8/72



Figure 3. Norway: Labor Market

Sources: Haver Analytics; and IMF staff calculations.1/ Employment numbers are based on the Labor Force Survey; working hours are based on the National Accounts.

345

350

355

360

365

370

375

380

385

390

1900

2000

2100

2200

2300

2400

2500

2600

2700

2800

1990 1993 1996 1999 2002 2005 2008 2011

Employment(thousands, sa) 1/

Quarterly hours workedper employed person(right scale, sa) 1/

After a mod erate reduction in 2009, employment isgrowing again...

1

2

3

4

5

1

2

3

4

5

1999 2001 2003 2005 2007 2009 2011

Labor Force Survey, SA

Regis tered, NSA

Unemployment Rate(Percent)

allowing for a gradual reduction of the unemploymentrate.

-6

-4

-2

0

2

4

6

8

10

-6

-4

-2

0

2

4

6

8

10

2000 2001 2003 2004 2006 2007 2009 2010

General government

Rest of the economy

Growth in Hours Worked(Year-on-year, percent, sa)

After falling sharply during the recession, workinghours in the pr ivate sector are now increasing. ..

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

49

50

51

52

53

54

55

56

57

1990 1993 1996 1999 2002 2005 2008 2011

Labor force (percent of population)

Net imm igration (last 2 quarters,annualized ra te, right scale)

but the labor force participation rate has not yetrecovered.

0

2

4

6

8

10

0

2

4

6

8

10

2001 2002 2004 2005 2007 2008 2010

Median ea rnings growthMedian labor cost growth

Earnings Growth and Labor Costs Across Sectors(Percent)

Lower unemployment and participation ra tes areputting p ressure on wage growth...

0

10

20

30

40

50

0

5

10

15

20

25

30

35

2006 2007 2008 2009 2010 2011

Labor a s constraint on production inmanufacturing (percent of surveyresponses)Unfilled vacancies (thousands, right scale)

and labor const raints are gradually becoming amore serious co ncern for manufacturing production.


9/72



3. This recovery partly reflects strongpolicy stimulus deployed during the crisis,which the authorities have begun to slowlywithdraw over the last two years :

Fiscal policy : The government deployedfiscal stimulus (as measured by the changein the structural non-oil budget deficit) of2 percent of trend mainland GDP in 2009.Fiscal policy then turned broadly neutral in2010 and 2011. Together with strongreturns on Norways sovereign wealthfundthe Government Pension Fund-Global (GPF-G)this brought thestructural non-oil deficit back below 4

percent of the GPF-Gs capital, thebenchmark target under Norways fiscalguidelines, from which the governmentcan deviate temporarily for cyclicalreasons.

Monetary policy : The key policy rate wasreduced by a total of 4 percentagepoints from October 2008 to June 2009,bringing the rate to a historic low of 1percent. As Norways cyclical positionstarted to improve, a tightening stance wasadopted, with quarter-point rate hikes inOctober 2009, December 2009, May 2010,and May 2011. With the global outlookweakening and the European Central

Banking (ECB) lowering rates, Norges Bankthen cut the policy rate by 50 basis pointsin December 2011, bringing it to its currentlevel of 1 percent.

Financial sector policy : The authoritiesimplemented a series of measures duringthe recession to bolster financial stability.These included easier collateralrequirements for access to central bankliquidity, a program that allowed banks toexchange less-liquid covered bonds formore-liquid government securities,purchases of corporate bonds, and bankcapital injections. Reliance on these

exceptional measures was graduallyreduced as the economy recovered.

B. A Strong Exchange Rate Has Contributed to Low Inflation

4. Despite buoyant domestic demand,inflation remains muted . Headline CPI

inflation is running at 0.2 percent as ofDecember 2011 (Figure 4). This very low rate ispartly due to transitory effects from volatileelectricity prices. However, inflation excludingenergy products and tax changes (CPI-ATE)akey measure of core inflation in Norwayisalso muted at 1 percent. Indeed, this is one ofthe lowest rates of core inflation amongst

-6

-4

-2

0

2

4

6

-6

-4

-2

0

2

4

6

DNK NOR USA GBR DEU SWE

Cumulative reduction ininterest rates (2008-10)Fiscal s timulus (2008-10)

Monetary and Fiscal Stimulus

Sources: IMF Fiscal Monitor; and individual central banks'websites.

0.0

0.5

1.0

1.5

2.0

2.5

0.0

0.5

1.0

1.5

2.0

2.5

FIN NLD DNK EA NOR SWE

Core Inflation(Year-over-year p ercent change, latest available)

Source: Eurost at and National Statistical Agencies.


10/72



Figure 4. Norway: Price Developments

Sources: Haver Analytics; and IMF staff calculations.

-6

-4

-2

0

2

4

6

-6

-4

-2

0

2

4

6

2004 2005 2006 2007 2008 2009 2010 2011

Headline CPI

CPI excl. tax changes and energy

CPI excl. tax changes and temporaryenergy price effects

Annual Inflation Rates(Percent)

Inflation has fall en considerably below the 2.5percent ta rget.. This partly reflects volatileelectricity prices, but core inflation is also low ...

-15

-10

-5

0

5

10

15

20

-6

-4

-2

0

2

4

6

8

2004 2005 2006 2007 2008 2009 2010 2011

Impo rted consumer goods

Dom. cons. go ods (right scale)

Annual I nflation of CPI Components(Percent)

reflecting in pa rt lower import pr ices resulting fromkrone app reciation.

-2

0

2

4

6

8

10

-2

0

2

4

6

8

10

2004 2005 2006 2007 2008 2009 2010 2011

Domestic onlyTotal (domestic & export)

Producer Price Index(Year-on-year change, pe rcent)

Producer price inflation has however resumed...

-15

-10

-5

0

5

10

15

20

-15

-10

-5

0

5

10

15

20

2004 2005 2006 2007 2008 2009 2010 2011

Oil, gas, and miningManufacturingHotel s and res taurantsRetail and wholesale trade

Average Monthly Full-Time Earnings bySector (Year-on-year change, percent)

... and wages are ris ing, especially in the retail andwholesale trade sectors.

0

5

10

15

20

25

0

5

10

15

20

25

2001 2003 2005 2007 2009 2011

Domes tic credit (C2)Broad money (M2)

Monetary and Credit Aggregates(Year-on-year change, percent)

The growth of money and credit aggregates isalso p icking up...

1.5

2.0

2.5

3.0

3.5

1.5

2.0

2.5

3.0

3.5

2002 2005 2008 2011

5 years ahead2 years aheadTarget

Survey-Based Inflation Expectations(Percent)

... though medium-term inflation expectationsremain broadly anchored near the t arget.


11/72



advanced economies, which is particularlystriking given solid wage growth and a smalleroutput gap than in other countries.

5. Exchange rate appreciation has been

a major contributor to recent inflationdevelopments . Following a significantdepreciation during the early part of the globalfinancial crisis, the Norwegian krone has sincerebounded and is now around its pre-crisis

rates (Figure 5). This appreciation and theresulting low growth of import prices (whichtakes several months to fully pass through)explains much of Norways low core inflationrelative to many advanced economies, asimported goods constitute 30 percent ofNorways consumption basket.

C. Improved Terms of Trade Have Boosted the External Sector

6. The impact of strong domesticdemand and an appreciating krone on thenon-oil trade balance has been offset byimproving terms of trade . Following therecovery in domestic demand, import volumeshave rebounded significantly (Figure 5). Keynon-oil exportssuch as aluminum andnickelhave also rebounded due to higherdemand from rapidly growing emergingmarkets, though at a slower pace than imports.The fall in non-oil net export volumes,however, has not translated into adeteriorating non-oil trade balancewhichhas been broadly stable at around -7 percentof mainland GDPdue to improvements in

Norways terms of trade, which reboundedsharply after a brief fall during the recession.

CAN

DNK

EU

JPN

NORSWE

CHE

GBR

USA

y = -0.5x + 10.2R = 0.4

-5

0

5

10

15

20

-5

0

5

10

15

20

25

-15 -10 -5 0 5 10 15 20 C u m u

l a t i v e c h a n g e i n i m p o

r t p r i c e s

Cumulative change in NEER (+=appreciation)

Sources: Haver; and IMF staff estimates.

Cumulative Change in Import Prices vs.Cumulative Change in NEER (Latest data compared to end 2009)

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

-20

-10

0

10

20

30

40

2009m1 2009m10 2010m7 2011m4

NEER (lagg ed 6m; +=depreciation)

Imported consumer goods prices (rightscale)

Norway: Imported Inflation and the Exchange Rate(Annual change, percent)

Sources: Stat istics Norway and IMF staff esti mates.

90

95

100

105

110

115

120

90

95

100

105

110

115

120

2000 2002 2004 2006 2008 2010

Norway: Terms of Trade(Excluding export price of crude oil and natural gas)

Sources: Stat istics Norway; and IMF sta ff estimates.

(Index, 2000Q1=100)


12/72



Figure 5. Norway: External Developments

Sources: Bloomberg; Haver Analytics; IMF Information Notice System; and IMF staff calculations.

4

5

6

7

8

9

10

11

4

5

6

7

8

9

10

11

2000 2002 2004 2006 2008 2010 2012

NOK/EUR

NOK/USD

Bilateral Exchange Rates

The Norwegian krone has fully recovered after asharp d epreciation at the end o f 2008...

85

90

95

100

105

110

115

120

85

90

95

100

105

110

115

120

1990 1993 1996 1999 2002 2005 2008 2011

NEERREERREER 10 year average

CPI-based Effective Exchange Rates (Index2000 = 100, increase indicates appreciation)

....and the real effective exchange rate is nowmod erately above its 10 year average.

-30

-20

-10

0

10

20

30

40

-30

-20

-10

0

10

20

30

40

2000 2002 2004 2006 2008 2010

Current account balanceEnergy exportsNon-energy exports and service trade balance

Current Account Surplus(Percent of GDP)

The current account is fairly s table...

80

90

100

110

120

130

140

150

160

170

80

90

100

110

120

130

140

150

160

170

2000 2002 2004 2006 2008 2010

Oil and gas exports

Oil and gas production

Energy Exports and Production(Billions o f 2006 NOK, sa)

...as the decline in energy export quantities has beenoffset by higher p rices.

40

5060708090100110120130140

40

5060708090

100110120130140

2004 2005 2007 2008 2010 2011

NorwayFinlandDenmarkSweden

Non-Energy Exports(Index, 2007 = 100, Euros)

Non-energy exports have fully recovered from therecession in real terms...

59.7 74.076.5

55.2

0

20

40

60

80

100

120

140

160

0

20

40

60

80

100

120

140

160

NOR SWE FIN DNK

Manufacturing Food-related

Chemicals Other commodities

Exports by Industry, 2010(Percent of non-energy exports)

...partly thanks to the good performance of the foodindustry, which accounts for a la rge share of total non-energy exports relative to other countries in the region.


13/72



7. Standard metrics suggest the kroneis moderately overvalued, though Norwaysnon-oil exports continue to perform well .Several rule-of-thumb measures point tosome krone overvaluation: purchasing powerparity measures, for example, indicate thatNorways price level is high relative tocountries with similar income levels. Similarly,although the CPI-based REER has beenrelatively stable, rapid wage growth hasresulted in strong appreciation of the ULC-based REER, leaving it substantially higher thanits historical average. More refined measuresof exchange rate valuationbased on current

account norms that take into account changesin the value of oil wealth over timepoint toovervaluation of around 12 percent (Annex II).Nonetheless, the non-oil sector in Norwayappears to remain internationally competitive.Market shares for Norways main non-oilexports have remained stable, if not slightlyincreasing, over the last decade. Still, furtherappreciation of the krone, continued highwage growth, or a turnaround in the terms oftrade would likely strain the profitability of thenon-oil export and import-competing sectorsgoing forward.

D. House Prices and Private-Sector Debt Levels Remain High

8. Despite broadly favorablemacroeconomic performance, imbalancesbuilt up prior to the downturn persist . In therun-up to the recession, household debtmainly mortgage debtincreased rapidly,reaching 200 percent of disposable income byearly 2008 (Figure 6), twice the euro areaaverage of 102 percent. During the downturn,the impact of falling incomes on householdsdebt-servicing capacity was mitigated by thedrop in interest rates, given that about 95percent of mortgages are at variable rates.

0.0

0.5

1.0

1.5

2.0

2.5

0.0

0.5

1.0

1.5

2.0

2.5

0 20,000 40,000 60,000 80,000 100,000

P r i c e

l e v e

l r e l a t

i v e

t o U S

Per capita GDP (PPP exchange rate)

Price Level vs. Per capita GDP

(PPP basi s)

Norway

Source: IMF.

100

120

140

160180

200

220

240

100

120

140

160180

200

220

240

2002 2004 2006 2008 2010

Household Debt (percent of disposable income)

Non-Financial Corporate Debt (percent of GDP)

Norway: Debt Ratios of Household andCorporate Sectors

Sources: Haver; and IMF sta ff estimates.

80

90

100

110

120

130

140

80

90

100

110

120

130

140

2000 2002 2004 2006 2008 2010

CPI-based REERULC-based REER

Norway: REER (Index, Jan. 2000=100)

Source: IMF.


14/72



Figure 6. Norway: Household and Corporate Sector

Sources : Haver Analyti cs; OPAK, Stati stics Norway; Norges Bank; and IMF sta ff calculations.1/ Adjusted so as to reflect only the cumulative effect since 2004Q1 of transactions in assets and liabilities, thus strippingout valuation effects.2/ High-standard offices centrally located in Oslo.

0

10

20

30

40

50

60

70

80

100

120

140

160

180

200

220

240

2004 2005 2006 2007 2008 2009 2010

Gross liabilities

Net financial ass ets (right scale)

Household Sector F inancial Position(Percent of annual disposable income)

Household debt has stabilized since the crisi s andfinancial assets are g radually increasing...

-6

-4

-2

0

2

4

6

8

10

12

-6

-4

-2

0

2

4

6

8

10

12

1980 1986 1992 1998 2004 2010

Household saving rateAverage 1979-2008

Household Saving Rate(Percent of dispo sable income)

... partly thanks to the strong rebound in the savingrate.

-15

-10

-5

0

5

10

15

20

25

30

-15

-10

-5

0

5

10

15

20

25

30

1996 1999 2002 2005 2008 2011

Nominal Real

House Prices(Year-on-year pe rcent change)

Househo ld balance sheets have also beenstreng thened by the recovery in house pri ces.

-30

-20

-10

0

10

20

30

40

50

60

120

140

160

180

200

220

240

260

280

300

2004 2005 2006 2007 2008 2009 2010

Gross liabilitiesNet financial asse ts (right scale)Adjusted net fin. asse ts (right scale)1/

Nonfinancial Corporate Sector FinancialPosition (Percent of annual mai nland GDP)

Nonfinancial corporations have moderately reducedliabil ities and witnessed a recovery in financialassets' valuations...

20

40

60

80

100

120

140

160

20

40

60

80

100

120

140

160

1986 1989 1992 1995 1998 2001 2004 2007 2010

Rental priceSelling price

Rental Price and Market Value of OfficePremises 2/ (Semi-annual figures, indices,June 1986 = 100.)

... and in commer cial real estate prices.

0

50

100

150

200

250

300

350

400

450

0

50

100

150

200

250

300

350

400

450

1995 1997 2000 2002 2005 2007 2010

EnterprisesPersonal

Number of Bankruptcies

The im provement in household and cor porate balancesheets has resulted in fewer bankruptcies.


15/72



Since the recession, households debt-to-income ratio has stabilized, reflecting asomewhat higher saving rate. However, the

debt ratio remains high and masks even moreconcerning developments at the high end ofthe distribution, where a growing share ofhouseholds have debt-to-income ratios inexcess of 500 percent. The ratio of nonfinancialcorporate sector debt to GDP in Norway is alsohigh relative to peers, but nonfinancialcorporations have a positive net financial assetposition (Figure 6).

9. Housing valuations continue toappear on the high side . House prices grewat an annual rate of 11 percent during theperiod 200407, much higher than the OECDaverage of 5 percent. Prices dipped brieflyduring the recession, but then resumed their

upward trend during the recovery, supportedby sharp interest rate cuts and reboundingdisposable income. House prices are now 20percent higher than they were at end-2007.Standard metrics, such as price-to-rent andprice-to-income ratios, indicate a risk ofovervaluation. Indeed, the deviation ofNorways price-to-rent ratio from its historicalaverage is the highest amongst all OECDeconomies. Model-based estimates that takeinto account a range of indicators suggest thatprice overvaluation could be in the range of15-20 percent, though there is admittedly ahigh amount of uncertainty around thisestimate (Annex III).

E. Financial Sector Balance Sheets Improving, but Vulnerabilities Remain

10. Credit growth has picked up, drivenby demand from both households and

corporates (Figures 7 and 8). Following amoderation during the recession due to sharpdeclines in bank borrowing by the nonfinancialcorporate sector, credit growth has begun toaccelerate and is currently growing at anannual rate of 6 percent. Norges Bankssurvey of banks points to strong demand forcredit, particularly from households, likely

driven by the relatively low levels of interestrates, low unemployment, and increases in

house prices.11. The financial sector has madeprogress in bolstering its balance sheets asit moves toward Basel III compliance(Figures 9 and 10). Tier-1 capital ratios haveincreased during the recovery due to higherretained profits on the back of strong earnings

0

50

100

150

200

250

300

350

0

50

100

150

200

250

300

350

DNK NOR SWE GBR USA EA FIN

Household debt-to-incomeNonfinancial private corporate debt-to-GDP

Debt Ratios(Percent, latest avai lable data)

Sources: Haver; and IMF staff estimates.

AUS

BEL

CAN

CHE

DEU

DNK

ESP

FIN

FRA

GBR

GRC

IRL

ITA

JPN

KOR

NLD

NOR

NZL

SWE

USA

0.5

0.7

0.9

1.1

1.3

1.5

1.7

0.5

0.7

0.9

1.1

1.3

1.5

1.7

0.5 0.7 0.9 1.1 1.3 1.5 1.7 1.9

P r i c e - t o - i n c o m e r a

t i o

Price-to-rent ratio

Housing: Price-to-rent ratio vs. Price-to-income ratio, 2011Q3(Relative to historical average 19802011)

Sources: OECD; and IMF staff calculations.


16/72



growth. Although changes to risk weightsthrough the use of internal models havehelped boost the average tier-1 ratio, the ratioof bank capital to total assets has alsoincreased during the recovery. However, thelargest bank, DNB, which accounts for about athird of lending, will still have to raise its coretier 1 ratio from 7.9 percent to 9 percent byJune 2012 to meet European BankingAuthority requirements. DNB has said it will

achieve this via internal resources. Banks non-performing loans increased during the

recession, but have stabilized at 1 percent oftotal loans. The loan loss rate has beenparticularly high for the shipping sector, whichcontinues to be a source of credit risk in theface of weaker global growth.

12. Funding remains a key vulnerability .Norwegian banks finance almost 20 percent oftheir assets with short-term foreign wholesalefunds. This funding structure exposes banks todisruptions in global interbank markets, asexperienced during the post-Lehman marketfreeze and more recently due to the euro areacrisis. The shortage of adequate liquid assetsand the low deposit-to-loan ratio will make itdifficult for Norwegian banks to meet theproposed Liquidity Coverage Ratio and NetStable Funding ratios, as currently tabled bythe Basel Committee.

13. The growing importance ofmortgage companies continues to affectthe structure of Norways financial sector .Starting in 2007, new legislation allowedspecialized mortgage institutionsmany ofwhich are owned by banksto raise funds byissuing covered bonds. This has increased theimportance of these institutions, which nowaccount for nearly half of new mortgages, andhas been a factor supporting the buoyanthousing market. It has also made the financialsector as a whole relatively more reliant oncovered bond financing relative to deposits.

0

4

8

12

16

20

24

14 16 18 20 22

C E T 1 - R

a t i o

Log Assets (Krone)

Norway: Capital Ratios of Selected Banks(Latest available)

Source: SNL.

Basel III minimum requirementplus conservation buffer

EBA req uirement

Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Mar-11

Regulatory capital to risk-weighted assets

11.2 11.7 11.2 13.0 14.2 13.7

Capital to assets 7.0 6.4 5.9 6.0 6.4 6.3

Nonperforming loans tototal loans

0.6 0.5 0.8 1.3 1.5 1.6

Provisions to

nonperforming loans74.2 67.0 53.5 33.3 31.2 33.8

Return on assets 0.9 0.8 0.5 0.8 1.0

Return on equity 18.4 17.0 10.7 11.6 13.4

Deposits to loans 1/

B anks 65.4 67.5 71.6 83.2 86.1 90.6

Banks and mo rtgagecompanies 63.9 62.6 60.7 60.2 59.0 55.0

Sources: IM F Financial Soundness Indicators, Norges B ank.

1/ Lates t o bservatio n as o f Septem ber 2011.

Norway: Banks' Financial Soundness Indicators

0

50

100

150

200

250

300

0

20

40

60

80

100

120

140

160

180

200

2007 2008 2009 2010 2011

DNB CDS (LHS)

NIBOR (RHS)

CDS Spreads for DNB and NI BOR Rate(Basis points)

Sources: Norges Bank; and Haver Analytics.


17/72



Figure 7. Norway: Credit Market Developments

Sources: Stati stics Norway; and IMF staff calculations.1/ Contains foreign exchange denominated debt as well. Growth ra te adjusted for exchange rate movements.

-10

0

10

20

30

40

50

-10

0

10

20

30

40

50

2004 2005 2006 2007 2008 2009 2010 2011

MunicipalitiesNonfinancial corporatesHouseholds

Growth in Domestic Credit by Borrower 1/

(3-month growth, percent, saar)

Domestic credit has grown solidly during the recovery,supported in particular by stronger household demand.

-5

0

5

10

15

20

25

3035

40

-5

0

5

10

15

20

25

3035

40

2004 2005 2006 2007 2008 2009 2010 2011

Banks and mortgage companiesState lending institutionOther lendersBonds and certificates

Growth in Domestic Credit by Source 1/ (12-month growth, percent)

All forms of financing are expanding....

-5

0

5

10

15

20

25

30

-5

0

5

10

15

20

25

30

2004 2005 2006 2007 2008 2009 2010 2011

Banks and mortgage companiesState and other lending institutionsBonds and certificates

Contribution to Annual Growth in DomesticCredit by Source 1/ (Percentage point)

... but credit growth is primarily drivenby lendingfrom b anks and mortgage companies...

Banks andmortgage

companies

Statelending

institution

Otherlenders

Bonds andcertificates

Composition ofDomestic Credit bySource(As of November 2011)

... which still pro vide about80 percent of totaldomestic financing.


18/72



Figure 8. Norway: Credit Standards and Lending

Sources: Haver Analytics; Norges Bank; and IMF staff calculations.

-120

-100

-80

-60

-40

-20

0

20

4060

-120

-100

-80

-60

-40

-20

0

20

4060

Dec-07 Sep-08 Jun-09 Mar-10 Dec-10 Sep-11

Total credit to nonfinancial corporationsCommercial real estate

Credit Standards for NonfinancialCorporations (


19/72



Figure 9. Norway: Nordic Banks' Relative Performance

Sources : IMF Financial Soundness Indicators , Danish Financial Supervisory Authority; Moody's;Norges Bank; Sweden FinancialSupervisory Authority; and IMF staff calculat ions.

8

10

12

14

16

18

8

10

12

14

16

18

2006 2007 2008 2009 2010 2011(March)

NorwaySwedenDenmarkUKGermany

Regulatory Capital to Risk-Weighted Assets(Percent)

Capita l ratios are within the regional range...

4

5

6

7

8

4

5

6

7

8

2006 2007 2008 2009 2010 2011(March)


Capital to Assets(Percent)

though Norwegian banks are less levered.

07Q1 08Q1 09Q1 10Q1 11Q1

DnBSwedbankSEBDanskeNordeaHandelsbanken

B+

B

B-

C+

C

C-

D+

D

Moody's BFSR

The market rating for DnB fell in line with o ther regionalbanks during the crisis.

0

1

2

3

4

5

6

0

1

2

3

4

5

6

2006 2007 2008 2009 2010 2011(March)

Norway SwedenDenmark UKGermany

Nonperforming Loan to Total Loans

(Percent)

Loan qual ity has de teriorated at a slower pace thanelsewhere in t he region...

-0.5

0.0

0.5

1.0

1.5

2.0

-0.5

0.0

0.5

1.0

1.5

2.0

2006 2007 2008 2009 2010

Norway Sweden

Denmark UK

Germany

Return on Assets(Percent)

...help ing support a recovery toward pre-crisisreturn on asset levels.

30

40

50

60

70

80

30

40

50

60

70

80

2006 2007 2008 2009 2010 2011(March)


Bank Provisions to Nonperforming Loans(Percent)

However, provisioning is so mewhat low, reflecting inpart low historical default rates.


20/72



Figure 10. Norway: Bank Performance

Sources: Bloomberg; Datastream; and Norges Bank.1/ All banks excluding branches of foreign banks in Norway. The 2011 return is computed over the 2010 Q4 -2011 Q3 period .2/ Simple average of RBS, Lloyds, Barclays, HSBC, and UBS.3/ Simp le average of Danske, Swebdank, SEB, and Handelsbanken.4/ All banks excep t branches of foreign banks in Norway.5/ All b anks and covered bond mortgage companies excluding branches and subs idiaries of foreign banks.

0

20

40

60

80

100

120

140160

0

20

40

60

80

100

120

140160

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Norwegian banks 1/ EU big b anks 2/ Swedish banks 3/

Banks' Equity Performance(1/3/2007 = 100)

The stock market performance of Norwegian bankshas been relatively strong during the recovery ..

0

50

100

150

200

250

300

350

400

0

50

100

150

200

250

300

350

400

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

DNBEU big ba nks 2/

CDS Spreads(Basis points)

...and heavy reliance on wholesale foreign fundingthat exposes banks to i nternational financial turmoil.

0

4

8

12

16

0

4

8

12

16

Sep-95 Sep-99 Sep-03 Sep-07 Sep-11

Tier 1 ratioEquity ratio (percent of total assets)Basel III required tier 1 ratio with co nservation and cou ntercyclical buffer

Regulatory Capital and Equity Ratios 4/ (Percent)

The banking sector has increased its capitalization...

50

60

70

80

90

100

110

50

70

90

110

Mar-95 Mar-99 Mar-03 Mar-07 Mar-11

Banks

Banks and covered bondmortgage companies

Deposit -to-loan Ratio 5/(Percent)

...and the depos it-to-loanra tio by transferringmortgage s to mortgage companies, many ofwhich are owned by banks.

0

20

40

60

80

100

120

140

0

20

40

60

80

100

120

140

All ban ks Dn B N OR +

commercialbanks

Savings banks

with assets>NOK 20bn

Savings banks

with assets


21/72



OUTLOOK, RISKS, AND SPILLOVERS14. In staffs central scenario, growth isprojected to continue at a moderate pace . Mainland GDP growth is likely to ease in 2012to 2.2 percent, reflecting global weakness,which has caused manufacturing andconsumer confidence indicators in Norway torecently dip. As this soft patch passes and withthe output gap nearly closed, mainland GDPgrowth should plateau over the medium termnear the potential growth rate of 2 percent(Table 2). This estimate for potential growth isbased on the sum of

labor productivity growth of 1.6 percentper yearthe average growth rate overthe last two decadesand

working-age population growth of 1.1percent per year; this relatively rapidgrowth is driven by high rates of netimmigration, which are expected to persistin the medium term.

Meanwhile, the growth rate of total GDP isexpected to be about percentage pointsbelow mainland growth over the forecasthorizon due to declining oil and gasproduction.

15. The composition of growth isexpected to gradually rebalance toward lessreliance on domestic demand . In the nearterm, growth will remain domestic demand-led, given (i) solid wage growth; (ii) continuednear-term momentum in the housing market;and (iii) sluggish growth in major tradingpartners. As a result, the non-oil trade deficit isexpected to deteriorate slightly. Over themedium term, growth is projected to slowlyrebalance as macroeconomic policies graduallytighten (see next section), housing valuationsslowly return to more normal levels, and

external demand gradually improves, resultingin a stabilization of the non-oil trade deficit.

16. However, this soft landing in therelatively benign central scenario is subjectto large risks, as highlighted in the RiskAssessment Matrix (Annex IV). Two of themost notable risks are the following:

Collapse in property markets : With housingvaluations elevated, there is a significantrisk of a large price reversal, which woulddepress residential investment anddampen consumption via wealth effects.High loan-to-value (LTV) ratios also imply

0

50

100

150

200

250

300

0

50

100

150

200

250

300

1970 1980 1990 2000 2010 2020 2030

Oil and Gas Production(Million standard cubic meter oil equivalent per year)

Source: Norweg ian Petroleum Directorate.

Projectionsincludingestimates ofundiscoveredresources

0

10

20

30

40

50

1997 1999 2001 2003 2005 2007 2009 2011

Mortgage loans with LTV 80-100 percent

Mortgage loans with LTV above 100 percent

Residential Mortgage Loans by LTV(Percent of tota l residential mortgages)

Sources: FSA; and Residential Mortgage Loan Survey.


22/72



that households do not have a large equitybuffer in the event of a fall in house prices,which could lead to higher default rates,placing stress on bank balance sheets.Overall, econometric evidence suggeststhat a 10 percentage point drop in houseprices is associated with lower GDP growthof roughly 1 percentage point in Norway(Annex III). Banks are also vulnerable to acorrection in commercial property prices,as lending to this sector accounts for thebulk of corporate lending.

Intensification of eurozone crisis : Directtrade and financial linkages to the most

vulnerable eurozone countries are limited(Annex V). However, the deceleration inglobal growth that would likely accompanyan intensification of the eurozone crisiswould significantly affect Norwayseconomy via lower non-oil exports (60percent of which are to Europe) andshaken consumer confidence. Severeeurozone turmoil could also precipitateother, interrelated risks flagged in the Risk

Assessment Matrix. For example, it wouldlikely heighten stress in internationalinterbank markets, hampering Norwegianbanks access to funding and possiblyleading to fire sales that threaten bankprofitability, though such liquidity stressescould be mitigated by official liquiditysupport, as during the Lehman crisis.Severe eurozone turmoil could also affectNorway through lower oil prices, especially

if these fall below US$70/barrelroughlythe cost of production in Norways mostexpensive oil fieldsfor an extendedperiod, as this would depress oilinvestment.

Authorities views

17. The authorities broadly share theseviews on the central scenario and key risks .The proposed government budget projects 3percent growth for 2012, somewhat higherthan staffs latest projection. However, thebudgets forecast was made in early Octoberand thus was not able to reflect the significant

deterioration in the international growthoutlook since then.

0.00.51.01.52.02.53.03.54.0

0.00.51.01.52.02.53.03.54.0

IMF Consensus Statist icsNorway

MoF NorgesBank 1/

Norway: Forecasts for 2012 Mainland GDP Growth(Percent)

Sources: Co nsensus Forecasts; 2012 Budget; Statistics Norway;Norges Bank; and IMF staff estimates.1/ Norges Bank' s forecast is based on the October 2011Monetary Policy Report . Norges Bank i ndicated in its Decembermoneta ry policy statement that the outlook has sinceweakened, but it has not yet published a new point forecast for2012.


23/72



POLICY DISCUSSIONSA. The Policy Mix

18. A careful policy mix will helpNorway address its multiple policychallenges . Macroprudential tightening isneeded to reduce financial stability risksassociated with high household debt andelevated house prices and to continue movingto a safer financial system, in line with globaland European reforms. Structural fiscaladjustment is also necessary to reduceprojected long-run fiscal gaps (see below).However, macroprudential and fiscaltightening should be sequenced carefully toavoid re-opening a negative output gap,especially in light of heightened global risks.Of the two, macroprudential tightening is the

more pressing near-term priority. To helpbalance this, the neutral stance envisaged inthe 2012 budget is appropriate, though fiscaltightening should commence starting in 2013under the central scenario. If macroprudentialand fiscal policies tighten over the mediumterm, monetary policy will be able to stay loosefor longer to help ensure that output stays atpotential. Such a policy mix will also reducerisks of excessive exchange rate appreciationand associated competitiveness problems.However, policies should adjust from the pathsenvisaged above if shocks cause substantialdeviations from the central scenario.

B. Fiscal Policy

19. The 2012 budget aims for a broadlyneutral stance . The budget targets a structuraldeficit approximately equal to 4 percent of theGPF-Gs capitalthe target under Norwaysfiscal guidelines. With the GPF-Gs capitalgrowing, the structural non-oil deficit as apercent of trend mainland GDP will increase,but only by 0.3 percent of mainland GDPimplying a broadly neutral fiscal impulse. Nomajor discretionary policy changes areplanned.

-2

0

2

4

6

8

-2

0

2

4

6

8

2002 2004 2006 2008 2010 2012(Budget)

Central Government Fiscal Stance andPerformance Relative to Guidelines

4-percent target

Structural non-oil deficit(percent of GPF-Global capital)

Fiscal impulse: change in structural non-oil deficit(percent of trend mainland GDP)

Sources: 2012 National Budget; and IMF staff estimates.


24/72



20. Norways overall fiscal position iscurrently strong . The central government isexpected to register an overall surplus of 10percent of trend mainland GDP in 2012. Grossgovernment debt will remain around 60percent of mainland GDP while thegovernments net asset position (including theGPF-G) will rise to 225 percent of mainlandGDP.

21. However, the government faceslarge fiscal challenges over the long run .The GPF-G will eventually start declining as ashare of mainland GDP as new oil revenuesslow and as its real return is spent each year.Returns on the GPF-G available for budgetaryuse will thus also fall as a percent of mainlandGDP, starting in the mid-2020s. At the sametime, spending on age and disability pensions

will rise steadily as a percent of mainland GDPdue to population aging. Healthcare spendingwill also rise due both to population aging andtechnological change. Non-oil revenue that isindirectly dependent on the oil sector (e.g.,VAT on consumption out of oil-related wagesand profits) will also decline with this sector.The net result is a substantial long-run fiscalgap.

22. In this context, there is a good casefor aiming to gradually spend less than 4percent of GPF-G capital over the medium

term . The following considerations supportthis approach:

With the output gap closing, someoverperformance against the 4 percentrule will be necessary during the expansionphase of the cycle to re-build a buffer touse for discretionary stimulus during thenext downturn, thereby ensuring that the 4percent target is at least met on averageover the cycle;

Real yields on long-term governmentbonds in major advanced countries havefallen sharply over the last decade,suggesting that maintaining a 4 percentreal return on the GPF-Gs assets may bechallenging for the foreseeable future; thisimplies that spending out of GPF-G assets

-11

-6

-1

4

9

14

19

24

-11

-6

-1

4

9

14

19

24

2002 2004 2006 2008 2010 2012(Budget)

Central Government Balances(Percent of trend mainland GDP)

Overall balance

Non-oil balance

Structural non-oil balance

Sources: 2012 National Budget; and IMF staff estimates.

0

10

20

30

40

50

60

0

50

100

150

200

250

300

2002 2005 2008 2011

Oil Revenue and Government Net Assets(Percent of mainland GDP)

Annualoil revenue(right scale)

General governmenttotal net assetsGovernment Pension

Fund-Global capital

Sources : 2012 National Budget; and IMF staff estimates.

0

4

8

12

16

20

0

4

8

12

16

20

2010 2020 2030 2040 2050 2060

Pension Expenses and the Expected Return on the GPF-G(Percent of trend mai nland GDP)

4 percent return on GovernmentPension Fund-Global

Age pensions

Age and disability pensions

Source: 2012 National Budget.


25/72



may need to be less than 4 percent if thegoal of limiting spending to the real returnis to be met; 3 and

Given the looming long-run fiscal gap,gradual tightening now will help smooththe path of eventual adjustment.

23. Further entitlement reform is alsokey to reducing long-run fiscal pressures .Options for such reform include the following:

Requiring employers to contribute to

longer-term sick leave benefits (currently theycontribute only for the first 16 days) toimprove their incentives to accept returningworkers and to monitor use of longer-termsick leave, which is very high by internationalstandards; this would need to be offset by cutsin employer payroll taxes or a reduction in thedays for which employers pay 100 percent ofbenefits in order to keep overall employmentcosts unchanged.

3 The fiscal guidelines, which have served Norway well,call for spending only the real long-run return on theGPF-G, whatever that return is deemed to be (i.e., the 4percent assumption should be changed if theexpected real long-run return is deemed to havefallen).

Increasing the use of social securityphysicians in assessing eligibility for disabilitybenefits in order to promote more uniform

assessments and limit abuse.

Reforming public sector pensions inline with recent reforms of the NationalInsurance Scheme in order to increaseincentives to remain in the labor force.

Changing the annual increase inpensions from wage growth minus 0.75percent to the more internationally commonpractice of CPI inflation. This would yield fiscalsavings while preserving the real value ofpensions during retirement.

24. Tax reform would also help reducemacroeconomic vulnerabilities .

Reducing tax subsidies for owner-occupiedhousing . One structural factor behind highmortgage debt in Norway is the veryfavorable tax treatment provided to

owner-occupied housing: mortgageinterest is tax-deductible, the tax onimputed rent was abolished in 2005, andeffective rates of property taxation areamongst the lowest in the OECD. Graduallyreducing the implicit tax subsidy forowner-occupied housingperhaps byintroducing a fixed nominal cap on the

0

1

2

3

4

5

-1

0

1

2

3

4

5

2000 2002 2004 2006 2008 2010

United KingdomUnited States

Real Yield on 20-Year Inflation-Indexed GovernmentBonds 1/ (Percent)

Source: Haver Analytics.1/ GBR: 20-year real ra te on zero -coupon bonds. USA:real yield on 20-yearTIPS.

0 1 2 3 4 5

JapanCanada

ItalyFrance

GermanyUS

OECDUK

SwitzerlandDenmark

SwedenNetherlands

Norway

Disability

Sickness

Public Spending on Disability and Sickness Benefits(2007, percent of GDP)

Source: OECD.


26/72



amount of a mortgage that is eligible forinterest deduction and by bringingproperty tax valuations closer to marketvaluationscould free resources forproductivity-enhancing tax cuts, improveprogressivity, and bolster financial stabilityby reducing risks associated with excessivemortgage debt.

Promoting increased use of equity finance.The corporate tax creates a bias againstequity finance and promotes excessiveleverage because interest on debt is tax-deductible while equity finance is not. Thisbias could be reduced by introducing an

Allowance for Corporate Equity (ACE)anexplicit deduction for the cost of equityfinance, as in Belgium (among othercountries) and as proposed by the IMFStaff Discussion Note Tax Biases to DebtFinance: Assessing the Problem, FindingSolutions . Such a reform could improveincentives for both financial andnonfinancial corporates to reduceleverage, thereby promoting financial

stability. Fiscal space for such a reformcould be created by the housing taxreforms noted above, other reforms to

corporate and personal income taxes, orrestraint on spending growth.

Authorities views

25. The authorities reiterated theircommitment to fiscal discipline and toadhering to the fiscal guidelines . Theyconcurred with staffs recommendation for asomewhat tighter structural deficit over themedium term to ensure that the guidelines aremet on average over the cycle, though theyconsidered 4 percent to remain an appropriateestimate of the likely real return on the GPF-Gover time. The authorities acknowledged the

long-run fiscal challenges, including the needto address high enrollment rates in sicknessand disability benefits. In this regard, theynoted that recent reforms had beenundertaken to require employers andphysicians to monitor use of sick leave benefitsearlier and more closely (Box 1). Regarding theintroduction of an ACE, the authoritiesexpressed concerns about possible fiscal lossesand prefer to further observe other countries

experiences before adopting it.

C. Monetary Policy

26. Inflation is expected to rise back tothe 2 percent target only gradually . Solidwage growth, the closing of the output gap,and stabilization of exchange rate appreciationare expected to increase inflation goingforward. On the other hand, the recentmoderation of global commodity prices shouldbe disinflationary. On balance, headlineinflation (currently 0.2 percent) is expected toslowly rise to the 2 percent target by 2013.Consistent with this view, survey respondentsexpect inflation of 2.4 percent two years hence(Figure 5).

27. Given this outlook, the currentmonetary stance remains appropriate . Thecurrent policy rate is broadly in line with bothcalibrated and estimated Taylor rules, asbelow-target inflation and a closed output gapimply that the current policy rate shouldremain below its steady state level, which isestimated to be 4 percent. 4 Moreover, the

4 The calibrated Taylor rule uses standard coefficients(those used by Taylor) of 1.5 on the deviation ofinflation from target and 0.5 on the output gap.
http://www.imf.org/external/pubs/ft/sdn/2011/sdn1111.pdfhttp://www.imf.org/external/pubs/ft/sdn/2011/sdn1111.pdfhttp://www.imf.org/external/pubs/ft/sdn/2011/sdn1111.pdfhttp://www.imf.org/external/pubs/ft/sdn/2011/sdn1111.pdfhttp://www.imf.org/external/pubs/ft/sdn/2011/sdn1111.pdfhttp://www.imf.org/external/pubs/ft/sdn/2011/sdn1111.pdfhttp://www.imf.org/external/pubs/ft/sdn/2011/sdn1111.pdfhttp://www.imf.org/external/pubs/ft/sdn/2011/sdn1111.pdf


27/72



Box 1. Authorities Response to Past IMF Policy Recommendations

The authorities macroeconomic policies over the lasttwo years have been broadly in line with past Fundadvice. They have also adopted some structuralreforms recommended by the Fund at the time of thelast Article IV consultation, though deeper reform isstill needed in some areas.

Monetary and financial sector policiesNorges Bank gradually reduced monetarystimulus during 2010 and early 2011, asrecommended by Directors at the time of the lastArticle IV consultation . Given Norways relativelyfavorable cyclical position, Norges Bank embarkedon a tightening cycle in 2009, raising the policy ratefrom a low of 1 percent to 2 percent by May2011. The pace of tightening was gradual to avoiddeflation and undermining the nascent recoverywhile, at the same time, addressing macrofinancialrisks associated with high house prices andhousehold debt. Norges Bank appropriately easedrates by 50 basis points in December 2011, givenheightened global risks and ECB rate cuts.

The government has made efforts to bolsterbanks capital and liquidity buffers, thoughvulnerabilities remain . Capital ratios have generallyimproved over the last 2 years (Figures 9 and 10), asthe FSA continues to encourage banks to bolster

capital through retained earnings by limitingdividends. However, progress on reducing liquidityrisks has been mixed: the average maturity ofwholesale liabilities has been lengthened, but thefinancial sector-wide (banks plus mortgagecompanies) deposit-to-loan ratio remains low andfalling.

The authorities have adopted targeted prudentialmeasures, but stronger measures are necessary . Following the recommendations made in the 2009Article IV consultation, the FSA introduced

guidelines in March 2010 that introducedrecommended limits on LTV and LTI ratios formortgages. The FSA further lowered these limits inDecember 2011. However, the recommendations

are not hard caps, and the percentage of loansexceeding these limits has actually risen since theywere initially introduced. More binding and stronglyenforced limits are thus necessary to contain risks.

Fiscal and structural policiesThe authorities have reduced the structuralnonoil deficit back below the 4 percent target . The 2009 Article IV consultation recommended thatthe deficit be brought back below 4 percent of GPF-G capitalthe target under Norways fiscalguidelinesby the end of the current parliament(2013) in order to reverse the stimulus employedduring the recession and ensure the target is met onaverage over the cycle, as called for by theguidelines. Large positive surprises in structuralrevenue in 2010 made it possible to return below thetarget in 2011.

There has been some progress onrecommendations to reform sickness anddisability benefit schemes, which are critical tocontain expenditure growth in the long run . Inthe summer of 2011, reforms were introduced toenable closer monitoring of sick leave with the aimof facilitating a more rapid return to work. Thesereforms are in line with past Fund and OECD advice.However, further efforts (as outlined in the Policy

Discussion section) are necessary to reduce thepersistently high enrollment rates in sick leave anddisability benefits.

Gradually reducing tax subsidies for housingalong-standing Fund recommendationremainschallenging . Modest measures were taken in 2010to move housing valuation assessments closer tomarket values. However, the tax code still features astrong bias toward owner-occupied housing andaccumulation of mortgage debt.


28/72



slight gap between the Taylor rule and thecurrent policy rate can be explained by thestandard Taylor rules failure to take intoaccount financial sector stress conditions,which are currently elevated and thus justify apolicy rate slightly below the standard Taylorrule level. Similarly, severe financial stress inearly 2009 justified some loosening relative tothe Taylor rule during this period, while thebuoyant financial conditions (i.e., low riskaversion and easy credit conditions) during the2004-07 boom period suggest that the policymay have been somewhat loose during thisperiod after taking this factor into account.

28. Norges Bank should be prepared torespond nimbly if the outlook changes . Inparticular, if macroprudential tightening does

not occur or is not sufficiently rapid to arrestrising risks associated with elevated houseprices and household debt, monetary policymay need to tighten. Conversely, a sharper-than-expected deterioration in externalconditions (e.g., due to intensified eurozoneturmoil) could necessitate monetary easing.

Authorities views

29. The authorities agreed thatmonetary policy should be the first line ofdefense if risks materialize . If conditionswarrant, measures could include not onlypolicy rate changes, but also liquidity

measures, as during the Lehman crisis.However, the authorities noted that monetarypolicy faces a delicate task of balancing theneed to address risks associated with aworsening global outlook against the need tocurb robust domestic credit growth. In thisregard, they concurred with staffsrecommendation for tighter macroprudentialpolicy, which should allow monetary policy tostay accommodative longer. However, they

also noted that there is much uncertaintyregarding the effectiveness of macroprudentialpolicies.

0

1

2

3

4

5

6

7

8

0

1

2

3

4

5

6

7

8

2005Q1 2007Q1 2009Q1 2011Q1

Policy Rate (quarterly avg.)Taylor Rule (calibrated)Taylor Rule (est imated)

Norway: Policy Rate Compared to Taylor Rule(Percent)

Sources: Sta tistics Norway; and IMF staff estimates.


29/72



D. Financial Sector Issues

Institutional Framework

30. Responsibility for financial stability

and macroprudential policy is somewhatfragmented in Norway . Norges Bank, theMinistry of Finance, and the FinancialSupervisory Authority (FSA), which is anindependent agency reporting to the Ministryof Finance, all produce regular assessments offinancial stability risks. Although cooperationbetween these agencies was relatively goodduring the 2008-09 global financial crisis,coordination and accountability could beenhanced by a clearer assignment ofresponsibilities aligned with institutionalstrengths.

31. The Norwegian governmentrecognizes these issues andlike a numberof other governmentsis reviewing itsinstitutional framework . Specifically, theNorwegian authorities have set up a workinggroup that is expected to makerecommendations on a new macroprudentialframework in early 2012.

32. Recent IMF staff analysis suggestsseveral guiding principles for strongmacroprudential frameworks .5 These include

promoting operational independence toshield macroprudential policy frompolitical cycles, as with monetary policy;

establishing clear lines of accountability;

5 See Towards Effective Macroprudential PolicyFrameworks: An Assessment of StylizedInstitutional Models (IMF, Monetary and CapitalMarkets Department, 2011).

facilitating information-sharing acrosspolicymaking institutions; and

bolstering the role of the central bank toharness its macroeconomic expertise andpromote coordination with liquiditymanagement, payment systems oversight,and monetary policy.

33. A recent proposal by the FinancialCrisis Commission (FCC) achieves many ofthese objectives . The FCC was set up toreview Norwegian financial sector regulation inthe aftermath of the crisis. The FCC hasrecommended that Norges Bank be given themain responsibility for assessingmacroprudential risks, given itsmacroeconomic expertise. Under this proposal,Norges Bank would have primary responsibilityfor assessing macroprudential risks andrecommending changes in macroprudentialpolicies. The FSA would then be required toeither implement Norges Banksrecommendations or publicly explain why ithas chosen not to do so. This proposal doeswell in promoting operational independence,creating clear lines of accountability, andharnessing central bank expertise. In addition,the comply or explain rule provides a usefulmechanism for institutions to challenge eachothers views. One drawback with thisapproach is that the institutional separationcould inhibit information-sharing and timelyrisk identification, though this concern could

be mitigated through the establishment ofappropriate fora and protocols. Proposals forother institutional frameworks have also beenmade, including giving a key role to theMinistry of Finance. However, this approachwould be less successful in shieldingmacroprudential policy from the political cycle.


30/72



Financial Sector Policies

34. The authorities are taking steps toreduce financial stability risks related tohigh levels of household debt and house

prices . In March 2010, the FinancialSupervisory Authority (FSA) instituted newguidelines for residential mortgage lending.These guidelines recommended that

LTV ratios on mortgages should generallynot exceed 90 percent;

LTVs on home equity loans shouldgenerally not exceed 75 percent; and

loan-to-income (LTI) ratios on mortgagesshould generally not exceed 300 percent.

In December 2011, the FSA tightened theseguidelines further, including by lowering themaximum LTV on mortgages to 85 percent,lowering the maximum LTV on home equityloans to 70 percent, and recommending thatbanks allow for an interest rate increase of 5percentage points when assessing a

borrowers debt-service ability.

35. These actions are welcome, but needto be more tightly enforced to besufficiently effective . The LTV and LTImaximums are not hard capsthey can beexceeded if, for example, banks undertake aspecial prudential assessment. Indeed, an FSAsurvey in Autumn 2011 found that loans withLTVs exceeding the recommended 90 percentaccounted for 38 percent of mortgages forhome purchases and 26 percent of all newmortgagesboth higher numbers than beforethe FSA issued its guidelines recommendingthat LTVs do not exceed 90 percent. Morebinding guidelines are thus necessary toachieve the desired reduction in high-riskloans.

36. Regulatory risk weights onresidential mortgages could also be raised,as these are relatively low . One risk with suchaction is that it could be undermined byincreased lending by Norwegian branches ofbanks based elsewhere in the EuropeanEconomic Area (EEA), since Norwegianregulation does not apply to these branchesunder EEA rules. To prevent such regulatory

arbitrage, the Norwegian authorities may needto seek agreement from foreign regulators to

apply Norwegian risk weights on mortgageloans extended by foreign banks to Norwegianhouseholds (i.e., jurisdictional reciprocity). Analternative approach would be for all Nordiccountries to raise risk weights on mortgages ina coordinated manner. Such cooperationshould be feasible, given that almost all majorforeign banks operating in Norway are basedin a few nearby Nordic countries. Indeed, therecently established Nordic-Baltic Stability

Group (see below) should help facilitate suchcooperation.

37. Continued build-up of liquidity andcapital buffers would further reduce risks .As noted earlier, meeting the new liquidityrequirements under Basel III will bechallenging for Norwegian banks, given their

0

10

20

30

40

50

60

0

10

20

30

40

50

60

S W E

B E L

F I N

D N K

N O R

G R C

N L D

D E U I T

A E S T

L T U

E S P

H U N

L V A

S V K

Mortgage Risk Weights 1/ (Percent)

Source: Speech by Riksbank Gov. Stefan Ingves, March2011.1/ As of March 2011.


31/72


32/72



STAFF APPRAISAL

40. Norways economy continues toperform well amidst considerable globalturbulence . Economic recovery has beenassisted by robust consumer spending,improving terms of trade, a reboundinghousing market, and supportive policies,including low interest rates and temporaryfiscal stimulus employed during the recession.

41. Going forward, moderately pacedgrowth is expected to continue . MainlandGDP is projected to grow by around 2

percent in 2012. Expansion will be mostlypropelled by domestic demand, given solidwage growth, continued momentum in thehousing market, and sluggish growth amongstmajor trading partners. The closing of theoutput gap, solid wage growth, andstabilization of exchange rate appreciationshould slowly push up inflation from its currentlow rates toward the 2 percent target overthe next two years. Over the medium term,

growth is expected to stay near its potentialrate of 2 percent, but gradually becomemore balanced as external demand slowlyimproves and as domestic demand eases dueto tighter macroeconomic policies andeventual cooling of the housing market.

42. This relatively benign centralscenario is subject to significant risks . Oneimportant risk is intensified turmoil in theeurozone. Although Norways economy isbetter placed than many in Europe to weathersuch stress, Norway would undoubtedly beaffected via shaken consumer confidence,lower non-oil exports and oil prices, andstrains in international interbank markets. Akey domestic risk is that buoyant house pricesmay eventually reverse, with adverse

consequences for consumption, residentialinvestment, and financial stability, especiallygiven very high levels of household debt.

43. A careful policy mix will help reducerisks while supporting growth . Tightermacroprudential policies are needed to reducerisks associated with high household debt andelevated house prices. Over the medium term,fiscal adjustment is also necessary (i) to rebuildprecautionary fiscal buffers and ensure that thefiscal guidelineswhich have served Norway

wellare met on average over the cycle and(ii) given that the real return on the GPF-G maywell fall short of the assumed 4 percent for anextended period. Fiscal adjustment will alsohelp reduce the large long-run fiscal gap.However, macroprudential and fiscaltightening should be sequenced carefully toavoid excessively contractionary policy in thenear term, especially given heightened globalrisks. Of the two, macroprudential tightening is

the more pressing near-term priority andshould proceed first. Fiscal tightening wouldbe appropriate starting in 2013 under thecentral scenario. The contractionary effectsfrom macroprudential and medium-term fiscaltightening can be largely offset by keepingmonetary policy looser than it would beotherwise. Such a mix of relatively tight fiscaland loose monetary policy will also reducerisks of excessive exchange rate appreciation

and associated competitiveness problems.

44. Monetary policy should be the firstline of defense if shocks cause deviationsfrom the central scenario . In particular, asharper-than-expected deterioration ofexternal conditions could necessitate monetaryeasing. Conversely, if macroprudential


33/72



tightening does not occur or is ineffective inarresting financial stability risks, monetarytightening may be necessary.

45. On macroprudential tightening, a

number of specific measures could helpreduce financial stability risks . Theauthorities have already taken some welcomeactions in this regard, such as the introductionof recommended limits on LTV and LTI ratiosfor mortgages. Further actions could includemaking these limits more binding, with lessscope for banks to exceed them based onsubjective judgment; raising minimum riskweights on mortgages, in coordination with

other Nordic countries to limit the scope forcross-border regulatory arbitrage; andreducing the degree to which the tax codeprovides incentives for households andcorporations to leverage themselves. Thephasing in of these measures should begradual and take into account their joint effectto avoid excessive disruptions to housingmarkets.

46. Ongoing efforts to bolster capitaland liquidity buffers are also welcome .Although capital ratios have strengthened inrecent years, some banks (especially largebanks) need to build further capital to ensurethat Basel III core tier 1 equity requirementsare safely met, given heightened risks bothdomestically and abroad. The encouragementof banks to achieve these goals via restraint ofdividends and remuneration is thus welcome.It will also be important to lower liquidityriskswhich remain an importantvulnerabilityby reducing banks reliance onshort-term wholesale funding.

47. Financial stability may furtherbenefit from establishing a more formalframework for countercyclical

macroprudential policy . Good guidingprinciples for such a framework include toestablish clear lines of accountability; to shieldmacroprudential policy from the political cycle;to facilitate information-sharing acrosspolicymaking institutions; and to bolster therole of the central bank to harness itsmacroeconomic expertise and promotecoordination with liquidity management,payment systems oversight, and monetarypolicy. Several institutional arrangementscould achieve these objectives, including theone recently proposed by Norways FCC,especially if mechanisms are included toensure robust collaboration between the FSA

and the central bank in regard to riskidentification and information sharing.

48. Recent progress on entitlementreform is welcome, but further efforts areneeded to address Norways long-run fiscalchallenges . With oil revenue expected todecline and pension and healthcare spendingrising, Norway faces a large long-run fiscalgap. To address it, it will be crucial to build

broad public consensus for further entitlementreforms aimed at reducing costs, increasingefficiency, and bolstering employment, whilemaintaining a strong safety net for those inneed. In this regard, recent reforms to enhancemonitoring of sick leave benefits are welcome.However, further entitlement reforms areneeded to reduce the growth of spending onsick leave and disability benefits, for whichenrollment rates are very high by internationalstandards; improve incentives for longerworking lives in public-service old-age pensionschemes; and contain the growth of old-agepensions by indexing them to CPI inflation.

49. It is recommended that the nextArticle IV consultation with Norway be heldon the usual 24-month cycle .


34/72


35/72



2008 2009 2010 2011 2012 2013 2014 2015 2016

Real GDP 0.0 -1.6 0.7 1.7 1.7 2.0 2.1 2.2 2.2Real mainland GDP 1.4 -1.6 1.8 2.6 2.2 2.5 2.7 2.8 2.8

Real Domestic Demand 1.3 -4.1 3.2 3.0 2.9 2.8 2.7 2.7 2.7Public consumption 2.6 4.3 1.7 2.5 2.5 2.1 2.1 2.1 2.1Private consumption 1.7 0.0 3.6 3.1 3.0 2.9 2.8 2.7 2.7Gross fixed investment 0.1 -7.4 -5.2 3.8 3.6 3.8 3.5 3.6 3.4

Public 4.6 6.9 -7.4 1.5 1.5 2.5 2.5 2.5 2.5Private mainland -2.4 -18.4 -1.0 6.1 5.4 5.4 5.1 5.1 4.8Private offshore 4.1 8.1 -10.8 1.0 1.5 1.5 1.0 1.0 1.0

Final domestic demand 0.7 -0.9 0.9 3.1 3.0 2.9 2.8 2.8 2.7Stockbuilding (contribution to growth) 0.6 -2.9 2.0 0.0 0.0 0.0 0.0 0.0 0.0

Trade balance of goods and services (contribution to growth) -1.0 2.1 -2.2 -1.1 -1.0 -0.6 -0.4 -0.3 -0.3Exports of goods and services 0.7 -4.6 1.1 0.4 0.3 1.0 1.2 1.5 1.6

Mainland good exports 3.7 -7.5 1.1 3.3 1.0 2.5 2.8 3.3 3.4Offshore good exports -0.4 -2.8 -5.5 -2.6 -1.3 -0.9 -0.9 -0.9 -0.9

Imports of goods and services 4.1 -12.7 9.3 4.0 3.7 3.2 2.8 2.8 2.8

Potential GDP 0.9 0.5 1.0 0.6 1.9 2.0 2.1 2.1 2.2Potential mainland GDP 2.3 0.6 2.2 1.5 2.4 2.5 2.7 2.7 2.7

Output Gap (percent of potential) 1.5 -0.7 -1.0 0.0 -0.2 -0.2 -0.2 -0.1 0.0

Labor Ma rketEmployment 3.3 -0.6 0.0 0.6 0.6 0.7 1.1 1.1 1.1Unemployment rate (percent) 2.6 3.2 3.6 3.6 3.6 3.5 3.5 3.5 3.5

Prices and WagesGDP deflator 11.0 -6.4 6.4 4.9 1.9 1.9 2.1 2.7 2.8Consumer prices (avg) 3.8 2.2 2.4 1.4 2.0 2.5 2.5 2.5 2.5Consumer prices (eop) 2.1 2.0 2.8 1.6 2.2 2.5 2.5 2.5 2.5Manufacturing

Hourly compensation 5.9 5.6 4.0 Productivity 6.8 3.0 2.8 Unit labor costs -0.8 2.5 1.2

Fiscal IndicatorsGeneral government fiscal balance (percent of GDP) 18.8 10.6 10.5 13.2 11.6 10.6 9.6 8.8 8.1

of which: nonoil balance (percent of mainland GDP) -2.4 -5.6 -6.1 -6.0 -5.8 -5.7 -5.7 -5.7 -5.7

External Sector

Current account balance (percent of GDP) 17.3 11.7 11.5 13.7 12.4 11.2 10.2 9.7 9.2Balance of goods and services (percent of GDP) 17.3 11.4 12.4 14.1 12.7 11.2 10.2 9.6 9.1

Mainland balance of goods 1/ -8.0 -6.9 -6.7 -6.5 -6.8 -7.0 -6.8 -6.6 -6.2

Sources: Statistics Norway, Ministry of Finance, and IMF staff estimates.

1/ Percent of mainland GDP.

Table 2. Norway: Medium-Term Indicators, 200816(Annual percent change, unless otherwise noted)

Projections


36/72


INTERNATIONAL MONETARY FUND 35

2008 2009 2010 2011 2012 2013 2014 2015 2016

Current account balance 78.6 43.8 48.0 66.0 59.4 54.6 51.0 49.7 48.8 Balance of goods and services 78.3 42.7 51.7 68.0 60.7 54.9 50.7 49.2 48.2 Balance of goods 78.2 41.5 51.0 67.0 59.8 54.5 50.5 48.9 47.6 Mainland balance of goods -26.3 -20.5 -21.9 -24.1 -25.6 -26.9 -27.2 -27.1 -26.5 Balance of services 0.1 1.2 0.7 1.1 0.9 0.4 0.2 0.3 0.6 Exports 212.3 147.8 171.8 203.6 198.4 198.3 199.6 203.6 208.5 Goods 169.5 112.1 128.9 155.2 149.5 147.9 147.2 149.0 151.2 of which: oil and natural gas 109.9 65.9 71.7 90.0 84.4 80.6 76.9 75.4 73.6 Services 42.8 35.6 42.9 48.4 48.8 50.4 52.4 54.6 57.3 Imports 133.9 105.0 120.0 135.6 137.7 143.4 148.8 154.5 160.3 Goods 91.3 70.6 77.9 88.2 89.7 93.4 96.7 100.1 103.6 Services 42.7 34.4 42.2 47.4 48.0 50.0 52.1 54.4 56.7 Balance of factor payments -5.9 -6.5 -3.7 -2.0 -1.3 -0.3 0.3 0.5 0.6Capital account balance -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2Financial account balance -81.9 -53.6 -46.5 -65.8 -59.2 -54.4 -50.8 -49.5 -48.6

Change in reserves (- implies an increase) -7.6 19.5 -4.0 -4.4 -4.2 -4.1 -4.0 -4.0 -3.9Net errors and omissions 3.5 10.0 -1.3 0.0 0.0 0.0 0.0 0.0 0.0

Current account balance 23.8 14.7 14.6 17.8 15.9 14.2 12.8 12.0 11.3 Balance of goods and services 23.7 14.3 15.7 18.3 16.2 14.2 12.7 11.9 11.2 Balance of goods 23.7 13.9 15.5 18.0 16.0 14.1 12.7 11.8 11.1 Mainland balance of goods -8.0 -6.9 -6.7 -6.5 -6.8 -7.0 -6.8 -6.6 -6.2 Services balance 0.0 0.4 0.2 0.3 0.2 0.

Documents

Norway 2011 Article IV Consultation Staff Report