Public Information Notice No.  10/14

Public Information Notice: IMF Executive Board Concludes 2009 Article IV Consultation with Norway

January 27, 2010

On January 22, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Norway.¹

Background

Norway was affected by the global financial crisis, but less severely than most other advanced economies. Falling asset prices and a sharp rise in uncertainty pulled down private demand in the second half of 2008. However, the ensuing recession was comparatively shallow, with mainland GDP already returning to growth in the second quarter of 2009. Unemployment has increased only modestly to about 3 percent and consumer confidence has recovered strongly, in sync with a rebound in the housing market. Still, the economic downturn has reduced earlier pressures on capacity constraints. Wage growth has eased, and CPI inflation has fallen below the target.

The authorities’ response to the slowdown was forceful and effective. Norges Bank cut interest rates by a cumulative 450 basis points through June 2009. At the same time, a large fiscal stimulus was implemented and a number of timely measures to support financial stability were put in place. Norway’s resilience has also been underpinned by buoyant activity in the offshore hydrocarbon sector, limited dependence on the hardest-hit segments of global manufacturing, and the temporary depreciation of the krone in late 2008.

The Norwegian financial system has held up well. The authorities’ stepped-up liquidity support after Lehman’s bankruptcy helped contain the effect of the global crisis on domestic financial institutions. Norwegian banks did not face solvency issues, the rise in
non-performing loans has been limited so far, and profitability has strengthened in the course of 2009. Credit conditions have recently started to ease, after a sharp tightening in late 2008. Banks’ good performance reflects low exposure to toxic assets, a robust domestic economy, and a relatively conservative prudential framework. Still, credit risks remain elevated as the banking system has large credit exposures to the shipping and commercial real estate sectors.

Looking ahead, the economic recovery is expected to continue, with private domestic demand progressively replacing public spending as the main driver of growth. Private consumption is projected to strengthen further as households continue to benefit from low interest rates, limited unemployment, and improved asset valuations. A turn in the inventory cycle should also support activity, while fixed investment may remain subdued somewhat longer, and net exports are likely to weaken. On balance, mainland GDP is expected to grow by 2¼ percent in 2010. Near-term inflation should be kept in check by slower wage growth and regained krone strength, although tight cyclical conditions are set to reemerge sooner than in many other advanced economies. The outlook for Norway’s economy is, however, subject to significant uncertainty related to future developments in global demand, commodity prices, and the exchange rate.

Executive Board Assessment

Directors observed that Norway entered the global financial crisis from a strong macroeconomic position and has faced a relatively mild downturn. The economy’s resilience has been bolstered by effective fiscal and monetary stimulus, a favorable industrial structure, and a relatively stable financial system. Directors expected the economic recovery to continue, while recognizing that uncertainty about the global economic environment posed a risk to the outlook. The near-term policy challenge will be to manage the gradual withdrawal of stimulus as the recovery takes hold.

Directors considered the large fiscal stimulus implemented in 2009 timely and well designed. However, they expressed concern that many of the temporary spending measures introduced in 2009 have been replaced by more permanent expenditure increases in the 2010 budget. Given the relatively limited slack in the economy and the high non-oil deficit, Directors called for strict expenditure control in the 2010 budget implementation.

Directors welcomed the authorities’ intention to steadily reduce the non-oil deficit to the
4-percent target as the economic recovery takes hold. Fiscal consolidation will reaffirm commitment to Norway’s fiscal guidelines, help preserve competitiveness, and restore flexibility to deal with future adverse shocks. Directors called for early identification of concrete measures to help enhance the credibility of consolidation plans, and supported the authorities’ emphasis on expenditure-side adjustment. They viewed the fiscal guidelines as appropriate but stressed that the flexibility to temporarily deviate from the fiscal target should be used symmetrically.

Directors commended the authorities’ pension reform, which aims to encourage longer working lives and contain the rise of pension outlays by tying benefits to demographic developments. The reform should be supplemented by concrete actions to reduce the high inflows into sickness and disability benefit schemes, with measures enhancing the incentives of both employees and employers.

Directors noted that aggressive monetary policy easing through mid-2009 has played an important role in mitigating the domestic recession. The moderate interest rate hikes in late 2009 are an appropriate response to the stabilization of the situation. Looking ahead, the strengthening outlook, a relatively tight labor market, and the macroeconomic risks implied by strong house price appreciation all point to the need for a gradual further withdrawal of the extraordinary monetary stimulus.

Directors considered that Norway’s financial sector has weathered the crisis well but vulnerabilities remain. They welcomed the authorities’ targeted measures to support banking sector liquidity and improve the functioning of the corporate bond market, which helped preserve financial stability during the crisis. Recent efforts to strengthen banks’ capital buffers, including through capital injections from the State Finance Fund, will allow banks to continue lending to creditworthy customers.

Directors saw scope for a further strengthening of Norway’s general prudential framework. Priorities in this area are strengthening the management of liquidity risks and the adoption of measures to limit excessive balance sheet growth. To contain the systemic risk associated with large household debt and high loan-to-value mortgages, Directors recommended reducing tax subsidies for housing investment and adopting targeted macroprudential measures. While regulatory improvements should be based on international practices, Directors pointed out that close coordination with Norway’s neighbors could be used to ensure higher common standards across the Nordic financial region as appropriate.