Press Release No. 16/318

IMF Executive Board Concludes 2016 Article IV Consultation with Norway

July 5, 2016

On June 29, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation ¹ with Norway.

The declines in oil prices and offshore investment have taken a toll on the Norwegian mainland economy: growth fell to 1 percent in 2015—the lowest level since the global financial crisis. The drag from private investment was offset by continued growth in household consumption, expansionary fiscal policy and a boost to traditional goods exports, aided by the weak krone. Unemployment has increased to 4.7 percent as of March 2016, with the rise mainly concentrated in oil-dependent regions. Core inflation reached 3.3 percent in April 2016 after peaking at 3.4 in February, above the 2.5 percent target, largely due to the effect of exchange rate depreciation on imported consumer goods prices. House price inflation accelerated recently after the slowdown throughout 2015, albeit with large regional variation, and household debt remains elevated at 220 percent of disposable income. Banks remain profitable and are well-positioned to meet regulatory capital requirements.

The 2015 structural non-oil deficit was 2.6 percent of the Government Pension Fund Global (GPFG) assets, equivalent to 6.25 percent of mainland trend GDP. This provided a fiscal impulse of .5 percent of mainland trend GDP. The structural non-oil deficit remains well below the 4 percent of GPFG assets that the fiscal rule targets, in part as the exchange rate depreciation contributed to a substantial increase in GPFG assets measured in Norwegian krone. The revised 2016 budget envisions a rise in the structural non-oil deficit to 7½ percent of mainland trend GDP (2.8 percent of GPFG assets), which will provide a fiscal impulse of 1.1 percent of mainland trend GDP.

Economic activity is set to remain sluggish this year, with mainland GDP growth of 1.1 percent, supported by public sector demand and mainland exports, while private domestic demand is set to remain depressed. A recovery should take root in 2017 alongside a gradual upturn in oil prices and a slowing of the pace of decline in oil investment. As the oil-related parts of the mainland economy adjust to lower demand, unemployment is projected to rise further this year before declining in 2017. Headline inflation is projected to be 2.8 percent this year and is expected to return to the 2.5 percent target next year as low capacity utilization weighs on domestic inflation and the effect of the exchange rate depreciation abates.

Downside risks predominate. Lower than expected growth in key advanced and emerging economies would have negative implications for oil prices and traditional exports. Combined with a sharp property price correction, this would weigh on consumption and domestic firms, especially those in the retail and construction sectors. Similarly, a delay in the transition to a less oil dependent economy could lead to higher unemployment for longer, thereby weakening confidence and consumption. In a downturn, a rise in defaults on corporate loans would in turn put pressure on banks’ balance sheets. In addition, tighter or more volatile global financial conditions could raise financing costs of Norwegian banks that are reliant on wholesale funding.

Executive Board Assessment²

Executive Directors noted that the Norwegian economy has suffered from the decline in oil prices, while the influx of refugees presents new challenges. A modest recovery is expected to take root next year, subject to downside risks, including weaker global growth and persistently lower oil prices. The broadly positive medium-term outlook hinges on a successful transition away from oil dependence. Directors concurred that supportive macroeconomic policies and steadfast structural reforms to boost productivity and cost competitiveness would be necessary to facilitate this transition and place growth on a stronger footing.

Directors considered that the expansionary stance of fiscal policy this year is broadly appropriate, given the output gap, rising unemployment, and the ample fiscal space. They stressed the need for well-targeted temporary measures that also promote rebalancing the economy toward non-oil tradable sectors. Directors recommended a gradual shift to a more neutral fiscal stance as the economy returns to potential. They supported recent reforms to shift from personal and corporate income taxation to promote productive investment. Directors welcomed the ongoing review of the fiscal rule, aimed at ensuring continued prudent management of the country’s oil wealth, taking into account the interests of future generations.

Directors agreed that, given the slack in the economy and well-anchored inflation expectations, monetary policy should remain accommodative until there are firm signs of durable recovery. In this regard, they welcomed the authorities’ readiness to reduce the policy rate further if warranted. Directors acknowledged the challenge of balancing the need to support economic growth against the risk of inflation from a further exchange rate depreciation and financial stability concerns from rising house prices. They recommended that the authorities continue monitoring the development of household debt and house prices, and promptly tighten macroprudential measures to address emerging financial stability risks.

Directors observed that banking sector performance remains relatively strong, and welcomed the significant progress in implementing the recommendations of the Financial Sector Assessment Program. They encouraged further efforts to mitigate systemic risks that might arise from high household indebtedness and banks’ reliance on external wholesale funding, including by further strengthening the framework for crisis management and resolution, as well as regional cooperation.

Directors emphasized the need for continuing structural reforms to support a successful transition and improve the efficiency of the economy. They saw merit in continued restraint in wage settlements and further reforms to reinvigorate productivity growth. Aligning public sector pensions with recent private sector reforms and reforms to sickness and disability pensions could increase labor force participation. Directors also saw scope for efficiency gains from reducing tax preferences for owner-occupied housing and relaxing supply restrictions in the housing market.

Directors commended the Norwegian government for its noteworthy efforts to absorb the increased number of refugees. They noted that further efforts to accelerate the integration of the newly arrived refugees into productive employment would help reduce fiscal costs and raise output.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

² At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summing up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.