Mission Concluding Statement 

Denmark Staff Concluding Statement of the 2024 Article IV Mission

June 19, 2024

Copenhagen, Denmark:

Denmark has demonstrated remarkable resilience in the face of the pandemic and energy crises. Staff expects robust growth to continue in 2024, but there are considerable external risks, including from geopolitical tensions. The financial system remains sound, but systemic risks are elevated due to still-high interest rates and heightened vulnerabilities in commercial real estate (CRE) markets. Demographic challenges and low productivity growth pose risks for long-term growth. Against this background, the policy priorities are as follows.

• Calibrate fiscal policy, taking into account both cyclical conditions and growing long-term spending needs.
• Safeguard financial stability by closely monitoring risks emanating from vulnerable and leveraged borrowers.
• Continue implementing structural reforms to sustain the welfare state, including in the areas of labor markets, education, innovation, digitalization, business dynamism, and green transition.

Economic outlook and risks

1. Staff expects growth momentum to strengthen in 2024 before moderating. Growth is projected at around 2 percent in 2024, driven by pharmaceutical exports, the reopening of the Tyra natural gas field, and a gradual rebound in the non-pharmaceutical sector. The growth of the non-pharmaceutical sector will be bolstered by a recovery in external demand, improved consumer purchasing power, and easing of financial conditions. In 2025, non-pharmaceutical output will continue to expand at a moderate pace, but GDP growth will decelerate to around 1½ percent as the growth of pharmaceutical exports tapers off. Beyond 2025, medium-term growth will stay at around 1.4 percent, down from the pre-pandemic average of 1.8 percent, largely due to lower global growth, demographic headwinds, and geoeconomic fragmentation.
2. Some signs of a cooling labor market have emerged, and inflation has fallen. Unemployment rates have crept up, and job vacancy rates and the number of businesses reporting labor as a factor limiting production have fallen from their peaks, but the labor market remains relatively tight. Wage growth has accelerated moderately. Inflation has sharply fallen to around 2 percent, reflecting the decrease in global energy prices and lackluster domestic demand. In the coming months, inflation might temporarily edge up due to the lagged effect of last year’s wage collective bargaining agreement but is expected to fall back to around 2 percent during the second half of 2025.
3. The balance of risks to growth is skewed to the downside. Should capacity pressures rise, inflation and wage growth would be higher than expected. However, the primary risks are a global slowdown in growth, the possible escalation of Russia’s war in Ukraine, and deepening geoeconomic fragmentation. Adverse shocks in other Nordic countries, including a correction in the housing and CRE markets, may spill over to the Danish economy.

Calibrating fiscal policy, taking into account cyclical conditions and growing long-term spending needs

4. In the short term, fiscal policy should avoid adding to capacity pressures. The new discretionary measures in the 2024 budget plan were small in size. In April, the government agreed to boost defense spending, with details yet to be announced. As a result, the fiscal stance in 2024 might turn out to be slightly expansionary. Given lingering capacity pressures and upside risks to inflation, the authorities should continue to exercise tight spending control and save any revenue above budget forecasts.
5. Over the medium term, Denmark’s accumulated fiscal space can help mitigate pressures from population aging, climate change, and defense spending. In the past decades, Denmark has prepared for the anticipated increase in aging-related costs and has steadily reduced its public debt to around 30 percent of GDP, creating substantial fiscal space. In addition, the government has launched several reform initiatives to enhance labor supply aimed at boosting growth and fiscal revenue. Against this backdrop, and given the expected easing of inflationary and capacity pressures, the anticipated slight easing of the fiscal stance starting in 2025 is appropriate and will help accommodate the increase in costs related to health and long-term care, coastal protection, and defense.
6. To ensure fiscal sustainability, the government should continue to closely monitor long-term fiscal pressures. The structural balance is projected to gradually deteriorate from a surplus of ½ percent of GDP in 2024 to a deficit of ½ percent of GDP by the mid-2030s. This is consistent with Denmark’s fiscal rules, and staff’s debt sustainability analysis suggests low stress on sovereign debt. However, risks to the long-term fiscal trajectory are tilted to the downside, given that (i) the supply-side measures may not generate the expected growth and revenues, (ii) climate change could accelerate at a faster-than-expected pace, requiring larger adaptation investments, and (iii) security conditions in Europe may further deteriorate, necessitating an additional increase in defense spending. Accordingly, if fiscal trends suggest the risk of breaching the structural deficit limit (minus one percent of GDP), the authorities will need to implement additional fiscal adjustment measures.

Safeguarding financial stability

7. The financial system is sound, but systemic risks remain elevated due to still-high interest rates and heightened vulnerabilities in CRE markets. To strengthen the resilience of the financial system, the authorities should:

• Ensure that banks closely assess how developments in real estate prices, labor markets, and financial conditions affect the balance sheets of vulnerable borrowers and update provisions for credit risks accordingly.
• In line with the new supervisory guidelines on CRE, ensure that banks maintain adequate provisioning against losses. Banks’ internal-rating models should adequately capture the risks.
• Continue working on the Nordic-wide bank stress testing exercise with other Nordic policymakers.
• Develop a framework for a systemic risk assessment encompassing banks and non-bank financial institutions (NBFIs) and incorporating domestic and cross-border interconnectedness. Building on this, going forward, strong consideration should be given to developing and deploying a system-wide stress testing framework.
• Continue efforts to strengthen resilience against cyberattacks.

8. The new capital-based macroprudential policy measure to mitigate risks in the CRE sector and the property tax reform are welcome, but additional borrower-based measures are needed to address pockets of vulnerabilities. The 7 percent sector-specific systemic risk buffer (effective at the end of June) will strengthen banks’ resilience to CRE-related risks. In addition, the new property tax system (which went into effect in January 2024) will help improve the stability of housing markets. To further enhance the robustness of the financial system, the authorities should consider introducing more stringent conditions on new mortgages extended to highly leveraged households. This could include lowering the maximum loan-to-value ratio below the current 95 percent or requiring mandatory amortization until a certain equity threshold is reached. The high tax deductibility of mortgage interest expense should also be reduced, and national legislation should incorporate borrower-based measures into the policy toolkit.
9. Systemic risks arising from NBFIs warrant closer monitoring and enhanced customer protection. Insurance and pension companies have ample capital buffers; and staff welcomes that supervisors have developed and implemented a stress-testing framework to identify and assess residual risks. At the same time, the share of non-guaranteed market-return products has increased significantly. While this has helped enhance the resilience of insurance and pension companies, it has also exposed customers to investment and longevity risks. The authorities should finalize a supervisory order by the end of this year aiming to strengthen the duties of these firms to provide their clients with clear advice on the financial and longevity risks.
10. The institutional arrangement of financial sector policymaking can be strengthened in line with the 2020 Financial Sector Assessment Program. The authorities have made important progress in implementing the recommendations, particularly in the areas of banking and insurance supervision and systemic liquidity. However, several recommendations, including in the area of systemic risk oversight and the governance of the resolution authorities, remain unaddressed.

Pursuing structural reforms

11. Continued efforts are needed to increase the quantity of labor and address skill mismatches. The proposed personal income tax reform is a step in the right direction to enhance work incentives. Beyond this, the authorities should continue efforts to address skill mismatches by implementing a comprehensive set of policies, including vocational training, education, and recruitment from abroad. Public sector wage setting should be reformed to better address labor shortages in certain sectors, in particular health and long-term care. Furthermore, the close monitoring of educational outcomes for students with an immigrant background should continue, with efforts to strengthen their integration into the Danish society.
12. Staff welcomes the authorities’ commitment to further enhance digitalization, innovation, and business dynamism. The implementation of Denmark’s Recovery and Resilience Plan is underway, which will help accelerate digitalization, including for small and medium enterprises, public administration, rural broadband, and the health sector. In addition, the government’s new strategy for entrepreneurship should support startups by improving their access to capital, lowering taxes, and easing the regulatory burden. Building on this, the authorities should consider further enhancing R&D tax incentives. Furthermore, following the expert group’s recommendation, business subsidies should be streamlined, except for those addressing market failures.
13. Further actions are necessary to achieve Denmark’s ambitious mitigation targets and prepare for climate change. The authorities’ latest projections suggest that additional measures are needed to meet the 70 percent reduction target (relative to 1990 levels) by 2030. Given the agriculture sector’s significant contribution to total greenhouse gas emissions, it is vital to reach political consensus on implementing carbon taxation on agriculture early. Regarding climate adaptation, the development of the 2023 National Climate Adaptation Plan I is welcome. The next steps include developing its implementation plan and updating the estimates of investment needs for adaptation. Furthermore, the property insurance scheme (“Storm Surge Scheme”) should be reviewed to make insurance premiums risk-based.

The mission thanks the authorities and private sector counterparts for their accommodative flexibility, warm hospitality, and for candid and high-quality discussions. The IMF team is especially grateful to the Danmarks Nationalbank for its assistance with meeting and logistical arrangements.