Public Information Notice No. 02/23

Public Information Notice: IMF Concludes 2001 Article IV Consultation with Norway

March 7, 2002

On March 1, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Norway.¹

Background

A consensual policy framework supported Norway's strong economic expansion since 1993. A policy of investing abroad a large part of oil revenues through the Government Petroleum Fund has continued to underpin stability by insulating the economy from the fluctuating fortunes of the oil sector and has helped build the foundation for an equitable sharing of oil wealth with future generations of Norwegians. The macroeconomic strategy contributed to achieving among the best economic fundamentals in Europe, most notably virtually full employment despite a sharp rise in the participation rate. A new coalition government, elected in September, set in train a policy redirection toward reducing Norway's high tax burden.

Real mainland (nonoil) GDP is estimated to have grown well below potential in 2001, at 1¼ percent. Although high oil prices supported household confidence and domestic activity through most of the year, the global slowdown has recently begun to affect Norway. Labor market conditions remain tight in service sectors, but weakened in technology and traditional export industries. Employment grew by ½ percent, keeping the average unemployment rate broadly unchanged at 3½ percent. A decline in competitiveness and slowing external demand impaired nonoil exports, but peak oil production and high oil prices through most of the year contributed to an expected current account surplus in excess of 12 percent of GDP. High oil revenues also contributed to a general government surplus of around 16 percent of GDP.

Despite high domestic cost increases, consumer price inflation has been held in check by low krone import prices. Consumer prices rose by 2.1 percent in the year through December 2001, down significantly from a mid-year peak of 3.8 percent. Labor costs continued to outpace that in trading partners by 1½-2 percentage points despite weaker productivity growth in Norway, and contributed to high inflation rates for home-produced consumer goods. However, global competition and an appreciation of the krone have kept imported goods prices stable.

Mainland GDP growth is expected to remain sluggish in 2002. The sharp fall in oil prices toward the end of 2001 contributed to a decline in household confidence in Norwegian economic prospects that is likely to persist this year. Weak overseas demand and recent losses of competitiveness are expected to hold back non-oil exports. Sustained high real interest rates, weak business profitability, and the continued decline of oil-related investment would also dampen demand. However, the economic slowdown in Norway is expected to be contained, assuming that the World Economic Outlook forecast of an upturn in the world economy in the second half of 2002 materializes and the level of employment remains high. On balance, mainland GDP is projected to grow by 1¼ percent in 2002, but downside risks remain. Double-digit external and fiscal surpluses as a percent of GDP are expected to persist. Various temporary factors are projected to restrain average headline inflation to around 2 percent in 2002, which is then expected to rise to 2½ percent in 2003 as these influences fade out.

An inflation targeting regime was formally adopted in March 2001. The operational target is defined as an annual increase in consumer prices of 2.5 percent. In general, inflation is expected to be within a 1 percentage point deviation from either side of the target. Monetary policy is to be forward looking and the direct effects on consumer prices stemming from changes in interest rates, taxes, excise duties, and extraordinary temporary disturbances would generally not be included. Norges Bank cut policy interest rates by 50 basis points on December 12, 2001 to 6½ percent.

A policy to accelerate the use of oil revenues was adopted in 2001, implying a cumulative fiscal stimulus in excess of 3 percent of GDP over this decade. The policy stipulates a structural nonoil central government deficit each year corresponding to the expected real return on the market value of Government Petroleum Fund assets at the beginning of the year, and would raise the nonoil structural deficit by an average of about 0.4 percent of nonoil GDP each year until 2010. The new government maintained a fiscal stimulus of about ½ percent of GDP, but shifted the balance of the fiscal strategy for 2002 toward reduced taxation.

Executive Board Assessment

Executive Directors noted that a macroeconomic strategy anchored in wage moderation and a policy of investing abroad a large part of oil revenues had contributed to a strong performance, and commended Norway for its solid economic expansion since 1993, marked by virtually full employment and low inflation.

Directors noted that the outlook for 2002 was for weak economic growth as a result of the fall in oil prices and the slowdown in global output growth. They saw the balance of risks to growth as being on the downside, although labor constraints in some service sectors would persist. Directors therefore considered the fiscal stimulus in the 2002 Budget—resulting from the policy to accelerate the use of oil revenues—to be supportive of economic activity. However, they cautioned that a continuation of the stimulus into 2003 could add to demand pressures as growth recovers.

Directors noted the recent change in the authorities' fiscal strategy to increase nonoil structural deficits in line with the expected real return on the Government Petroleum Fund. They observed that the accelerated use of public wealth, combined with Norway's generous public pension system, could have adverse implications for Petroleum Fund assets over the next few decades, as the rising costs of a demographic transition emerge. This could pose risks to long-term fiscal sustainability and Norway's objective of ensuring intergenerational equity. Directors therefore called for timely public pension reform and an appropriate buildup of assets in the Petroleum Fund. Some Directors suggested that the authorities adopt a medium-term expenditure plan to anchor the budget and to underpin fiscal sustainability. Directors expressed concern over the spending level of local government.

Directors welcomed Norway's adoption of a well-designed inflation targeting framework in 2001 to anchor monetary policy in pursuit of low and stable inflation. While welcoming the focus on underlying inflation, several Directors cautioned against frequent changes to the definition of the underlying price index. They also welcomed the recent easing of monetary policy, but noted that a lasting reduction in high interest rates will only be possible if wage moderation is achieved in the upcoming bargaining round and if fiscal policy is not excessively stimulatory when economic activity picks up.

Directors supported the shift in medium-term policy priorities toward reducing Norway's high tax burden. They agreed with the authorities' intentions to restore the principles of tax efficiency and neutrality and to close loopholes in the tax system: such measures could alleviate the economic costs imposed on the private sector by the planned fiscal expansion.

Directors endorsed the authorities' efforts to modernize the public sector, noting the desirability of a strategy to increase the efficiency of public spending through better pricing, management and incentives structures. They expressed concern at Norway's high level of public spending and the high share of its labor force employed in the public sector, and encouraged the authorities to reduce bureaucracy and increase the use of private participation in the provision of public services.

Directors encouraged the authorities to consider a comprehensive reform of the public pension system aimed at ensuring financial viability, by establishing a closer link between contributions and benefits. The reforms should also remove the major disincentive effects of the current tax and pension system on labor supply, and prepare for the increased health and elderly care costs expected as the population ages.

Directors noted that Norway's wage bargaining system had contributed to strong labor market outcomes by assigning a lead role in negotiations to the internationally exposed sector. Noting that this lead role may now be eroding, Directors encouraged the social partners to ensure that wage increases do not harm competitiveness. They underscored the need for structural measures to ease labor supply constraints, and welcomed the authorities' intention to liberalize immigration. Directors recommended that the authorities address the rise in costs and the decline in labor supply associated with the over-generous disability and early retirement programs, and the steep increase in sickness leave.

Directors recommended significant further progress in structural reforms including privatization and deregulation to foster competition. They encouraged the authorities to reform Norway's protectionist agricultural policies, by lowering subsidies and trade protection to this sector.

Directors applauded Norway's continued generous official development assistance, which was among the highest provided by advanced economies. They strongly welcomed the authorities' intention to further raise such assistance to 0.9 percent of GNP, as well as the proposed lifting of import duties and quotas on imports from the poorest countries from July, 2002.

Directors commended Norway for being at the forefront in combating money laundering and anti-terrorist financing. They welcomed Norway's intention to participate in a Financial Sector Assessment Program, noting that the financial sector appears resilient, although some concerns were raised about the increased indebtedness of enterprises and households.

Norway's economic statistics are adequate for surveillance purposes in their coverage, quality, and timeliness.