Public Information Notice No. 97/24

Press Information Notice: IMF Concludes Article IV Consultation with Sweden

September 2, 1997

The IMF Executive Board on August 22, 1997 concluded the 1997 Article IV consultation¹ with Sweden

Background

Sweden has in most respects been remarkably successful in dealing with the consequences of the deep economic recession of the early 1990s. The fiscal deficit has been narrowed from above 12 percent of GDP in 1993 to 2 1/2 percent in 1996 through a strong program of fiscal consolidation; inflation has been brought to record lows despite the forced de-linking of the krona from the ECU (European Currency Unit) in late 1992; and the banking crisis, that accompanied the recession, has been successfully resolved. These achievements have led to significant credibility gains, as reflected in the narrowing of interest rate differentials against Germany and the appreciation of the krona in the latter half of 1995 and through most of 1996. However, the recovery of recent years has made little dent in unemployment, which rose from among the lowest in the industrial world to continental European levels in 1991-92.

In 1996, the strong export led recovery of 1994 and 1995 slowed as GDP growth fell from above 3 percent to barely 1 percent. Exports continued to grow but domestic demand stagnated because of the sharply contractionary stance of fiscal policy, the slowing of the investment boom in the export sector, and a decline in stocks. After rising somewhat in 1994 and 1995, employment contracted by more than 1/2 percent and open unemployment rose from 7 3/4 percent to 8 percent; total unemployment, including participants in labor market programs, rose to 12 1/2 percent.

The fiscal policy measures implemented under the June 1995 convergence program have led to a dramatic--and faster-than-expected--improvement in the general government finances. The general government deficit declined from 10 1/4 percent of GDP in 1994 to 2 1/2 percent in 1996, compared with an original target of 5 percent of GDP. Overall, the strengthening of government finances was in equal measure the result of revenue increases and expenditure reductions, and most of it reflected a strengthening of the underlying structural balance. Government projections point to a deficit of 2 percent of GDP in 1997--well below the Maastricht ceiling--and budget balance in 1998. The government has announced a medium-term target of a fiscal surplus of 2 percent of GDP over the business cycle as well as intermediate targets for surpluses of 1/2 percent of GDP in 1999, rising to 1 1/2 percent in 2000.

Monetary policy has in recent years been geared towards an inflation target of 2 percent with tolerance limits of +/-1 percentage point. The growing credibility of Sweden's financial policies allowed the Riksbank to lower its repo-rate by almost 5 percentage points during 1996 to just above 4 percent--the lowest level of the Bank's instrumental rate in thirty years. These cuts in the repo-rate resulted in a significant easing of monetary conditions although their effect was moderated by the appreciation of the krona through most of 1996. The effective depreciation of the krona since October last year--mainly against the U.S. dollar--has led to a further easing of monetary conditions. Projections indicate that CPI inflation will gradually rise in the course of 1997 and 1998, and be close to the target of 2 percent at the end of next year.

The macroeconomic conditions conducive to accelerating growth in 1997 and 1998 appear to be in place: most of the contractionary effects of the consolidation program have fed through already, inflation and interest rates are low, manufacturing competitiveness is strong and private consumption growth should be supported by rising wealth. On this basis, growth is projected to accelerate to 2 percent in 1997 and to 3 percent in 1998.

The increase in unemployment, notwithstanding positive growth since 1994, has raised the priority given by the government to lowering unemployment with the adoption of a target of lowering open unemployment by half by the year 2000. A five-point program for work and education was announced as part of the 1997 Spring Budget Bill, including increased resources for local government employment, and for expanded adult education programs.

Executive Board Assessment

Executive Directors welcomed Sweden's remarkable success in bringing the fiscal deficit and inflation under control over a relatively short period, and in resolving the banking crisis successfully. Given those successes, they considered that the significant credibility gains Sweden had achieved in financial markets, as reflected in significantly lower interest rate differentials, were fully warranted. Nevertheless, Directors underscored the need for improvements in macroeconomic stabilization to be complemented by structural reforms to strengthen medium-term employment and growth prospects. The main task ahead was to reduce unemployment, which would require continued fiscal consolidation and labor market reforms.

Directors endorsed the target of a balanced budget in 1998, which would carry fiscal consolidation further. Given the vulnerability of government finances to adverse cyclical developments, and the need to lower government debt, Directors also supported the long-term goal of an average annual surplus of about 2 percent of GDP over the cycle. They cautioned against a repetition of the earlier experience of weakening underlying structural balances at times of cyclical strength. In that regard, several Directors expressed concern about the recent use of the room for maneuver that had emerged under the fiscal targets to fund new spending programs to reduce open unemployment.

Directors expressed concern at the high cyclical sensitivity of public finances, which reflected the very high levels of government expenditure and revenue in relation to GDP. They considered that the heavy tax burden was an obstacle to growth and employment creation in the private sector, and suggested that the main fiscal policy objective for the medium term should be to achieve a significant reduction of both expenditure and taxes while also meeting the target for the fiscal balance. Such a fiscal stance would not only lower the cyclical sensitivity of government finances, but also create room for reducing the large tax wedges created by payroll and income taxes that were serious obstacles to job creation in the private sector.

Directors commended the Riksbank's conduct of monetary policy, based on inflation targeting, that, in tandem with a restrictive fiscal policy, had brought inflation to a record low level. Noting that monetary conditions had continued to ease as a result of the depreciation of the krona during the first half of 1997, Directors concurred that the overall monetary stance appeared, for the time being, well balanced.

Directors welcomed the recent multiparty agreement to enhance the Riksbank's independence, and enshrine price stability as the primary objective of monetary policy into law. That would further strengthen confidence in Sweden's commitment to low inflation, and facilitate the implementation of monetary policy. Directors emphasized that the decision not to seek to participate in EMU from the start did not lessen the need for tight financial policies, and for rapid labor market reforms.

Directors expressed serious concern about developments in the labor market, as Sweden appeared to be moving toward the persistently high unemployment rates that had become characteristic of European labor markets over the previous two decades. Several Directors regretted that the government's plan for reducing open unemployment relied more on shrinking the labor force through expanded education and early retirement than on private sector employment creation. Directors considered that expanding education and training, while essential to allow workers to upgrade their skills, would not be sufficient to resolve the unemployment problem. A few Directors cautioned about the tendency of early retirement schemes to become entrenched, even when introduced on a temporary basis. Directors therefore called for a bold and comprehensive program of labor market reforms, drawing on the experience of the Netherlands and some other European countries, in order to address structural rigidities, and foster employment growth in the private sector. Such reforms would also serve to foster further productivity gains, and help maintain Sweden's competitiveness in increasingly globalized international markets. The importance of labor market reforms for supporting fiscal consolidation was also noted by several Directors. Some Directors also drew attention to the importance of pension reform, in view of the aging of the population.

To strengthen the demand for labor, Directors recommended that greater consideration be given to a strategy that used the room for maneuver that had emerged on the fiscal side to narrow the wide tax wedges. Several Directors also saw a need to improve the supply side of the labor market by reforming unemployment benefits and the social security system, and easing job protection provisions. They also suggested that wider wage differentiation was needed in Sweden.

A number of Directors welcomed Sweden's record of providing generous official development assistance, and expressed the hope that it could be restored to its earlier level in relation to GDP.