Public Information Notice No. 00/7

Public Information Notice: IMF Concludes Article IV Consultation with Norway

February 15, 2000

On January 28, 2000, the Executive Board concluded the Article IV consultation with Norway.¹

Background

Norway's economic record over the past decade has been exemplary in many respects. Prudent management of revenues from the exploitation of its large reserves of oil and gas, coupled with a broadly successful macroeconomic policy framework has enabled Norway to raise living standards substantially. Indeed, over the past quarter century, Norway's per capita GDP (on a purchasing power basis) has risen from a level equal to the average of the European Union (EU) countries to a third above the EU average, approaching that of the United States. In notable contrast to many EU countries, Norway has succeeded in achieving virtual full employment and a sharp rise in the labor participation rate.

The policy framework came under considerable strain in 1998 in the face of an erosion of wage and fiscal discipline, and pressures on the exchange rate. With the fiscal stance insufficiently restrictive to counter excess demand, and labor market conditions very tight, wage increases averaged around 6½ percent-double the level in main trading partners. At the same time, oil prices plunged by over 40 percent through 1998, contributing to sustained downward pressure on the krone and the first current account deficit in the decade.

Economic activity was sluggish during the first half of 1999, but rebounded somewhat in the third quarter. Mainland GDP grew by 1½ percent in the year to the third quarter of 1999, while overall GDP rose by 2¼ percent. Business investment contracted, both in petroleum and manufacturing, as high wage growth and stagnant productivity with only moderate increases in producer prices squeezed profits and depressed business sentiment, and as some large investment projects were completed following several years of strong growth. Consumption, fueled by large wage gains and sustained by high household confidence, has been the engine of growth. The external balance has recovered in the course of 1999 in the wake of an upturn in oil prices by about 150 percent from below $10 per barrel at end-1998. Imports also fell in conjunction with the sizeable decline in investment, thereby improving the non-oil trade balance. Employment growth has tapered off since mid-1998, although the level of employment remains very high.

Consumer price inflation remained moderate despite a rapid rise in wage costs. The large wage settlements of 1998 had a carry-over of about 3¼ percent into 1999-an off year of the two-year wage bargaining framework. However, the Arntsen Committee, set up to represent the social partners, was instrumental in reviving the consensus on wage policy. The outlook for average earnings in 1999 is broadly in line with the committee's recommendation that wage growth in 1999 should not exceed 4½ percent. However, even with this relatively moderate outcome, wages will have risen by a cumulative 6 percent in real terms in 1998-99. Consumer prices rose by 2.5 percent in the year to October 1999. Falling import prices helped offset price increases for services, domestically produced goods, petroleum products, and electricity.

The present slowdown in economic growth is expected to continue into 2000. Mainland real GDP is forecast to grow by only about 1 percent while aggregate GDP is projected to rise considerably faster, reflecting the resurgence in oil exports. However, in view of strong household income and confidence and the strength of activity in the third quarter of 1999, and with major wage negotiations due to take place next spring, the risks to the projection are on the upside.

Monetary policy has been eased gradually since early 1999 as inflation expectations moderated with the appreciation of the krone and the adherence to the wage agreement. The krone appreciated by over 7 percent in response to the sharp reversal in oil prices and by early December was trading slightly above the implicit target range. Policy rates were reduced by a total of 2½ percentage points in five steps since the turn of the year in view of low inflation expectations and the economic slowdown.

The fiscal stance has been moderately tight in 1999. Unlike in 1998, when tightening in the central government budget was offset by an expansionary stance by local governments, the tightening at the central level in 1999 is reflected at the general government level. Both the central and general government stance imply a tightening of the cyclically adjusted non-oil fiscal position by ½ percent of GDP, with the general government budget surplus projected to increase by 1 percentage point to 5½ percent of GDP. The State budget sets a neutral fiscal stance for 2000, which is also broadly consistent with a neutral general government stance.

Executive Board Assessment

Executive Directors commended Norway for its exemplary economic performance over the past decade, as reflected in strong economic growth, and low inflation and unemployment. They noted the contribution to this performance of the Solidarity Alternative policy framework that is aimed at preserving the competitiveness of the non-oil economy and smoothing income and employment through a combination of consensual incomes policy and prudent management of the country's oil wealth. To further consolidate those achievements, Directors considered that priority issues facing the authorities were to bring inflation in line with the corresponding target in the euro area, and to move forward with structural reforms to enhance efficiency and provide the basis for sustained growth in the mainland economy.

Given the slowdown in mainland economic growth against the backdrop of capacity constraints and a tight labor market, Directors viewed the neutral 2000 fiscal budget as broadly appropriate. However, they generally considered that if growth were to pick up more quickly than expected, it would be advisable for the authorities to respond with a sufficiently tight revised budget in May. Directors also noted that the countercyclical fiscal stance of the central government had been offset at times by the procyclical fiscal tendencies at the municipal level. In this regard, they recommended that the authorities focus their countercyclical fiscal policy at the level of the general government.

Directors were of the view that the policy of nominal exchange rate stability had provided benefits to Norway throughout the 1990s. However, recent experience pointed to the difficulty that could arise in maintaining a stable exchange rate in the short run, especially in the face of large asymmetric external shocks that could affect Norway's prominent oil sector. Directors thus welcomed the fact that, in its conduct of monetary policy, Norges Bank had allowed greater short-term deviations of the exchange rate from its implicit target range. They also welcomed the authorities' efforts to enhance the transparency and credibility of their monetary policy framework, and some Directors observed that a more explicit mandate to the central bank affirming the objective of low and stable inflation could be useful. Directors stressed that fiscal and wage discipline would play a key role in maintaining economic stability, regardless of the monetary framework adopted. The cautious approach to monetary policy followed over the past year should continue, given the upside risks to activity and inflation.

Directors welcomed the authorities' aim to achieve wage moderation, but noted the risk stemming from rising wage pressures ahead of the spring negotiations. They observed that the already tight labor market and high level of labor participation have been testing the bounds of incomes policy and risked causing a pickup in inflation, which it was important to avoid since Norway's inflation rate was already above that of its partners. Some Directors cautioned that wage moderation should not be achieved at the cost of excessive growth in social and labor market programs whose long term fiscal cost could be substantial.

Directors commended Norway for consistently transferring oil-related revenues to the State Petroleum Fund. This had helped to insulate the economy from the effects of fluctuations in oil revenues, and to preserve the benefit of Norway's oil wealth for future generations. In a longer term perspective, Directors viewed with some concern the recent increases in early retirement programs and in pension benefits. They encouraged the authorities to seize the present opportunity to initiate reform of the public pension scheme. Options for doing so included policy changes to stimulate a higher labor force participation rate, adjusting pension benefits, and moving to a partial funding of the compulsory pension plan while introducing supplementary private pension schemes.

Directors considered that the long run challenge for the authorities would be to engineer a smooth transition to the post-oil era. They generally considered that measures to improve the functioning of product markets (including a review of agricultural subsidies) and of labor markets would help to sustain growth in the longer run. Some Directors observed that growth prospects would also be helped by restraining public expenditure so as to allow a reduction in the relatively high tax burden.

Directors encouraged the authorities to pursue the privatization process. Several Directors suggested that the authorities should not be inhibited in their privatization goals by the desire to preserve national ownership in key sectors. A few Directors stressed that in cases where the authorities' desire to preserve a national identity in an industry restricts options for complete privatization, the development of alternative policies to ensure an efficient and competitive market structure is all the more urgent.

Directors applauded Norway's continued development assistance, which was among the highest provided by advanced economies. They welcomed the authorities' intention to increase ODA to 1 percent of GDP over the medium term.