Public Information Notice No. 01/10

Public Information Notice: IMF Concludes Article IV Consultation with Norway

February 5, 2001

On January 26, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the 2000 Article IV consultation with Norway.¹

Background

Norway, one of the world's richest economies and its second largest oil exporter, has been a model of prudent economic management of resource wealth in recent years. The policy of investing abroad a substantial part of the government's oil and gas export revenue through the State Petroleum Fund, pursued in the 1990s, has helped insulate the mainland (non-oil) economy from fluctuations in oil revenue. Coupled with a consensual incomes policy framework, this strategy has been generally successful in managing the economic cycle and has helped raise living standards markedly over the past quarter century.

With the cycle maturing, labor market conditions have tightened and pressures on capacity intensified, straining the solidaristic wage-setting framework. After a brief pause in the first half of 1999, mainland GDP growth picked up to 3 percent in the first half of 2000 over the corresponding period in 1999. Private consumption, driven by large wage gains and positive wealth and confidence effects, rose by 3½ percent, with public consumption also providing a steady impetus to demand. The strength of residential and mainland business investment more than offset a continued contraction in petroleum investment. Solid export growth and the lagged effects of the relaxed monetary stance of 1999 also underpinned economic activity. The renewed expansion since late 1999 boosted employment growth, mostly in services, with the participation rate—already among the highest in the advanced economies—reaching a new high. With the rate of unemployment at 3¼ percent for over a year, acute labor shortages continued in construction and services, strengthening labor unions' bargaining position. The settlement under the two-year centralized bargaining framework was reached in May 2000 only after a nationwide general strike, increasing wage costs by about 5 percent in 2000 and at least 4½ percent in 2001.

External and domestic impulses pushed headline inflation to its highest rate since 1991. A sharp rise in energy prices as well as rising labor costs raised consumer price inflation in the year to October 2000 to 3.1 percent, 0.7 percent above that for the euro area as measured by the harmonized index. Asset prices have also risen steeply, with house prices up by 18 percent in the year through the second quarter of 2000, and the Oslo share price index increasing by 21 percent in the year through November 2000.

The coincidence of a surge in oil prices, peaking oil output, and a strong U. S. dollar—which boosts the krone value of dollar-denominated oil exports—led to a doubling of oil export earnings in 2000. Exports of natural gas, of which Norway is one of the ten largest exporters, have also risen to a record level. Favorable prices for other staple raw material exports—fish and aluminum—have helped raise the average terms of trade by 27 percent in the year to June 2000. This, and a strong recovery in the EU market, has contributed to an expected current account surplus of about 15 percent of GDP for 2000—the largest in relation to GDP for an advanced economy since at least 1970. Net foreign assets are projected to grow from 11 percent to over 25 percent of GDP in the year through end-2000.

Despite some erosion vis-à-vis the euro area since 1997, overall competitiveness has been sound. The real effective exchange rate has declined by nearly 5 percent over the past three years as nominal depreciation of the krone, particularly against the U.S. dollar and the pound sterling, more than offset the adverse inflation differential. However, while the krone/euro exchange rate has returned to levels prevailing in 1997, Norwegian inflation has outpaced that in the euro area since 1997. Wage costs will have risen by a cumulative 17 percent in 1998-2000, about double the rate of increase in the euro area, while productivity growth in Norway has been lagging in recent years.

The general government fiscal stance in 2000 is slightly expansionary. Spending by local authorities in excess of budget estimates has contributed to an expansionary change in the general government non-oil structural balance of about 0.3 percent of GDP. This will mark the third straight year that a slight tightening of the state budget has been more than offset by laxity in local government finances. With oil prices at a ten-year peak, the overall fiscal surplus is projected at over 14 percent of GDP, 6 percentage points above the 2000 budget projection, which was based on the assumption of an oil price of US$15 a barrel.

The 2001 state budget, approved by parliament in November 2000, embodies a broadly neutral fiscal stance. It includes an increase in the general VAT rate by one percentage point to 24 percent, an 11 percent tax on dividend income, to be offset by cuts in taxes on fuel as well as reduced VAT on food. Spending initiatives in education and health care contributed to the proposed 2½ percent rise in underlying real spending. With lower projected growth of petroleum revenue, the general government surplus is expected to decline to 12½ percent of GDP.

Over the past few years, the conduct of monetary policy has gradually moved toward treating nominal exchange rate stability as a medium-term goal rather than as a short-term operational target, to be achieved by bringing inflation down to the level aimed at in the euro area. Norges Bank raised policy interest rates by a total of 150 basis points to 7 percent during April-September 2000 to reduce inflation pressures. Nonetheless, although the krone has been strong relative to the euro, the nominal effective exchange rate has depreciated by 4 percent since mid-1999.

Executive Board Assessment

Executive Directors commended Norway for its impressive track record of economic performance over the past decade, marked by sustained solid growth, low inflation and unemployment, and strong fiscal and external positions. This strong performance owed much to the authorities' successful macroeconomic strategy—anchored to the consensual framework of the Solidarity Alternative—that aims to ensure financial stability and competitiveness of the non-oil economy through prudent management of Norway's sizable oil wealth.

Directors noted that the outlook for 2001 was for continued solid economic growth, at a more moderate pace. With mainland output expected to remain above potential and continuing resource pressures, however, the balance of risks is on the upside. Directors therefore recommended the authorities to pursue appropriately tight fiscal and monetary policies, and to accelerate the pace of structural reform. This would strengthen the foundations for continued favorable economic performance in the medium term.

Directors noted that countercyclical fiscal management was a key pillar of the authorities' strategy, which had served Norway well in the past by helping to smooth aggregate demand. A number of Directors, noting the political constraints, supported the neutral fiscal stance of the 2001 budget, but recommended that the authorities be prepared to respond to any indications of continuing resource pressure by an appropriate tightening in the revised budget in May. A few other Directors, however, considered that a tighter budget for 2001 would have been desirable to avoid placing a disproportionate burden on monetary policy.

Directors welcomed the monetary authorities' timely policy tightening in 2000 to counter inflation risks. They endorsed the increased weight given to inflation in formulating monetary policy, and encouraged the authorities to continue to pursue their objective of bringing inflation down towards the corresponding euro area target range. A number of Directors felt that there was no compelling reason at this time to change the present monetary policy framework: they welcomed the authorities' efforts to promote transparency through comprehensive communication. A few Directors suggested that the authorities consider formally mandating Norges Bank to ensure low and stable inflation, and guaranteeing its full operational independence, as a means of improving the transparency and credibility of monetary policy.

Directors welcomed the measures to widen the tax base, including through the extension of the value added tax to cover more services and the closing of some tax loopholes. They emphasized the benefits of maintaining a neutral and predictable tax system, and recommended the authorities to adhere to the principles underlying the 1992 tax reform and refrain from ad hoc increases in taxes that could undermine Norway's generally efficient tax system.

Over the long term, Directors noted that the twin tasks for economic policy will be to facilitate the economy's transition to the post-oil era and to address the pressures on the public pension and health care systems implied by the impending demographic change. They commended the authorities on their ideal of intergenerational equity and their prudent management of Norway's oil wealth. Directors supported the authorities' adherence to a sound long run fiscal strategy, and stressed the importance of not easing fiscal policy during periods of windfall oil revenues. They underscored the need for measures to reform the pension regime and the social insurance programs to ensure that future generations will share in the benefits from oil wealth. Reforms in these areas should incorporate steps to improve incentives, including by tightening the eligibility requirements for disability and sickness benefits, and by restructuring of pension and early retirement schemes.

Some Directors encouraged the authorities to consider the potential benefits of adopting a medium-term expenditure plan that would contain growth in public spending within a strategic framework. They noted that expenditure restraint would reinforce the prospects for long-term fiscal sustainability and permit a reduction of Norway's tax burden over time.

Directors noted that Norway's centralized wage bargaining system has contributed to its long record of strong employment growth and low unemployment. They observed, however, that the system has become more fragile in recent years, and the wage structure is compressed by international standards, pointing to the need to improve employment and wage flexibility. Directors noted that recent employment expansion had been mainly in the public sector. They recommended the authorities to encourage the creation of private sector jobs and promote the acquisition of skills through greater wage differentiation.

Directors welcomed the recent structural measures in product markets, including the decision to sell the second largest public bank. They encouraged the authorities to move forward with the remaining agenda for deregulation and privatization, and to reduce Norway's high protection of the agricultural sector, including through trade liberalization.

Directors praised Norway's continued official development assistance, which is among the highest provided by advanced economies. They strongly welcomed the authorities' intention to increase such assistance to 1 percent of GNP over the medium term.

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