On August 30, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Norway.¹

The Norwegian economy continues to perform well with mainland (i.e. non-oil) GDP growing steadily at 2.5–3 percent, driven by private consumption, investment, and low interest rates. Despite strong domestic demand, inflation remains subdued, running below the 2.5 percent target, mostly due to declining import prices. Unemployment remains low at around 3–3.5 percent. The current account surplus was 19 percent of mainland GDP in 2012, boosted by strong oil prices and production. The general government balance was in surplus in 2012 and the non-oil structural fiscal deficit was 4.8 percent of mainland GDP or about 3.2 percent of the sovereign wealth fund (Government Pension Fund Global or GPFG) capital. This is below the deficit permitted under the authorities’ fiscal policy rule, but it still implies a slightly positive fiscal impulse due to the strong growth in GPFG assets.

However, the overall strength of the mainland economy masks divergent trends. A strong and growing set of industries supplying goods and services to the offshore sector coexist with a non-oil related subset of the mainland economy under increasing cost and competitiveness pressures. This divergence is also evident in cost pressures especially because of rapidly rising unit labor costs (ULC). Norway’s ULC-based real effective exchange rate appreciated substantially over the past decade, suggesting an erosion of long-term cost competitiveness.

House prices are high and increasing, and household debt is also high. The authorities tightened lending guidelines for mortgage loans in December 2011, and they are considering options for further tightening macroprudential limits including by increasing risk weights on mortgage loans. They are also consulting with other Nordic countries on how to regulate the operations of bank branches operating in Norway but headquartered elsewhere in the region.

Growth in the mainland economy is projected to continue at a moderate pace, largely supported by high activity in the petroleum sector and strong domestic demand. However, this central scenario is subject to key risks. A substantial and prolonged reduction in oil prices could undercut growth in the event that downside risks to the global growth outlook materialize. Also, a correction in the buoyant housing market could reduce household consumption with adverse consequences for retail trade, construction, commercial real estate, and lenders to those sectors.

Executive Board Assessment

Executive Directors appreciated the additional context provided by the Nordic Regional Report. They welcomed Norway’s sound macroeconomic management, which has underpinned steady growth and low unemployment in a difficult global environment. Directors agreed that the main challenge is to maintain macroeconomic and financial stability while containing vulnerabilities stemming from elevated house prices and high household indebtedness. In the longer run, competitiveness pressures on the mainland economy and the fiscal impact of population aging need to be addressed.

Directors concurred that the current monetary policy stance is appropriate. Inflation remains below target and is likely to increase only gradually as the economy approaches its potential and upward pressures on the exchange rate recede. Directors agreed that overheating in the property market should be addressed by tightening macroprudential policies and reducing the tax advantage of residential investment.

Directors welcomed the authorities’ prudent use of flexibility in the fiscal rule. Most Directors considered that wage pressures and eroding competitiveness in the non-oil sector argue for a slower rate of spending—in the 2014 budget and beyond—than the strictest interpretations of the fiscal rule would suggest. In addition, a conservative approach would help address future spending pressures connected with population aging.

Directors stressed the importance of further strengthening supervision and the regulatory framework in the financial sector. They supported the proposed legislation to increase capital requirements for banks in line with Basel III requirements. They also noted that more capital would appropriately support exposures and hedge against risks such as property price reversals or a disruption to external wholesale funding. In this context, Directors welcomed the proposal to reassess risk weights for residential mortgages and the consideration of measures to address risks related to covered bonds. In addition, they encouraged the authorities to enforce tighter limits on loan-to-value ratios and interest-only mortgages. Directors concurred that greater cross-border coordination on macroprudential measures—as recommended by the Nordic Regional Report—is necessary to limit regulatory arbitrage and ensure that foreign-headquartered bank branches lend in line with economic conditions in Norway.

Directors agreed that structural reforms are needed to enhance the competitiveness of the mainland economy. Priority areas include labor market, pensions, trade in agriculture products, and public sector services. Sickness and disability benefits could be further reformed to improve efficiency and help contain future pressures on government spending.