On August 28, 2014 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Norway.¹

The Norwegian economy slowed in 2013 with both mainland (i.e. non-oil) and offshore growth below the 2012 pace. Mainland growth moderated to 2.1 percent in part due to weak private consumption and mainland investment, while lower oil production kept offshore growth down. The unemployment remains low, at around 3.5 percent, in spite of a growing labor force due to immigration. House prices stabilized in mid-2013 although at high levels and the housing market shows signs of cooling. Inflation rose to about the inflation target, 2.5 percent, partly due to last year’s exchange rate depreciation. The structural non-oil deficit was 3.1 percent of Government Pension Fund Global (GPFG) assets and 5.1 percent of trend mainland GDP. This is below the deficit permitted under the authorities’ fiscal policy rule, but it still implies a positive fiscal impulse due to the strong growth in GPFG assets. The overall current account surplus remains high at 14 percent of mainland GDP but declined in 2013 partly due to weaker petroleum exports.

Banks’ profitability has improved and capital ratios have strengthened. Banks continue to rely on wholesale funding, mostly in the form of covered bonds, and many banks still have some way to go before meeting the Liquidity Coverage Ratio (LCR) requirement. Norway’s financial system is part of a tightly integrated Nordic-Baltic system. Inward links are mainly from Swedish and Danish banks with a combined market share of a quarter to a third. Outward links are relatively modest and concentrated in Nordic and Baltic countries and the shipping industry.

The near-term outlook remains stable with moderate growth and inflation. However, the medium and longer term present new challenges and uncertainties, particularly because of expected slowdown in oil and gas investment. Steadily increasing oil and gas investment over the last decade culminated in a 17 percent growth rate in 2013. With this investment expected to flatten out in 2014-15 before beginning a slow decline, new sources of growth are needed. Staff’s central forecast is a continuation of growth with only a modest rise in unemployment in the next few years and inflation gradually rising back toward the target. However, this is based on a scenario in which the sources of growth shift away from supplying the oil and gas sector and toward other sectors of the economy or exports of oil-related goods and services.

There are risks to this scenario. A substantial decline in oil and gas prices could undercut growth through a reduction in demand for mainland goods and services, and through a reduction in private demand due to confidence and income effects. A significant reduction in housing process would likely reduce household consumption with adverse consequences for retail trade, construction, and commercial real estate and lenders to those sectors. Also, a more difficult transition to a growth model less dependent on supplying the oil and gas sector could result in slower growth and higher unemployment during the shift.

Executive Board Assessment²

Executive Directors commended Norway’s continued steady economic growth, moderate inflation, low unemployment, and large current account and fiscal surpluses. Nevertheless, challenges remain. Directors agreed that policy priorities and structural reforms should be geared towards preserving financial stability, supporting the transition to an economy less dependent on oil and gas, and improving productivity and competitiveness.

Directors concurred that the current stance of monetary policy, under the authorities’ inflation-targeting framework, is appropriate. Given that the economy is roughly at its potential, inflation is close to target, and house prices are stabilizing, the argument for a rate increase has diminished for now. Directors noted that the policy rate might eventually have to normalize to a level above the inflation target to meet the objectives of monetary policy, and to mitigate risks of overheating, particularly, in the real estate market.

Directors welcomed the authorities’ prudent fiscal policy, in particular the decision to keep the spending of oil revenues well below 4 percent specified under the fiscal rule. While acknowledging the availability of resources for additional investments, most Directors saw merit in a more neutral fiscal policy stance as long as the economy remains near capacity. Directors welcomed the stronger capital requirements for banks ahead of the Basel III deadlines, in particular the higher capital requirements for mortgage lending. Given that these requirements are still in their early stages, they may need to be adapted as implementation proceeds. Directors commended the agreement among Nordic authorities on aligning capital requirements for mortgage lending by branches and subsidiaries to local economic conditions. They agreed that tighter capital standards and loan-to-value limits on mortgages should be maintained given the vulnerabilities stemming from high house prices and household debt and banks’ reliance on wholesale funding, even if the housing market softens further.

Directors emphasized the importance of further structural reforms to improve productivity and competitiveness, and to promote the non-oil economy, and they looked forward to the report of the Productivity Commission. Priorities include further reforms of the labor market, pensions and public services, greater wage differentiation across sectors, and reducing protection and subsidies in agriculture. Directors also recommended increased use of cost-benefit analysis in the selection of infrastructure projects, and a simpler income tax system with fewer incentives for promoting housing to encourage productive investment.