Country Report Denmark
The recovery since the deep recession in 2009 has been slow and GDP growth even turned slightly negative in 2012. The Danish economy is hampered both by headwinds in the external sector and weak domestic demand, which is due to continued private sector deleveraging and housing market correction. GDP growth is expected to remain subdued in 2013. The government is committed to fiscal prudence and growth enhancing reforms, even in a weak economic environment. Although the banking sector has come a long way in addressing its weaknesses, there are still a number of challenges in the road ahead. Finally, we note that the Danish public finances are healthy and contingent liabilities from the financial sector are not likely to impair fiscal sustainability.
Subdued growth despite expansionary fiscal and monetary policy
Denmark was the first European country to enter a recession in 2008, as a result of a sharp housing market correction (nominal prices have dropped 20% since their peak in 2007). The deflation of house prices led to the bankruptcy of 12 small lenders, and caused a steep fall in domestic demand as the private sector started deleveraging. The Danish economy experienced a very slow recovery since the deep recession in 2009. The intensification of the European debt crisis and ongoing private sector deleveraging pushed GDP growth once again to the negative territory in 2012 (-0.6%). Reflecting the flexible labor market, unemployment rose quickly from 3.2% in 2008 to 7.6% in 2012.
In order to stimulate growth, the government has introduced (i) temporary tax breaks in the Spring of 2012, (ii) policy measures such as the June 2012 tax reform aimed at increasing household disposable income, and (iii) plans to increase public investment in infrastructure, education, and R&D. To defend the currency peg versus the euro and to reduce the upward pressure on the krone amid safe-haven inflows, the Danish central bank cut its policy rate to below the ECB’s policy rate. This ultimately led to a historically low benchmark lending rate (0.2%) and even negative certificate of deposit rates (-0.2%) in the Summer of 2012. In January 2013, both policy rates were raised, to 0.3% and -0.1%, respectively, as a consequence of fading safe-haven flows. Interest rates still remain low, which might also support domestic demand going forward. Despite the expected gradual recovery of external demand, policy measures to stimulate private consumption and investments, and low interest rates, we expect growth to remain subdued in 2013, before gaining traction in 2014. This is because, amongst other things, domestic demand continues to be hampered by household and financial sector deleveraging and falling house prices.
Healthy public finances and a committed government
As a consequence of the severe recession, expansionary fiscal policy in 2008 and 2009, and the relatively large impact of automatic stabilizers in Denmark (partly due to the flexible labor market), public finances deteriorated significantly in recent years. Gross public debt rose from 28% of GDP in 2008 to 46% in 2012 (the net debt ratio, which accounts for financial assets of the government, remains around zero). The healthy stance of public finances and a track record of prudent fiscal policy measures are rewarded by the market, indicated by bond yields below that of Germany. Steps taken by the current minority government to improve Denmark’s long term public finances include, among others, the pension reform agreed in December 2011, which will increase the retirement age to 69 years in the coming two decades. The budget law adopted in the Spring of 2012 introduces binding expenditure ceilings for the government from 2014 onwards. For municipalities a binding expenditure ceiling was already introduced in 2012.
Households still face high (mortgage) debt…
As opposed to the public sector, the household’s gross debt position is extremely large (149% of GDP and 301% of disposable income). Between 1994 and 2009 private sector credit has grown substantially (from 149% to 255% of GDP). Significantly large household financial assets (263% of GDP and 516% of disposable income in 2011) including large pension assets, reduced the need to increase precautionary savings and made households comfortable with high debt levels. Despite the private sector deleveraging and negative credit growth in the years following the burst of the housing bubble (2007), household mortgage debt levels remain elevated (around 70% of total household debt). This makes households vulnerable to large housing price and interest rate movements. As regards the latter, 74% of the outstanding mortgage debt has adjustable or floating interest rates. Given households’ susceptibility to both labor and housing market shocks deleveraging, though it will weigh on domestic demand, is beneficial from a longer term sustainability point of view.
…while the corporate sector is in a relatively healthy shape…
The financial position of the Danish non-financial corporate sector is average from a European perspective. Firms are competitive, but productivity growth has been low compared to other European countries in the past 15 years. The relatively large rise of unit labor costs has deteriorated their price competitiveness. In light of this, both the recent agreement on wage moderation and the tax cuts that will ease inflation (on top of the measures mentioned above) should help to underpin the strong financial position of Danish firms. Overall, the history of steady current account surpluses (5% of GDP in 2012) is expected to continue in the coming years.
…and the weak financial sector is improving
As far as the financial sector is concerned, large banks have significantly increased their capital buffers and have tightened credit conditions. Furthermore, (mortgage) banks are adjusting their business models to reduce the refinancing risk on adjustable-rate loans, the potential need for top-up collateral if house prices fall , and their reliability on short-term market funding. That said, the banking sector remains a weak spot in Denmark as banks are still vulnerable to wholesale funding conditions. Besides that, the future of the large covered-bond market is uncertain as it is not entirely clear whether covered bonds will be fully eligible under the Basel 3 liquidity regulation. Therefore, the availability of sufficient funding might become an issue for Danish banks, especially given the tight (and therefore expensive) Danish savings market (the loan-to-deposit ratio is extremely large at 224%). Risks related to the banking sector could hamper economic growth and deteriorate public finances via government guarantees. That said, contingent liabilities from the financial sector are not likely to impair fiscal sustainability.
 ^ The loan-to-value ratios of housing loans that are financed via covered bonds are not allowed to exceed 80%. If house price declines lead to higher loan-to-value ratios, the bank has to pledge additional collateral.