Country Report Norway
Though slowing, growth remained strong in 2012 mostly due to large (petroleum) investments. Rising house prices and low interest rates boosted the recovery, but have also led to an increasing risk of housing market overvaluation and high household indebtedness. The controlled cooling of the housing market should be a key policy priority in the coming years. That said, from a relative risk perspective, the position of Norway remains solid amid a financially healthy public sector and a still competitive private sector.
Remarkable economic growth
After a relatively modest economic contraction following the global financial crisis in 2009, the Norwegian economy experienced a strong recovery. GDP growth slowed in 2012 but still amounted to an impressive 3.2% y-o-y. Strong growth last year was mainly the result of large (petroleum) investments. Although the pace of economic activity slowed in the second half of 2012, robust domestic demand was able to limit the negative effects of the European debt crisis. The labor market performed extremely well during the last couple of years, which is also reflected by the lowest unemployment rate (3.2%) in Europe.
The growth outlook for the coming years is solid and remains mainly based on growth of (petroleum) investment and household consumption. The latter is expected to grow on the back of real wage growth and low unemployment. Private sector domestic spending is necessary to push the economy forward given that the government budget for 2013 is fiscally neutral and export growth will continue to be hampered by weak foreign demand as well as the strong appreciation of the Krone. As a response to these headwinds, the Norwegian central bank reduced its key policy rate from 1.75% to 1.50% in April 2012. Since inflationary pressures are expected to remain contained, and the risks of a further appreciation of the Krone are high, monetary policy is expected to remain accommodative throughout this year.
Public finances are very healthy
The large oil and gas reserves (many of which are state-owned) make the Norwegian government financially very healthy (net public financial assets amount to 158%-GDP in 2011). To ensure natural resources wealth also benefits future generations and to facilitate savings to finance rising pension expenditure, government income from the petroleum activities are transferred to the Government Pension Fund Global (GPFG). Norway’s key budget rule (since 2001) stipulates that the non-oil structural government deficit should not exceed 4% of GDP, which equates to the expected annual real return of the GPFG, unless the business cycle requires fiscal expansion to counter output fluctuations. This was the case in 2009 and 2010, but in 2011 and 2012 the rule was met again. Note that future oil price movements have consequences for a large share of government income. But only a very large drop in oil prices (below USD 70 per barrel) might have consequences for the real economy through lower oil-related investments.
Risks for the private sector stem from household indebtedness and elevated house prices
The financial position of Norwegian firms is average from a European perspective. Norway’s world export market share of non-oil exports remained more or less stable over more than a decade, while market shares of almost all other European countries dropped during this period. This is remarkable given the strong increase of wage growth and an appreciating Krone. So firms managed to boost their non-price competitiveness. Although the contribution of non-oil trade to the current account is structurally negative, Norway is running large current account surpluses since the early 1990’s (15.2% in 2012).
As opposed to firms, indebtedness of households is large (household debt amounted to 200% of disposable income in 2011) and financial assets are below average when compared to its peers (219% to disposable income in 2011). Low interest rates and high income growth have strongly increased demand for housing and, therefore, led to rising house prices. Housing is substantially financed by borrowing, which in combination with steeply rising house prices has led to large mortgage debt levels (190% of disposable income in 2011). The stretched household balance sheets are considered a risk to financial stability, as there exists a risk of overvaluation of housing prices. If a price correction occurs or interest rates rise substantially, thereby raising debt-servicing costs , there will be adverse effects on both the real economy and on the financial sector.
Although the banking sector is well-capitalized, the effects of a large and quick housing market correction on bank’s balance sheets can be significant. The government has already taken measures to reduce the risks stemming from the housing market, but more can be done. The measures already taken include higher capital requirements for credit institutions based on Basel III and the requirement to assume a higher loss probability on home loans, which has already led banks to increase lending rates. Recent recommendations to the financial sector on a maximum of loan-to-value ratios on home loans of 90% could be improved by introducing an obligatory cap. That said, the government does have plenty of scope to use its balance sheet to support banks if required, though it might worsen its long term fiscal sustainability.
 ^ A large proportion of loans are financed by variable interest rates.