Country Report Sweden
The strong economic recovery came to a halt by the end of 2011 due to the spillover effects of the European debt crisis. The outlook for the Swedish economy is determined by the strength of external demand, and is, therefore, expected to remain subdued in 2013. That said, if needed, the country has ample space to stimulate domestic demand through both expansionary fiscal and monetary policy. Despite risks stemming from the high level of private sector debt, the housing market, and the funding scheme of the financial sector, we do not believe Sweden will experience financial instability owing to the healthy public sector balance sheet.
After the 2008-2009 recession, Sweden experienced a strong recovery in 2010 and 2011. GDP grew by a stunning 10% during the two years. The rapid recovery was led by a strong increase in exports, partly due to the sharp depreciation of the Krona, but business investment and household consumption also played their part. By the end of 2011, growth came to a halt and it was clear that Sweden was no longer immune from the European debt crisis. Meanwhile, the rate hikes by the Sveriges Riksbank (the central bank) from mid-2010 until the autumn of 2011, meant to cool the housing market, did not only curtail growth of domestic demand, but also led to a strong appreciation of the Krona. This was exacerbated by safe-haven flows due to the European debt crisis.
To stimulate growth, the Riksbank has since lowered its official policy rate from 2% in November 2011 to 1% in December 2012. In the spring of 2012, growth made a comeback before slowing again in the autumn due to deteriorating economic sentiment. GDP increased by 1% in 2012. Going forward, economic activity is expected to remain subdued this year. Investment is expected to drive growth as financing conditions remain favorable and fiscal policy will be expansionary. Export growth is not expected to pick up strongly amid the weak global demand and the appreciation of the Krona. The unemployment rate increased during the crisis from 6.1% in 2007 to 8.4% in 2010, but is on a downward path again (7.5% in 2012). The stronger labor market together with an increase in household disposable incomes could support private consumption growth towards the end of 2013.
Healthy public finances
The financial position of the government is one of the healthiest in Europe. Besides a very low debt-to-GDP ratio (38% in 2012), the government owns substantial assets which means the net debt ratio is actually negative (-18% of GDP in 2012). Since the Nordic banking crisis, the government established a policy anchor (effective in 1997) to aim for a budget surplus of 1%-GDP over the business cycle and remain below a pre-announced tight expenditure ceiling. A track record of budget surpluses and falling gross debt-to-GDP ratios in the pre-crisis decade shows that Sweden’s fiscal policy (rule) is prudent and reliable. This has led to very low interest rates on government bonds, comparable to that of Germany, and high debt affordability. That said, given last year’s disappointing economic performance, a small public deficit (-0.2%) was recorded.
Government committed to fiscal prudence and economic growth
Prudent budgetary policy in pre-crisis years now provides ample room for fiscal expansion to boost economic growth. While the announced budget for 2013 is expansionary, it remains within the set expenditure ceiling. The government has, among other things, announced to increase investments in infrastructure as well as R&D and to simplify the tax system. The 2013 budget bill also includes labor market measures to increase jobs opportunities and work incentives. More action should be taken, however, to reduce the high levels of employment protection and relatively high labor costs at the lower end of the labor market. This should serve to lower the risk of a high structural unemployment rate. Over the longer term, Sweden is able to cope well with the relatively rapid ageing population.
Competitive private sector to face high debt and elevated house prices
Where the public sector is extremely healthy, the private sector does face some risks. The private sector credit-to-GDP ratio has grown substantially between 2004 and 2009 (58%-points), and after a drop, it increased again last year. Furthermore, liabilities of non-financial corporations and household debt are elevated. To put matters into perspective, we must note that households have a substantial amount of financial assets. In any case, the high competitiveness of Swedish firms allows the country to book large current account surpluses (7.2% in 2012). However, this has not translated yet into a net foreign investment position (-9.5% of GDP 12Q2), which is due to Krona’s strength.
Another area where we do see some potential risks to the outlook is the Swedish housing market. Real house prices have risen markedly between 2000 and 2010 (+74%) and rose again last year after a decline during 2011. The surge in house prices can be largely explained by economic fundamentals and limitations on housing supply. Due to large household mortgage debt levels (over 150% of disposable income in 2011), the widespread use of variable rate mortgages (over 50% of total mortgage loans) and amortization-free loans in the past decade, households are vulnerable to a sharp rise in interest rates as well as house price corrections. The housing market, therefore, remains a risk to the economic recovery and financial stability, though the regulatory cap on the loan-to-value ratio (85%) introduced in 2010 acts as a mitigating factor for banks. It should be noted that while credit standards have been high and the capital ratios of the major banks are favorable from an international perspective, most banks are vulnerable to adverse market conditions due to a large dependency on wholesale funding. We believe the risk of financial instability is muted, however, owing to the large fiscal space that can be utilized to support banks if required.