Country Report Denmark
The economic outlook is improving, public and external balance sheets are healthy, and institutions strong. Denmark’s banking system has become more stable, though large dependence on wholesale funding does pose risks. But, the main source of concern is the very high household debt.
Strengths (+) and weaknesses (-)
(+) Healthy public finances
Debt ratios are very low and debt affordability high. Also, from 2014, government expenditure is bounded by an expenditure ceiling and the structural budget deficit must not exceed 0.5% of GDP. Recent pension reforms have improved Denmark’s ability to cope with its ageing population.
(+) Very strong institutions and high quality politics
Denmark has a well performing and transparent public administration system, a strong higher education and training system, a flexible and efficient labour market with high participation rates, adequate and effective policymaking, and perceived corruption is almost zero.
(+) Strong net creditor position
Denmark has been running current account surpluses for decades, despite losing competitiveness and market share. Accordingly, Denmark’s net international investment position has become strong.
(-) Very high household debt
Significantly large household financial assets, mostly pension savings, reduced the need to increase precautionary savings and made households comfortable with extremely high debt levels; but also the tax system raises incentives to borrow. Net liquid wealth of households is negative.
1. GDP volume grew again and government aims to boost growth
The Danish economy has experienced a very slow recovery since the deep recession in 2009 (figure 1). In 2013, GDP volume grew with 0.4% after having shrunk with 0.4% in 2012. The positive growth in combination with a lower public deficit has led the public debt-to-GDP ratio to decrease from 45.4% in 2012 to 42.4% in 2013. Going forward, GDP growth is expected to pick-up, mainly on the back of domestic demand. The Danish government aims to boost the annual potential growth rate with a third percentage point between 2014 and 2020. The government tends to improve the conditions for private companies, increase spending on education, modernise the public sector and reform the labour market. Regarding the latter, due to Denmark’s flexible labour market, unemployment rose quickly during the crisis years as did long-term unemployment. In order to avoid large losses of human capital, the government has already increased the use of active labour market policies, but time will tell if current measures will actually pay off.
2. Minor increase in house prices and fall in household debt
In the past year, house prices have risen with about 1.5%, i.e. house price have been stabilising since 2012 (figure 2). That said, houses are still believed to be overvalued by about 10%. Household debt decreased slightly in the past year but is still very large (figure 3 and figure 4). In 13Q3, the household debt-to-GDP ratio stood at 136% and the household debt-to-disposable income ratio at 265%. Both ratios are far above the eurozone average (64% and 98%, respectively) and that of peers. Around 66% of total household debt consists of mortgage loans, of which more than half are deferred amortization loans and about 74% adjustable rate loans. Accordingly, households are vulnerable to rising interest rates and unemployment and a significant fall in house prices. These risks are mitigated by the fact that a large share of household debt is held by high income households and that household financial assets are very large (figure 4). That said, net liquid wealth is negative according to the IMF. Though, the Danish National Bank has estimated that vulnerable households hold only slightly more than 1% of total bank debt.
3. Banking sector has become more resilient to shocks
Banks have significantly increased their capital buffers. The core tier 1 ratio as a percentage of risk weighted assets has risen from 13.9% in 10Q4 to 17% in 13Q3. Furthermore, banks’ liquid assets to short term liabilities keep increasing (69.4% 13Q3), whereas short-term debt issuance as a share of total debt issuance has decreased from almost 50% in 2007 to 11% in 2013. Meanwhile, in October 2013, seven banks were classified as a systemically important financial institution (SIFI) as recommended by the interagency committee on SIFIs in March, with the aim to reduce financial stability risks stemming from such institutions. From 2015 onwards, measures for these SIFIs like stricter capital and liquidity requirements will be implemented and the setup of a stability fund and recovery and resolution plans started. Besides, mortgage credit institutions have also taken measures to lower the risks related to variable rate and interest-only loans and to their financing model in which they use short-term funding for long-term loans. But, mismatches are still large. Finally, last year some measures have been introduced to improve the strength of the mortgage credit system. Since May, mortgage banks are only allowed to offer variable-interest and deferred amortisation loans to households who would also be able to serve a fixed-interest loan with amortisation. And since July, different mortgage loans need to be labelled according to the risks involved in these loans, such that borrowers can better decide what kind of loan to obtain.
Denmark is a wealthy and diversified economy with high GDP per capita and low income inequality. The Danish krone is successfully pegged to the euro, albeit at the cost of more tailor-made monetary policy. Denmark maintains a stable consensus-based political system; hence the fact that the Social People’s Party left the minority government at the 30th of January is unlikely to lead to major political instability. Passing legislation will of course be more difficult for the current coalition (64 of 179 seats). Denmark was the first European country to enter a recession in 2008, as a result of a sharp housing market correction (prices have dropped by 30%). The deflation of house prices led to the bankruptcy of 12 small lenders. The banking sector is highly integrated within the Nordic financial sector and concentrated among few large banks. Banking sector assets account for almost 400% of GDP, financial sector external liabilities are substantial (114% of GDP) and banks are heavily reliant on wholesale funding, as the domestic savings market is very tight. The small deposit base is the result of large mandatory pension savings. Then again, these savings are invested in bonds issued by mortgage banks, owing to which the domestic bond market is large and liquid and remained performing well during the financial crisis. The high dependence on wholesale funding does, however, still render banks vulnerable to financial market distress and changes in investor confidence. Meanwhile, the future of the large covered-bond market is uncertain as it is not entirely clear whether Danish mortgage bonds will be fully eligible under the Basel 3 liquidity regulation. The availability of sufficient funding might therefore become an issue for Danish banks. In recent years, Danish banks did improve their funding structure, with a rising share of retail deposits, also because the Danish Financial Supervisory Authority has introduced requirements on excess liquidity coverage (>50%) and a binding funding ratio (<1, since 2012).