Country Report Norway
The economic outlook is stable, public and external balance sheets are exceptionally healthy, institutions strong and policymaking is adequate and effective. But, Norway has to deal with very high household debt alongside overvalued houses and is dependent on oil and gas (related) production.
Strengths (+) and weaknesses (-)
(+) Very healthy public finances
Large government oil and gas revenues are transferred to a sovereign wealth fund (the GPFG) and the non-oil structural government deficit should not exceed the expected annual return of 4% on this fund. As a result, net public assets are very large (183% of GDP) and gross public debt is low.
(+) Strong institutions and highly qualified government officials
The efficiency and transparency of institutions is high. Furthermore, the judicial system is very strong and Norway has a track record of prudent, adequate and effective (fiscal) policymaking. As a result, Norway is also expected to be able to cope with the risks of an ageing population.
(+) Exceptionally strong net creditor position
Norway has been running large current account surpluses since the early 1990s, owing to petroleum exports and supportive terms of trade, while the contribution of non-oil trade has been negative. Accordingly, the net international investment position is remarkably strong (104% of GDP).
(-) Overvalued houses and very high household debt
Low interest rates, strong income growth, high immigration, and preferential tax treatment increased housing demand; while land use regulations and quality standards restrict supply. Housing is substantially financed by borrowing and therefore household debt is extremely large.
1. GDP growth slows, but outlook is stable
Growth in mainland GDP volume eased from 3.4% in 2012 to 2.0% in 2013. The lower economic growth was mainly due to a diminishing increase in household consumption and exports. Going forward, exports might slightly benefit from the smaller headwind stemming from Norway’s expensive krone. After having appreciated by 25.5% against the euro between 2008 and 2012 on account of safe haven flows, it depreciated with 14% last year owing to a reversal of these flows as the economic environment in the eurozone improved. That said, though also the ULC-based REER depreciated, it still has a long way to go to nullify the trend of the prior decade (figure 1). Overall, consensus expectations for mainland GDP growth are around 2.2% in 2014 and 2.5% in 2015. Furthermore, the unemployment rate is expected to remain at a very low 3.5%.
2. House price stabilisation and minor household debt increase
In the decade prior to 13Q2, real house prices rose with 65% on average. In fact, since the fall in house prices in the second half of 2008, house prices had risen by 25%. However, since 12Q3, the increase had been very minor and over the second half of 2013 real house prices even decreased again (figure 2). That said, according to the price-to-rent ratio (measures the house price compared to renting), houses were overvalued by almost 70% in 13Q3 and according to the price-to-income ratio (measures housing affordability) by almost 30% (figure 3). Moreover, the IMF estimates the overvaluation in Norway at 30 to 40%. The large overvaluation of housing raises the risk of a strong housing market correction, which would significantly impair household balance sheets and domestic demand, as a significant part of houses is mortgage financed. Besides, total household debt is extremely high and a very large proportion of interest rates on private loans is variable. Consequently, households are also vulnerable to rising unemployment and interest rate shocks. The debt-to-disposable income ratio has increased from 207.1% in 2012 to 209.5% in 2013; which is far above the eurozone average of 97.6%. Actually, only Danish and Dutch households are more indebted (figure 4). Meanwhile, the net household asset-to-disposable income ratio (38.4%) is significantly lower than the eurozone average (210.5%); besides, net liquid wealth is in fact negative according to the IMF. As an aside, debt-to-income ratios and financial buffers to absorb economic shocks are about equal among different income deciles.
3. A new sheriff in town
In September, the centre-left government lost the elections from the right opposition, after eight years of office. The new government has made some changes to the former government’s budget proposal for 2014, due to which the budget has become slightly more expansionary. Nevertheless, the non-oil budget deficit is still substantially lower than suggested in Norway’s fiscal policy guidelines (four percent of the Government Pension Fund Global’s assets, which is the sovereign wealth fund to which the government’s oil and gas revenues are transferred). The new government has indicated that lower than suggested spending of oil-related revenues is necessary in order to become better able to cope with future increases in pension and other age-related expenditure; in the same line of thought social security contributions will be increased. Moreover, the new government has said Norway needs to prevent further rising cost pressures as a result of too much public spending, which would further hurt competitiveness of traditional non-oil related export sectors. Other measures proposed in the budget 2014 to address the competitiveness challenge include lower taxes (compared with higher taxes implemented by the former government) and measures to boost potential growth, such as the setup of a productivity commission and more tax incentives for R&D spending.
Norway is a wealthy and highly developed country, and its GDP per capita ranks fourth of the world. It is a natural resource rich country: it’s the world’s third largest gas exporter and seventh largest oil exporter. The natural wealth has brought the country prosperity and wealth, but has also triggered some challenges as the large focus on oil and gas related activities are crowding out non-oil related exports and make the country vulnerable to large and sustained oil price drops. The share of mainland producers serving off-shore sectors has risen and output growth in petroleum-related sectors is strong, while that in non-oil related production is stagnant. The former in combination with a rising share of oil-revenue spending by the government as a percentage of mainland GDP has fuelled wage growth, undermining the competitiveness of the non-oil related export sectors. This endangers Norway’s long-term growth sustainability, as petroleum activities are not inexhaustible. Note though, that while the market share of non-oil exports fell significantly in the 1990s, it held up fairly well in the last decade. In the longer term, an ageing population poses challenges, but ageing is relatively modest and expected to be adequately dealt with. The banking sector is well-capitalized and according to the IMF and the Norges Bank it is able to absorb expected losses related to a deteriorating economic environment, provided that funding costs do not rise at the same time. As a result of the sector’s relatively large reliability on international wholesale market funding, it is vulnerable to stress at European capital markets and exchange rate swings. The previous centre-left government took some measures to reduce risks stemming from the housing market, including higher capital requirements for credit institutions and the requirement to assume a higher loss probability on home loans. That said, the new government has advocated to lower mortgage rates and to increase loan-to-value ratios.