OREANDA-NEWS. On June 22, 2016 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Denmark.

Economic performance has been relatively weak for an extended period, notably on account of low productivity growth that has lagged peers. Recently, a trend decline in oil and gas production has also started to weigh on output. Moreover, Denmark was hard hit by the 2008/09 global crisis, which coincided with the puncture of a local housing bubble. The initial recovery was interrupted by renewed weakness in 2012–13, broadly following developments in the neighboring euro area to which the Danish economy is closely tied. A moderate recovery resumed from 2014.

The outlook is for a gradual further recovery. Supported by low interest rates and oil prices, private consumption will continue to be the main driver for growth in the short term. However, investment is also projected to pick up, reflecting the diminishing impact of firm deleveraging and the strong recovery in the housing market. Export growth is likely to remain low, in line with the weak external environment. On these trends, the economy is forecast to grow by 1.3 percent in 2016 and 1.6 percent in 2017. Inflation is expected to remain subdued in 2016, reflecting lower oil prices, but then rise steadily, reaching 2 percent in the outer years reflecting a tightening labor market and a closing output gap.

Risks are tilted to the downside. A sharper than expected slowdown in Europe or in emerging markets could derail the recovery given Denmark’s deep integration in the world economy. Also, in view of exceptionally high household debt and a high share of adjustable rate mortgages, volatility in global financial conditions leading to a spike in market interest rates could abruptly raise households’ debt service and depress consumption. The disruption of trade and financial flows that would likely accompany a “Brexit” compounds these risks. Domestically, an unchecked continuation of rapid house price increases would heighten the risk of a correction over the medium term.

Executive Board Assessment

Noting the extended period of relatively weak growth and the considerable downside risks to the outlook, Executive Directors encouraged the authorities to build on a strong track record of sound policies to help sustain the economic recovery, reduce financial sector vulnerabilities, and raise growth prospects.

Considering Denmark’s moderate public debt level and the absence of an independent monetary policy, Directors broadly supported plans for a gradual fiscal consolidation while allowing flexibility for fiscal policy to act as the main stabilizer of cyclical fluctuations. They emphasized that if downside risks materialize automatic stabilizers should be allowed to operate and short-term fiscal support would be warranted. Conversely, they considered that a faster fiscal tightening may be needed if the recovery gathered pace faster than expected. Directors agreed that monetary policy should continue to focus on maintaining the exchange rate peg.

Directors noted that rapid price increases in segments of the housing market together with high household indebtedness could pose macroeconomic and financial stability risks. They therefore welcomed the recent measures that are expected to restrain mortgage lending, and the strengthened risk management guidance for lenders. However, Directors believed more should be done to mitigate medium-term risks, and encouraged the authorities to strengthen the macroprudential toolbox and to consider introducing debt-to-income limits as well as reducing the tax deductibility of mortgage interest payments. They also encouraged efforts to alleviate supply constraints and ease tight rental market regulations. Directors called on the authorities to end the procyclical valuation freezes for land and property taxes.

Directors commended the authorities for the good follow up on the 2014 FSAP advice, and encouraged implementation of the remaining recommendations. In particular, they suggested measures to strengthen the operational independence of the financial supervisor (DFSA). Given the interconnectedness of the Nordic banking system, Directors welcomed the ongoing efforts to enhance regional cooperation on financial stability issues and underscored the importance of reaching strong agreements on information sharing, cross-border supervision, depositor protection, and resolution arrangements.