International Monetary Fund concludes article IV consultation with Denmark
The outlook is for continued robust growth, which is projected to exceed its trend in the near-term, reaching 2.0 percent in 2018 and 1.9 in 2019.
The Danish economy continues to enjoy solid growth and the output gap has seemingly closed for the first time since the global financial crisis. Unemployment is low and close to its estimated structural level with signs of labor shortages and capacity constraints in some sectors. Inflation remains subdued.
Property prices in urban areas are rising swiftly and household debt remains elevated despite recent deleveraging. The increasingly binding constraints highlight Denmark's reduced growth potential, reflecting structurally weak productivity growth and the post-crisis investment slowdown. The banking system remains sound and profitable.
The outlook is for continued robust growth, which is projected to exceed its trend in the near-term, reaching 2.0 percent in 2018 and 1.9 in 2019. Activity is expected to be driven by strong and balanced private demand. Consumption and investment will be stimulated by low interest rates, employment gains and higher asset prices. Investment will also be supported by the need to offset domestic capacity constraints. Exports are projected to remain robust due to favorable external growth, while imports are expected be backed by stronger consumption. Inflation should gradually rise, as capacity pressures intensify in the near term.
The risks around these forecasts are broadly balanced. Stronger than expected consumption growth could lead to widespread labor shortages, potentially intensifying wage pressures, eroding
competitiveness, and hindering medium-term growth prospects. Higher than expected foreign demand could aggravate wage pressures. Conversely, international trade tensions and significant tightening of financial conditions, due to uncertainty surrounding monetary policy normalization by major central banks, could restrain the upswing.
Executive Board Assessment
The economy is performing well but potential growth remains weak. The output gap has seemingly closed and there are emerging signs of capacity constraints. Labor shortages and rising house prices coupled with elevated debt level are important domestic risks. External environment is favorable, but also involves risks. Benign macroeconomic environment provides conditions for renewing efforts aimed at raising potential growth and bolstering financial resilience.
Fiscal policy should draw on existing fiscal space to support growth-enhancing reforms, while remaining anchored on the medium-term objective. Fiscal space should be used to incentivize private investment through corporate tax reforms. Increasing growth-enhancing public spending to improve broadband access in rural areas, strengthen digital skills, and upgrade public and transport infrastructure—especially around inner-city areas experiencing strong house price growth—would help boost productivity and mitigate house prices pressures. Incentives to switch from social benefits to employment would support labor supply. However, a tighter fiscal stance may be called for in case of excessive demand pressures.
Monetary policy should focus on maintaining the peg. Lack of foreign exchange interventions is in contrast with past years and reflects the absence of currency pressures. A gradual reduction of Danish monetary policy spreads relative to the ECB would be desirable if market conditions permit.
House price pressures in urban areas coupled with elevated household debt call for coordinated policy action. Tightening of existing macroprudential measures would better protect families from house price declines and higher interest rates. Taking advantage of the current low interest rates, a further than envisaged reduction of mortgage interest rate deductibility should be considered. Reduction of rent controls and relaxation of zoning restrictions would encourage more housing supply and alleviate demand for housing.
Banks are well-capitalized and progress was made with upgrading the regulatory framework. Banks remain profitable notwithstanding low interest rates and modest aggregate credit growth. Additional increases of the countercyclical capital buffer may be warranted if risks continue building up. The operational independence of the DFSA should be strengthened and adequate resources should be ensured for continued effectiveness.
Employment rates continue rising on the back of past reforms, but there are untapped resources involving mainly young and migrants. Higher youth participation in the labor market could be achieved by reducing the duration of student grants and graduates' access to unemployment insurance. The integration of migrants could be facilitated by improving the accreditation of foreign degrees, relaxing restrictions on employment rules for refugees, lowering the minimum remuneration requirement, and granting more exceptions to the pay limit scheme for residency permits.
Incentivizing private investment to boost productivity is a key challenge. The investment slowdown since the crisis suppressed capital accumulation, weighing on labor productivity growth. Product market deregulation efforts in retail, taxi, and utility sectors would boost competition and encourage more investment. The ongoing digitalization initiatives are also important. Capital income tax reforms in the areas of dividend taxation, losses carried forward, R&D deductions, and business asset taxation would support investment by startups and high-technology firms. An allowance for corporate equity would more generally reduce disincentives to invest and reduce the debt bias.
The external position is stronger than implied by fundamentals. However, this assessment is subject to large uncertainties. In recent years the surplus is increasingly driven by offshore trading activities and investment income. While the EBA model does not identify policy gaps that explain most of the excess current account surplus, structural policies that raise investment would help reduce the surplus.