IMF team visits Denmark to discuss 2019 Article IV consultation

Denmark's economic performance, based on a model that prizes social inclusion, continues to impress with high living standards.

The outlook is for continued strong growth but with downside risks.

The fiscal stance should remain neutral and policies should pursue higher potential growth and strengthen financial resilience.

An International Monetary Fund (IMF) staff team, led by Mr Miguel Segoviano, visited Copenhagen during April 30-May 13, 2019 to conduct discussions on the 2019 Article IV consultation. At the conclusion of the visit, Mr Segoviano issued the following statement:

"Denmark's economic performance, based on a model that prizes social inclusion, continues to impress with high living standards. Growth remained solid in 2018, supported by domestic demand, with the economy operating above potential. The economy is projected to grow by 1.7 and 1.9 per cent in 2019 and 2020 respectively. Private consumption and investment are expected to be the key drivers of growth, with financial conditions remaining accommodative and the fiscal stance broadly neutral for some time. Inflation and wages are expected to gradually rise. From 1.4 per cent in 2016, potential output growth is projected to increase to 1.8 per cent over the medium term, as a result of structural reforms and higher investment.

"The outlook is for continued strong growth but with downside risks. A sharper than expected slowdown in Denmark's main trading partners could slow export growth. A disorderly Brexit could weigh on the economy, notably through trade and supply chain disruptions. High household debt amid elevated house valuations remains a key vulnerability. The ongoing money laundering case could further affect confidence in the financial sector and undermine financial stability.

"Denmark's public finances are sound with substantial fiscal space in the medium term. The fiscal stance should remain neutral while letting automatic stabilizers operate fully. In the event of a severe downturn, additional temporary loosening should be considered, while remaining anchored to the medium-term objective. Efficiency-improving reforms that cover both revenues and expenditures could be implemented in a fiscally-neutral way or designed to provide stimulus if loosening is warranted.

"The banking system is profitable, liquid and solvent, but pockets of vulnerabilities remain. Lending surveys suggest that some banks are relaxing credit standards for corporate loans. To strengthen financial resilience, a combination of micro- and macroprudential tools should be considered to increase capital buffers, in addition to the Counter-Cyclical Capital Buffer, if risks continue to build up.

"The authorities should build upon their recent efforts to strengthen cross-border anti-money laundering and combating the financing of terrorism (AML/CFT) supervision. The priority next steps are to (i) develop a comprehensive institutional risk assessment model; (ii) increase the depth of the DFSA's AML/CFT on-site inspections; (iii) further expand its sanctioning powers, including so as to enable it to levy administrative fines; and (iv) strengthen international cooperation.

"The housing market in Denmark is the major link between the economy and the financial sector. Vulnerabilities due to high household leverage amid elevated house valuations should be addressed by enhancing the macroprudential toolbox, reducing overly favourable tax incentives, and through policies to promote housing supply.

"The labour market is strong, with pressures gradually building in some sectors of the economy. Increasing benefits to low-income workers would help alleviate inactivity traps and promote youth employment. Reducing labour tax rates would increase hours worked. The authorities could also further incentivize the upgrading of technical and digital skills, integrate migrants, and attract skilled foreign labour.

"Productivity growth remains weak, as in many advanced economies, partly because of lower investment rates following the crisis. The authorities should consider making R&D expenditures fully refundable to incentivize innovation among a larger spectrum of firms. Addressing the debt bias and improving access to equity finance for SMEs would also promote investment and help reduce the current account surplus. The complex Danish institutional framework for the competition should be streamlined and strengthened.

"The IMF Executive Board is expected to discuss Denmark's economic developments and policies on June 17, 2019. A staff report is expected to be published soon afterwards.