Norway could be described as a paragon of virtuosity amid Europe’s present travails – a strong and stable country boasting policy credibility and a steady stream of inward foreign investment mostly directed toward the offshore oil and gas sector.
And, from a risk perspective, the country has an enviable level of debt. There isn’t any. Norway has a positive net external asset position with the rest of the world and a large general government budget surplus, swelled by oil and gas tax revenue.
The prudent use of the country’s offshore mineral endowment ensures that a portion of income flow from the tax on hydrocarbons production is stored in the Government Pension Fund Global, a gigantic sovereign wealth fund invested abroad to earn a return. At the last count, at the end of the third quarter of last year, the fund was worth more than NKr3 trillion ($500 billion), despite a fall in stock market value. Some of it is even about to be lent to the International Monetary Fund (IMF) without too much domestic quibbling.
Other indicators confirm Norway’s relative strengths. Mainland GDP (which excludes the offshore oil, gas and shipping sectors) grew by 2.6% in real terms in 2011. While other countries in Europe were weakening during the fourth quarter, Norway managed to grow at a decent clip of 0.6% quarter on quarter (seasonally adjusted), even if that was at a reduced pace relative to Q3, as demand for non-hydrocarbons exports shrank.
Unemployment, at just 3.4% of the labour force, is the envy of eurozone policymakers, despite the shortages of skilled labour often cited as a bugbear crimping growth potential, and underlying inflation is low, guaranteeing real-wage growth. On top of that, several important discoveries of oil and gas have been announced lately, some big ones too, that will extend the life of oil and gas production and generate high levels of investment and growth.
Yet, there are cracks forming in Norway’s miraculous tale of prosperity. With inflation well below the 2% target rate, a strong currency supported by capital inflows and worries that banks might need a hand in maintaining sufficient credit growth, Norges Bank, the Norwegian central bank, has lowered its main policy interest rate to 1.75%.
With mortgages freely available at around 4% interest, household borrowing is cheap by Norwegian standards and has typically fuelled a housing market boom accompanied by high levels of household debt. House prices increased by an average of 8% last year, according to Statistics Norway, a buying frenzy that has spread more or less country-wide, with the exception of the more remote northern parts.
Home-loan surveys undertaken by Finanstilsynet, Norway’s financial supervisory authority, indicate that a substantial chunk of new mortgage lending – around 95% of which is secured on variable rates – is at high loan-to-value ratios. Plus, more homeowners are taking out interest-only mortgages, and on longer repayment terms. No wonder household debt, which is predominantly mortgage borrowing, is fluctuating at close to 200% of disposable income.
These risks have been flagged by Norges Bank in its regular financial stability reports, and by the IMF and the Organization for Economic Cooperation and Development. Monetary policy is a key risk.
Norges Bank feels compelled to support bank credit growth and avoid any further appreciation of the krone, which is riding high on petro-currency flows and its safe-haven status in Europe. However, any delayed monetary tightening might allow imbalances to build, storing up problems.
Norway’s banking crisis of some 20 years ago should serve as a salutary warning. The crisis lasted from 1988 to 1993 and caused operational difficulties for almost 60% of the banking system. Non-performing loans particularly affected small- and medium-sized lenders. However, although the crisis then was preceded by a strong increase in bank lending, and the inevitable boom and bust in the property market, financial deregulation was a main protagonist.
This led to an unprecedented consumer boom. Private consumption grew by an average of 7.5% in real terms from 1985 to 1986. Plus, banking sector supervision was extremely weak, unlike today. To cap it all, the price of oil collapsed in 1985, causing devaluation of the krone. Norway had been operating a fixed exchange rate at the time – now a freely floating currency is able to absorb the shocks.
The risk of a personal debt crisis is nonetheless beginning to alarm the authorities again. This is apparent from new guidelines instituted last year by Finanstilsynet that lowered the maximum loan-to-value ratio on mortgage lending from 90% to 85%, unless additional collateral is provided.
When the proposals were announced, Finanstilsynet noted the rise in debt among those households that already possess the highest debt levels – those exceeding 500% of disposable income. Yet, the new loan guidelines are not legally binding and unlikely to have any sizeable impact in the credit market.
Norges Bank appears equally concerned about personal financial distress when interest rates start to rise again. The bank has identified an upturn in the number of households with low financial margins – post-tax liquid assets net of debt servicing, living expenses and principal repayments. The figure is seemingly benign – just 14% of households have a financial margin less than a month’s wages. However, the figure is dated – it refers to 2009 – and Norges Bank’s projections suggest it will rise to 23% after a five percentage point rise in interest rates. This would take it up to a similar level prevailing in 1987.
The authorities are likely to come up with new measures to prick the consumer boom and minimize the risks. Raising interest rates in smaller, perhaps, 10-basis-point increments might prove a usefully cautious measure, but has not entered into current Norges Bank policymaking debate – the focus is on minimizing financial system stability risks by boosting bank capital and the like.
Alternatively, the government might seek to encourage more home building and remove the tax subsidies that favour owner-occupied residential housing investment. The latter has been suggested by the IMF repeatedly, but to no avail, and the government is unlikely to pursue unpopular policies in the run-up to parliamentary elections in September 2013.
Doing too little too late is not a serious option. That could plunge Norway into another housing crisis, which, given the precarious nature of lending to commercial property and other at-risk sectors – such as shipbuilding and construction – and against the backdrop of eurozone vulnerability, could have serious ramifications for the banking system and mainland economic growth. Such risks require careful monitoring.
Jeremy Weltman is the managing director of MJEconomics. He is an expert member of Euromoney Country Risk (ECR) and contributes a country risk score for Norway.
This article was first published on Euromoney Country Risk
