Swedbank Economic Outlook June 2009

Swedbank Economic Outlook Swedbank’s analysis of the international and Swedish economies 11 June 2009

Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46 (0)8-5859 1028 e-mail: [email protected] Internet: www.swedbank.se Responsible publishers: Cecilia Hermansson +46 (0)8-5859 1588

Magnus Alvesson +46 (0)8-5859 3341, Jörgen Kennemar +46 (0)8-5859 1478 ISSN 1103-4897

Deepening recession with glimmers of hope

• The financial crisis is easing and confidence among households, businesses and financial market players is rising in light of major stimulus packages around the world. We see the economy headed for a turnaround, but the recovery will be slow due to remaining imbalances.

• The global economy is expected to shrink by 1.6% this year and grow by 2.2% in 2010. This is significantly lower than the growth rate of about 5% achieved in 2007 and even lower than the long-term trend of around 3.5%. As a result, the global economy will continue to struggle with overcapacity for some time to come.

• The Swedish economy is affected by global developments, not least the export industry and auto industry in particular. GDP will fall by 4.7% this year and rise marginally by 0.4% in 2010. Shrinking investments are driving the slowdown, at the same time that lower demand is weakening the labour market. Unemployment is expected to rise toward 11% in 2010.

• As the financial crisis abates and the economy slowly improves, the Swedish krona could potentially strengthen against the dollar and euro. The Riksbank is expected to begin raising interest rates in late 2010, but monetary policy will continue to support the economy. Fiscal policy will also be expansive – but restrictive enough to maintain financial stability – with rising deficits and public debt as a result of economic conditions and policies. The need for structural reforms is increasing to offset the effects of the recession.

• Swedish households are increasing their precautionary savings during the period and holding back on spending. Because of the Riksbank’s rate cuts, there is the chance of a W-shaped trend in consumption and the housing market, where conditions improve short-term but where rising unemployment continues to exert pressure on households.

Cecilia Hermansson Jörgen Kennemar Magnus Alvesson

2 Swedbank Economic Outlook • 11 June 2009

Contents

Recession poses challenge to economic policy 3

National accounts and economic indicators 6

Slow global recovery on the way 7

Substantial decline in foreign trade 14

Auto industry's importance to the Swedish economy 16

Investments plunge 19

Deep decline in labour market 22

Households save like never before 27

Fiscal policy: Restraint, but big deficits are still expected 31

Monetary policy and financial markets: 34 Inflation, interest rates and exchange rates

Introduction

Swedbank Economic Outlook • 11 June 2009 3

Recession poses challenge to economic policy In March we predicted that 2009 would be characterised by a major decline in Sweden's GDP, but an even stronger drop in global and domestic demand has necessitated a further revision in our forecasts. This may seem strange considering the growing number of reports signalling an impending stabilisation and rebound.

We reaffirm in this Economic Outlook that the financial crisis has eased – partly with the help of stimulus measures by governments and central banks – and that investors have shown an increasing appetite for risk in the financial markets. Some players have become slightly less pessimistic about the future, though not yet optimistic, either. This is a positive first step toward a turnaround. Glimmers of hope in the financial markets and in public sentiment have not been matched by an equally robust upswing in the real economy, however. Industrial production and trade are still falling, though not as dramatically as before.

We expect overall demand in the global economy to shrink by 1.6% this year before beginning a slow recovery at the end of the year, with GDP growing by 2.2% in 2010. Beyond the forecast period we see the possibility of GDP growing at nearly at the long-term average of about 3.5% by 2012. Not until then will the global production gap be closed, and the process of doing so could take another few years.

The slow recovery is based on our view that it will take time to reduce high loan ratios, that labour markets will continue to weaken and limit growth, and that the growing public debt in many countries will lead to budget consolidation and weaker growth prospects.

The risk of a setback cannot be overlooked, either. Progress will be anything but stable. Despite that trends point higher, we could see a “W-shaped” curve that makes for a rockier picture than usual. The reasons could be rising commodity prices and long-term market interest rates, which lead to higher costs, though we don’t see a great risk of inflation at the consumer price level in the years ahead. Until the recovery is “assured,” the risk of deflation will weigh more heavily than that of inflation, but uncertainty about economic and political stimulus measures and how they are eventually phased out is still a factor that could raise concerns about rapidly rising inflation in the next couple of years.

Stronger confidence is the first step toward a turnaround

Global GDP is expected to grow next year – but remain below the long-term trend

The rebound is likely to be anything but stable, and risk of a setback is great

Introduction


Countries with strong export industries and auto production, such as Germany, Japan and Sweden, have suffered more than most others in terms of demand. Whether the upturn will be faster there once global demand rebounds will depend on whether the industrial crisis is economic or structural. We anticipate a structural transformation in which many auto suppliers will have to switch businesses. Boosting domestic demand and deregulating labour and product markets will be even more important in these countries. Countries with their own financial and real estate crises are also being hard hit by the recession. This includes the UK, US, Ireland, Spain and the Baltic countries. It is hard to reduce imbalances. Reforms will be needed to make these countries more competitive. The structural transformation is being fuelled by the crisis and it has become essential to develop new growth engines.

We expect Sweden's calendar-adjusted GDP to fall by 4.7% this year and grow marginally by 0.4% next year. The biggest reason for the decline this year is investments, followed by net exports and household consumption. Investments will continue to fall in 2010, while consumption and net exports will contribute positively to growth. During the period households will increase their precautionary savings, mainly as a result of higher unemployment and a further decline in their net worth. The reason why investments will shrink in both years is low capacity utilisation, which we expect will rise more slowly than in previous recoveries.

Weak corporate investment demand is also impacting the Swedish labour market. Jobs are expected to be cut mainly by goods-producing companies, but also in service sectors. In total, a quarter-million people will lose their jobs. Unemployment will rise to an average of nearly 11% next year, at the same time that the number of people in labour market interventions will increase. We think it will take time before the labour market again sees the same favourable conditions as in 2007-2008. The challenge for economic policymakers is to make sure that unemployment doesn’t permanently get stuck at such high levels, especially among young people. There is also a future labour shortage to contend with. Making the labour market more flexible is becoming more important due to the recession.

Economic policy is expansive from both a fiscal and monetary standpoint. After the Riksbank’s 50 bp cut, we think the repo rate is as low as it’s going to get. Interest rates will remain steady through 2010, after which a gradual normalisation will begin, though monetary policy will still support the economy for a while. The likelihood of a quantitative easing has decreased of late. Fiscal policy is mainly providing support through so-called automatic stabilisers. The government is also taking discretionary measures, though showing some restraint in doing so, to ensure financial stability. We expect a stimulus package this fall worth SEK 30 billion (about 1% of GDP), in addition to the SEK 10 billion committed in the spring fiscal policy bill.

The recession is creating a need for reforms in many countries – the crisis is probably both economic and structural

Investments are the biggest reason for a GDP decline of nearly 5% this year

It is probably going to take time for the labour market to rebound

Economic policy must address the crisis while strengthening the Swedish economy long-term

Introduction


Public finances will worsen this year and next, contributing to an increase in public sector debt. Despite this, we expect the Swedish government’s finances to remain healthy. Using economic policy to stimulate demand while strengthening Sweden competitively through incentives for businesses and innovation will be a challenge for the Swedish government in the years ahead.

Cecilia Hermansson

Supplay balance and key financial ratios


Swedbank’s economic forecast for Sweden June 2009

National accounts

Changes in volume, percent 2007 2008 2009 P1) 2010 P1) Household consumption 3.0 -0.2 -1.6 (-1.0) 0.6 (1.2) expenditure Government consumption 0.4 1.5 1.5 (1.5) 0.5 (1.7) expenditure Gross fixed capital formation 7.5 2.7 -12.3 (-8.5) -4.3 (-4.0) - private excl. housing 8.4 4.6 -14.5 (-9.9) -8.0 (-7.0) - public 2.4 4.0 7.7 (9.5) 5.9 (8.0) - housing 8.7 -5.4 -22.3 (-20.0) -0.8 (2.5) Changes in inventories 2) 0.8 -0.6 -0.8 (-0.3) 0.3 (0.2) Exports, goods and services 5.8 1.8 -14.0 (-4.5) 2.5 (1.5) Imports, goods and services 9.4 3.0 -13.8 (-4.8) 1.0 (1.3) GDP 2.6 -0.2 -4.6 (-2.3) 0.7 (0.6) GDP, calendar-adjusted 2.7 -0.5 -4.7 (-2.4) 0.4 (0.3) Domestic demand2) 2.9 0.9 -2.7 (-1.8) -0.4 (0.2) Net exports 2) -1.1 -0.4 -1.1 (-0.2) 0.8 (0.2) 1) The figures from our last forecast in March 2009 are given in parentheses 2) Percentage change in previous year’s GDP

Economic indicators

Annual change in percent unless otherwise indicated 2007 2008 2009 P 2010 P Nominal hourly wages, total 3.6 4.0 3.0 2.2 Nominal hourly wages, industry 3.9 4.3 3.0 1.8 Industrial production 2.3 -3.1 -15.0 1.5 CPI, annual average 2.2 3.5 -0.4 1.1 CPI, Dec-on-Dec 3.5 0.9 0.7 1.5 CPIX, annual average 1.5 2.7 1.7 1.2 CPIX, Dec-on-Dec 2.4 1.6 1.9 1.3 Real disposable income 3.9 3.3 0.8 1.3 Savings ratio 9.3 11.9 14.0 14.5 Open unemployment 3) 6.1 6.1 8.9 10.9 Total unemployment 3) 4) 8.1 8.1 11.6 15.5 Total labour force 2.6 1.1 -3.0 -2.7 Current account balance 5) 9.0 8.2 4.2 4.5 Financial savings in public 3.5 2.5 -2.5 -4.1

sector 5) Central government 40.6 38.0 45.0 49.3

debt (Maastricht) 5) 3) Percentage of labour force, EU-harmonised 4) Open unemployment and labour market measures (individuals aged 15-75) 5) Percentage of GDP

International economy


Slow global recovery on the way

Increased risk appetite – but historically weak demand Since our March forecast, the outlook has brightened thanks to stronger future confidence among households, businesses and players in the financial markets. On the other hand, this optimism isn’t yet reflected in a similarly robust improvement in the real economy.

Access to liquidity and long-term financing has improved, at the same time that credit spreads have shrunk since confidence between banks rose in the aftermath of government and central bank stimulus packages. Long-term market interest rates have risen significantly, probably as a result of increased inflation concerns and government borrowing needs as well as a growing risk appetite. Prices of oil and certain metals have risen more than expected. Stock markets have turned higher, especially growth markets but even in mature economies. Households and companies have become less pessimistic about the future.

What we are seeing in the financial markets isn't fully supported by fundamentals in the real economy. It’s more a reflection of hopes of a turnaround than any certainty that a bottom has been reached. Confidence that the slowdown in demand has eased is based on the purchasing managers’ index, among other things. With few exceptions – e.g., modest growth in China and India – there are few signs of stronger underlying demand. On the contrary, quarterly GDP growth in mature economies was the weakest since World War II. On average, production fell from the previous quarter by 2.5% (or by 9.4% at an annualised rate). Compared with the first quarter 2008, the decline was 4.7%.

Gross domestic product (GDP) in the US, Japan and Euroland 2005-2009 (Q1) (quarterly change on an annualised basis)

S o u r c e : R e u t e r s E c o W i n

Q 1 Q 3 Q 1 Q 3 Q 1 Q 3 Q 1 Q 30 5 0 6 0 7 0 8

- 1 7 . 5

- 1 5 . 0

- 1 2 . 5

- 1 0 . 0

- 7 . 5

- 5 . 0

- 2 . 5

0 . 0

2 . 5

5 . 0

7 . 5

J a p a n

U S A

E u r o la n d

Sources: National statistical authorities in the US and Japan as well as Eurostat

Green shoots are evident mainly in public sentiment and in financial and asset markets

Demand is dropping more slowly, but it isn’t growing yet



The biggest decline in mature economies in the first quarter was in Japan, followed by Germany, the Netherlands and Austria. In growth economies, Mexico, Hong Kong and Singapore noted the largest production declines.

Among the BRIC economies, which have seen their stock markets rise since March (Brazil +78%, Russia +123%, India +84% and China +52%), GDP growth has been more mixed. In countries with relatively few imbalances or problems in the financial sector, the recession has mainly been the result of slumping export demand or a collapse in commodity prices (Brazil and Russia). In Central and Eastern Europe, GDP has fallen most notably in the Baltic countries, but also in Hungary and Slovakia. Domestic demand continues to grow in India and China, where huge stimulus packages have already had an impact.

Q1 GDP growth at an annualised rate (Q1 2009 vs. Q1 2008)

Sources: National statistical authorities, Eurostat and the Conference Board

Possible recovery in the second half of 2009 Uncertainty whether or not the economy will soon stabilise is great. Although leading indicators point to a recovery within a half-year, it is difficult to see where consistent growth in demand will come from. We think a bottom is near, however, and that a slow recovery will begin in 2009 and continue in 2010.

At this point US households have increased their savings ratio to just over 5%, and this is expected to further increase (probably upwards of 7%) due to rising unemployment, difficulty obtaining credit and weak balance sheets. New unemployment claims have slowed, but people are still losing their jobs. European and Japanese households are mainly being hurt by the weaker job market. Inventories are still being sold off, though at a slower rate. Industrial production continues to fall and could remain weak next year due to sluggish demand for inputs and investment goods. Investments are expected to continue to decline in many countries this year and next. Weak

A distinction among BRIC economies is clear

The bottom is near and a slow recovery will soon begin

Even when GDP grows again, several underlying problems will still remain

-12

-10

-8

-6

-4

-2

0

2

4

6

8

China India Brazil Russia Central andEastern Europe



demand is preventing companies from raising prices, leaving them to struggle with lower profits while having to bolster their balance sheets. This creates a further incentive to cut costs and lay off employees.

The inventory cycle will eventually force an increase in industrial production. Moreover, monetary and fiscal stimulus programs will encourage higher asset prices and a growing risk appetite – and eventually lead to slightly higher demand among households and businesses.

The bottom is likely to be reached during the second half of 2009 and a recovery can begin, probably in the US and then in Europe and Japan. (China and India are already growing, but cannot drive the global economy alone.) There is a risk that the recovery could be weak, however, and could derail considering that:

It takes time to reduce excessive debt ratios, and because a weakened financial sector will restrict credit growth;

Overcapacity in many sectors will mean shrinking investment volumes and stagnant credit demand;

Unemployment is rising and it will take time before job numbers improve;

Burgeoning public debt eventually will have to be reduced with the help of spending cuts and tax increases;

Long-term interest rates could rise as a result of growing debt in many countries;

Economic stimulus packages can create new bubbles in asset markets despite weak overall demand in the economy. When commodity prices rise, growth is impacted in countries dependent on imports of raw materials.

Instead of a clear V- or U-shaped recovery, there is a risk of a soft “W”. Economic stimulus plans are rarely enough to create sustainable growth. The underlying problem of weak financial systems and high debt ratios must be resolved first. Credit demand is weaker than normal, which has reduced the importance of interest rates. If the health of the financial sector continues to deteriorate, affecting credit availability, the recovery could be undercut.

Poor growth prospects in 2009, slightly better in 2010 Since our March forecast, we have revised the GDP growth outlook downward in Japan, Russia and Euroland, as well as in the US, Brazil and the UK. Only China’s and India’s GDP growth has been revised higher. The slowdown in the fourth quarter of 2008 and first quarter this year has impacted GDP throughout this year.

The stimulus packages and a turnaround in the inventory cycle will increase production

We see several reasons why the recovery will be weak and slow

A U-shaped recovery is what we want – and is possible – but the risk of a W-shaped recovery remains high



Global GDP growth (%), 2007-2008, with forecasts for 2009-2010

Sources: National statistical authorities and Swedbank

Forecast risks and structural issues

1. Two years is probably too short of a forecast horizon Even if GDP growth for 2010 looks decent at around 2.25%, it is considerably lower than average global growth in the last two decades of around 3.5% per year. Not until 2011 or 2012 at the earliest will GDP in mature economies return to the 2008 level we saw before the recession. Available resources in the global economy will continue to grow in upcoming quarters. Getting back to 3.5% will take a while. The production gap won’t be closed for a very long time.

It is easy to be blinded by the potential of a turnaround during the forecast period, but the long-term strength of the recovery during and beyond the forecast period is actually of greater interest. How is growth potential affected by the recession, financial crisis and slowdown in globalisation? A W-shaped recovery could stretch significantly beyond 2009-2010.

2. The importance of confidence cannot be underestimated At the same time that forecast risks are still leaning toward the downside, there are factors that could give a quick boost to the global economy. The economic stimulus packages are a positive uncertainty. A growing risk appetite among investors and improvement in confidence indicators are also an important initial step in a recovery. We believe, however, that there is a risk that confidence could fall again if the real economy can't keep pace with the upswing in the financial and asset markets.

Far to go before we see sustainable growth

Closing the output gap is more interesting than the impending turnaround

Increased optimism is decisive to an economic rebound

GDP growth (%) 2007 2008 2009 2010 2008 2009 2010USA 2.0 1.2 -2.7 1.2 1.2 -2.0 0.7

EMU countries 2.6 0.8 -4.5 0.1 0.8 -2.5 0.3Of which Germany 2.6 1.1 -6.0 0.2 1.1 -3.0 0.3

France 2.1 0.7 -3.5 0.3 0.7 -2.1 0.6Italy 1.4 -0.6 -4.2 0.2 -0.6 -2.4 0.4Spain 3.7 1.1 -3.5 -0.3 1.1 -2.8 -0.1

UK 3.0 0.8 -4.0 0.2 0.8 -3.0 -0.2

Japan 2.4 -0.2 -6.5 0.4 -0.2 -3.3 0.5China 13.0 9.0 6.5 7.5 9.0 6.0 6.8India 9.3 5.3 5.0 6.0 5.3 4.5 5.2

Brazil 5.4 5.3 -1.0 2.0 5.3 1.8 3.0Russia 8.1 6.0 -6.0 1.0 6.0 -2.2 2.0

Global GDP 4.9 2.9 -1.6 2.2 2.9 -0.4 2.0

March forecastJune forecast



3. Are the economic stimulus packages having an impact? Until now interest rate cuts and increased liquidity have mainly led to stronger confidence in the financial markets, an increased risk appetite and upward pressure on commodity prices. There are signs of improvement in the housing market and retail sector owing to lower mortgage rates.

When interest rates essentially reached bottom, the central banks in a number of countries chose to buy bonds and utilise quantitative easing to further reduce long-term rates, add liquidity to the system and raise inflation expectations. It is still too early to tell the impact of this easing on the real economy. Interest rates have begun to rise again – maybe because the stimulus measures are working – as markets normalise and risk appetites grow. There is also the possibility that higher interest rates are due to worries about rising inflation, a scenario that could become reality if the stimulus packages are not phased out quickly enough after a rebound.

Fiscal stimulus packages are also gradually impacting labour markets, investments and consumption. There is a risk – and Europeans seem especially suspicious – that these measures could ultimately lead to higher taxes and/or spending cuts and that households, in keeping with the Ricardian equivalence proposition, are already reducing their spending and increasing their precautionary savings. There would seem to be less of a risk of such behaviour in the US, where the hope is that growth will surpass the long-term rate within a couple of years so that deficits are eliminated “automatically.” Structural imbalances may limit growth, however, requiring substantial budget cutbacks.

Even if the stimulus packages don't have quite the effect we had hoped, they will at some point lead to higher, though not yet sustainable, growth. In a couple of years the programs will instead lead to slower growth when they have to be phased out. If the recovery is not “assured,” there is the risk of a setback. This is what happened in Japan. New stimulus measures would then be needed to get the activity going again. The growing public debt burden in many countries such as the US and Japan is limiting opportunities for expansive economic policy.

4. Are concerns about deflation and inflation overblown? We face a choice. On the one hand, the stimulus measures could be phased out too quickly, or prove insufficient, which would drag the global economy back into recession with the risk of deflation. On the other hand, the stimulus packages could be kept in place too long, sparking inflation expectations. Even if the risk of dangerous deflation and inflation is overblown, deflation remains a concern until the recovery is assured.

Too early to determine the effect of quantitative easing

The likelihood of Ricardian equivalence is greater in Europe than the US

It is important to phase out stimulus measures in time, but also to make sure that the recovery is assured first

Before the recovery feels stable, we will have to face deflation risks



Households in the world's three largest economies (the US, Japan and Euroland) are unlikely to contribute to inflation at the consumer price level in the years ahead. Balance sheets need tweaking. Jobs and salaries are developing weakly. Businesses are contributing to deflationary pressures by reducing costs, laying off staff and generally cutting back. The only dynamic component of demand right now is government spending.

Expectations of high inflation by the financial markets stem not only from growing borrowing needs and public debt, but also higher commodity prices. There is probably a bigger chance that corporate earnings come under pressure, however, than that consumer prices will rise rapidly.

5. What is happening to the global imbalances? The US current account deficit has shrunk both in absolute terms and as a share of GDP as exports have outperformed imports (or at least not performed as badly). The same applies to Central and Eastern Europe. The opposite is true in the Middle East and Russia in 2009 due to lower oil prices. China’s current account surplus has grown in both absolute and relative terms since the crisis worsened, which means that exports are still outpacing imports despite huge stimulus measures. Euroland reported a current account surplus through 2007, but now faces a deficit.

Current account balance as share of GDP in a number of countries/regions 2000-2009

Source: IMF

The question is whether current account balances will revert to the old pattern after the recession is over. Oil-producing countries are likely to see higher surpluses once oil prices rise again. Whether the US current account deficit increases will depend on interest in financing it in the medium term. If interest wanes, domestic savings will have to increase for the deficit to shrink. China’s surplus could continue to grow, but that will also be affected by whether it is serious about stimulating domestic demand. Changes in China’s exchange rate policy would also help.

Consumers won’t contribute to inflation in the short term …

… but expansive fiscal policy and commodity prices are question marks

If interest in financing the US current account deficit declines, a structural shift in domestic savings will be needed

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Euroland Central and Eastern Europe Middle EastChina Germany USA



6. Keep an eye on the US and the dollar! China, with its huge dollar reserves, is worried about the US government's finances, the risk of higher inflation in the US and a weaker dollar. Interest among foreigners in financing the US twin deficits has decreased significantly in Asia and Europe of late. Americans, on the other hand, are buying more foreign securities, speeding up the dollar’s decline. The budget deficit is estimated at 13% of GDP this year and is expected to remain sizable in 2010. Treasury Secretary Tim Geithner may have to issue bonds denominated in yen, euro or renminbi to attract foreign buyers, similar to the Carter bonds in 1978.

7. Decoupling – true or false? No country has been unaffected by the slowdown in global demand and the financial crisis. So logically there is little basis for a decoupling between OECD members and emerging markets, for instance. On the other hand, there are countries that entered the crisis in a stronger position by avoiding their own imbalances. Those whose exports have been hurt for economic reasons (lower commodity prices and temporarily weaker demand) are likely to handle a recovery better than countries with structural problems in certain sectors (e.g., autos and financials). In this sense, a decoupling cannot be ruled out when the global economy bounces back.

8. Where are the world's new growth engines? Without the financial and real estate sectors as growth engines, globalisation could stagnate and growth potential could be affected for a while. New drivers of global growth have to come about organically, preferably other than through public investment. The service sector will continue to account for a growing share of production and jobs in many countries. Other important growth engines include utilities, transportation and other infrastructure. Public-private partnerships are becoming increasingly common as well. Moreover, environmental and climate threats are leading to new investment in technology and businesses. Such investments are tied to many different areas: energy, transports, housing construction, tourism, etc. These sectors also have the potential to raise productivity through efficiency improvements and innovations.

In their rhetoric, China and Japan have stated that they have to focus more on domestic demand. The same may eventually apply to other major exporters such as Taiwan, South Korea, Germany and Sweden. While this doesn't mean that the export sector won't remain essential, their economic policies can concentrate more on domestic wealth building, business and demand for private services.

Cecilia Hermansson

Interest in US government securities is already slowing – Geithner may have to resort to new measures!

There are two sides to decoupling

New growth engines will be developed more easily if a structural transformation is accepted

Foreign trade


Substantial decline in foreign trade

Weak global economy is limiting exports The downturn in Swedish exports has worsened since our March forecast. Results for the first quarter of 2009 indicate that export volume shrunk by no less than 16.2% on an annual basis after dropping by slightly over 7% in the fourth quarter of 2008. This is more severe than we had predicted in March and is the largest decline since World War II. The financial crisis and its impact on the real economy have hurt global conditions more than expected. This is especially true of the European market, the buyer of more than three fourths of Sweden's exports. At the same time, the types of goods Sweden exports, with a large concentration of investment goods, is a disadvantage when global investment is sharply lower.

Goods exports account for the largest decline, down slightly over 20% in volume compared with the same quarter last year. This is being driven primarily by lower demand for investment goods such as machinery and passenger cars. Since the first quarter of 2008 the value of auto exports has dropped by half. Today auto products account for only 8% of exports, against 13% last year. Exports of raw materials such as forest products and minerals have also dropped substantially, while electronics noted a surprisingly positive trend during the first three months of 2009. As trade in goods falls, demand for services is affected as well. In the first quarter service exports dropped by 2.5% on an annual basis compared with the same period last year.

What can we expect for the rest of 2009? In our latest international economic outlook, growth prospects for 2009 have been revised downward by just over one percentage point compared with our March forecast. We expect the global economy to shrink by around 1.5% this year. For Swedish exporters this means that their global market will drop by 6-7%, more than we projected in March. Low capacity utilisation in the global economy implies continued weak demand for inputs and investment goods, suggesting that Swedish exports will shrink by more than the estimated global growth rate. Improving economic indicators such as the purchasing managers’ index are a sign that the sharp decline in exports is slowing, however. Even if we assume that exports stabilise during the second half of the year, average overall export volume will fall by as much as 14.0% in 2009 compared with the previous year.

We expect Swedish export opportunities to be limited next year as well. If the global economy grows by just over 2% in 2010 as expected, the market for Swedish exporters will increase by a modest 1.5%. With a relatively well-diversified export structure and competitive companies, however, Sweden could see exports slightly outpace estimated market growth. Unit labour costs are expected to fall in 2010 when productivity growth picks up, at the same time that wage increases slow. The weak

Auto exports are down 50% since 2008

Low capacity utilisation in the global economy is hurting Swedish exporters

A growing global markets and lower unit labour costs in 2010 will improve export opportunities for Swedish industry

Foreign trade


krona is also making Swedish companies more competitive relative to competing countries.

Global demand for raw materials and input goods is expected to increase slightly faster in 2010, not least due to an anticipated inventory build-up in industry. This helps Swedish raw materials producers, which account for 20% of goods exports. Investment goods are under pressure from overcapacity and weak investment conditions. Not until 2011 do we expect global demand for input goods to rise in pace with improving capacity utilisation worldwide. In 2010 we don’t anticipate a repeat of this year’s 50% drop in Swedish passenger car exports, which is expected to reduce total goods exports by upwards of 8 percentage points. Sweden is less dependent on passenger car exports than Germany and Japan. This is an industry that will continue to face pressure from overcapacity in 2010. The telecom sector, which accounts for 14% of Sweden's exports, offers great growth potential that Swedish companies can capitalise on. This is especially true of emerging economies in Asia, though there is a risk that the global financial crisis could delay telecom investments. Service exports are expected to rise in 2010, partly through increased foreign spending in Sweden due to the weak krona. Overall, we expect total exports to rise by 2.5% in volume in 2010, making it the third weakest year in the past decade. On average, Swedish exports have risen by 5.8% per year during this period.

Industrial slowdown is affecting import demand The exceptional slowdown in Swedish industry is clearly reflected in imports of goods and services. Major cutbacks in production and inventories by Swedish industry, along with fewer investments, are greatly reducing imports. During the first quarter of the year goods imports fell by 14.8% on annual basis after having dropped by 5.2% in the fourth quarter last year. Service imports, which last year grew by 12.8% on an annual basis, fell by just over 6% during the first three months of 2009.

We expect Swedish import demand to decrease further in 2009. Industrial production is not expected to rise until next year at the earliest, when global demand and Swedish exports slowly begin to climb. Low capacity utilisation among businesses means that investments will decline substantially, especially in 2009. A weak krona is holding imports down. Higher household savings is another factor why imports are expected to fall faster than exports in the quarters ahead. A similar trend occurred during the recession at the start of the decade and after the financial and real estate crisis in the early 1990s.

Not until next year do we see import demand rising in Sweden, after industrial production levels off. A projected increase in imports of nearly 1% in 2010 is expected to come partly from an inventory build-up in industry after a period of major cutbacks. Our expectation that 2011 will be a better year growth-wise

Swedish exports are expected to rise by 2.5% in volume next year, below the long-term trend

Falling investments, a weak krona and lower consumer spending are keeping imports in check

Foreign trade


presumably will also force industry to add to inventories of raw materials and input goods.

In summary, net exports will have more of an adverse effect on GDP in 2009 than we had forecast in March. The major slide in exports in the first quarter is the main reason why. In subsequent quarters we expect imports to be weaker than exports, due not least to lower investment and higher import prices. As a result, net exports could have less of a negative effect on GDP. For 2010, we expect foreign trade to provide a positive contribution to GDP as exports slowly rebound.

Net exports’ contribution to GDP, export and import growth (%)

Auto industry’s importance to Swedish economy Autos have been harder hit by the global recession than any other industry in Sweden. During the first quarter production fell by slightly over 60% on an annual basis. This is leaving its mark on the Swedish economy, with a risk that a recovery could be slowed. The auto industry contributed an estimated 1.3 percentage points to the 6.5% decline in GDP during the first three months. Production was down 24% for industry as a whole, but excluding autos the downturn was 18%.

An estimated 75,000 people are directly employed by the Swedish auto industry, equal to around 11% of all industrial jobs or slightly over 1.5% of the labour force. This represents an increase from 2005, when the share was 9% of industrial jobs. Among European countries, only Slovakia and Germany have a larger share of their workers in the industry. Including subcontractors, the figure is considerably higher. In Sweden the auto industry employs an estimated 140,000-185,000 people, or between 3% and 4% of the total workforce.

Net exports are expected to contribute positively to GDP in 2010 after three years as a negative contributor

Sweden’s dependence on the auto industry is among the highest in Europe

-16

-14

-12

-10

-8

-6

-4

-2

0

2

4

2008 2009 2010

ExportsImportsNet exports

Foreign trade


Autoworkers as % of manufacturing workforce, 2005

Source: Nutek

The export value of auto products represented about 14% of Sweden's total goods exports in 2008. The industry is also a big buyer of goods and services, and a growing share of its production value is supplied by other industries. Purchases have trended higher in recent years in connection with specialisation and growing competition. Investments in research and development have therefore become increasingly important to stay competitive. Today the auto industry accounts for 16% of Sweden's total R&D expenditure, as well as about 12% of the total value-added generated by Swedish industry.

The risk is that the dramatic downturn in the auto industry will spread to other sectors of the economy. The most vulnerable are corporate services and retail/wholesale. The detrimental conditions faced by the industry could also impact R&D. This underscores the vulnerability of the Swedish economy, where more than two thirds of R&D is concentrated in a few large corporations.

Production volume by industry, Q1 2009, annual rate %

Source: Statistics Sweden

The downturn in the auto industry is spreading to the service sector

0 2 4 6 8 10 12 14 16

Denmark Finland

Portugal Netherlands

Italy Romania

Poland Ireland

Hungary UK

Austria Spain Belgium

France Czech Rep.

Sweden Germany

Slovakia

Other electrical industry 14.7Office equipment/computers 8.7Electrical/optical equipment 5.7Chemicals 1.9Foods and beverages -2.5M edical, precision/optical instruments -13.1Other manufacturing -17.4Non-metallic mineral products -18.1Pulp and paper -21.3Wood and wood products -22.6Coke and petro leum products -24.3Rubber and plastics -25.6Fabricated metal products -26.2Other transport equipment -28.2Textiles -30.1M ining and quarrying -32.7Basic metals -33.3M achinery and equipment -41.5Ferrous and non-ferrous metals -47.4Transport equipment -57.0

Foreign trade


The slump in the auto industry is not only economic but also structural. Global overcapacity and a shift in demand to more environmentally friendly products are creating great challenges for automakers around the world. Suppliers to the industry that are at risk of losing their business have already begun to target other sectors, including utilities, energy, infrastructure and environmental technology. Increased R&D investments to develop new products may eventually create new jobs and help to reduce the impact of climate change. The Swedish shipbuilding and textile crises in the 1970s are a clear example of the structural changes that the Swedish business sector has undergone from time to time.

Jörgen Kennemar

Increased need for transformation in business

Investments


Investments plunge

Investments are down four quarters in a row A sliding investment trend from last year intensified in the first quarter of 2009.1 The decline was driven mainly by private investment, which fell by slightly over 17% compared with the same quarter last year. Housing investment also fell substantially, by 24%. Inventories continued to shrink during the quarter, contributing 1.2 percentage points to the GDP decline. The exception was public investment. Municipalities in particular have been busy with construction and road projects. Investment here grew by 17%, while state investment fell by just over 3% compared with the same period of 2008. Despite rising public investment, fixed gross expenditure, including inventory, was the main reason for the GDP decline in the first quarter.

Change in gross investments and investments in certain sectors

Gross Fixed Capital Formation (SA, RHS) Gross Fixed Capital Formation, Construction

Gross Fixed Capital Formation, Machinery Gross Fixed Capital Formation, Manufacturing

Source: Reuters EcoWin

Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q104 05 06 07 08 09

Per

iod

chan

ge in

per

cent

-6

-5

-4

-3

-2

-1

0

1

2

3

4

Ann

ual r

eal c

hang

e in

per

cent

-50

-40

-30

-20

-10

0

10

20

30

40

50

Economic growth in 2004-2007 produced huge investment volumes, which are now shrinking at a rapid pace. At the same time domestic and external demand is falling, as a result of which businesses are facing major cutbacks in production capacity. Private sector investment reached 13.5% of GDP in 2008, the highest level in two decades. Inventory build-up was also high until mid-2008. The changes needed to adapt to current economic conditions will be dramatic, and probably will be protracted as well. As demand shrinks, companies are now beginning to slash production and meeting remaining demand by reducing their inventories.

1 Statistics Sweden’s revised, seasonally adjusted volume data show that the slowdown in investment began in the second quarter last year. This coincides with the gradual economic slowdown.

The dramatic decline in investments pummelled GDP in the first quarter

Past investment and low capacity utilisation are causing a protracted adjustment

Investments


Change in business investment and capacity utilisation in Swedish industry

Gross Fixed Capital Formation (annual change) Capacity Utilization Manufacturing Sector (SA, RHS)


94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

Per

cent

70.0

72.5

75.0

77.5

80.0

82.5

85.0

87.5

90.0

Per

cent

-20

-15

-10

-5

0

5

10

15

20

Investments continue to shrink Against the backdrop of the substantial decline in domestic and foreign demand and the expansion in production capacity in recent years, we expect investments to continue to fall during the forecast period. For 2009 we expect investments to drop by 12.3%, then continue to shrink in 2010, but at a slower pace, 4.3%. Given current overcapacity and weak demand, it will take a while before production levels reach the capacity ceiling and investment needs grow again.

Businesses have shown much less willingness to invest. In Statistics Sweden’s investment survey in May, industrial companies indicated they plan to slash their investments by slightly over 20% in 2009. Other industries such as energy and transportation are not quite as pessimistic, while the construction sector is forecasting that investments will fall by half. We see fixed expenditure in the business sector declining by slightly over 14% in 2009. In 2010 we expect companies to continue to adjust their production capacity and investments to drop by 8%. Lower investments will be most evident in the auto industry, where cutbacks of 25% are planned in 2009, according to the survey. The inventory downturn cycle is expected to continue in 2009 following the major build-up from 2006 to mid-2008. With demand uncertain, companies will want to cut inventories to a minimum. We expect this to reduce GDP by just over 0.8 percentage points in 2009. For 2010 we see a slight inventory build-up, adding 0.3 percentage points to growth.

We don’t anticipate a turnaround in housing investments anytime soon. Prices are expected to fall, and the impact of rapidly rising unemployment on income security will lead to greater cautiousness in new housing construction. Falling interest rates and the introduction of government subsidies for renovations and additions will soften the blow, but are unlikely

Investment cutbacks in 2009 will continue in 2010

Industrial companies in particular are planning to reduce investments

Housing investments are falling despite government subsidies and lower interest rates

Investments


to reverse the trend. Leading indicators such as construction permits point to a rapid decline in housing construction. We project a drop of slightly over 22% in 2009 and a further slowdown in 2010 with essentially stagnant housing investments.

Public investment is compensating somewhat for cutbacks by businesses, but with municipalities facing tight budgets and the government showing restraint, any increases are likely to be small. The government’s spring fiscal policy bill, which included a slight increase in investment and higher municipal appropriations, provides the flexibility to launch major investment projects ahead of schedule and capitalise on lower production costs. As a whole, we expect public investment to rise by 8% in 2009.

Despite a gloomy start to the forecast for 2009-2010, most of the risks are on the downside. Global economic conditions remain uncertain. A further downturn would delay any industrial capacity increases. Public finances are also shadowed by uncertainty, and the government is showing restraint given the major fiscal risks it faces in the next two years. The slowdown in investments could ease if the global economy recovers more quickly in the latter half of 2009 and 2010.

Magnus Alvesson

Public investment is easing the downturn slightly

Risks are still significant

Labour market


Deep decline in labour market Since we released our March forecast, there have been a number of signs that the Swedish labour market is rapidly deteriorating. This is especially evident by the number of layoffs, which remains high despite levelling off slightly in April and May. The number of available jobs is half that of last year. The major production contraction in the Swedish economy has not yet been fully felt by the labour market. In the first four months of the year the number of employed workers decreased by an average of 55,000 or 1.2% compared with the period a year earlier. The number of hours worked also fell slightly (1.5%). Companies are primarily eliminating temporary positions as the economy worsens.

Employment growth and unemployment, 15-74 year-old workers

Manufacturing industry accounts for the largest job losses in both absolute and relative terms. In the private service sector, on the other hand, the number of jobs increased until March before shrinking by 40,000 in April, compared with 47,000 in industry. The worsening job market is placing increasing pressure on government finances and forcing municipalities and county councils into efficiency gains. First-quarter data show that municipalities are slashing personnel, even if this is partly due to privatisations.

The major production cutbacks in the private sector and continued weak economic conditions are expected to lead to more layoffs during the second half of the year and in 2010. Production volume in the goods-producing sector has dropped to the lowest level since late 2004. For service businesses, production has decreased in recent quarters, though at a more modest pace.

Production cutbacks in the Swedish economy have not yet fully impacted the labour market

Industry accounts for the largest share of job losses

Low production levels signal more layoffs


May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar06 07 08 09

-3 -2 -1 0 1 2 3 4 5 6 7 8 9

Employment growth, %

Open umemployment, % of workforce

Labour market


Production volume for goods- and service-producing sectors, 2000=100

The private service sector has also begun to feel the effects of the recession. Its dependence on industry has grown substantially in recent decades due to specialisation and service outsourcing by industrial companies. Continued weak conditions will eventually require efficiency improvements by B2B service providers, which in recent years have had low productivity growth. Increased household savings is expected to lead to fewer new jobs in the retail sector at the same time that the industry's profitability is under pressure from a weak krona and lower domestic demand.

Worsening labour market conditions are placing municipalities and county councils under growing economic pressure. In 2008 one out of every five municipalities reported a budget deficit, a figure expected to rise in the next two years. Increased state subsidies to municipalities and county councils and higher municipal taxes probably won't be enough to hold off further layoffs in the public sector in the next two years.

As a whole we expect job losses of 3% this year, a downward revision from our March forecast of 2.75%. Next year we see the number of jobs declining by 2.5%, more than we had previously forecast partly due to a larger-than-expected production decline this year and lower global market growth for Swedish exports in 2010. In total we expect the loss of slightly over 260,000 jobs in 2009/2010, or nearly 6%, a faster decline than in the recession of the early 1990s. Goods-producing sectors account for the biggest losses in absolute terms.

The number of hours worked is expected to fall more than the number of jobs, especially in 2009. Extraordinary measures were taken by several unions and employer confederations this spring to slow job losses and keep unemployment in check. The agreements, which expire in March 2010, provide the option to reduce work hours and slash incomes by up to 20%. This has been widely accepted by labour market parties and means that the total number of hours worked is likely to decrease by about

The service sector’s dependence on industry is growing

More layoffs are expected among municipalities and county councils

A total of 260,000 jobs are expected to be lost in 2009/2010


00 01 02 03 04 05 06 07 0895

100

105

110

115

120

125

130

135

Goods producers

Private service companiesIndex=2000

Labour market


4.5% for the full year 2009. For 2010 we project that the number of hours worked will drop by slightly over 2.5%.

Change in number of employed workers in 2009-2010, thousands

High unemployment and expanded labour market measures The labour supply was higher during the first four months of the year than the same period of 2008 despite a rapidly worsening job market, which generally reduces the supply of available workers. Besides demographic factors, the labour supply is being affected by the structural changes the government has implemented in recent years. Lower unemployment compensation and tougher rules on sick leave have increased the incentive to participate in the workforce. The number of long-term sick leave absences has trended lower and is expected to continue to do so through the forecast period.

Changes in labour market programs are also helping to maintain the workforce participation rate. Much of the government’s action plan to fight rising unemployment consists of training. These measures are expected to grow from 90,000 participants in 2008 to 210,000 next year. In all, 4.5% of the working population will be involved in labour market initiatives within one year, 80,000 more than we predicted this spring. Since most of them are included in the workforce, the decrease in the labour supply was limited to around 30,000 workers in 2009/2010, significantly fewer than in previous recessions.

The modest decrease in the labour supply at the same time that the employment rate fell by over 260,000 means that open unemployment will rise to over 11% of the working population in 2010, against nearly 9% this year. Not until late 2011 do we expect open unemployment to decline.

The number of people participating in labour market measures will rise to 4.5% of the workforce next year, against 2.7% in our March forecast

Open unemployment will begin to decrease in late 2011

-160

-140

-120

-100

-80

-60

-40

-20

0

20

Goods producers Industry Construction

Service sector State Municipalities

Labour market


Recession is limiting wage increases Rapidly rising unemployment and a shrinking labour shortage are slowing wage increases in Sweden. Contracts signed in 2007, which resulted in 3.3% annual increases, are limiting the wage slide, however. We expect total nominal wages in the Swedish economy to rise by an average of 3% in 2009. The rate of increase will further slow when a majority of the contracts from 2007 expire in early 2010. Shrinking job numbers and unemployment of over 10% will lead to significantly lower collective agreements than before. Expectations of future wage increases have been significantly revised downward, particularly short-term. In a survey by Prosperas, wages are expected to rise by nearly 2.5%, while in the longer term there are fewer revisions. We anticipate that nominal wages, including wage drift, will rise by 2.2% for the economy as a whole.

Wage expectations for the Swedish economy

Higher productivity and falling labour costs Production in the private sector has dropped substantially in the last two quarters, particularly in industry. The biggest decline has been in the auto sector, where production fell by over 60% in the first quarter 2009 on a year-over-year basis. Auto production is now the lowest since 1999! Service companies are also cutting production, though much more modestly.

It takes time, however, for companies to adapt their personnel to lower production volumes, partly for legal reasons. As a result, productivity will continue to trend lower. The Q1 result was –5.2%, making it the ninth consecutive negative quarter.

Next year we expect corporate layoffs to lead to higher productivity growth, at the same time that production slowly begins to rebound. The biggest gains during the forecast period are expected in the goods-producing sector. An estimated productivity increase of around 3% is predicted for the economy as a whole in 2010, compared with a decrease of 0.5% this year (calendar-adjusted).

High unemployment and continued weak economic growth are limiting possible increases in next year's wage negotiations

Productivity growth in the Swedish economy will rise by upwards of 3% in 2010

Wage expectations 1 year Wage expectations 2 years Wage expectations 5 yearsSource: Prospera, EcoWin

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

% - f ö r ä n r i n

2.25

2.50

2.75

3.00

3.25

3.50

3.75

4.00

4.25

Labour market


Given our forecast of low nominal wage increases and stronger productivity growth, unit labour costs for the economy as a whole should fall by 1% in 2010 after rising by slightly over 3% in 2009 and 5% in 2008. This means that the Swedish export industry is in a good position to strengthen its competitive position, provided that costs do not increase faster than in our most important competitor-countries.

Jörgen Kennemar

Low nominal wage increases and higher productivity are leading to falling unit labour costs

Household finances


Households save like never before

Uncertainty about labour market and asset prices is affecting households’ willingness to spend Since we published our most recent economic outlook in March, we have gotten a clearer picture of Swedish households’ reactions to the current recession. Consumer spending has dropped on an annual basis for three consecutive quarters. Household savings reached a record-high level of slightly over 16% of disposable income in the first quarter. Despite fairly decent income gains in real terms, concerns about a weaker economy and the financial crisis, along with the impact on the Swedish labour market and their net worth, have encouraged households to tighten their belts.

Household confidence in the Swedish economy, their personal finances and the labour market (net figure – higher minus lower)

Source: National Institute of Economic Research and Swedbank

Since the beginning of the year households have become less pessimistic about the Swedish economy. At this point more people expect conditions to improve in the next year than to worsen. Expectations with regard to their personal finances in the year ahead remained relatively stable, though at a lower level than in recent years. Labour market expectations improved slightly in May despite significant concerns about jobs. Still, a majority expect higher unemployment. Not since 1991-1993 has this figure been as high as in the first five months of the year.

The slight improvement in household confidence is mainly the result of the Riksbank’s rate cuts. Last fall household margins were under more pressure, but mortgage costs have gradually dropped since then, leaving more money for savings or other consumption. This is more evident in sales of consumables than durable goods, which remain low due to worries about higher unemployment.

Swedish households have cut back on their spending faster than anticipated

Households are more pessimistic than normal, but to a slightly lesser extent

00 01 02 03 04 05 06 07 08 09

t

-75

-50

-25

0

25

50

75

100 Households’ view of their own finances

Unemployment expectations

Households’ view of the Swedish economy

Household finances


One way to study household finances is to look at the interest coverage ratio, i.e., households’ interest expense in relation to disposable income. When the repo rate rose, households felt pinched financially. The situation has since eased considerably for households with mortgage loans. The interest coverage ratio is expected to fall from 6.5% in 2008 to 4.5% this year and slightly lower in 2010.

Households’ interest expense as share of disposable income, %

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: National Institute of Economic Research and Swedbank

The main factor affecting household consumption is disposable income. This includes the impact of inflation, interest rates, fiscal policy, jobs and wages. We expect the decline in the number of hours worked to reduce real disposable income by 4 percentage points this year, at the same time that fiscal policy (income tax credits and increased transfers to households), low inflation and interest rates contribute positively to real income.

Contribution to households’ real disposable income, percentage points

Source: Statistics Sweden, National Institute of Economic Research and Swedbank

The interest coverage ratio has fallen significantly since last year

Households as a group are reporting unusually low income gains – and some people have it even worse

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Factor income Public transfers Taxes and fees Private transfers

6.2

3.61.4

1,3 1.6

1.2

4.6

3.3

3.6

3.30.8

1.3

Household finances


Real disposable income is expected to rise by 0.8% this year and 1.3% next year as the decline in the number of hours worked eases. We expect the government to introduce further stimulus measures to help households (mainly seniors and the unemployed), though it is also trying to hold spending in check, so the effects will be relatively small compared with previous years.

Despite that households as a group have seen their incomes rise in real disposable terms during the recession and financial crisis, they are cutting their spending and saving more. One reason is that their financial net worth has decreased at the same time that debt ratios continue to rise. Even if interest rate cuts contribute to a slower correction in household balance sheets, we can expect increased savings to gradually replace the lost wealth. Uncertainty about both the labour market and housing market is contributing to further cautiousness.

Households’ financial net assets and debt in relation to disposable income (%)

Source: Statistics Sweden and Swedbank

Household spending could follow W-shaped trend Indications are that households will maintain, or slightly increase, their short-term spending on everyday items and services. There is still some cautiousness about durable goods such as cars and home furnishings. We also expect foreign travel to be replaced by more vacations at home, at the same time that the weak krona is raising interest in travel to Sweden among foreigners. As a result, the net difference between foreigners’ consumption in Sweden and Swedes’ consumption abroad will also contribute negatively to spending data.

Once the effect of lower interest rates begins to subside and unemployment rises to even higher levels, there is a risk that

Households may have to save more to give their net worth a boost and reduce debt

0%

50%

100%

150%

200%

250%

83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 100%

50%

100%

150%

200%

250%

Debt ratio

Financial net wealth ratio

Financial net wealth and debt as % of disposable income

Financial net wealth ratio excl.tenant ownership rights and insurance technical reserves

Household finances


consumer spending could again slow. As a result, we are likely to see a W-shaped spending curve during the forecast period.

Households’ disposable income in real terms, savings ratio and consumption trend with forecast for 2009-2010 (%)


This year we expect household consumption to fall by 1.6% before rising weakly by 0.6% next year as confidence improves slightly and economic conditions brighten. Savings will rise from 11.9% relative to disposable income (savings ratio) to 14% this year and stabilise at just over 14% next year before the ratio retreats once again in 2011.

Housing market could also see W-shaped curve Lower interest rates and significantly improved household buying power according to Swedbank’s latest Housing Index mean that housing prices could potentially increase slightly in the short term. When the labour market further weakens during the second half of 2009, there is a risk that prices could fall again. As with consumer spending, there is therefore a risk of a W-shaped curve in housing prices.

Cecilia Hermansson

Unemployment could slow the housing market

-3

0

3

6

9

12

15

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010-3

0

3

6

9

12

15

Real disposable income Private consumptionHousehold savings ratio Savings ratio, excl. collective pensions

Fiscal policy


Restraint, but big deficits are still expected Public finances are worsening quickly as the recession grows. This is to be expected. Sweden's finances are cyclically sensitive because of the country’s high taxes and extensive transfer systems (automatic stabilisers). In addition, recessions require fiscal stimulus measures, which further add to projected deficits.

We expect the impact of automatic stabilisers to be significant in the years ahead. A recent study by the OECD shows that Sweden has among the highest automatic stabilisers, and estimates show that the public sector's budget shrinks by approximately 0.7 percentage points of GDP when economic growth falls by 1 pp2. The biggest impact is on the revenue side, mainly because tax revenue falls as unemployment rises, and consumer spending decreases. Unemployment also leads to higher costs in the form of compensation payments. Against this backdrop, we estimate that the slower economic growth reduced the public sector's financial savings by about 2.5 pp of GDP in 2009. With a slight recovery in growth in 2010, we expect financial savings to improve by about 0.2 pp.

Relatively extensive stimulus measures have already been announced in 2009. In addition to the SEK 30 billion reduction in financial savings in the budget for 2009, appropriations in the spring fiscal policy bill increased by a total of slightly over SEK 14 billion. The largest item was an extra contribution to municipalities of about SEK 7 billion, though this will affect the 2010 budget year, while the cost of labour market programs will increase by nearly SEK 3 billion. This is in addition to a decrease in revenue of about SEK 5 billion mainly due to construction subsidies for renovations and additions and stimulus measures for “new start jobs.” In total, the fiscal stimulus, excluding the effects of worsening macroeconomic conditions (as indicated above), corresponds to about 1.5% of GDP. This does not include an increase in pension outlays corresponding to about 1% of GDP to assist a growing number of retirees.

The budget forecast for 2010 is more uncertain. The government has signalled its commitment to more conservative spending to ensure the stability of public finances. Furthermore, it wants the flexibility to implement additional stimulus measures if the recession worsens and its extensive guarantee and lending programs are called upon. The government has already announced a stimulus package worth SEK 10 billion more than in 2009. With the economic downturn deeper than expected and 2010 being an election year, we feel it is likely that fiscal stimulus measures will increase by an additional SEK 30 billion (1% of GDP). Among other things, the government has indicated that it may offer further assistance to seniors and

2 Including labour market programs (Flodén, 2009).

Rapid turnaround in public finances

The recession automatically increases deficits

A major stimulus package has already been presented for 2009

Further spending increases in sight in 2010

Fiscal policy


partly compensate retirement investors for a recent reversal of profit distributions by insurers. Measures to slow unemployment may also receive renewed attention, including more training programs. Moreover, in 2010 the surplus in the retirement pension system is expected to shrink by another 0.3% of GDP, while the municipal sector can expect a deficit of 0.4% of GDP.

The worsening state of Sweden’s public finances will remain an issue for years to come as deficits and public debt grow. This isn't necessarily alarming. Sweden's debt is manageable, and we feel that the level in question is appropriate given current circumstances. In all, we expect negative financial savings equivalent to 2.5% of GDP in 2009 (or SEK 75 billion). This is a downward revision of 0.5 pp compared with our previous forecast. For 2010 we expect total negative financial savings of 4.1% of GDP, or about SEK 125 billion. Macroeconomic conditions are significantly worse this year as well, and there is still a need for fiscal stimulus.

Due to the severity of the recession, the regulations governing Swedish budget policy are being put to the test. To strengthen budget discipline and ensure the long-term sustainability of Sweden's financial position, the goal is to maintain a 1% surplus of GDP over the business cycle. The Riksdag sets three-year spending caps as a framework. The surplus target is calculated over several years, so a large deficit in one or two years isn't problematic if it can be compensated by tighter fiscal policy in the medium term. Swedish fiscal policy is also tied up by membership in the Stability and Growth Pact, according to which the deficit may not exceed 3% of GDP. Under certain circumstances the limit can be lowered. Given current conditions, with negative growth in a number of member states, larger deficits are considered acceptable.

Public sector financial savings and debt as % of GDP

General Government Balance General Government Debt (RHS)Source: Reuters EcoWin

94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Perc

ent o

f GD

P

35

40

45

50

55

60

65

70

75

Pe

rce

nt

of

GD

P

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

Downward revision of financial savings

The regulatory framework is being put to the test

Fiscal policy


Public sector debt is difficult to forecast right now. A number of one-time effects are impacting debt levels in 2009. Moreover, the National Debt Office will increase funding in foreign currency by the equivalent of SEK 100 billion to strengthen the Riksbank’s currency reserves. This will increase the public sector’s consolidated gross debt by approximately 3 pp of GDP. The Riksbank has stated that these resources will be needed during the current financial crisis. This means that the national debt will grow to nearly 50% of GDP, though this is still significantly below the Maastricht Treaty limit of 60%.

Magnus Alvesson

Government debt is growing

Monetary policy and financial markets


Inflation, interest rates and exchange rates

Consumer prices are falling this year In our March forecast we predicted that the CPI would fall by 0.6% this year before rising by 1.2% next year. Now in June the picture has changed slightly. The CPI forecast has been revised to -0.4% and 1.1% for 2009 and 2010. Gas prices explain why inflation will be less negative despite a sustained downturn in the real economy.

The Riksbank’s rate cuts – and to some extent lower food and energy prices – are an important reason why consumer prices are falling from a year earlier. Weaker demand and low resource utilisation are relieving pricing pressures on consumers, which in terms of CPI with constant interest rates (CPIX) will mainly impact next year.

Even though mortgage rates are expected to hit bottom in the early summer, the rate cuts will curb the CPI for a few more months. Not until December do we expect inflation to return. The CPIX is more consistent, fluctuating between 1% and 2% during the forecast period. In late 2010 the CPIX will reach 1.3% at an annual rate, significantly below the inflation target of 2%.

Outcome and forecast for CPI and CPIX (at constant interest rates) (%)


Since the CPI is falling mainly due to rate cuts and the effects of last year’s big jump in energy and food prices, we do not see an imminent risk of deflation. As the global economy recovers, albeit at a slow pace, inflation expectations will rise.

The CPI with constant interest rates will fall from 1.7% in 2009 to 1.2% in 2010 and remain below the inflation target

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Jan 05 Mar Maj Jul Sep Nov Jan 06 Mar Maj Jul Sep Nov Jan 07 Mar Maj Jul Sep NovJan 08 Mar Maj Jul Sep NovJan 09 Mar Maj Jul Sep NovJan 10 Mar Maj Jul Sep Nov

CPICPIX CPI Swedbank CPIX Swedbank



Monetary policy will remain expansive An easing of the financial crisis, higher inflation expectations and improving economic conditions beyond the forecast horizon will allow the Riksbank to begin a period of gradual hikes in late 2010 in order to normalise interest rates. Worries that an extended period of unusually low rates could lead to new bubbles in asset prices suggest that rates should be normalised more quickly if possible. We feel it would be positive if the Riksbank and other central banks gave greater consideration to financial stability in their monetary policy.

In our economic outlook the production gap in both the global economy and Sweden will be bridged slowly. If the recovery continues into 2011 and 2012, there is a chance we will come closer to maximising growth potential. A repo rate of 1% is negative in real terms if inflation expectations rebound to 2%. There is still considerable support from monetary policy at this level, given that lending is normalising.

Although the Riksbank can still influence interest rates by buying bonds on the market (so-called quantitative easing), we feel that the likelihood of its doing so has decreased. As a small country with limited impact on the global bond market, Sweden has little chance of influencing long-term interest rates. If anything, its purchases of bonds with shorter maturities could have an effect if rates continue to rise despite the weak economy.

Interest rates and currency outlook

Outcome Forecast ---> ---> ---> --->8 June 2009 30 Aug 2009 31 Dec 2009 30 June 2010 31 Dec 2010

USAFed Funds 0,125 0,25 0,25 0,25 1,0010yr Gov Bond 3,80 3,60 3,40 3,40 3,80

EMU/GermanyRepo rate 1,00 1,00 0,50 0,50 0,7510yr Gov Bond 3,69 3,4 3,20 3,10 3,50

SverigeRepo rate 0,50 0,50 0,50 0,50 1,0010yr Gov Bond 3,77 3,60 3,40 3,40 3,90

FX

EUR/USD 1,38 1,43 1,47 1,39 1,34EUR/SEK 10,89 10,60 10,10 9,80 9,70USD/SEK 7,85 7,41 6,87 7,05 7,24

TCW (SEK) 144 139 133 130 130 Source: Swedbank

The US and European central banks are also expected to begin a period of rate hikes in late 2010. Long-term interest rates should retreat after rising temporarily because of the growing risk appetite in the financial markets, but then increase again next year when economic and inflation expectations improve.

By the end of the period we expect the Riksbank to launch a period of rate hikes…

… but with inflation expectations rising, monetary policy will continue to support the economy

The likelihood of a quantitative easing has decreased slightly



Swedish krona has potential to rise The Swedish krona has weakened since the financial crisis began. There are several reasons why. Major currencies have benefited from investors who have sought out safe havens. Swedish exports, where the emphasis is on investment goods, have been hard hit by the financial crisis and global slowdown. At certain points, especially lately, the economic problems in the Baltic countries have impacted the krona. Since our March forecast the krona has strengthened slightly in trade-weighted terms (TCW), however, partly because of the weaker dollar and euro resulting from the easing financial crisis and growing risk appetite.

The krona’s exchange rate against the euro and dollar as well as the krona in trade-weighted terms (ITCW index)

We expect the Swedish krona to continue to rise against the dollar this year. It will also strengthen against the euro and regain some of the ground lost in the aftermath of the crisis. Sweden has an opportunity to grow slightly faster than Euroland in 2011 and 2012 given the economy’s focus on raw materials, inputs and investment goods, which will benefit from a global recovery. The auto industry remains a question mark from this perspective, however.

Based on our assumptions, there is still far to go until we see exchange rates return to the levels of mid-2008 – before the recession and financial crisis. The krona will not be returning to those levels (TCW around 123) during the forecast period, probably dropping to an average of 130 in 2010.

Cecilia Hermansson

The krona is expected to rise against the dollar and euro …

… but the TCW index will not return to the pre-crisis level


92 94 96 98 00 02 04 06 085

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I n d e

x 1 0 0 = 1 8 n o v e m b e r 1 9 9 2

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130

140

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160 <---- TCW

Against USD --->

Against the euro

Economic Research Department SE-105 34 Stockholm, Sweden Telephone +46-8-5859 1588 [email protected] www.swedbank.se Legally responsible publishers Cecilia Hermansson, +46-8-5859 1588 Magnus Alvesson, +46-8-5859 3341 Jörgen Kennemar, +46-8-5859 1478 ISSN 1103-4897

Swedbank Economic Outlook is published as a service to our customers. We believe that we have used reliable sources and methods in the preparation of the analyses reported in this publication. However, we cannot guarantee the accuracy or completeness of the report and cannot be held responsible for any error or omission in the underlying material or its use. Readers are encouraged to base any (investment) decisions on other material as well. Neither Swedbank nor its employees may be held responsible for losses or damages, direct or indirect, owing to any errors or omissions in Swedbank Economic Outlook.

Swedbank Economic Outlook June 2009

Economy & Finance

Transcript of Swedbank Economic Outlook June 2009