With activity having strongly recovered from the protracted recession of the 1988-92 period, the economic policy setting in Norway is geared towards creating the conditions for sustained economic growth while avoiding a re-emergence of inflation. Monetary policy is tied to the commitment of a stable value of the krone against European currencies, at the level prevailing after the floating of the exchange rate in December 1992. Exchange rate stability is deemed to: i) provide a credible low-inflation anchor, thereby contributing to low interest rates; ii) preserve a "level playing field" for the social partners with a view to making wage negotiations focus on real rather than nominal increases; and iii) create a stable economic environment for the mainland tradeables industry, in order to help reduce the economy's petroleum-dependency. Fiscal policy, after having been extensively used to stimulate the economy during the recession, currently aims at budget consolidation in anticipation of the decline in State petroleum revenues and the increase in welfare expenditure associated with the ageing of the population. Tight fiscal policy, however, is also considered essential on conjunctural grounds. At the same time, incomes policy attempts to moderate the wage settlements between employers and labour unions in order to preserve the international competitiveness of Norwegian exports along the lines of the "Solidarity Alternative" agreement adopted by the government and the social partners in 1993.(7) This agreement is based on a stable exchange rate, without which imported inflation (in case of a depreciation) or losses in competitiveness (if the krone appreciates) risk undermining the wage settlements. Finally, structural policies focus essentially on the harmonisation of trade regulations and competition laws with the EU's Acquis Communautaire in the framework of the EEA-agreement (in force since early-1994)(8) and, more recently, the implementation of the WTO-agreement.
The pursuit of this strategy may prove quite demanding in the current environment of strong economic growth, booming petroleum activity, large current account surpluses and tighter labour market conditions. With the objective of keeping a stable exchange rate as a binding constraint on the active use of monetary policy for stabilisation purposes, the authorities are essentially relying on restrictive fiscal policies as a means to choke off excess demand and prevent the economy from overheating. Although this approach has been successful so far, whether this will continue to be the case is highly uncertain, the more so since the government's soaring petroleum revenues could complicate the task of the fiscal authorities in implementing a budget austerity programme. As a result, the authorities may face the dilemma of either giving priority to exchange rate stability, with the risk of undermining inflation control, or raising interest rates to keep a rein on inflation expectations but with the risk of feeding the upward pressure on the krone.
The present chapter reviews the progress in implementing and maintaining this strategy. It starts with a discussion of fiscal policy developments, with an emphasis on possible approaches for the management of the government's petroleum wealth in the long run. It then examines monetary management and financial market behaviour in the last eighteen months or so. This is followed by a brief appraisal of structural reform in the fields of agriculture and financial services. Structural initiatives in other areas, as well as incomes policy, are discussed in Chapter III dealing with the implementation of the OECD Jobs Strategy.
The fiscal stance
Widening budget surpluses in 1995 and 1996
After having been in deficit in 1992 and 1993, the general government account has been showing widening surpluses, ranging from 0.3 per cent of GDP in 1994 to 3.5 per cent in 1995 and an estimated 6.3 per cent in 1996 (Table 7). The bulk of these surpluses originate at the State level, due to the surge in oil-related revenues, which more than doubled between 1994 and 1996. But even excluding such revenues, the State balance also posted a significant improvement, [TABULAR DATA FOR TABLE 7 OMITTED] with the non-oil deficit declining from 7.4 per cent of mainland GDP in 1994 to 4.3 per cent in 1995 and to 3.1 per cent in 1996 ([ILLUSTRATION FOR FIGURE 11 OMITTED], Panel A). Although most of this improvement resulted from the strong growth of the mainland economy, fiscal consolidation played a role in this regard. In fact, since the recovery started in 1993 the authorities have aimed at restraining real growth in central government "underlying" expenditure (excluding unemployment benefits and one-off spending items and corrected for changes in accounting methods) to less than 1 per cent per year. As a result, the stance of fiscal policy has moved markedly towards restriction, as indicated by the State's non-oil cyclically-adjusted primary deficit (net of debt interest payments) - which is estimated by the authorities to have decreased by 2 and 0.9 percentage points in 1995 and 1996, respectively ([ILLUSTRATION FOR FIGURE 11 OMITTED], Panel B).
Although such favourable fiscal outcomes in part reflect policy actions, the extent of the improvements has largely come as a surprise to the authorities (Table 7). Indeed, the results for general government net lending have exceeded the initial budget estimates by as much as 4 per cent of GDP in 1995 and 4.5 per cent in 1996. In both years, roughly half of the difference was due to better-than-projected non-oil tax revenues, resulting from the greater strength of the mainland economy since 1994, with the central government's mainland tax revenues outstripping earlier budget estimates by NKr 9 billion in 1995 and NKr 14 billion in 1996. Local governments' tax revenues portrayed a similar development - although their net lending position deteriorated as their expenditure rose strongly at the same time. Moreover, as indicated in Chapter I, official projections of oil and gas production underlying the budget have been exceeded by around 15 per cent in both 1995 and 1996. As a result, the State's net cash flow from petroleum activities in 1995 was NKr 7 billion higher than the initial projections and, given the substantial unexpected increase in the oil price, three times that amount in 1996.
Given such favourable fiscal outcomes, the government has started to transfer sums into the foreign-currency denominated Government Petroleum Fund, in order to build up foreign financial assets as a means to preserve the public wealth emanating from the oil and gas sector - an official objective which was reiterated in the Revised National Budget released in May 1995. The first allocation of NKr 2 billion took place in May 1996 when the fiscal accounts for 1995 were finalised. For the fiscal year 1996 over NKr 45 billion - an amount equivalent to the estimated central government surplus, and four times that announced in the 1996 Budget - was transferred into the Fund at the end of the year. The Fund, which is managed by the Central Bank in the same way as the ordinary currency reserves, consists of foreign currency-denominated deposits and bonds (see Box 2 for further details). According to current plans, the Fund should contain assets equivalent to NKr 270 billion, or roughly 30 per cent of GDP, by the end of the year 2000. According to new guidelines for monetary policy formulated in the 1995 Revised Budget, and which have been reiterated in subsequent budget documents, the Bank of Norway is committed to purchase foreign currency in the exchange market corresponding to the sums allocated to the Petroleum Fund. As discussed further below, this has so far not conflicted with the objective of exchange rate stability. In fact, upward pressure on the value of the krone has led the bank to purchase even larger amounts of foreign currency than required by Petroleum Fund transactions.
Consolidating the surplus in 1997
The Approved Budget for 1997 foreshadows continued fiscal restraint, aimed at maintaining the general government surplus at around 6 1/2 per cent of GDP in spite of some slowdown in mainland output growth and a levelling-off of petroleum revenues.(9) The extent of further fiscal tightening, as gauged by the increase in the State's non-oil cyclically adjusted primary balance, is officially estimated at 3/4 per cent of mainland GDP ([ILLUSTRATION FOR FIGURE 11 OMITTED], Panel B). Unadjusted for the impact of the business cycle and interest payments, the non-oil State deficit would reach 2.8 per cent of mainland GDP. As has been the case in previous budgets, fiscal consolidation measures are concentrated on expenditure restraint. As a result, the increase in the central government's "underlying" expenditures is projected to reach 1 per cent in real terms.(10) Areas where expenditure should grow strongly include health care (due to the construction of new hospitals in the Oslo and Bergen areas) and education (through the introduction of special grants to municipalities in view of the extension of the compulsory school age by one year - see Chapter IV).
Taxes, on the other hand, will be slightly reduced, although the impact on the economy is likely to be rather small. The tax threshold, below which no tax is paid, has been raised by somewhat more than the estimated nominal earnings growth of 3 1/2 per cent, while the special tax rebate for small children has been increased - although this has been partly compensated by the freezing of the standard tax deduction for dependent children at its 1996 level. Moreover, State revenues from custom duties are projected to decline consequent to the WTO agreement, although this is to some extent offset by an increase in excise duties on tobacco, diesel and packaging. A noteworthy initiative has been a shift in income taxation from municipalities to the State, which explains part of the increase in State non-oil tax revenues projected for 1997 (Table 7). This measure has been implemented in order to prevent higher municipal tax revenues, due to stronger economic activity, from further boosting local spending. The associated increased emphasis on block grants from the State for the financing of local governments has reduced the need for "perequation" transfers (inter-municipal transfers to offset regional differences in economic strength) through the off-budget "Tax Equalisation Fund", which will therefore be phased out.(11)
Although the oil price is assumed to remain at its 1996 level of NKr 125 per barrel in 1997, the State's net cash flow from petroleum activities should rise further, reaching NKr 78 billion for the whole year. As a result, overall State net lending is projected to attain 6.6 per cent of GDP - 0.2 percentage points higher than in 1996. A widening deficit at the local level, however, is expected to lead to a stabilisation in general government net lending at around 6 1/2 per cent in 1997. The State budget surplus is planned to be invested in the Petroleum Fund, which, as a result, is expected to have accumulated assets worth 11 per cent of GDP, or NKr 100 billion, by the end of 1997. The current policy is thus to let the accumulation of assets prevail over debt redemption - in fact keeping the amount of outstanding debt fixed at roughly 30 per cent of GDP. Accordingly, the central government borrowing requirement in 1997 is projected to be practically nil (less than 1/2 per cent of GDP), as it has been the case since 1994.
In light of the experience with previous episodes of rising budget surpluses, in particular in the early 1980s, there is a distinct risk that such a comfortable fiscal situation may trigger political claims for additional government expenditure. This risk would be heightened if oil prices turn out to be higher than projected in 1997 (as a rule of thumb, a NKr 1 increase in the annual average oil price raises the overall State surplus by NKr 1 billion). Given the already tight conditions in product and labour markets, further government spending would make it very difficult to avoid an overheating of the economy, in particular if growth in household expenditure were also to accelerate due to the perceived increases in public financial wealth. The section below discusses possible strategies to reduce such risks in the future.
Managing the petroleum wealth in the long run
Together with the favourable budget outcomes, the recent review of pension rules, following the government's White Paper on the future of the social security system,(12) has eased concerns about the sustainability of fiscal policy in the long term. Indeed, an update of Norway's generational accounts(13) - estimating net transfers of wealth between generations through taxes and public expenditure programmes (assuming unchanged individual entitlements to pensions, social transfers and government services such as health care and education) - suggests that major inter-generational imbalances are unlikely to emerge, despite the ageing of the population. In this regard, Norway is in an unique position compared with other OECD countries, where the financing of future pension entitlements would require major tax increases in the future.(14) The main reason for this is the petroleum wealth, which allows the accumulation of substantial financial assets by the Norwegian Government well before public pension expenditure is expected to surge in the second and third decades of the next century [ILLUSTRATION FOR FIGURE 12 OMITTED]. According to official projections, a sharp increase in pension expenditure, ranging from 8 per cent of GDP in the period 1995-2010 to 15 per cent in 2030, will be preceded by a doubling of the State's net cash flow from petroleum activities from 4 per cent of GDP in 1995 to 8 per cent in 2000.
While generational accounts are useful as a means to illustrate the impact of changes in policies on the inter-generational distribution of wealth, they are very sensitive to the underlying assumptions, such as the rate of interest used in the calculations. In particular, a small but sustained fall in the real interest rate from its present level of around 4 per cent would make it more difficult for Norway to keep public finances balanced in the long run, due to a decline in the return on the government's financial assets, including those accumulating in the Petroleum Fund.(15) Moreover, long-run projections for entitlement programmes are also highly dependent upon the cyclical position of the economy in the given base year on which the generational accounting model is calibrated (usually the latest year for which a budget is available). For example, if the economy appears to have been at a cyclical peak in the base year, benefit claims (unemployment, disability, early retirement, social welfare, etc.) may increase in the subsequent downturn, thus accentuating the rise in social expenditure emerging from the ageing of the population.
Such uncertainties call for a mechanism to prevent undue increases in government spending as these would jeopardise the accumulation of financial assets in the Petroleum Fund and thereby the financing of future expenditure. At present, transfers to the Petroleum Fund are decided as part of the normal budget procedure and, therefore, are subject to approval by the parliament on an annual basis. As a result, the parliament is entitled to reduce the allocations to the Petroleum Fund if needed to finance current expenditure. A possible way to avoid this could be to legally earmark a portion of the financial assets accumulating in the Petroleum Fund - e.g. to finance public pension obligations. A drawback of this approach may be that such earmarked assets could then no longer serve as a fiscal buffer against adverse economic shocks - which is currently one of the official aims of the Petroleum Fund. However, it is unlikely that the whole Fund would be needed for that purpose, notably if the projection of 30 per cent of GDP in the year 2000 is realised.
As an alternative strategy, the government could aim at reducing the need for public financial asset formation by shifting the responsibility for retirement compensation partly to the private sector. For example, as recently proposed by the Norwegian Banker's Association, the government could legally require large firms and/or branch organisations to set up funded occupational pension schemes to cover earnings-related pension entitlements. According to this proposal, the start-up capital for such schemes would be provided by the government and financed by a liquidation of part of the Petroleum Fund.(16) Next, the government would give tax credits to workers contributing to such schemes. Proceeding this way could have a number of advantages. First, the reduction in income taxation would narrow the "tax wedge", which should help improve the functioning of the labour market. Second, the relationship between pension contributions and benefits would become more transparent, and possibly reduce the incentives for early retirement (including retirement through the disability pension scheme).(17) Third, the creation of pension funds could help strengthen the local stock market, thus widening the scope for equity financing of Norwegian firms and possibly serving as a lever for corporate growth. However, such an approach would also make it more difficult for the government to ensure that the national saving surplus be largely invested in financial assets abroad, which is one of the official objectives of the Petroleum Fund. Indeed, solvency requirements would normally lead occupational pension schemes to invest mainly in domestic assets, given their future obligations in national currency.(18) A recently installed official commission is expected to report on this overall approach and possible alternatives by July 1998.
The policy formulation
After the decision by the Norwegian monetary authorities to let the krone float in response to the turmoil in European exchange markets in late 1992, monetary policy has been geared towards maintaining a stable exchange rate vis-a-vis countries pursuing low-inflation objectives. Such an orientation was formalised by the adoption of a policy framework in the May 1994 Revised National Budget, stipulating that the Bank of Norway should focus on "the stability in the value of the krone as measured against European currencies" at the level prevailing after the floating, which was about 3 to 5 per cent below the pre-floating ECU parity. The 1996 National Budget set out additional guidelines, which legally commit the Bank of Norway to purchase foreign currency "at a scale that over time corresponds to the net allocation of capital to the Petroleum Fund", although "in a situation with a strong krone and a sharp cyclical upturn, it may be appropriate for the Bank of Norway to undertake net purchases of foreign currency exceeding the Petroleum Fund allocations".(19) It is within these constraints that monetary policy and other policy instruments (fiscal policy, incomes policy) need to operate with a view to keeping inflation under control.
As the inflation record since the currency depreciation in 1992 has been favourable, financial markets have shown confidence in the ability of the monetary authorities to maintain price stability while achieving the stable exchange rate objective. This has been reflected in the behaviour of long term interest rates, which have gradually declined to a low level by Norwegian historical standards. However, due to the rising external surplus, the exchange rate has been subject to upward pressure in 1996. This has required the Bank of Norway to purchase large of amounts of foreign currency and has prevented a tightening of monetary policy which would have been expected given the strength of the economic upswing. In fact, as discussed below, the authorities may face the dilemma that avoiding an appreciation of the currency would call for a relatively easy stance of monetary policy at a time when activity is strong and the economy is continuing its upturn. The monetary policy framework would be subject to further strains if, as argued in the previous chapter, inflation risks materialised as a result of tight labour market conditions and budget discipline was weakened by the rising oil revenues.
Exchange and interest rate developments
Since the start of the economic recovery in 1993, the 4 per cent depreciation against the ECU in the aftermath of the floating of the currency in December 1992 has been fully reversed ([ILLUSTRATION FOR FIGURE 13 OMITTED], Panel A). Moreover, with the depreciation after the floating almost negligible in wider trade-weighted terms - due to the simultaneous steep fall in the value of the Swedish krone and the Finnish markka ([ILLUSTRATION FOR FIGURE 13 OMITTED], Panel B) - the effective exchange rate currently exceeds its pre-floating level. Since the beginning of 1996, large spot interventions by the Bank of Norway have been needed to contain upward pressure on the krone resulting from the sharp widening of the current account ([ILLUSTRATION FOR FIGURE 13 OMITTED], Panel C). Foreign currency purchases by the Bank of Norway between January and December 1996 totalled NKr 92 billion,(20) raising official reserves to a record high of NKr 215 billion - more than twice the amount prior to the floating of the exchange rate in December 1992. In order to sterilise the liquidity generated in the banking system by such foreign exchange interventions, the Ministry of Finance issued short paper in the same proportion, in the form of Treasury Bills with a one year maturity. This facility for open market policy was created in the summer of 1993, but was used on a large scale only from early 1996.(21)
In order to offset the upward pressure on the exchange rate, the stance of monetary policy has been progressively eased since late 1996. In 1995 and most of 1996, the Bank of Norway succeeded in maintaining the three-month money market rate around 5 to 5 1/2 per cent, notwithstanding a small cut in the official deposit and overnight lending rates by 0.25 per cent to 4.5 and 6.5 per cent, respectively, on 8 March 1996 ([ILLUSTRATION FOR FIGURE 14 OMITTED], Panel A). As a result, the short-term interest differential with Germany gradually widened to reach almost 200 basis points by October 1996 ([ILLUSTRATION FOR FIGURE 14 OMITTED], Panel B). Similarly, the differential against the official trade-weighted ECU rate turned positive in late 1995, and increased to nearly 100 basis points in October 1996 ([ILLUSTRATION FOR FIGURE 14 OMITTED], Panel C). Since then, however, speculative capital inflows in anticipation of a possible appreciation of the krone have forced the monetary authorities to lower official interest rates, with the deposit and overnight lending rates cut by 125 basis points in December 1996 and January 1997 to 3 1/4 and 5 1/4, respectively. This resulted in a sharp decline in the three-month rate to some 3 1/2 per cent last January, practically on a par with the equivalent German rate. While such monetary easing, combined with the temporary suspension of intervention in the foreign exchange market, appears to have succeeded in containing the capital inflows, there is a risk that exchange rate pressure will re-emerge once incoming indicators point to a further strengthening of Norway's economic fundamentals.
Long-term rates have tended to follow the movements in money market rates quite closely since late-1994. The ten-year bond rate mostly fluctuated between 6 1/2 and 7 per cent until the fall of 1996, thus maintaining a substantial positive yield gap of around 150 basis points. The interest rate differential varied around 50 basis points against equivalent German and zero against equivalent ECU rates [ILLUSTRATION FOR FIGURE 14 OMITTED]. Since November, however, the ten-year rate sharply declined, to below 6 per cent, as bond prices were boosted amid speculation by foreign investors on an appreciation of the currency and/or further easing of monetary policy. As a result, the long-term differential against Germany had virtually disappeared at the time of writing, indicating that the markets have fundamentally changed their risk appraisal of Norwegian financial assets.
Money and credit growth
After having hovered around 6 per cent in 1995, the rate of growth of the broad money aggregate M2 (narrow money plus time deposits) has been quite irregular in 1996, slowing down to 3.7 per cent on a twelve-month basis in November following an acceleration to the 7 to 9 per cent range in the first half of the year ([ILLUSTRATION FOR FIGURE 15 OMITTED], Panel A). At this stage it is unknown why broad money supply has abated recently, although it may be a temporary phenomenon related to the pickup in housing investment in the second half of the year. On average, the year-on-year growth rate of M2 attained 5.5 per cent in the eleven months until November 1996. While a shift from sight to time deposits has reduced the expansion of the narrow money aggregate M1 in the course of 1995, it has converged to the growth rate for M2 in 1996.
Such developments in monetary aggregates have resulted from a recovery in domestic credit from the trough in the early 1990s, while money creation from foreign currency inflows (excluding those induced by tax payments by oil companies, which normally accrue to the government and hence do not affect domestic liquidity) has been largely sterilised (Table 8). The marked improvement in banks' balance sheets (see below) suggests that lending by commercial and savings banks is no longer bound by supply constraints, notwithstanding a gradual decline in lending margins ([ILLUSTRATION FOR FIGURE 15 OMITTED], Panel B). Indeed, such lending has continued to grow strongly in 1995 and 1996, spurred by lower lending rates, booming private investment and rising credit demand by households to finance purchases of consumer durables ([ILLUSTRATION FOR FIGURE 15 OMITTED], Panel C). By contrast, loans by the [TABULAR DATA FOR TABLE 8 OMITTED] traditional State banks continued to fall as their favourable lending rate differentials relative to commercial and savings banks have virtually disappeared. Moreover, the recent decline in residential investment (see Chapter I) and the associated weakening in demand for mortgage loans has had a negative effect on credit by the State's Housing Bank and the commercial mortgage institutions. With commercial and savings bank lending accounting for almost half of the total domestic credit stock, overall credit growth doubled from 3 per cent in 1994 to around 6 per cent in the last two years.
The experience in late 1996 and early 1997 suggests that the present monetary policy set-up, based on the commitment to exchange rate stability, may become difficult to sustain as upward pressure on the krone may increase with the rising current account surplus. Already, monetary policy has had to be eased in order to ward off speculative capital inflows, a move which, if continued, risks providing undue impetus to domestic credit and private demand, with resultant economic overheating. Therefore, whatever room exists within the present framework of maintaining a stable exchange rate in the medium run should be used to reverse the recent relaxation of monetary policy. At the same time, the current tight stance of fiscal policy would need to be maintained, or even reinforced, to ease the strain on monetary policy by reducing the potential conflict between exchange-rate stability and inflation control.
Since the adoption of a wide range of structural measures implied by the 1994 EEA-agreement, only a limited number of new initiatives have been taken in the last eighteen months or so. The main areas where structural policy actions have been significant are: i) agriculture, where a programme of measures aimed at reducing foreign trade protection has been initiated consequent to the WTO agreement; and ii) the financial industry, with further steps towards privatising the commercial banking sector after the government bail-outs during the crisis in the early 1990s. The sections below briefly review the reform process in these areas and identify scope for further action.
Norwegian agriculture stands out in Europe for its small scale farming, with an average farm size of ten hectares - considerably less than the average in the EU countries - occupying only 3 per cent of the total land mass [ILLUSTRATION FOR FIGURE 16 OMITTED]. International trade in agricultural products in Norway is limited mainly to imports of fruit, vegetable and grain, and the export of one-fifth of the dairy production ([ILLUSTRATION FOR FIGURE 17 OMITTED], Panel A). The virtual absence of agricultural exports - which amount to 1 per cent of total exports - is related to high relative prices. Moreover, the small size of agricultural imports - only about 6 per cent of total imports - is due to the significant government support, including border protection, market regulation and direct support, with the effective tariff rate in some cases exceeding 300 per cent. The producer subsidy equivalent (PSE) - including both direct and indirect forms of support - amounted to 74 per cent of the total production value in 1995, almost twice the PSE in the EU area, and exceeded only by Japan, Switzerland and Iceland.(22) More specifically, the total transfers (associated with agricultural policies) per full-time farmer equivalent amounted to $43 500, almost three times the OECD average. In terms of transfers per hectare of cultivated land, support in Norway is thirteen times the average in the OECD area. All of this indicates that the agriculture sector in Norway is relatively inefficient by international standards.
Consequent to the agriculture policy reform of 1993,(23) the annual Agricultural Agreements - between the farmers union and the government - have led since to reductions in administered prices for all products (by almost 4 per cent in total) and cuts in direct budgetary support (3 per cent).(24) At the same time, the composition of budgetary support has shifted away from production-linked assistance to general income transfers. In addition, the Uruguay Round agreement has prompted the government to implement several trade measures. The state monopoly over cereal imports was abolished. Quantitative import restrictions were replaced by tariffs and remaining minimum access import quotas were allocated through auctioning of import licenses - the quota rents thereby accruing directly to the government. Moreover, the entire agreed tariff reduction of 36 per cent, which originally was to be spread over a six-year period, has been implemented at once with effect from 1 July 1995. In order to offset the adverse income effects of these reforms, the agro-food industry received investment grants and was allowed some duty free importation of raw materials. Despite the above reforms, Norway has not yet achieved a market orientation of agricultural production and the percentage PSE has remained at the same high level, indicating a continued burden on consumers and tax payers.(25) Although the progressive introduction of a tariff-based import regime has rendered border restrictions more visible, the very high tariff levels are highly punitive, virtually excluding competing imports.
Having overcome the banking crisis which occurred in the early 1990s, the financial industry in Norway is now facing the challenge of more intense competition from elsewhere in the Scandinavian region and Europe, due in part to the opening-up of the local market for foreign bank branches consequent to the EEA agreement. Indeed, while banks have become profitable again and have had satisfactory BIS capital adequacy ratios in recent years (Table 9), the improvement in banks' operating results has been tapering off - despite further reductions in provisions against loan losses(26) - amid increasing competition within the [TABULAR DATA FOR TABLE 9 OMITTED] banking industry. Moreover, despite concerns of remaining overcapacity in the provision of financial services and low interest margins, the process of rational-isation of the banking industry appears to have slowed down, with the number of bank branches and employees practically stable since 1993 and merger activity subdued as concentration in the industry is already high (Table 10 and [ILLUSTRATION FOR FIGURE 18 OMITTED]).(27) On the other hand, a recently-agreed merger between the postal and banks' payment systems could yield substantial cost savings.
In addition to a review of the deposit insurance scheme, which was recognised to be a factor inducing bank managers to take excessive risk, as it allowed full bail-out of depositors in case of insolvency,(28) the government has continued the partial re-privatisation of Norway's three main commercial banks - which have been in state ownership since the bail-out in the early 1990s. In October 1995, the State sold its entire 96 per cent stake in the share capital of [TABULAR DATA FOR TABLE 10 OMITTED] Fokus Bank, the smallest of the three commercial banks in government ownership. This initiative was followed in June 1996 by the sale of 19.8 per cent of the shares in Den norske Bank (DnB), the largest of the three, bringing the State's stake in DnB to 52 per cent. As a result, the State now holds slightly over 50 per cent in two out of the three top domestic commercial banks. The government reiterated in early 1996 an earlier decision to maintain its shareholdings of at least 50 per cent in DnB and Kreditkassen, Norway's second commercial bank, over the present term of the parliament - e.g. until the end of 1997.
The State thus remains strongly involved in the banking industry. As argued in the 1996 Economic Survey the rationale for such a policy is not obvious as, despite the stated policy that banks should function as commercial financial institutions, there is a risk of distortions in credit markets due to government interference. It would thus seem desirable for the long-run efficiency of these markets that the government exercise its role as owner to assure that the banks are managed efficiently and keep earning the required rate of return on their capital.
The role of the "traditional" State banks, in particular the Housing Bank and the Regional Development Fund (SND), also would need to become subject to closer scrutiny. The Housing Bank, which provides mortgage loans to private households, mainly finances owner occupied accommodation in the low-priced segment of the housing market. Such financing may reach 80 per cent of the market value of the real estate, subject to a maximum amount per household, at lending rates equal to the interest rate on government bonds plus a 1/2 percentage point mark-up - disregarding credit rating and risk pricing of the borrowers. Similarly, SND combines banking activities with subsidy provision to small and medium-sized enterprises, and is engaged in risk lending at favourable rates. To the extent that SND provides credits to high-risk business which is typically beyond the scope of commercial banking, these practices can be very useful. However, there is also a risk of SND capturing market segments which are normally covered by commercial banks. In sum, there appears to be ample scope for better targeting of lending by the State banks, with the emphasis shifting to the servicing of clients who are in genuine need of government support, while leaving other business to the commercial banking sector.
RELATED ARTICLE: Box 2. The Government Petroleum Fund
In the 1995 Revised National Budget, the government re-emphasised the future role of the Petroleum Fund, reiterating its wish to build up financial assets as a means to preserve wealth emanating from the petroleum sector. The Fund should invest in foreign currency-denominated assets in order to: i) absorb the currency inflows associated with the government's petroleum receipts from abroad (and hence contribute to containing the upward pressure on the Krone exchange rate); and ii) to diversify away from the risk of a combined fall in oil prices and market values of domestic assets.
While the Petroleum Fund was formally established in 1991, the first allocation of NKr 2 billion took place in May 1996 (accruing retroactively to the 1995 final accounts), followed by a second allocation of over NKr 45 billion at the end of the year. By the year 2000 the Fund should contain around NKr 270 billion, including the accrual of returns on the capital. The capital is valued against its historical cost or its market value, which ever is the lowest.
Pursuant to [section]7 of the Act of 22 June 1990 No. 36, the Government Petroleum Fund:
* Is managed by the Bank of Norway on behalf of the Ministry of Finance, involving also the reporting on the management and keeping the accounts for the Fund in accordance with the criteria laid down by the Ministry of Finance.
* Is placed as Krone deposits in a Treasury account with the Bank of Norway. The Bank should invest these resources separately in its own name in assets denominated in foreign currencies. The value of the Treasury account is set equal to the value of the corresponding portfolio of foreign financial assets, including the book return.
* Should achieve the highest possible return within the following limits: i) bonds, bills, notes and equivalent instruments must be issued by sovereign nations, enterprises with government guarantees or highly-rated international organisations; ii) investments may also be made in securities where the authorities are considered to back the lending programme, but for which there are no formal guarantees; iii) it is not permitted to invest in shares or other forms of equity capital, or in securities issued by borrowers other than those approved by the Central Bank Governor for the investment of foreign exchange reserves; iv) Bank deposits shall not exceed a value of 25 per cent of the Fund's market value. Such deposits can have up to six months' maturity; and v) the Fund's resources can only be invested in highly liquid instruments and in banks approved by the Central Bank Governor.
* Should be invested in foreign currencies, with the currency shares reflecting the geographical composition of Norwegian imports and an interest-rate risk limited to a maximum of 5 per cent of capital loss associated with a I percentage point increase in yields.
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|Publication:||OECD Economic Surveys - Norway|
|Date:||Mar 1, 1997|
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