Denmark can weather the financial crisis

BY SENIOR ECONOMIST FRANK ØLAND HANSEN, DANSKE BANK

Illustration by Lars Chrois

The subprime crisis has turned into a global financial crisis that will affect all countries around the globe, including Denmark. Global growth will be weak next year and unemployment will rise in most countries. Fortunately Denmark is likely to weather the current crisis relatively well, as it has entered the crisis from a very strong position.

Denmark has had fiscal surpluses for the past ten years and during this decade public debt has been reduced substantially from 81% of GDP to just around 26%. The fiscal surplus – around 5% of GDP in 2005-07 – has been one of the largest in Europe for several years. The current account has also showed substantial surpluses for several years. In particular, Denmark, as an oil-exporting country and a major shipping nation, has benefited from both high oil prices and elevated freight rates.

Unemployment in Denmark has fallen continuously for more than three years to the lowest level since 1974 – just 44,800 people, or 1.6 % of the labour force. This is well below the structural level, which implies that if unemployment stayed this low wages would accelerate and competitiveness worsen. Denmark’s economy was just a few degrees from overheating.

This is not to say that Denmark is unaffected by the financial crisis. In October Denmark experienced a small krone-crisis. It resulted from the withdrawal of foreign portfolio investment rather than outright speculation against the Danish krone (which is fixed to the euro). Denmark’s National Bank nevertheless decided to hike the interest rate twice and did not follow when the European Central Bank lowered its policy rate. The exchange rate has been almost unaffected, but the foreign reserves were drained by about EUR 4bn.

Falling global demand has resulted in sharply falling oil prices and freight rates. This impacts negatively on Danish export revenues. Danish exports are nevertheless performing quite well on Denmark’s major export markets. The domestic slowdown is simultaneously pulling imports down, so the current account is likely to stay in surplus, although the very large current account surpluses of the past are not expected to be seen for years to come.

Falling oil and share prices and the ongoing economic slowdown will also reduce the fiscal budget surplus substantially. In fact, it is possible that Denmark will see a small fiscal deficit next year – the first in eleven years. This is partly a result of the automatic stabilisers: in economic downturns fiscal expenditure should increase while revenues decrease. This makes the fiscal budget quite volatile, but it also helps to dampen the business cycle.

Economic growth may turn negative next year, but most Danes will still see a substantial increase in their disposable income due to planned tax cuts and wage increases. Nevertheless, due to the elevated level of uncertainty and losses on both the housing and the stock market consumers are likely to be restrained. The unemployment level is likely to bottom out in the near future, and is expected climb toward 100,000 people (3.2%) in two years’ time. This is still a lower unemployment level than many countries have entered the crisis with.

If the impact of the financial crisis on Denmark becomes more severe than expected, the good fiscal position means that the government has substantial elbowroom to put the economy back on track. But for now it should keep its powder dry. As long as unemployment is at historical lows, an expansive fiscal policy would hamper Denmark’s competitiveness.

Although economic prospects have turned to the worse, Denmark is still in a very fortunate position and is likely to weather the crisis relatively well. And of course, the negative impact of the financial crisis will not be allowed to derail Denmark’s strong ambitions on both climate policies and development aid.