A neutral fiscal stance has facilitated an aggressive monetary policy which is expected to boost the private sector of the economy. Real growth in fiscal budget (central government) expenditures is estimated at 2 per cent in 2004. Growth in MainlandNorwayGDP (i.e. excluding petroleum and shipping) is forecast at 2.6 per cent in 2004, up from 0.5 per cent in 2003. Labour market developments have been disappointing, but are expected to improve during 2004 due to resumed economic growth. Still, the unemployment rate is estimated to average 4.7 per cent in 2004, up 0.2 percentage points from the present year.

As set out in the guidelines for economic policy (Report No 29 (2000-2001) to the Storting, available here), fiscal policy shall be geared towards a gradual and sustainable increase in the use of petroleum revenues: Over time, the structural, non-oil budget deficit shall correspond to the real return on the Government Petroleum Fund, which is estimated at 4 per cent. This rule should not be used mechanically, and the actual implementation should take into account business cycle fluctuations. As a consequence of lower estimates on the capital in the Petroleum Fund and higher estimates on the structural budget deficit, the room for future increases in the use of oil revenues is significantly reduced compared to previous projections.

In the present phase of the cycle, with unemployment increasing in particular in the manufacturing sector, the appropriate policy mix should primarily rely on an expansionary monetary policy. At the same time, fiscal policy should support growth in overall production and employment.

The fiscal budget proposal for 2004 implies a structural, non-oil deficit of NOK 50.7 billion. This implies an excess spending of NOK 16^2 billion compared to a mechanical application of the 4 per cent rule. Measured by its impact on Mainland GDP, the budget proposal implies an approximately neutral fiscal stance.

Fiscal policy

The main features of fiscal policy in 2004 are:

• A structural, non-oil budget deficit in 2004 estimated at NOK 50.7 billion, NOK 9 billion more than in 2003. As a share of trend-GDP for Mainland Norway, the deficit is estimated to increase by 0.6 percentage points. On a broader basis, the proposed budget is estimated to be neutral, measured by the effect on the overall activity level of the economy.

• A real underlying growth in fiscal budget expenditures of about 2 per cent from 2003 to 2004

• A reduction in paid taxes and excises of about NOK 2 billion from 2003 to 2004, of which nearly NOK 1.5 billion is a consequence of previous decisions and about NOK 550 million stems from new tax measures

• A non-oil budget deficit estimated at NOK 67.8 billion in 2004. This deficit is covered by a transfer from the Petroleum Fund

• Based on an estimated oil price of NOK 170 per barrel for next year, the central government net cash flow from the petroleum activities is estimated at NOK 143.5 billion in 2004

• Net transfers to the Petroleum Fund, excluding transfers to the fiscal budget, are estimated at NOK 75.7 billion. In addition, interests and dividends on the accumulated capital in the Fund are estimated at NOK 30.2 billion. The consolidated surplus of the Fiscal Budget and the Petroleum Fund, including interests and dividends, is thus estimated at NOK 105.9 billion in 2004

• General government net lending (public sector surplus) is estimated at NOK 107 billion in 2004, equivalent to 6.7 per cent of GDP. General government net assets are estimated at about NOK 1 320 billion or 82 per cent of GDP at the end of 2004.

Tax policy

A key aspect of the Government’s economic policy is to reduce the tax level, with an aim to strengthen the economy's growth potential. So far, reductions of NOK 19.4 billion have been implemented. The budget proposal for 2004 includes new changes in direct and indirect taxes that amount to a net reduction of approximately NOK 510 million, on an accrued basis. This will reduce tax revenues by approximately NOK 550 million in the 2004-budget.

Main tax proposals for 2004 include:

• In order to comply with the obligations under the EEA agreement, the system of regionally differentiated employer’s social security contributions will be changed, except for areas in the northernmost part of Norway (Finnmark and the Northern part of Troms). The current scheme will also be maintained for the agriculture, forestry and fishing sectors.
• The Government proposes a temporary exemption from the electricity tax system for all production sectors from 1 January 2004. A new electricity tax system for industries will be implemented from 1 July 2004.

• A new, low VAT-rate of 6 per cent on public transportation is proposed from 1 March 2004. This will lead to an estimated yearly tax relief for the public transportation sector of approximately NOK 500 million.

• A general VAT compensation scheme for municipalities will be introduced. The scheme will level the playing field between private and municipal producers of services.

• The tax on spirits-based alcoholic beverages is brought in line with the taxes on spirits with an alcoholic content of more than 22 volume percentage. The increased revenue will be used for a general reduction in the surtaxes on alcoholic and non-alcoholic beverages.

• The Government proposes to raise the tax on smoking tobacco, to equalize this with the taxes on cigarettes. This will increase accrued tax revenues by NOK 645 million in 2004.

• The tax on imputed income from owner-occupied housing is reduced, by increasing the threshold for assessed housing value from NOK 80 000 to NOK 90 000.

Monetary policy

The Government is committed to the monetary policy regulation of March 2001 (confer Report No. 29 (2000-2001) to the Storting). Norges Bank’s implementation of monetary policy is geared towards maintaining low and stable inflation. The operational target is defined as an annual increase in prices close to 2.5 per cent over time. The conduct of monetary policy should also contribute to stabilize developments in output and employment. Monetary policy should be forward looking, and direct effects on consumer prices stemming from changes in interest rates, taxes, excise duties and extraordinary, transient disturbances should in general not be taken into account. Consumer price inflation is as a general rule expected to remain within 1 percentage point of either side of the target.

The rate of increase in consumer prices adjusted for tax changes and excluding energy products, CPI-ATE, has since May been more than 1 percentage point lower than the inflation target. The year-on-year rise in CPI-ATE was 0.9 per cent in August.

Norges Bank has reduced its key rates by 4.5 percentage points since December last year. The key deposit rate is now 2.5 per cent.

As part of an assessment of the conduct of monetary policy, the Ministry of Finance asked Norges Bank to provide a review of monetary policy in 2002 and in the first eight months of 2003. Norges Bank submitted its report to the Ministry on 17 September.

According to Norges Bank, the low core inflation in 2003 has in particular been due to a decline in prices on imported consumer goods. The fall in prices on imports must be seen in context of the appreciation of the NOK through 2002 and low inflation internationally. Norges Bank expects the core inflation to increase gradually to around 2^2 per cent within a two year period.

A pick-up in inflation is in line with the Ministry’s forecasts. The Ministry underlines the uncertainty as to when the CPI-ATE inflation will reach 2^2 per cent and emphasizes that it may be appropriate to use a shorter or a longer time horizon than two years to reach the inflation target.

In accordance with the regulation, monetary policy shall also contribute to stable expectations concerning exchange rate developments. In its report, Norges Bank calls attention to the strong reversion mechanism in the exchange rate. Based on the experience so far, Norges Banks does not see any evidence indicating that the reversion mechanism in the exchange rate has been weakened by the introduction of an inflation target. The Ministry of Finance agrees with this assessment. The Ministry also emphasizes that analysis and communication from Norges Bank about such a mechanism may contribute to stabilizing exchange rate expectations.

The Government Petroleum Fund

By the end of the second quarter 2003, the market value of the Government Petroleum Fund was NOK 775 billion. The market value is now estimated to increase to NOK 857 billion by the end of 2003 and to NOK 966 billion at the end of 2004.

In the National Budget 2004 there is a broad review of the Fund’s investment strategy, including an evaluation of the current mix of equities and fixed income investments and a discussion of new investment alternatives. The review is based on reports from Norges Bank and Mercer Investment Consulting. The Ministry concludes that the overall investment policy should remain unchanged. However, it proposes some extensions to the list of eligible countries, adding thirteen new countries for equity investments and eight new countries for fixed income investments. The Fund’s equity “benchmark portfolio” will also be amended to include South-Africa and to exclude Turkey (for reasons relating to technical aspects of the Turkish market). There will be no change in relation to the countries of the benchmark portfolio for fixed income investments.

A public commission appointed to propose ethical guidelines for the Petroleum Fund submitted its report in June. The report is now subject to a regular public consultation process. The Government will propose ethical guidelines for the Petroleum Fund in the Revised National Budget in May 2004.

The full discussion in the National Budget 2004 on the Petroleum Fund will be made available here.

Outlook for the Norwegian economy

Economic growth internationally seems to pick up, but the outlook is mixed. GDP-growth for Norway’s main trading partners is expected to increase from 1^1 per cent in 2003 to 2^1 in 2004.

The easing of monetary policy in Norway has been both quicker and more pronounced than projected in the Revised National Budget 2003. Lower interest rates have contributed to the upswing in household demand during the last few months. The weakening of the NOK exchange rate has improved the competitive situation for the exposed industries. Strong growth in private consumption and marked increases in petroleum investments will contribute to stronger economic growth next year. Mainland GDP is estimated to increase by ^2 per cent in 2003 and 2^2 per cent in 2004.

Labour market

The weak development in the mainland economy over the last 1^2 years is reflected in the labour market. In particular, employment in manufacturing has fallen, and total employment is expected to decline by 20 000 persons this year. Unemployment has continued to increase over the last months, but the growth rate seems to be slowing down. In the three-month period to end-August, unemployment (Labour Force Survey) was 4.5 per cent, seasonally adjusted.

Unemployment is expected to stabilize towards the end of this year, and to decline somewhat during next year. On an annual basis, unemployment is expected to increase from 4.5 per cent in 2003 to 4.7 per cent in 2004.

Prices and wages

Consumer price inflation has declined substantially this year, due to the decline in the prices on imported goods and lower electricity prices. The consumer price index (CPI) is expected to increase by 2^2 per cent this year. With electricity prices returning to more normal levels, CPI growth is set to decline to 1^1 per cent next year. Excluding changes in excise duties and energy prices (CPI-ATE), consumer price inflation is expected to pick up from 1^1 this year to 1^3 per cent in 2004.

Key projections for the Norwegian economy. Volume change from previous year, per cent

Source: Statistics Norway and Ministry of Finance

Central government net lending (surplus). NOK billion

Source: StatisticsNorwayand Ministry of Finance.

Key figures for the Fiscal Budget (incl. social security) and the Government Petroleum Fund before loan transactions. NOK billion.

Key figures for the petroleum sector

Source: Statistics Norway, Ministry of Petroleum and Energy and Ministry of Finance.