Revised National Budget 2006: Strong Growth in the Norwegian Economy

The strong performance of the Norwegian economy continues. Economic activity is high, the labour market is improving rapidly and unemployment is falling towards low levels. The Government proposes to revise the 2006 Fiscal Budget within the same structural, non-oil deficit as in the approved budget, thus maintaining a prudent fiscal policy stance.

Growth in Mainland Norway (excluding petroleum and shipping) is forecast at 3 per cent in 2006. Employment growth has picked up and is estimated at 2 per cent this year. The unemployment rate is expected to average 3.8 per cent in 2006, down 0.8 percentage points from the 2005 average.

The fiscal policy guidelines of 2001 provide for a gradual and sustainable increase in the use of petroleum revenues. Over time, the use of petroleum revenues, measured by the structural, non-oil central government budget deficit, shall correspond to the real return on the Government Pension Fund – Global (the former Government Petroleum Fund), estimated at 4 per cent. Due to adverse economic developments, deficits have exceeded 4 percent real return on the Fund since 2002, but the gap is narrowing. The gap is expected to narrow from NOK 15.5 billion in 2005 to NOK 10 billion in 2006. Long-term budget challenges due to the future increases in pension costs in the National Insurance Scheme and other age-related expenses, underline the need for a prudent fiscal policy.

The Government proposes a revision of the Fiscal Budget for 2006, keeping the structural, non-oil fiscal deficit unchanged at NOK 65.9 billion. Nevertheless, the budget revision allows for some important policy measures. Priority is given to increase the number of day-care places, to increase appropriation for roads, environmental measures and prisons. Labour market measures for disabled workers will also be strengthened.

Fiscal policy
The main features of fiscal policy in 2006 are:

• A structural, non-oil budget deficit of NOK 65.9 billion, which is unchanged from the approved budget for 2006. Excess spending of petroleum revenues compared to the expected 4 per cent real return on the Fund is estimated at NOK 10 billion.
• The structural, non-oil budget deficit corresponds to 4.5 per cent of Mainland trend-GDP, which is 0.5 percentage point higher than in 2005. The increase must be seen in connection with a downward revision of the 2005 deficit in the final accounts.
• A real underlying growth in the Fiscal Budget expenditures from 2005 to 2006 of 2¼ per cent. This is an increase of ¾ percentage point compared to the approved budget.
• A non-oil fiscal budget deficit estimated at NOK 68.8 billion, compared to an estimated NOK 70.8 billion in the approved budget for 2006.
• An increase in total revenues for local governments of 3.1 per cent from 2005 to 2006, equivalent to NOK 7.1 billion.
• A central government net cash flow from the petroleum activities of NOK 350 billion, an increase of NOK 22 billion from the approved budget. The estimate is based on an average oil price of NOK 420 per barrel.
• A net allocation to the Government Pension Fund-Global of about NOK 280 billion.
• A consolidated surplus in the Fiscal Budget and the Government Pension Fund-Global, including interest and dividends, estimated at NOK 327 billion.
• General government net lending estimated at 18.4 per cent of GDP in 2006, compared to 15.9 per cent in 2005.

Tax policy
As of 2006, all employees are covered by compulsory tax-favoured pensions schemes and all self-employed may save within the same schemes. As a result, the Government will propose to abolish the preferential tax treatment of other pension savings schemes. Otherwise, only minor changes are proposed in the tax rules.

Monetary policy
The monetary policy regulation of 29 March 2001 stipulates a flexible inflation targeting regime for monetary policy. The long-term role of monetary policy is to provide the economy with a nominal anchor. In the short- and medium-term, monetary policy shall balance the need for low and stable inflation against the outlook for output and employment.

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 consumer prices of close to 2.5 per cent over time. The interest rate decisions of Norges Bank shall be forward looking, and pay due attention to the uncertainty attached to macroeconomic estimates and assessments. It shall take into consideration that it may take time for the policy changes to take effect, and it should disregard disturbances of a temporary nature that are not deemed to affect underlying price and cost increases.

The key rate (the sight deposit rate) was on 17 March increased by 0.25 percentage points to 2.5 per cent. Norges Bank has advised that monetary policy is oriented towards a gradual increase in the interest rate – in small, not too frequent steps – towards a more normal level.

The Government Pension Fund
The Government Pension Fund was established 1 January 2006 pursuant to the Government Pension Fund Act of 20 December 2005. The Government Pension Fund is comprised of the Government Petroleum Fund and the National Insurance Scheme Fund. As of 1 January the two parts of the fund are titled “The Government Pension Fund – Global” and “The Government Pension Fund – Norway”. The activities in these two parts are maintained.

In the Revised National Budget, the Government presents a draft regulation on the management of the Government Pension Fund – Norway. The draft reflects the change in the legal basis, but implies no other significant changes from today’s regulation. The Government intends to let the Fund increase its investments in market instruments by NOK 10 billion, with effect from the beginning of next year.

At the end of 2005, the market value of the Government Pension Fund – Global was NOK 1390 billion, about NOK 80 billion higher than expected when the 2006 budget was approved. The value is estimated to grow to about NOK 1 700 billion by the end of 2006, equivalent to 84 per cent of GDP.

General outlook for the economy
The activity in the Norwegian economy is high. Domestic demand is fuelled by low interest rates and strong growth in petroleum investments. At the same time, new orders in the manufacturing and construction industry are high, and profitability in the mainland business sectors is good.

Mainland GDP is expected to increase by 3 per cent in 2006. Lower growth compared to 2005 is mainly due to lower hydroelectric power production, reflecting an assumed return to more normal precipitation in 2006 after an unusually wet 2005. Excluding this sector, growth in 2006 is estimated at close to 3½ per cent, slightly outperforming 2005.

Following nearly three years of economic growth above trend, the labour market is now tightening. Employment is increasing and the unemployment rate is falling towards a level at which wage growth has picked up in previous upturns. So far, however, inflow of workers from new EU members has given a welcome addition to the Norwegian labour force. The unemployment rate based on the Labour Force Survey (LSF) is estimated to average 3¾ per cent in 2006.

On the basis of wage negotiations concluded so far this year, wage growth is estimated to increase from 3¼ per cent in 2005 to 3½ per cent in 2006. The relatively modest wage growth so far in this business cycle must be seen in connection with the significant inflow of labour from other Nordic countries and from the new EU member countries.

The consumer price index (CPI) is expected to increase by 2¼ per cent in 2006. Adjusted for changes in excise duties and excluding energy prices, consumer price inflation (CPI-ATE) is expected to pick up from 1 per cent in 2005 to 1¼ per cent in 2006. This is ¼ percentage points lower than estimated last autumn, due to, inter alia, the strong exchange rate which points to continued weak growth in prices on imported goods.

Key projections for the Norwegian economy. Per cent ¹>

¹> Constant 2003 prices
Sources: Statistics Norway and Ministry of Finance

Key figures for the petroleum sector

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

Source: Ministry of Finance

General government net lending (surplus). NOK billion

Sources: Statistics Norway and Ministry of Finance