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Norway warned to show 'fiscal restraint' over oil fund

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  • Norway warned to show 'fiscal restraint' over oil fund

NORWAY - Norway should exercise "some kind of fiscal restraint" in the short-term use of oil revenues if it is to limit rising inflation and reduce the predicted "financing gap" caused by increased pensions and an aging population, the OECD has warned.

In its latest economic survey of Norway, the Organisation for Economic Cooperation and Development (OECD) said Norway has performed well since the global financial crisis began in 2007, but weaker growth in the first quarter of 2008 and an increase in the headline inflation rate to 4.3% in July suggested Norway "has not totally escaped".

Patrick Lenain, supervisor of the OECD report, said the usual response to rising inflation is increased interest rates, but warned "we are in unusual times" as the global financial turmoil had resulted in tighter lending conditions among banks and other financial institutions.

He said: "It is a tough call but in our view rising inflation is the more serious concern. That would call for slightly higher interest rates in Norway especially if inflation keeps rising, to avoid a wage spiral."

The OECD admitted Norway's decision to place oil revenues in the Norwegian Government Pension Fund - Global and introduce a fiscal rule to limit the country's structural budget deficit to what can be financed by a 4% return on the pension fund's assets, "have protected Norway from the ups and downs in oil prices".

However, the report claimed "the increasing value of assets in the pension fund poses some awkward questions as to how they should be used".

It stated the assets in the fund are "currently equivalent to over 90% of GDP", so the estimated real rate of return of 4%, on assets "should provide around 4% of national income", compared to 22% for oil and gas extraction, nearly 9% for manufacturing and 1.2% for agriculture, forestry and fishing.

This is only likely to increase in the future, however the report revealed between 2001 and 2005 Norway actually spent more than the 4% rule provided, and only started to come in under budget in 2006 ad 2007.

And despite the rapid growth of the fund - estimated at an average of 25% a year - the Norwegian Ministry of Finance has predicted by 2060 there will be a "financing gap" of 7% of GDP, which the pension fund will not be able to fill.

As a result, Lenain said the survey recommended Norway "should try to inject less oil money into the economy both this year and next year" to help deal with both rising inflation and the long-term affects of an ageing population.

The report admitted Norway has less immediate pressure from an ageing population, as the effects "will not fully unfold" until after 2020, but between this point and 2060 spending on pensions will start to increase and extend the fiscal gap to 7% of GDP.

Lenain said "it would be a mistake not to act now" on pensions, because "the longer you wait the more painful the measures will be", as he claimed faster productivity and higher immigration rates would not solve the pensions problem.

Instead, the OECD warned Norway must continue to implement its agreed pension reforms on schedule, and not "extend any further concessions, particularly to younger people".

Norway's reforms, due to be implemented from 2010, include converting the state pension system into an unfunded notional defined contribution (DC) scheme; increasing the retirement age; transitioning to wage/price indexation of benefits after retirement and placing the state pension onto an "actuarial basis" - so people can choose whether to retire early on a lower pension, or later on a higher income.

However, the OECD claimed Norway's unusual and "potentially deleterious" practice of discussing policy changes with social partners before passing legislation means labour market and fiscal policy can become part of wage negotiations, as demonstrated by the concessions made over the reform of the AFP early retirement scheme. 

Both the government and social partners agreed the existing supplementary scheme, partially subsidised by the government, should be reformed from 2010 to eliminate current disincentives for older people to continue work, including placing the system on an a similar "actuarial basis" to the state pension scheme.

During the 2008 private sector wage negotiations the government agreed to an additional temporary subsidy to the AFP to cover older people born between 1948-53, to be phased-out from the 1963-cohort onwards, and to "partially defer" the life-expectancy related adjustments to benefits accrued under the existing scheme.

While the overall pension reforms are estimated to reduce pension spending by 3%, the two concessions on the AFP scheme are believed to have cost the government budget the equivalent of NOK 100bn (€12.6bn) or 6% of the current total GDP, resulting in an annual cost of 0.2% of GDP in the late 2020s.

The OECD argued while this may seem small, "the principle of buying short-term industrial peace towards the peak of a cycle, with concessions that have long-term effects is a poor one".

Roger Schjerva, finance state secretary, said: "The Norwegian authorities are in broad agreement with the OECD regarding the main challenges for the Norwegian economy. These include the need for a proper management of our oil wealth, the need to complete the pension reform, and the need for further structural reforms to sustain high labour force participation and high productivity growth,"

If you have any comments you would like to add to this or any other story, contact Nyree Stewart on + 44 (0)20 7261 4618 or email nyree.stewart@ipe.com

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