The Norwegian economy is entering a period with lower growth compared to the recent few years. In Norway, oil sector investments have increased by nearly 9 per cent in each of the last three years. This has created activity and employment growth in the mainland economy, and has also contributed to rising immigration for employment purposes and increasing real estate prices. This year oil based investments are expected to decline by approximately 15% and exhibit a further drop of 7% in 2016. Due to these declines the Norwegian economy is losing an important growth driver. However, a weaker Norwegian krone exchange rate will contribute positively to growth in traditional (non-oil) export industries. Another effect of a weaker currency is that private consumption expenditures are likely to be shifted more towards domestically produced goods and services, and non-Norwegian residents will probably perceive added value with regards to holidays in Norway. There is ample room for increasing public investments if the growth trajectory should disappoint. The banking sector has increased its capital coverage over the last few years and will be able to withstand a period with weaker growth and a potential increase in credit losses. Norway's mainland GDP growth will probably be approximately 1% this year and 1.5% in 2016.
Norway: oil investment survey
Norway: Business sentiment survey
Source: SpareBank1, Macrobonds
It remains uncertain exactly how large the negative effects of the decline in the oil sector investments are likely to be. The estimates range from a modest negative impact to great consequences for employment with an associated large decline in residential real estate values. The household sector carries a high debt load relative to income and this, together with an increase in uncertainty about future employment and income, may lead to an increase in personal saving rates. The average ratio of debt to disposable income of 200% may lead to increasing savings even with lower interest rates. This lower interest rate however is a catalyst for higher residential real estate prices in the years ahead, despite increases in the level of unemployment. The unemployment rate is likely to be around 4% in 2016, while wage growth is likely to stabilize at 3% for the next couple of years.
There are mainly four channels through which the price of oil influences the Norwegian economy:
Statistics Norway highlights in a recent analysis that one third of the growth in the mainland economy in 2013 can be attributed to increased petroleum sector investments. The number of oilfields which are contributing to the aggregated oil production has increased from 43 in 2004 to 68 today. With that the number of employees on the fields has increased and increased building and maintenance work is required. The number of persons engaged in administrating processes around the oil production has also increased significantly. Despite an increasing activity level the net operating profit margin in the oil producing companies has come under some pressure. When the price of oil declines it becomes necessary to adjust the cost base. The effects of these cuts will be felt mostly by western Norwegian regions and the Stavanger area in particular.
With the significant increase in the price of oil over the past 10-15 years the Norwegian sovereign wealth fund (oil fund) has grown materially. The drop in the price of oil lately has on the other hand led to that lower taxes are now paid by the oil producing companies. Lower prices and volume declines will reduce the government's tax take in the future, and the continued rise of the oil fund be paused. At the same time, cheaper oil will spur growth in the world economy and thus positively affect the equity markets, which in turn Norway's large fund will benefit from. As the fund's mandate is to invest outside of Norway, a weaker NOK will appreciate the value of the fund in NOK. According to the fiscal spending rule adhered to by successive Norwegian governments, more than 4 per cent of the size of the fund may be withdrawn for certain periods. In 2015 the Norwegian administration planned to spend an amount equal to 3 per cent of the fund's size. There is therefore ample room to stimulate the economy in the short term if the need is deemed to have occurred.
Because the oil sector is in that part of the labour market which negotiates wage settlements first it sets the tone and creates a reference point for wage settlements throughout the economy. With a cooling oil ector the wage growth is likely to moderate in the time ahead. In 2014 wage growth probably ended close to 3.5%. With inflation at close to 2% that means a real wage growth of approximately 1.5%. In 2015 inflation will increase temporarily as a consequence of imported price growth when the NOK exchange rate is weak. This will probably result in a more modest real wage growth this yea. Unemployment will increase, but probably not beyond 4% in the next few years. The labour market in Norway is flexible in the sense that high employment related immigration has been the norm in the recent past. When unemployment rises this trend is likely to reverse and workers in Norway may choose take up employment elsewhere.
Slower growth will let the inflation pressure in Norway abate and contribute to a lower exchange rate for the NOK. This is important for the export industries. A weak exchange rate contributes to higher price growth in Norway, as approximately a third of what Norwegians consume is imported goods and services. This pares real wage growth to a more moderate number compared to that which Norwegians have experienced in recent years. This again will contribute to a further cooling of economic conditions.
A weaker exchange rate is the mechanism which will assist the transformation of Norwegian industry in a time of decreased oil-related activities. A weak exchange rate makes all exporting businesses more competitive. At the same time it will become easier for non-oil areas of Norwegian industry to attract qualified personnel. Norway's central bank has signalled that with decreasing oil-related activities the monetary policy rate will be further reduced from todays' level of 1.25 per cent. A rate cut is expected in March and further that the policy rate is heading towards 0.5 per cent over the course of the next couple of years.
Norway: unemployment rate, survey (AKU)
Source: SpareBank1, Macrobonds
Norway: saving ratio, % of disposable income
Source: SpareBank1, Macrobonds
Elisabeth Holvik is the Chief Economist at SpareBank 1.