Executive summary 1

1. Scene setter: economic situation and outlook 3

2. Imbalances, risks and adjustment 10

2.1. Private indebtedness 11

2.2. Housing market 18

2.3. Banking sector 26

2.4. Assessment of inter-linkages and potential impacts 31

3. Other structural issues 38

3.1. Taxation, public debt sustainability and fiscal framework 39

3.2. Labour market, education and social policies 41

3.3. Competitiveness, innovation, infrastructure and environment 50

A. Overview Table 57

B. Standard Tables 61

LIST OF Tables

1.1. Key economic, financial and social indicators 8

1.2. The MIP scoreboard 9

2.1.1. Composite index of tax incentives for owner-occupied housing 17

2.3.1. Financial soundness indicators 27

2.4.1. Stress test results: common equity Tier 1 ratio (CET1) 34

2.4.2. Estimated maximum impact of 10% decline of house prices 35

2.4.3. Maximum impact of 1 pp. increase of interest rates 36

B.1. Macroeconomic indicators 61

B.2. Financial market indicators 62

B.3. Taxation indicators 63

B.4. Labour market and social indicators 64

B.5. Expenditure on social protection benefits (% of GDP) 66

B.6. Product market performance and policy indicators 67

B.7. Green growth 68

LIST OF Graphs

1.1. External and domestic demand, contributions to growth - Sweden 3

1.2. Export market share decomposition 3

1.3. Dynamism and Competitiveness of Exports (goods) on top-10 country destinations (2012-2013)- Sweden 4

1.4. Current account balance by component - Sweden 5

1.5. Decomposition of real effective exchange rate 5

1.6. Gross capital formation by type – Sweden 6

2.1.1. Debt ratio for different groups in 2013 11

2.1.2. Change in household indebtedness since 2008 and since peak, % 11

2.1.3. Household debt growth (1999=100) 12

2.1.4. Decomposition of y-o-y changes in debt-to-GDP ratio, quarterly data, % 12

2.1.5. Estimated range of potential deleveraging needs, % 13

2.1.6. Credit supply and demand deleveraging pressures, 2013 13

2.1.7. Household debt and real property price index, (2000=100) 14

2.1.8. Proportion of mortgage borrowers who have increased, decreased or kept their debts unchanged between 2012 and 2013, % 14

2.2.1. Real house prices in the Nordic region, Index 2007=100 18

2.2.2. Average annual growth rates of real disposable income and real house prices between 2000 and 2014 19

2.2.3. Price to rent and price to income 19

2.2.4. Overvaluation gap with respect to main supply and demand fundamentals 20

2.2.5. Interest burden vs debt per gross disposable income 20

2.2.6. Real housing prices, household debt and disposable income growth (2000=100) 21

2.2.7. Revenues from property taxes (in % of GDP, 2012) 21

2.2.8. Real land price and real house price growth (2007=100) 22

2.2.9. Rent of newly built apartments vs existing stock 24

2.2.10. Change in the proportion of rental flats in blocks of flats in Greater Stockholm 1990-2012, in thousands 25

2.3.1. Lending to private sector 26

2.3.2. Loans to deposits, % 27

2.3.3. Leverage ratios (%) 28

2.4.1. Loan-to-value ratios 31

2.4.2. Household expectations of the variable mortgage rate one, two and five years ahead 32

2.4.3. Household debt ratio in different income groups (only mortgage borrowers), % 33

2.4.4. Share of financial and real assets held by indebted households in different income groups, 2007, % 33

2.4.5. Relationship between debt ratio and consumption growth, 2007-2012, % 34

2.4.6. Swedish house price correction in 1990s, 1990=100 35

2.4.7. Swedish households' interest expenditure, % of disposable income 36

2.4.8. Interest rate increase and share of households with a deficit, % 37

3.2.1. Labour market 41

3.2.2. Youth unemployment rate in EU Member States by educational status, 2013 41

3.2.3. Number of asylum seekers coming to Sweden 1995-2014 42

3.2.4. Employment rate (20-64) for non-EU born and non-EU nationals compared to total population in Sweden, 2013 43

3.2.5. Unemployment rate (15-64) for non-EU born and non-EU nationals compared to total population in Sweden, 2013 43

3.2.6. Deteriorating trend of education outcomes in Sweden 45

3.2.7. Lower secondary teachers' salaries in some EU member states at different points in their career (2012) 46

3.2.8. Age distribution of asylum applications of unaccompanied children in 2014 48

3.3.1. Employment and value added growth in market services, 2008-12 51

3.3.2. Swedish goods sector: comparative advantage 51

3.3.3. Overall efficiency of pre-insolvency framework 52

3.3.4. Greenhouse gas emissions and real GDP growth in Sweden 54

3.3.5. Share of renewables in gross final energy consumption, 2012 and Europe 2020 target 55

3.3.6. Share of SOEs turnover in total, railway 2012 56

3.3.7. Evolution of the flagged fleets of some EU Member States, 2004-13 (% change in deadweight tonnage 56

LIST OF Boxes

1.1. Economic surveillance process 8

2.1.1. Corporate indebtedness 14

LIST OF Maps

No table of contents entries found.

In 2014 and early 2015, GDP and employment growth in Sweden were supported by expanding domestic demand relying on robust consumption and an expanding construction sector, while Sweden’s export sector is struggling. As external demand gradually improves, investment and stronger exports will help Sweden's GDP growth to rise from 1.8% in 2014 to 2.3% in 2015.

Household consumption grew dynamically supported by low interest rates, growing disposable incomes and an expansionary fiscal policy in recent years. Government consumption expands due to higher spending on integration of migrants, education and elderly care.

Sweden's level of investment is high compared to its peer countries. Further investments in research and development and education could help to reverse the declining R&D investment trend and to boost the long-term competitiveness of the country. Investments in transport infrastructure to improve connectivity within and between urban areas could help to alleviate some of the constraints caused by the housing shortage.

Employment recovered more quickly in Sweden than in other EU Member States after the financial crisis. The employment rate of 79.8% is already close to pre-crisis levels and is the highest among EU Member States. Nevertheless, due to the dynamically rising labour force, unemployment has been stuck around 8% for several years and is particularly high among low-educated young people. The employment gap between those born in Sweden and non-EU migrants also remains large, especially for women.

This Country Report assesses Sweden's economy against the background of the Commission's Annual Growth Survey which recommends three main pillars for the EU's economic and social policy in 2015: investment, structural reforms, and fiscal responsibility. In line with the Investment Plan for Europe, it also explores ways to maximise the impact of public resources and unlock private investment. Finally, it assesses Sweden in the light of the findings of the 2015 Alert Mechanism Report, in which the Commission found it useful to examine further the persistence of imbalances or their unwinding. The main findings of the In-Depth Review contained in this Country Report are:

· The high level of household indebtedness in Sweden has been identified as a remaining risk for macroeconomic stability. Household debt, notably in the form of mortgages, remains at very high levels (roughly 160% of disposable income on average in 2013) and keeps expanding, with net credit flows outpacing nominal GDP growth. The challenge is particularly pronounced in metropolitan municipalities and in general negatively affects the ability of the real economy to withstand shocks.

· Unlike in many other EU Member States, house prices have not gone through any major correction in Sweden. On the contrary, they keep increasing, partly due to favourable fundamentals such as higher disposable income, low interest rates, strong demographics etc. Structural issues also contribute to house price growth in Sweden: the housing market is characterised by several market inefficiencies and weak competition. As a result, construction activity has been weak for many years, which has resulted in a housing shortage. Supply is further held back by an ineffective use of the existing housing stock due to rigidities on the rental market. However, the above-mentioned factors cannot alone explain the extent of price increases, which suggests that levels might be above their fundamental value.

The Country Report also analyses macroeconomic and structural issues and the main findings are:

· In the short and medium term, Sweden faces no major risks in terms of fiscal sustainability. Nevertheless, the budgetary impact of population ageing, in particular in the area of long-term care, is a risk element in terms of long-term fiscal sustainability. Swedish taxation is the fourth highest in the EU with a tax-to-GDP ratio (including social contributions) of 44.2% in 2012.

· The Swedish labour market, to a large extent governed by negotiations between social partners at sectorial level, is characterised by positive labour market outcomes, for instance, in terms of high employment rate. However, low-educated and low-skilled young people and non-EU nationals face high unemployment, inter alia in the context of an overall deterioration of education outcomes.

· School education results in Sweden have weakened (for instance Sweden is now performing below both the EU and OECD averages according to PISA surveys) and equity in education has been declining. The system of integrating newly arrived migrant pupils shows a number of shortcomings.

Overall, Sweden has made limited progress in addressing the 2014 country-specific recommendations.

As regards policies relevant to macroeconomic imbalances, steps have been taken to improve the efficiency of the housing market and to stem household indebtedness, such as an increase in the risk weight floor on mortgages and the forthcoming compulsory amortisation on new mortgage loans. However, no action has been taken to reduce tax deductibility of mortgage interest or to reform the rental market. Some elements of the macroeconomic imbalance relevant recommendations have thus remained unaddressed and overall, limited progress was made in implementing them.

As regards the recommendations to address other policy challenges, while this Country Report excludes an assessment of compliance with the Stability and Growth Pact, it can be noted that the Swedish government has a continued commitment to fiscal responsibility. Some progress has also been made to address challenges linked to the Swedish labour market, in particular regarding widening the use of work-based learning and apprenticeships, and fully implementing the youth guarantee.

The Country Report reveals the policy challenges stemming from the analysis of macroeconomic imbalances:

· The debt-bias in taxation still gives Swedish households incentives to take on debt. More specifically, mortgage interest deductibility and recurrent property taxation can be important drivers in this context. Sweden has made no progress in these areas, which would require a carefully sequenced implementation, minimising potential unease on the housing.

· Housing market developments are intimately linked to structural inefficiencies. Further efforts to streamline and simplify planning and building regulations, support public infrastructure investments and promote better competition in the construction sector could help increase new constructions. Reforming the rent setting procedure in order to allow wider divergence of rent levels could lead to a more effective use of the existing housing stock. Due to the municipalities' pivotal part in new constructions, any policy actions should also consider their role and revise their incentives to support new construction. Addressing the supply side constraints could smoothen house price dynamics and ease economic and social constraints.

Other challenges are:

· Developing the human capital of the low-skilled could contribute to higher employment of vulnerable groups and positively contribute to higher competitiveness. Ensuring that employment subsidies are adequately targeted is also important.

· Municipalities' strengthened responsibility for young people who are neither in employment, education or training, paves the way for additional improvements in outreach. A better developed partnership between the public employment service and various services and actors at the local level will be a key success factor.

· Deteriorating school education outcomes risk putting pressure on Sweden's competitiveness and innovation capacity in the long run. The quality of education resting on multiple pillars, a well-rounded and comprehensive approach appears important.

Overview

While domestic demand is growing at a healthy pace thanks to consumption and construction, Sweden’s export sector is struggling. Consequently, export-oriented industrial sectors remain weak while service sectors are growing at a strong pace. As external demand gradually improves, investment and stronger exports will help Sweden’s GDP growth to rise from an estimated 1.8 % in 2014 to 2.3 % in 2015 and 2.6 % in 2016 (Graph 1.1 below).

Graph 1.1: External and domestic demand, contributions to growth - Sweden

Source: European Commission

Expansionary fiscal policy and low interest rates contributed to the strong domestic demand over recent years. Although fiscal policy is expected to become neutral or slightly contractionary, household consumption growth will still find support from low interest rates, growing disposable incomes and steady employment growth in the coming years. Household saving is projected to have reached a new peak in 2014, and will only gradually decline in the coming years as economic uncertainties are waning and unemployment is starting to decrease. Government consumption is projected to expand at a strong pace due to higher spending on integration of migrants, education and elderly care.

Trade developments

Despite being one of the most competitive economies in the EU, Sweden has been continuously loosing export market shares since 2008. The cumulative export market shares loss of 17% between 2008 and 2013 is higher than of traditional peer countries', such as Germany's or the Netherlands' decline (which is approximately 9.2%), but comparable to Denmark, while outperforming Finland, which suffered almost 30% loss during the same period. The loss in Swedish export market share is concentrated in goods export, while services show moderate gains since 2010 as shown on Graph 1.2 below.

Graph 1.2: Export market share decomposition

Source: European Commission

Sluggish export performance can be attributed to several factors. As regards geographical specialisation, Sweden's export performance has been negatively affected by the deteriorating market dynamism in several of its main trade destinations (such as the Netherlands or Finland) resulting in lower import growth in those countries. Swedish export is to a large extent dependant on EU countries: almost 70% of the Swedish export goes these countries, which have been suffering from sluggish growth. The Swedish export sector could not gain additional impetus from more dynamic Asian or South-American markets in comparison with, for instance, Germany.

Furthermore, machinery, chemicals and transport equipment represent a large fraction of Swedish exports, which were the least dynamic sectors between 2000 and 2013. As investments growth was weak in Sweden's main trading partners, demand for Swedish exports remained subdued. Looking at both the dynamism of destination markets and of product basket, Sweden - together with Finland and the Netherlands - had a less favourable export composition in 2013 compared with the other EU countries.

Finally, Sweden faced deteriorating competitiveness in most of its main trading partners. This witness both price competitiveness (a typically successful strategy when competing in markets of standardised goods or in lower-income markets) and non-price competitiveness (important when competing in higher-income destination countries or in differentiated products). Graph 1.3 below provides a summary in this respect. Market dynamism is a proxy for Sweden's destination markets that compares their import growth rates with world total import growth. Competitiveness indicator compares the growth of Sweden's exports with the growth of total world exports to these markets. The size of the bubbles indicate the countries' weight from Swedish export goods.

Graph 1.3: Dynamism and Competitiveness of Exports (goods) on top-10 country destinations (2012-2013)- Sweden

Source: European Commission, Comtrade

The Russian-Ukrainian crisis had so far limited direct impact on Swedish trade and growth as the direct trade exposure towards these countries is small. Russia constitutes less than 1.5% of Sweden’s goods exports (most importantly automobiles, telecommunications equipment and chemicals) and approximately 1% of its services exports. While Russia constitutes 5% of Swedish imports, these are almost exclusively raw materials, in particular crude oil and coal (and there are no imports of natural gas) ([1]).

Sweden's current account surplus gradually declined from its peak of 9.4% of GDP in 2008 to 5.8% in 2014. As demonstrated in Graph 1.4 below, while the contribution of services and net incomes to the current account balance have been slightly increasing, the trade surplus from goods export is diminishing resulting in declining current account surplus. As Swedish households' record high savings rate decrease and investments pick up, the adjustment of the current account surplus will likely continue.

Graph 1.4: Current account balance by component - Sweden

Source: European Commission

Sweden displays a moderately negative net international investment position, which, however, has been improving in recent years. At ‑6.4% of GDP in 2013, the Swedish net international investment position is well within the MIP scoreboard threshold of -35% of GDP and thus presents no sustainability concerns. High current account surplus will contribute to slowly improve the net international investment position. Furthermore, if foreign direct investments are valued at market terms and not at book value, the NIIP has been in positive territory already since 2006([2]).

Swedish cost developments against those of its trading partners do not indicate major challenges in terms of competitiveness. While the real effective exchange rate has appreciated between 2010 and 2013, as shown in Graph 1.5 below, the weakening Swedish krona since 2014 could positively impact export performance. Unit labour costs have been growing in line with Sweden's main trading partners, but consumer price inflation, measured by the Harmonised Index of Consumer Prices has been growing more slowly (see also Section 2.3).

Graph 1.5: Decomposition of real effective exchange rate

Source: European Commission

Investments

Overall investment levels in Sweden are higher than in comparable EU economies (such as Germany, the Netherlands or Denmark). Investments have been weak in industry, but service sector and public sector investments have been rising. High public sector investment is driven by a major need for improvements in both local and central government infrastructure including housing. Residential housing investment has been particularly low for a long time despite dynamically rising house prices, but in light of the strong demographic developments, rising urbanisation and a housing shortage, there are major investment needs in the country. For instance, investments in transport infrastructure to improve connectivity within and between urban areas could help to alleviate some of the constraints caused by the housing shortage. Rising house prices together with supply side constraints hindering new constructions are considered as a macro-economic imbalance of the country and analysed in detail in Section 2.2.

As a small, open economy where export constitutes to approximately 50% of GDP, external market development strongly affect Swedish manufacturing investments. Weak Swedish export market performance was thus mirrored in sluggish industrial production and weak manufacturing investments. As a result, Swedish productivity growth also struggled to recover to pre-crisis levels, because the expanding service sector increased the share of the low-productivity jobs at the same time that manufacturing investments and jobs were shrinking. Besides the challenges related to Swedish export market destinations, product diversification coupled with deteriorating competitiveness discussed above, improving local business environment could also positively impact export performance and thus indirectly manufacturing investments. Compared with its main peer countries such as Germany or Denmark, Swedish SMEs fall behind in level of internationalisation in the form of foreign trade. should increase The proportion of high value added exports goods and services of Swedish companies could also increase. The Swedish government announced to launch a new export strategy in order to address these challenges.

Following a contraction of 0.4% in 2013, Swedish investments have increased at a rate of 4.7% in 2014. The acceleration was mainly driven by investments in housing, expanding at the range of 20%. While growth of housing investments is expected to slow down, other investments will catch up based on stronger external demand. Nevertheless, low capacity utilisation and fragile external developments will continue to mute manufacturing investments.

Graph 1.6: Gross capital formation by type – Sweden

Source: European Commission

Employment

Despite a relatively modest economic activity, employment growth has been particularly strong in recent years. Employment recovered better in Sweden following the financial crisis than in other EU countries. The current employment rate is already close to pre-crisis levels and is the highest among EU countries. Nevertheless, due to the dynamically rising labour force, unemployment has been stuck around 8% for several years. The ongoing challenge for the Swedish labour market is to integrate the growing number of economically and socially vulnerable groups (see also Section 2.2).

Inflation

Inflation in Sweden has been around 0% since the end of 2012 because of low price increases for energy and services and because import prices have been weak as a result of subdued international economic activity. In February 2015, the Swedish central bank cut its repo rate from 0% to -0.1% and announced the purchase of government bonds. In spite of growing consumption and employment, a negative output gap and a high unemployment rate suggest ample spare capacity in the economy, which would suppress price increases. Falling oil prices are also pushing inflation down. Policy discussions continue to take place in Sweden on the use and impact of further non-conventional monetary measures to fight deflationary pressures.

Public finances

In December 2014, the opposition parties’ budget was voted by the Swedish Parliament, causing a political crisis in the country. However, since both the opposition and the government budgets contain only fully-funded measures in line with the ‘krona for krona’ principle, this will not have a significant impact on the government balance. After the nadir in 2014, public finances are expected to improve, and the deficit to reduce to 1.6% in 2015 and 1.0% in 2016. Negative risks to the budget could come from a potentially worse macroeconomic outlook and higher costs for integrating the large inflow of migrants.

Domestic debt

Public debt stands at a relatively low level of around 41% of GDP in 2014, below the 60% of GDP reference value stipulated in the Treaty (see also Section 2.1). As government budget deficit is expected to gradually improve, public debt will gradually decline in the coming years.

Consolidated private indebtedness remains at 201% far above the MIP threshold of 133% of GDP. The main concern is household debt, which is still dynamically increasing driven by favourable credit conditions and house price increases, and for which reason it is analysed in detail in Section 2.2.

Table 1.1: Key economic, financial and social indicators

1 Domestic banking groups and stand-alone banks. 2 Domestic banking groups and stand-alone banks, foreign-controlled (EU and non-EU) subsidiaries and branches. 3 Real effective exchange rate (*) Indicates BPM5 and/or ESA95 Source: European Commission, ECB

Table 1.2: The MIP scoreboard

Figures highlighted are the ones falling outside the threshold established by EC Alert Mechanism Report. For REER and ULC, the second threshold concerns non-Euro Area Member States. (1) Figures in italic are according to the old standards (ESA95/BPM5). (2) Export market shares data: the total world export is based on the 5th edition of the Balance of Payments Manual (BPM5). Source: European Commission

Box 1.1: Economic surveillance process The Commission’s Annual Growth Survey, adopted in November 2014, started the 2015 European Semester, proposing that the EU pursue an integrated approach to economic policy built around three main pillars: boosting investment, accelerating structural reforms and pursuing responsible growth-friendly fiscal consolidation. The Annual Growth Survey also presented the process of streamlining the European Semester to increase the effectiveness of economic policy coordination at the EU level through greater accountability and by encouraging greater ownership by all actors. In line with streamlining efforts this Country Report includes an In-Depth Review — as per Article 5 of Regulation no. 1176/2011 — to determine whether macroeconomic imbalances still exist, as announced in the Commission’s Alert Mechanism Report published on November 2014. Based on the 2014 IDR for Sweden published in March 2014, the Commission concluded that Sweden was experiencing macroeconomic imbalances monitoring and policy action, in particular, developments in the areas of household debt, linked to the high levels of mortgage debt and structural characteristics of the housing market, as well as unfavourable developments in export market shares. This Country Report includes an assessment of progress towards the implementation of the 2014 Country-Specific Recommendations adopted by the Council in July 2014. The Country-Specific Recommendations for Sweden concerned public finances, private indebtedness, housing market and labour market.

Households' indebtedness developments

Households' debt in Sweden is high and growing faster than in the rest of the EU

The economy-wide debt to disposable income ratio was 160% in Sweden in 2013. However, for indebted individuals the ratio is substantially higher. A recent study by the Riksbank ([3]) shows that the debt ratio reaches 313% for households that have a mortgage and even 370% for new mortgage borrowers ([4]) as reflected in Graph 2.1.1.

Graph 2.1.1: Debt ratio for different groups in 2013

Source: Riksbank

Moreover, for households with mortgages the debt ratio averages over 400% in the three metropolitan municipalities (Stockholm, Göteborg, Malmö).

Households' indebtedness is still growing in Sweden while some deleveraging has already taken place in peer countries, i.e. the debt to GDP ratio has come down. While most EU Member States' households reached a peak in indebtedness in the post-2008 period - for instance, Denmark and the UK peaked in 2009 and the Netherlands in 2010 - household debt in Sweden, as in Finland, is still growing (Graph 2.1.2).

Graph 2.1.2: Change in household indebtedness since 2008 and since peak, %

Source: European Commission

Moreover, household debt has been growing faster in Sweden than in the rest of the EU especially since 2007 (Graph 2.1.3).

Graph 2.1.3: Household debt growth (1999=100)

* Excluding Luxembourg and Malta Source: European Commission

Households' debt to GDP is still increasing mainly driven by net credit flows outpacing nominal GDP growth (Graph 2.1.4).

Graph 2.1.4: Decomposition of y-o-y changes in debt-to-GDP ratio, quarterly data, %

Source: European Commission

Comparative analysis puts Sweden among the Member States with the highest need for deleveraging

Two methods are used for estimating the deleveraging needs: one is based on a Commission analysis of debt sustainability ([5]), the other on an analysis by the IMF ([6]) of historical boom and bust episodes. The first method defines a country-specific sustainable level of debt by inferring debt that is consistent with households' assets corrected for valuation effects (marked with a grey dot in Graph 2.1.5). The second method is based on the "typical" extent of deleveraging in past episodes, and is a function of the preceding debt increase, this is the historic method (marked with a yellow square). The midpoint line shows the average of the results provided by these methods.

For Sweden deleveraging needs for households may be above 20% of GDP ([7]). This is also the case for Denmark and Greece. However, the implications of these deleveraging needs - in terms of pace, of mode of deleveraging and of the overall implications for economic activity- will largely depend on the state of credit demand and supply, which reflect the strength of the economy as well as the state of the financial sector (for the latter, see Section 2.3).

Graph 2.1.5: Estimated range of potential deleveraging needs, %

Source: European Commission, IMF

In Sweden, credit demand and supply conditions are benign and have even improved since 2009. Graph 2.1.6 combines two composite indicators to reflect the two sides of credit market conditions. For Sweden both supply and demand sides conditions improved since 2009 suggesting a potentially smooth and gradual adjustment of household debt. It could be mostly driven by nominal growth of the economy in the medium term if appropriate policy measures are taken to contain the growth pace of net credit flows.

Graph 2.1.6: Credit supply and demand deleveraging pressures, 2013

Source: European Commission

Debt-containing measures and still effective debt-drivers

Incentives to take on debt are still strong

Measures taken by the Swedish authorities have not been sufficient so far to curb the progression of household debt to GDP. Even though net credit flows moderated since Q4 2010, they still amounted to 3.8% in 2013 and still outpace nominal GDP growth driving household debt to GDP further upward.

Several factors lie behind the continuous increase of household debt:

The continuous increase in housing prices -fuelled by housing supply constraints - over the past two decades has led to larger mortgage loans (Graph 2.1.7). Housing price developments have been even sharper for tenant-owned apartments (see Section 2.2).

Graph 2.1.7: Household debt and real property price index, (2000=100)

Source: Riksbank

Generous tax incentives on mortgage interest payments create an incentive towards home-ownership via indebtedness.

Low interest rates and benign credit conditions make higher loan-to-value mortgages more affordable. Moreover, the possibility to take unsecured loans on top of the 85% loan-to-value cap increases the potential amounts borrowed.

· A weak amortisation culture translating into limited amortisation and long actual repayment periods favours a growing stock of debt. As illustrated on Graph 2.1.8 only 38% of mortgage borrowers amortise fully their mortgage loan in less than 50 years, 23% amortise over a longer period and 39% are not amortising.

Graph 2.1.8: Proportion of mortgage borrowers who have increased, decreased or kept their debts unchanged between 2012 and 2013, %

Source: Riksbank

Policy responses so far have mainly focused on macro-prudential measures

Several measures, mainly macro-prudential, have been adopted to contain the demand for credit, promote amortisation and strengthen banks' resilience. On the demand side for credit, an 85% loan-to-value cap was introduced by the Financial Supervisory Authority in 2010. Moreover, several measures have been introduced to promote a stronger amortisation culture. In March 2014, the Swedish Bankers' Association recommended that new mortgage loans be amortised down to 70% (instead of previously 75%) over 10 to 15 years. In November 2014, the Financial Supervisory Authority announced a forthcoming regulation: New loans will have to be repaid in two steps; mortgage holders with a loan-to-value ratio above 70% will repay at least 2% of their original loan each year. Once at 70% or below, households will repay at least 1% each year until the loan-to-value ratio reaches 50%. The regulation is still forthcoming and the definitions of “new loans” and of “temporary exceptions” (e.g. linked to sickness and unemployment) are to be determined.

Furthermore, individual amortisation plans are being applied by banks since July 2014 following an initiative by the Financial Supervisory Authority and the Swedish Bankers' Association. A discussion between the lender and the borrower about amortisation should take place before the final amortisation plan is proposed. Also, this plan should be in the best long-term interest of the customer. The objective is to allow households to make a decision about amortisation by having banks clearly showing how amortisation affects a household's finances in the long-run. This measure together with the public debate on amortisation seems to have incentivised new borrowers to take on an amortisation plan ([8]). However, for the moment, this plan can be interrupted and household can decide to repay interests only.

A new government regulation on fairer rules for repayment of mortgages entered into force in July 2014. This regulation aims at facilitating the possibility for the consumer to repay one's fixed rate mortgage or to switch banks, thus increasing competition in the market. It has two main components. First, the government proposes a new model for the calculation of interest rate compensation for the banks, corresponding to the actual costs for the bank. Second, the regulation limits the creditors' right to ask for the repayment of a mortgage when the value of the security for the loan has decreased as a result of a general downturn in the housing market. From a financial stability perspective, this measure restricts banks' option to transfer the risk of a general market fall to the household sector. This recent measure doesn't seem to have incentivised more repayments so far possibly because households might not be aware of it.

Further measures have been implemented regarding banks' resilience (Section 2.3) and housing supply (Section 2.2).

No reform has been undertaken in Sweden to limit the generous tax deductibility on mortgage interest payment or increase recurrent property taxation to reduce households' incentives to take on debt.

Box 2.1.1: Corporate indebtedness Consolidated corporate debt is slightly decreasing compared to 2012 and reached a level of 125% of GDP in 2013. Since the peak in 2009, the leverage ratio fell by nearly 20% of GDP. This development is mainly driven by negative credit flows due to relatively weak economic growth. Considering the contribution of different underlying variables to deleveraging, 'other changes' contributed increasingly positively to the debt-to-GDP level in recent quarters including e.g. valuation changes due to foreign currency denominations, debt write-downs or other. The restructuring of firms' financing from abroad might have contributed to the deleveraging of firms. Restricted tax deductibility for intra-group interest expenses has reduced the attractiveness of intra-group loans while lower corporate tax rates should support a favourable business environment. The new tax rules together with a reduction of the corporate income tax from 26.3 to 22% in 2013 showed considerable effect on intra-company loans as the annual growth rate of these loans plummeted by 20% in 2013. Sweden's corporate marginal tax rate of 22% is now slightly above EU average (21.3%) and lower than the tax rate in comparable countries. Graph 1: Right picture: Contribution to deleveraging, Left picture: Inter-company loans

Source: European Commission, Statistics Sweden

Non-financial corporations' balance-sheet indicators are healthy and interest payments are decreasing due to the low interest rate environment. Gross saving as a per cent of gross value added is largely positive (average of 23.2%), indicating that profits are sufficiently high to avoid taking on liabilities. Gross debt-to-equity ratio is decreasing and reached 59% at the beginning 2014. Debt-to-financial-asset ratio is stable and slightly decreasing in the last two years ([1]).

Notwithstanding healthy balance sheets, some studies suggest the need for a further deleveraging (of a magnitude that can be accomplished by passive deleveraging). The analysis takes different deleveraging indicators into account as well as different time periods (2). This range of deleveraging values should only be taken as an indication. Cross-border lending might overstate the deleveraging need. Additionally, favourable credit demand and supply conditions in Sweden are expected to support a smooth "passive" deleveraging path where the debt-to-GDP ratio decreases while positive nominal credit flows are outpaced by nominal GDP growth.

([1]) The debt-servicing ability of the corporate sector has improved with the low level of interest rates and the favourable economic predictions. This is shown by a declining default rate.

(2)The methodology has been described in the Quarterly Report on the euro area 4, December 2014.

This contrasts with several Member States where taxation reforms concerning mortgage interest deductibility have been undertaken to curb households' demand for mortgage loans. For instance, Spain and Ireland removed interest relief entirely for new mortgages from 2013, while Denmark, Finland and the Netherlands are reducing it gradually ([9]). The UK is also an example of a gradual and complete phase-out of the tax subsidy. These reforms have proven effective in reducing tax incentives to home-ownership via debt. As demonstrated in Table 2.1.1, after completely phasing out mortgage interest deductibility, the UK scores as "low" on tax incentives. Denmark went from "high" in 2011 to "medium" in 2013 after reducing the value of the deduction on mortgage interest payments. Sweden still scores high on tax incentives due to a very high score on mortgage interest deductibility.

Table 2.1.1: Composite index of tax incentives for owner-occupied housing

Source: European Commission calculations

To conclude, household debt in Sweden is high and still growing leading to households' deleveraging needs estimated at 20% of GDP. Rising housing prices, substantial tax subsidies, a weak amortisation culture and historically low level of interest rates are fuelling the rise in indebtedness. Even if households' assets are high at aggregate level and disposable incomes have grown over the past years, the household sector in Sweden is more vulnerable than before as described in Section 2.4. Sweden currently benefits from benign credit market conditions which indicate that with appropriate policy measures, Swedish households could engage in a passive deleveraging mode. The Financial Supervisory Authority's announcement of a regulation to push amortisation down to 50% on new mortgage loans is a significant step to re-establish an amortisation culture. However, the debt-bias in taxation, particularly the tax deductibility of mortgage interests, has not been tackled so far.

Housing market developments

Rebounding Swedish house prices

Swedish house prices grow again strongly since mid-2013. While real house prices grew by 1.9% in 2012 and 2.8% in 2013, they accelerated to 7.4% in 2014. Such dynamic growth rates were last observed between the period of 1997 and 2007, when real house prices grew at a yearly average of 8% and real house prices doubled during this ten year period.

On the EU level, house prices have been declining since 2007. Sweden, however, is characterised by growing house prices over the same period, as shown in Graph 2.2.1 below. Among countries comparable to Sweden, Denmark and the Netherlands have gone through steep adjustments, with real house prices in 2014 close to 25% lower than in 2007. In Finland, house prices have remained broadly stable during this period. By contrast, Sweden is among the small group of EU countries, where house prices have not gone through a major correction, have not reached their peak yet and also show no signs of possible correction in the near term.

Graph 2.2.1: Real house prices in the Nordic region, Index 2007=100

Source: OECD

After historically low levels in 2013, preliminary figures show that housing investment rebounded sharply in 2014 by 27 %, or 38 500 units. The construction of new housing could stay around this level in the coming years ([10]). Nevertheless, even with this surge, Swedish investment in housing stays below the level of its peer countries or the EU average as percentage of GDP. Despite steadily growing demand for housing and rising house prices in Sweden, investment to new housing has been subdued now for a prolonged time now. Between 2000 and 2014, housing investment amounted to an average of 3.4% of GDP in Sweden, lower than in Finland or Denmark where these values reached 6% and 4.9% respectively, but comparable to the UK.

House price developments

Indicators point to overvaluation

Previous in-depth reviews have indicated that Swedish house prices appear to be above their fundamental values. They also concluded that favourable fundamentals cannot fully explain the situation; other factors appear to contribute to elevated house prices. Real house prices have been growing at a higher pace than real disposable incomes similarly to the UK, but contrary to other European peer countries, as demonstrated in Graph 2.2.2 below.

Graph 2.2.2: Average annual growth rates of real disposable income and real house prices between 2000 and 2014

Source: OECD

House price increases have been particularly large in the urban areas of Sweden driven by strong urbanisation trends and constraining housing supply factors.

Traditional indicators show house prices above long-term average levels. According to price to income (affordability) and price to rent (dividend) ratios Sweden's house prices point to an overvaluation territory of 25-40% compared to 15-30% of last year (see Graph 2.2.3 below). Even if such calculations have to be taken with caution, they corroborate the main trends: house prices are increasing with reinvigorated strength since mid-2013 from the already high levels.

Graph 2.2.3: Price to rent and price to income

Source: European Commission, OECD, ECB, BIS and European Commission calculations

Econometric models also suggest that house price cycles in Sweden cannot be explained only by fundamental factors. Swedish house price have not gone through a bust period comparable to those observed during past cycles, as depicted on Graph 2.2.4 below. Rather they possibly entered into another boom period starting from 2012 indicating a growing potential overvaluation with respect to the main supply and demand fundamentals. Econometric models suggest that even small changes in the underlying drivers of the house prices (for instance when the interest rate is set too low or mortgage tax deductions too high) could have strong and sudden implications on stability.

Graph 2.2.4: Overvaluation gap with respect to main supply and demand fundamentals

(1) Data for 2014 is provisional Source: European Commission calculations

Demand side drivers

Strong demand side incentives remain

Swedish house prices are driven by a strong structural demand: Sweden has experienced a prolonged period of robust disposable incomes growth and the population of the country is growing dynamically also due to the high number of immigrants arriving (section 3.2). The fact that inhabitants per dwelling has been slightly increasing since 2009 is mitigating immanent demand ([11]).

Credit incentives have been particularly favourable. Low inflation is translated into decreasing mortgage loan rates, which allow households to take higher loans while keeping their monthly payments at the same or decreasing level. The high share of variable mortgage is translating lower interest rates to lower monthly payments expanding households' perceived ability to borrow. As a result, although private indebtedness compared to disposable income has been growing steadily, the interest burden of households shows a declining trend (Graph 2.2.5 below).

Graph 2.2.5: Interest burden vs debt per gross disposable income

Source: European Commission

Favourable credit conditions have been magnified by the availability of amortisation-free mortgage loans. The average actual repayment period could be even more than 140 years ([12]). These types of loans started to increase substantially in Sweden from 2007 and have become dominant on the Swedish mortgage market ([13]). The availability of these loans allows households to significantly expand their borrowing capabilities in particular with low interest rates([14]).Graph 2.2.6 below shows that house prices and private indebtedness have been growing in tandem until 2007. After 2007, although real house price growth moderated, private indebtedness grew at a higher pace, inter alia, on account of favourable mortgage conditions. Incentives for risky debt-taking in Sweden are one of the highest among EU countries, due not least to the high proportion of non-amortised loans and loans with variable interest rates.

Graph 2.2.6: Real housing prices, household debt and disposable income growth (2000=100)

Source: European Commission, Statistics Sweden, OECD

The current taxation system in Sweden tends to push up house prices. Sweden (together with the Netherlands) applies the highest incentives in the tax system for home ownership. Taxation of properties in Sweden is below the EU average, producing revenues equivalent to 1% of GDP in 2012 as shown in Graph 2.2.7. In addition, the most generous tax subsidies to mortgage interest in the EU are recorded in the Netherlands, Sweden and Denmark, which further incentivise household to take debts ([15]). While most countries made efforts to reduce tax incentives and to apply more neutral tax treatment to home ownership (also due to strong fiscal consolidation needs), these incentives have been unchanged in Sweden.

Graph 2.2.7: Revenues from property taxes (in % of GDP, 2012)

Source: European Commission

Supply side drivers

Supply sides constraints hamper new constructions and effective use of the existing housing stock

Structural issues also contribute to house price growth in Sweden: the housing market is characterised by several market inefficiencies on the supply side. As a result, construction activity has been suppressed for many years and resulted in a widespread housing shortage all across Sweden. The housing shortage of between 90 000 and 160 000 thousand dwellings could exist currently in Sweden. At least the construction of 40-50 000 new apartments would be necessary to gradually eliminate this shortage on medium term ([16]), which would not be reached if the current supply side constraints remain in place. Supply is further suppressed by ineffective use of the existing housing stock due to rigidities on the rental market.

Regulation

Municipalities have a central role in supporting new constructions: they have the planning monopoly, plan and finance public infrastructure projects and own high proportion of land eligible for construction. Nevertheless, municipalities do not have sufficient (financial) incentives to support construction activities. Tax revenues increase, if at all, only moderately and in the mid-term, while increased residential construction will entail public infrastructure investments to be financed by them.

Municipalities, having the planning monopoly, often impose different local standards and requirements which fragment the market. Such fragmentation reduces efficiency, increases building costs and raises uncertainty for construction companies.

Sweden's residential investment market is characterised by long and complex planning and zoning process that negatively impact supply responsiveness. Swedish authorities' made some improvements to streamline and simplify planning regulation in recent years. As a result the amount of time needed for approval of new construction has been reduced to 5-6 years from 8-10 years, but is still long compared to the 3 years average of, for instance, Germany.

Public infrastructure projects can positively impact housing supply in the medium term. Investment in road, railways or metro line facilitates commuting to main urban areas. In Sweden, the County Administrative Boards are responsible to draw up and adopt a plan for regional transport infrastructure development. A good example is the plan to extend metro lines in Stockholm which could involve the construction of 78 000 additional homes until 2030. Nevertheless, municipalities enjoy relative independence in their public transport strategy including the funding. Considering wider regional perspective across municipalities would also allow to better incorporate housing aspects when designing infrastructure projects.

Municipalities also retain extensive ownership of the land: across the country roughly 60-70% of all housing starts takes place on municipal land that has been transferred to construction companies. In this context, the Swedish Competition Authority has found that the land allotment procedures are often inefficient and non-transparent in Sweden. Since the value of the land is increasing at a higher pace than the value of new housing (as shown in Graph 2.2.8), large construction companies can "wait-and-see" by initiating only limited new constructions and rather capitalising on rising land prices ([17]).

Graph 2.2.8: Real land price and real house price growth (2007=100)

Source: Statistics Sweden

Once building permits have been granted, municipalities do not have leverage on real estate developers to start constructions ([18]).

The Planning and Building Act was modified in 2014 to simplify the planning permission process in order to increase supply of housing. Effective as of July 2014, house owners are allowed to carry out certain modifications and additions to their property without having to acquire a building permit from the municipality. In principle, these are the construction of ancillary buildings (such as garages and storage), as well as small dwellings of a total of 25 m2. These buildings are popularly known as “Attefall houses”, after the previous Minister for Public Administration and Housing. It is too early to assess whether the measure is indeed playing a real role in addressing the housing shortage. Nevertheless, an evaluation of the first few months of implementation in the three most populated urban municipalities of Stockholm, Gothenburg and Malmö suggests that the uptake has been slow, at least in the first period: most notifications in these areas (almost 60%) concern the extension of existing houses, while Attefall houses account for less than 6%.

Competition

The Swedish construction sector is characterised by weak competition. The issue has repeatedly been addressed by the Swedish Competition Authority, which has identified challenges both regarding the construction of buildings as well as infrastructure such as roads, bridges, tunnels etc. While foreign companies are typically competing in infrastructure projects, housing constructions tenders are typically left to domestic companies. Entry barriers on the market are high deriving among other factors from the extensive ownership of land, exclusive contacts with local authorities, complex and diverging building requirements across the country. The lengthy and cumbersome planning and zoning procedures also mean that companies need to be knowledgeable of the local conditions and understand how to navigate the municipal planning monopoly([19]).

Small and medium-sized enterprises (SMEs) in the construction sector face difficulties to access finance, which can be a large constraint in terms of launching new projects, even such ones that the firms themselves consider relatively low-risk and into which they are willing to invest their own capital ([20]).

The construction material sector is operating in a heavily regulated environment, due to various standards and norms and the need for very precise qualities as regards for instance durability, size, compatibility with other products etc. Both the production and the distribution of construction materials are in general characterised by large economies of scale. As a result, the construction sector is dominated by four large, vertically integrated companies, whereof the three biggest account for half of the turnover in the industry. These four companies also produce important input such as concrete and asphalt, giving them a competitive advantage over smaller and/or foreign companies that still largely face difficulties penetrating the market. Recently, there are signs that foreign actors are becoming more active in large-scale infrastructure projects, while their involvement still remains limited as regards housing and construction material.

The Swedish government decided in 2014 to commission a public inquiry on how to promote competitions. The results of the inquiry are due to be published in October 2015.

Rental market

The Swedish rental market is characterised by growing structural imbalances, in particular, in dynamically growing urban areas. Therefore it does not seem to fulfil its role in alleviating house price pressure or support mobility needs. Ineffectiveness can be witnessed in the long waiting queues and low turnover of rental units, a developing black market (for instance, sub-letting without the permission of the landlord and at rent levels higher than those of equivalent rental units or trade with rental contracts), suppressed construction of rental units and increased rate of transformation of existing rental apartments to owner-occupied dwellings, in particular in the main urban areas ([21]). Sub-optimal use of the existing housing stock, in particular on the rental market, is one of the main reasons for the housing shortage in Sweden resulting in significant welfare loss.

Market inefficiencies are primarily attributed to the high level of rent control. Sweden is characterised by the highest levels of rent control among EU Member States ([22]). Rent levels are negotiated between the Swedish Union of Tenants (Hyresgästföreningen) and the housing companies. Rental prices are based on a rent valuation model based on a set of characteristics defined as the so-called 'utility value' of any given dwelling. These characteristics include factors such as the standard, services offered and the condition of the dwelling, but location is only taken into account to a very limited extent.

The current rent control, hence, does not allow more differentiated rental prices in the most attractive areas. As a result a significant gap has opened up between actual rental prices and market prices in urban areas. The difference between those prices is apparent if rents on the existing stock are compared with newly constructed rental apartments (in which case rent levels can be set outside the utility value system for the first 15 years). As depicted in Graph 2.2.9, the rent for newly built apartments is considerably higher than for the existing stock.

The growing difference between actual and market rents triggers excessive demand for rental units and creates a lock-in effect. Existing tenants would not want to give up their favourable conditions for renting the apartment below market prices while new entrants cannot access rental apartments. Students, young and low-income households cannot access cheap, entry-level housing thereby negatively affecting labour mobility, as well as having important social implications.

Graph 2.2.9: Rent of newly built apartments vs existing stock

Source: Statistics Sweden

Divergence between actual and market rents also incentivises conversion of rental units to owner occupied dwellings. As a result the numbers of rental units have decreased by almost 20% in Stockholm between 1997 and 2012, mainly due to the high conversion of existing rental dwellings as shown on Graph 2.2.10. By contrast, in areas where the gap between existing rental price and market prices have not opened so widely, the number of rental units have even increased and the incentives for conversions have been limited (for instance in Uppsala or in Örebro).

The insufficient supply on the rental market creates a pressure on other type of housing; most notably on tenant-owned apartments (which are the closest substitute in urban areas) further intensifying their price increase. Inefficient use of the existing rental units also contribute to the supply side constraints of housing and could result in significant welfare loss primarily in the urban areas and an undersupply of 40 000 rental units has been accumulated in the country - out of which 27 000 in Stockholm([23]).

Graph 2.2.10: Change in the proportion of rental flats in blocks of flats in Greater Stockholm 1990-2012, in thousands

Source: Boverket, Statistics Sweden

Subletting rental units or tenant-owned apartments remains constrained. Such a possibility is subject to the agreement of the building association owning the apartment, rental prices cannot be set freely and remain uncertain due to possible litigations. Reforming the rent price setting procedure in order to allow wider divergence of rental prices, for instance by considering location and rental prices for private and/or newly built apartment rental prices would allow to close somewhat the gap between market prices and existing rental prices in urban areas and/or could allow cheaper rental prices in less attractive areas.

Further challenges will emerge to address the housing needs of the big number of migrants in Sweden. Elevated house prices, non-availability of social housing, high requirements (for example regarding income levels) or unavailability of rental apartments pose serious challenge for these people to integrate in the labour market.

No new policy action has been taken in 2014 to tackle these shortcomings. The Swedish authorities aim to evaluate first the impact of already implemented policy measures on the rental market.

Housing market concerns are closely interlinked and reinforce each other. For instance, unavailability of rental dwellings forces people to buy apartments, thereby fuelling house price growth. Inefficient use of existing dwellings supresses existing housing supply thereby increasing pressure on new construction and rental market. Lack of infrastructure investments would put further upwards price pressure on house prices in core urban areas, which could further incentivise the conversion of rental dwellings. Therefore a coordinated policy approach could tackle these inefficiencies.

The increase in private indebtedness is fuelled by bank credit. Lending for house purchases in Sweden is growing at a relatively high rate, despite a slow-down after 2010 (Graph 2.3.1). Mortgages are an ever growing part of banks' assets. The banking sector is not only contributing to the growth of household debt, but it is also exposed to related risks such as credit risk and funding risk, which are analysed in this section. Swedish banks might bear negative consequences should those risks materialise. More importantly, they could act as a transmission channel amplifying the impact of developments in the housing market on the economy. Hence, banks need robust capital and liquidity buffers to absorb such potential shocks.

Recent developments and challenges

Sweden has a large and internationally exposed banking sector. At the end of 2013, total domestic and foreign assets accounted for 400% of GDP. Swedish assets constitute more than half of the total balance sheet. The domestic exposures have been increasing in recent years on the back of credit expansion. In 2014, the banks' foreign business has also picked up. The banking sector is dominated by four large groups: Nordea, Svenska Handelsbanken, SEB and Swedbank, which together have 83% market share in terms of total assets.

Swedish banking groups have systemic importance in the Nordic-Baltic region. Total foreign exposure of banks amounted to 168% of GDP in mid-2014, up from 160% in mid-2013. It was mainly directed towards Denmark, Finland, Germany, the US and the UK. Exposure to the Baltic countries corresponded to about 10% of GDP. While the Baltic business holds a relatively minor share on Swedish banks' balance sheets, the Swedish banks constitute the pillars of the Estonian, Latvian and Lithuanian financial sectors. In the wake of the crisis, Swedish banks have been passively deleveraging the Baltic markets and replacing their funding credit lines with local deposits.

Loans constitute majority of the banking assets. The structure of lending to the private sector becomes increasingly household-biased, reflecting the banks' search for safe assets (such as mortgage loans) and supporting the trend of growing private indebtedness (see Section 2.1). Mortgage loans amount to 21% of the balance sheet, compared with 18% in 2004. In recent years this loan category grew at rates above 5% annually, which was double the rate of corporate loans (Graph 2.3.1). The latter account for 16% of the balance sheet, down from 22% ten years ago.

Graph 2.3.1: Lending to private sector

Source: ECB

Swedish banking profitability is amongst the highest in Europe. The average sector's return on equity (ROE) in 2014 stood at 12.5% and the return on assets (ROA) 0.6% (Table 2.3.1), putting Sweden above most other European markets. Profitability of the major groups is even higher, with ROE ranging between 14% and 21% in the third quarter of 2014. The high leverage, high cost efficiency and high asset quality are the key factors behind banks’ profitability.

Table 2.3.1: Financial soundness indicators

*Q2 Source: ECB

Swedish banks benefit from high asset quality. In recent years, the average non-performing loan ratio (NPL) stayed below one percent, which was one of the lowest levels in the EU (Table 2.3.1). Not only the disposable income of borrowers and their payment discipline contribute to this phenomenon. A substantial role is played by the very efficient public framework for debt enforcement, based on the Swedish Enforcement Authority (Kronofogden). Most of impaired loans are resolved in less than twelve months and do not pile up in banks' book. The average coverage ratio of non-performing loans with loan loss provisions stands at 63%, above the EU average (46%).

The average capital adequacy ratio is high but the leverage ratio remains low. The average Tier 1 regulatory ratio for the Swedish banking sector amounted to 18% in mid-2014. However, in previous years the average Tier 1 ratio was consistently the lowest in the group of peer markets. The proxy leverage ratio, which relates banks' total accounting capital to their total assets, also reveals the relatively low level of capitalisation of the Swedish banking sector. At 6% it is one of the lowest in the EU. The particularities of the Swedish capital adequacy are analysed in the second part of this section.

Financial markets play a major role in funding of Swedish banks. Deposits account for 32% of the banking sector liabilities, equal to the share of debt securities issued by banks. Market funding is also partially covered by external liabilities (21%), as banks also borrow on foreign wholesale markets and accept foreign deposits. The low share of deposits is mirrored in the high loan-to-deposit ratio, second highest in the EU after Denmark (Graph 2.3.2). The maturity mismatch between assets (long term, often non-amortised loans) and liabilities (mainly short and medium term debt securities) is particularly marked in the Swedish banking sector. This funding structure stems partially from the cultural patterns, as Swedes tend to place their savings in investment funds, pension funds and insurance products. It is also incentivised by low funding costs for banks, owed to their high market ratings and ample liquidity in international markets.

Graph 2.3.2: Loans to deposits, %

Source: IMF

Assessment of policy responses

The Swedish Financial Supervisory Authority (FSA) is responsible for micro-prudential supervision and macro-prudential policy. The Riksbank and the Ministry of Finance remain involved in the areas of their competencies, notably through participation, together with the National Debt Office, in the Financial Stability Committee.

Credit risk

The high and increasing exposure to the household sector is the main credit risk of Swedish banks. While the financial soundness indicators present a sound picture of the banking system, they are by their nature backward looking and do not fully capture all the risks. A slump in households’ disposable income or an external economic shock could translate in deteriorating asset quality of the Swedish banks. The possible overpricing in the Swedish property market poses a risk to banks’ balance sheets through a shrinking value of collateral of mortgage-backed loans. This would put some borrowers in a situation where the value of a loan exceeds the value of the house, which for banks could increase losses on foreclosures and also indirectly contribute to funding problems.

Sweden has set higher capital requirements than imposed by EU regulations. The four large banks are required to hold minimum 13.5% of Common Equity Tier 1 capital as of 2015. The risk weight floors on mortgage exposures provide for an additional capital backstop. In order to address concerns about low risk weights used in banks' internal risk calculations, the Financial Supervisory Authority introduced a 15% floor on risk weights for mortgage exposures in May 2013, further increased to 25% in September 2014. The floor is applied in the framework of the supervisory review (the Pillar 2 process, where an individual assessment of financial soundness of each bank is carried out by the supervisor, leading to defining own fund requirements on top of the regulatory minimum) and translates into capital add-ons ranging from 0.7% to 4.8% of Common Equity Tier 1 for the four largest banks. According to Financial Supervisory Authority reports, in the third quarter of 2014 all banks complied with the new requirements.

Compliance with new capital requirements was primarily achieved by the reduction of risk weighted assets. In 2014, the risk-weighted asset density, a measure of the share of risk weighted assets in total assets, fell to a half of the end 2013 level in three large banking groups. The fall was caused by the banks' transition to advanced internal risk based models for calculation of capital requirements on corporate exposures, following the approval by the Financial Supervisory Authority. As a result, the increase of capital adequacy ratios of Swedish banks was driven by the denominator effect.

Despite supervisory measures taken in recent years, the ratio of capital to total assets remained stable. This proxy leverage ratio (not taking off-balance sheet exposure into account) (Graph 2.3.3) confirms that compliance with the higher capital requirements has been reached without substantially increasing the amount of capital in the banking system. At the same time, the global trend was to increase the share of capital in banks' balance sheets, as demonstrated by the evolution of the average leverage ratio for the EU. It increased from 6.5% to 8.1% between 2009 and 2014.

Graph 2.3.3: Leverage ratios (%)

*October data Source: ECB, European Commission calculations

Funding risk

The Swedish banking sector is characterised by a high share of market funding in its liabilities, complementing the deposit funding. Loan-to-deposit ratios of major banks have been gradually decreasing, but the funding structure remains market-oriented. It is linked with the high degree of the banking sector leverage and increases potential vulnerability to market shocks. The wholesale market funding of Swedish banks also entails currency risks as banks issue the bulk of their debt abroad. About 60% of the major banks market funding is denominated in foreign currencies, mainly US dollars (especially short-term securities) and euros, in quasi-equal shares. The foreign currency instruments are typically held by foreign investors ([24])

The average maturity of market funding instruments held by the banks increased in recent years. This is likely a result of both the Swedish authorities' actions and the favourable market conditions for issuing long-term debt in the Nordic countries, which were regarded by international investors as a safe haven during the sovereign debt crisis in the euro area.

Swedish banks benefit from low funding costs linked with low risk premia charged by investors. It is related to high ratings and low credit default swap (CDS) spreads of the main Swedish banks, supported by the triple-A rating and low credit default swaps spreads of the sovereign. The low funding costs contribute to the banks' high profitability. However, market conditions are prone to change. It may be due to domestic factors (e.g. a drop in house prices) or come as external shocks, for example with background in the military conflict in Ukraine and its consequences such as trade restrictions, commodity prices or monetary policy of major global economies.

Major banks have made some progress in reducing their structural liquidity risks. Banks have started to adapt their funding structure in the wake of the 2008 financial crisis extending the average maturity of their funding instruments, but the process stalled in last couple of years. Per Riksbank's recommendation, the banks should approach the minimum level of 100 per cent in the Net Stable Funding Ratio (NSFR) ([25]). In the third quarter of 2014, the NSFR, which is not binding until 2018, was at 89% or higher for the major banks. Since 2013, the Financial Supervisory Authority requires banks to abide by the minimum Liquidity Coverage Ratio (LCR) ([26]). In 2014, all major banks complied with this requirement and their average LCR ranged between 120% and 140%.

In 2012, the Riksbank decided on a 30% increase of its foreign exchange reserves. An amount of SEK 100 billion (approximately EUR 10.4 billion) was added to the existing pool of SEK 314 billion (approximately EUR 32.7 billion). The motivation to increase the reserves was to provide a backstop for banks' growing demand for liquidity in foreign currencies. The government in agreement with the Riksbank and the Financial Supervisory Authority put forward a proposal to charge the costs for maintaining the additional currency reserves to banks in proportion to the foreign currency exposures in their liabilities. The objective is to incentivise banks to reduce their currency risk. The consultation process on the draft law is underway.

To summarize, the set of macro-prudential measures taken by the Swedish Financial Supervisory Authority in response to the growing private indebtedness is becoming close to complete. They tackle both the credit demand side (i.e. loan-to-value cap, amortisation requirements) as well as the credit supply side (capital requirements, risk weigh floors). Yet, the effectiveness of these measures is limited as lending to households has been increasing on the back of strong demand, pushing up private sector indebtedness. Once the proposed requirements to amortise loans to 50% of their original value are implemented, the set of macro-prudential instruments applicable to banks will be more akin to the variety of tools applied by Sweden's EU peers (e.g. Denmark, the Netherlands).

The low share of deposits and the high share of market funding constitute a structural risk of the Swedish banking sector. An abrupt increase in funding cost due to market shocks would be largely transferred to borrowers, given the high share of variable interest rate loans. It would also impact negatively on banks' profitability through primary and secondary effects (growing losses from non-performing loans). The Basel III supervisory measures: the Liquid Coverage Ratio and the Net Stable Funding Ratio, will contribute to mitigate the refinancing risk of Swedish banks. However, given the banks' high dependence on (foreign) financial markets, this risk cannot be eradicated.

As the level of household indebtedness, the evolution of the housing market and the stability of the financial sector are interconnected, this section jointly analyses the macroeconomic and financial stability risks stemming from the high indebtedness of Swedish households and the imbalances on the housing market.

Households' financial resilience

Trends affecting households' resilience

The sharp increase in mortgage lending over the last 20 years has gone hand in hand with several trends which can render households less financially resilient:

· Between 2002 and 2010, the loan-to-value ratio of new mortgages has increased from 59% to 71%. This trend was curbed after the introduction of an 85% loan-to-value cap in 2010 but rose again to 70% in 2013 ([27]) (Graph 2.4.1). In parallel, actual repayment periods as well as the share of unamortised loans have been growing.

Graph 2.4.1: Loan-to-value ratios

Source: Financial Supervisory Authority

· Variable interest rate loans have become predominant, making households more sensitive to interest rate changes ([28]). In March 2014, 53% of the borrowers had a variable interest rate (in practice adjusted every three months) compared to 46% in March 2013. As 73% of the new mortgage loans taken in the autumn 2014 were subscribed at a variable rate, the share of household with such loans further increased to 57% ([29]). Furthermore, households' interest expectations are currently misaligned with the Riksbank's projections (Graph 2.4.2). When the Riksbank starts increasing its interest rate in the medium-term, this could have a significant impact on households' budget and reduce their scope for consumption as their interest expenditure would increase.

· Possible income loss due to unemployment or sickness has become more significant. Since the 1990s the unemployment and sickness insurance schemes have changed and an increasing number of people are reaching the unemployment benefits ceiling, which has not been increased since 2002.

Graph 2.4.2: Household expectations of the variable mortgage rate one, two and five years ahead

Source: The National Institute of Economics Research, Riksbank

Mitigating factors exist but need to be qualified

Rising households' disposable income and substantial assets at aggregate level are often presented as mitigating factors for high household indebtedness. However, the strength of these buffers needs to be qualified.

Households' disposable income has strongly increased in the past years following the implementation of the in-work income tax credit in several steps. This growth in disposable income provides buffer for households but it has also fuelled home ownership via indebtedness. Moreover, housing prices have increased faster than disposable income.

At aggregate level, households have substantial assets. The value of assets has increased in line with rising housing and share prices and amounted to 600% of disposable income at the end of 2013 ([30]).

However, a large proportion of households' assets is illiquid. For instance, pension savings can only be used at retirement. Also, a large part of households' assets rests in their house or apartment which might be difficult to sell, particularly in periods of economic or financial shocks. This means that the proportion of households' assets that can be quickly converted into liquidities is much less than the aggregate value of households' assets.

Moreover, assets can vary substantially in value across time as exemplified by the recent house price corrections in Denmark and in the Netherlands. In Denmark, it impacted both the financial resilience of some households and the economic growth despite large households' assets at aggregate level.

Both assets and debts are unevenly distributed across households. For households with mortgages, the debt ratios are highest among low-income earners (Graph 2.4.3) ([31]). It is conceivable that households with a low income also have fewer assets to cushion difficult situations.

Graph 2.4.3: Household debt ratio in different income groups (only mortgage borrowers), %

The results in decile 1 should be interpreted with a certain amount of caution, as this group includes households with varying types of incomes. Source: Riksbank

Following the abolition of the wealth tax in 2007, there is a lack of recent statistics on the distribution of assets). However, statistics from 2007 confirm that the indebted households with the highest incomes owned the majority of real and financial assets and on the other hand, low-income earners owned only a small proportion of total assets (Graph 2.4.4).

Graph 2.4.4: Share of financial and real assets held by indebted households in different income groups, 2007, %

Source: Riksbank

Transmission channels

A high level of indebtedness makes the real economy more sensitive to shocks. If households are affected by a shock to their income, their mortgage interests expenditure or the value of their housing, their consumption will likely fall. ([32]) Several studies show that during the financial crisis that broke out in 2007, consumption decreased more in countries with high household indebtedness than in countries with lower indebtedness ([33]). Graph 2.4.5 illustrates this relationship between debt ratio and consumption growth. Moreover, as consumption growth decreases, this would also impact companies' production and investment which would lead to more defaults in the corporate portfolio of banks.

Graph 2.4.5: Relationship between debt ratio and consumption growth, 2007-2012, %

Adjusted consumption growth has been calculated as actual consumption growth minus contributions from growth in debt ratio, current account and consumption. For further information, see Flodén, Martin (2014) Did household debt matter in the great recession? Source: OECD, Riksbank

Should an adverse macroeconomic shock occur combined with increased loan losses for banks, confidence in the Swedish financial system could be affected which would negatively impact banks' access to wholesale funding. The increased funding costs would be transmitted to higher interest rates for borrowers. This would in turn aggravate the borrowers' situation and amplify the negative effects on consumption and economic growth. The high refinancing risk is a structural feature of the Swedish banking sector. The major banks have a large deposit gap and have to fund half of their loan book on the financial markets, mostly in foreign currencies. Supervisory measures taken by the Financial Supervisory Authority may mitigate but not substantially alter the risks related to dependence on foreign financial markets.

The banking sector as such should be relatively resilient to a macroeconomic downturn. According to stress tests, banks' capital buffers are large enough to absorb losses under the adverse scenarios. Stress tests based on Q3 2014 financial statements by the Financial Supervisory Authority estimate the Common Equity Tier 1 capital ratio decline to range between 1.1 and 2.5 percentage points for the four major banks over a three year horizon. With the current capital requirement set as the threshold, two banks would fall below the line and the capital shortfall would dent their capital conservation buffers (Table2.4.1). The ECB/EBA stress tests published in October feature similar results, with the Common Equity Tier 1 capital ratio drop at 1.6 – 1.9 percentage points for the same group of banks. In the EU exercise the threshold was set at a single and much lower level (5.5% Common Equity Tier 1 capital). Under these assumptions, no Swedish bank recorded capital shortfall. The capital buffers of Swedish banks are underpinned by their high profitability, owed to high cost efficiency and payment discipline of Swedish borrowers which translates into low levels of non-performing loans. The dominant share of variable interest rate loans limits the risk to banks' profitability in case of market interest rate increases.

Table 2.4.1: Stress test results: common equity Tier 1 ratio (CET1)

Source: European Banking Authority, Financial Supervisory Authority

Macroeconomic risks linked to high household indebtedness and imbalances on the housing market

This part analyses the potential impact of a housing price decrease and an interest rate increase in the light of a model developed by the European Commission and stress tests developed by the Financial Supervisory Authority, the Riksbank and National Institute of Economic Research.

Impacts of a housing price shock

Table 2.4.2: Estimated maximum impact of 10% decline of house prices

Source: European Commission

The European Commission model suggests that e.g. a 10% decrease in housing prices would cause a 1.4% decrease in GDP and 2% in private consumption. For both of these variables, the maximum effect of the shock is reached in the first year and it takes slightly more than 3 years to return to the long term trend. These estimates are in line with the average impact on GDP and private consumption observed in countries comparable to Sweden.

Residential investment is much more sensitive to house price movements, reaching an estimated maximum decrease of 27% in the second year with only minimal return to the trend. In this regard, Swedish residential investment seems to be more vulnerable to house price shocks than in comparable countries. It should be noted, however, that this relatively larger elasticity of residential investment to downward or upward price changes is partly related to the relatively low level of residential investment in Sweden (if measured as a share of GDP) since the 1990s crisis.

The direction of these shocks is in accordance with expectations and the results are comparable to other models. Indeed, increasing house prices should contribute to increase consumption through wealth effects, incentivise further residential investment and increase GDP growth. The results obtained are comparable to the results of a topical IMF model ([34]) and show a more significant contraction in private consumption than a model developed by the National Institute of Economic Research where a twice as big fall in house prices over 4 quarters would produce a 1.8% fall in consumption ([35]). However, the National Institute of Economic Research reaches similar conclusions regarding the large reductions in both residential investment and the negative effect on GDP growth.

Graph 2.4.6: Swedish house price correction in 1990s, 1990=100

Source: OECD, IHS Economics

Historic episodes of significant housing price corrections in Sweden and comparable countries also confirm the model's estimates. In the 1990s, Sweden experienced a significant house price drop of almost 30% which was associated with a fall of more than 5% in GDP and of almost 6% in private consumption within the first two years. In response, residential investment fell by more than 70% within four years. Moreover the recent Danish house price correction also provides a comparison point. Since 2007, Danish house prices have fallen by almost 30% while the residential investment registered a comparable decline; by the end of 2013 the GDP was still 5% below its pre-crisis level ([36]).

Impacts of an interest rate shock

An increase in interest rates should lead to a decrease in consumption, residential investment and GDP. Simulations from the model point to a decrease in consumption by 0.8% after 12 quarters without significant return to the trend. GDP also decreases by 0.9% and this maximum is reached around the same time as for consumption. The correction for residential investment is most significant with a 4% decrease.

Table 2.4.3: Maximum impact of 1 pp. increase of interest rates

Source: European Commission

In the current low-interest environment any sudden increase in interest rates could have a very significant impact on macroeconomic variables whereas the impact of the same percentage point increase from a higher starting interest rate could be less pronounced.

This rise in interest rates can increase the number of households with low or negative discretionary income (the income net of housing costs and subsistence costs). This could quickly reduce households' scope for consumption. Moreover as interest rates increase, household interest expenditure would also increase, leading to a contraction in consumption. According to the Riksbank (Graph 2.4.7), interest expenditure currently represents less than 3.4% of household disposable income. This is below the historical average of 5% and the long term interest of 7.2%. According to the Financial Supervisory Authority (Graph 2.4.8), a 3 percentage points interest rate increase would raise the share of households with a negative discretionary income from 2% to 4%, and from 2% to 7% if the interest rate increases by 5 percentage points ([37]). However, an interest rate rise by more than 5 percentage points could lead the share of indebted households with a negative discretionary income to exceed 21%([38]).

Graph 2.4.7: Swedish households' interest expenditure, % of disposable income

Source: Statistics Sweden and the Riksbank

Both the Financial Supervisory Authority and the Riksbank point out that most households would be able to service their loans but many would have to reduce their consumption. This is in line with the econometric model results which show that the effect of an interest rate increase by 5 percentage points could lead to a 4.5% reduction in private consumption.

An increase in interest would also negatively affect housing prices as the availability of loans and profitability of residential investment would be reduced. Lower residential investment leads to lower GDP which along with subdued private consumption would both affect housing prices. The model estimates a 2.6% decrease in house prices as a response to a 1% increase in interest rate.

Graph 2.4.8: Interest rate increase and share of households with a deficit, %

Source: Financial Supervisory Authority

The well-established fiscal framework in Sweden has contributed to provide the necessary margin for automatic stabilisers to play their role in a context of a weaker economic activity, even making room for discretionary fiscal stimulus in 2014. As Sweden has used its available fiscal space to support the economy, the general government balance has deteriorated in the short-term. However, Sweden appears to face no major fiscal sustainability risks in the medium-term.

Taxation

Swedish taxation is the fourth highest in the EU with a tax-to-GDP ratio (including social contributions) of 44.2% in 2012. Sweden has a relatively high tax burden on labour.

In 2014, Sweden was recommended to reduce the effects of the debt-bias in household taxation by gradually limiting tax deductibility of interest payments on mortgages and/or by increasing recurrent property taxes. This relationship was discussed in Section 2.1. Two public inquiries have tabled proposals on tax reform. However, the proposed reforms that would be relevant for reducing the debt bias are limited to redefining the calculation of the tax base and they would not result in the necessary move away from debt bias in income taxation.

Overall, there has been no significant progress in reducing the debt bias in taxation affecting housing. The government has abstained from any reform of the taxation of immovable property on the basis of the argument that such measures could potentially be damaging to the efforts to restore growth. Measures to increase the pace of amortisation of mortgages and other non-tax measures related to mortgages have been deemed more suitable to reduce debt bias.

Regarding corporate taxation, in 2009, tax provisions were introduced which reduced the tax deductibility of interest payments for intra-group loans related to the acquisition of shares from an affiliate. New legislation in 2013 further extended the restrictions on interest deductibility to all types of loans, regardless of their purpose. Interest payments are tax deductible if the creditor is taxed on the interest at a rate of at least 10%, should the interest income be the only income for the creditor (10% tax test), or if the debt has been taken on for ‘sound commercial reasons’. These measures, combined with the corporate income tax rate cut from 26.3 to 22% at the beginning of 2013, aim to eliminate a large proportion of corporate debt that is solely driven by tax avoidance motives for which there is an increased risk in the case of cross-border intra-group lending. A corporate tax expert committee delivered a report in June 2014. The committee proposed further reductions of the tax-deductibility of financial costs. It is noted that this would result in an increased tax burden for companies with a high debt ratio. The committee also proposed that those measures could be accompanied by further reduced corporate tax rates. The measures recommended are aimed at further reducing debt bias in the corporate sector and to counter tax avoidance.

Public debt sustainability

Sweden appears to face no major fiscal sustainability risks in the medium-term. Government debt (41.4% of GDP in 2014 and expected to decrease to 40.6% by 2016) is currently below the 60% of GDP reference value in the Treaty. It is projected to remain broadly stable until 2025.

The budgetary impact of population ageing poses some challenge to long-term fiscal sustainability in Sweden, in particular in the area of long-term care. Risks would be lower in the event of the structural primary balance reverting to higher values observed in the past, such as the average for the period 2004-2013.

The Swedish government has revised expenditure linked to migration upwards in the coming years. In the longer term, the resulting net population growth should contribute to an expansion of the work force and GDP. ([39]) However, the long-term forecasts of the Swedish National Institute of Economic Research also links migration to a marginally higher equilibrium unemployment rate and lower productivity. ([40])

Fiscal framework

The Swedish fiscal framework, which is characterised by a cautious approach, has been stable over time. In the past 20 years, Sweden's fiscal framework has put public finances on a strong footing at both the central and local level. The framework comprises three key components. First, a surplus target, encompassing the finances of both central and local governments and the pension system, stipulates that an overall budget surplus of 1% of GDP should be achieved over the business cycle. In March 2014, the government issued a legislative proposal to increase the accountability of the surplus target, by yearly follow-up with the parliament and a requirement to demonstrate how the target is to be reached in the event of a deviation between the target and forecast development. However, the legislative proposal does not clarify the calculation method for the surplus target. The achievement of the target is assessed against seven different indicators, largely forward-looking. The multitude of indicators without clear weights allocated to each impairs the clarity of the assessment and could lead to an opportunistic interpretation. Second, a three-year nominal expenditure ceiling for central government and the pension system controls budget overruns and forces government departments to prioritise. Third, the balanced-budget rule for local authorities forbids municipalities and counties to approve ex ante deficit budgets and requires them to compensate for any ex post deficits within three years. In 2013, new rules were adopted to allow municipalities and counties to balance revenues counter-cyclically over time through ‘results-balancing reserves’.

In addition to the budgetary rules, the Fiscal Policy Council (FPC) was established in 2007 with the task of providing an independent evaluation of the government’s fiscal policy and compliance with the fiscal rules. Two aspects of the functioning of the FPC could be improved. First, to avoid ‘opportunistic’ behaviour, the right to access information from the Ministry of Finance could be guaranteed in the legislation. Second, as legislators perform critical accountability functions in budgetary processes, mechanisms could be put in place to ensure an appropriate level of accountability of the FPC to the parliament. In its current set-up, the FPC is a government agency that reports directly to the government, which has the final say on appointing its members.

The Swedish budgetary framework complies with Council Directive 2011/85/EU on requirements for budgetary frameworks of the Member States but Sweden lacks a regular evaluation of the government’s macroeconomic forecasts and budget forecasts, as required by the Directive ([41]). The inquiry therefore proposed to maintain the overall process and add a requirement for the government to regularly publish evaluations of the forecasts presented in the autumn and spring Budget Bills. The government acted upon these conclusions with a proposal in its 2014 autumn Budget Bill, which was adopted by the Riksdag on 18 December 2013. Moreover, another legislative proposal in March 2014 codified and extended the current practice on the expenditure side of the budget to the revenue side: bills affecting government revenues will have to be proposed as part of the legislative package during the autumn and spring Budget Bills. These packages would also include supplementary budgets detailing the impact of revenues or expenditures of these bills.

The well-established fiscal framework has played a specific role in preventing strong tax revenue in good times from translating into pro-cyclical expenditure increases. This has provided the necessary margin for automatic stabilisers to play their role in recessions, even making room for discretionary fiscal stimulus.

The Swedish labour market is overall characterised by a high employment rate (79.8%). However, the outcome is relatively poor for low-educated and low-skilled young people (with unemployment turning around 40%) and people (especially women) with a non-EU migrant background (56.2% of non-EU born women and 67.9% of non-EU born men are in employment). This should be seen in the light of strongly increasing migration into Sweden over the last few years. Moreover, basic skills attainment of young people has undergone a continuous decline which may impact their employability in the longer-run and pose wider challenges to competitiveness and innovation capacity in the future. As regards social policies, analysis shows that the at-risk of poverty rate of women above 65 years in Sweden has increased considerably.

Labour market

The Swedish labour market, to a large extent governed by negotiations between social partners at sectorial level, is characterised by positive labour market outcomes. The employment rate was 79.8% in 2013 for those aged 20-64, the highest in the EU. Wage increases have been robust, averaging about 3% annually since 2005. Since the onset of the crisis, the unemployment rate has turned around 8%. The proportion of long-term unemployed is one of the lowest in the EU at 1.5% of the active population, which limits the risk that unemployment becomes entrenched, i.e. that people get further and further away from the labour market through long unemployment spells (Graph 3.2.1).

Graph 3.2.1: Labour market

(1) NEET refers to 'Not in education, employment or training' Source: European Commission

Youth unemployment remains high (22.9% in 2014), in comparison to other Member States with strong overall labour market performance. However, some 77 000 out of the 163 000 young unemployed were full-time students, with an additional 12 000 also in education but on leave (Graph 3.2.2). Moreover, the Swedish ratio of the unemployment rate for non-student young over total unemployment is similar to these other Member States, and unemployment spells are typically short (16 weeks) compared with that of adults (42 weeks for 25-54-year-olds in 2013).

Graph 3.2.2: Youth unemployment rate in EU Member States by educational status, 2013

Source: European Commission

Insufficient educational attainment is an important explanatory factor behind youth unemployment. Low-educated and low-skilled young people experience almost 40% ([42]) unemployment, whereas for young with completed tertiary education the rate is 14.9%. The share of young persons not in employment, education or training is low compared with EU-28 (7.5% in 2013) ([43]), but not in comparison to Member States with relatively good labour market outcomes. Although the early school leaving rate remains well below the EU average (7.1% compared to 12% in 2013) and the national and EU target of 10%, the share of young people who have not completed upper secondary education successfully at the age of 20 remained close to 25% and at a higher level than in the early 2000s.

The transition from school to work remains a challenge. Participation in vocational education and training is decreasing rapidly. While until 2009 the same share of students attended academic and vocational programmes at upper secondary level, in 2014 almost twice as many students opted for an academic programme. This shift coincides with the 2010 Education Act, which no longer grants basic eligibility to higher education to vocational programme students. Furthermore, apprenticeships have suffered from low take-up and high drop-out rates since the 2008 piloting phase. Although between 2013 and 2014, the number of apprentices increased from 6 000 to 7 300, it represents only 7.3% of all students in the vocational track, and it is still far lower than the 30 000 apprentices projected by the government for 2011-14. In addition, in the period 2008-11, 25% of apprentices dropped out already in the first year and only 44% completed the three-year programme compared to a 68% completion rate in a school-based vocational programme. ([44]). Vocational introduction employment (a type of collective agreements) is gaining in popularity and has the potential to become a new pathway to jobs for young people. However, it is mainly available for people who have completed upper secondary education.

Over the last few years, migration into Sweden has increased substantially (Graph 3.2.3) and in proportion to the number of inhabitants, Sweden receives a comparatively large number of refugees. Last year, more than 80 000 asylum seekers were registered in Sweden (i.e. roughly 1% of the total population). The Swedish Migration Board estimates that the number of asylum seekers is likely to stay at high levels going forward and increase to 80 000-105 000