EUROPEAN COMMISSION Brussels,7.3.2018 SWD(2018) 225 final COMMISSION STAFF WORKING DOCUMENT Country Report Sweden 2018

Including an In-Depth Review on the prevention and correction of macroeconomic imbalances Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2018 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2018) 120 final}





Contents Executive summary 1.Economic situation and outlook 2.Progress with country-specific recommendations 3.Summary of the main findings from the Macroeconomic Imbalance Procedure in-depth review 4.Reform priorities 4.1.Public finances and taxation 4.2.Financial sector 4.3.Labour market, education and social policies 4.4.Investment 4.5.Sectoral policies Annex A: Overview Table Annex B: Macroeconomic Imbalance Procedure scoreboard Annex C: Standard Tables References LIST OF Tables Table 1.1:Key economic and financial indicators – Sweden Table 2.1:Summary table on CSR assessment

Table 3.1:MIP assessment matrix (*) — Sweden 2018 Table 4.2.1:Financial soundness indicators Table B.1:The MIP Scoreboard for Sweden (AMR 2018) Table C.1:Financial market indicators Table C.2:Headline Social Scoreboard indicators Table C.3:Labour market and education indicators Table C.4:Social inclusion and health indicators Table C.5:Product market performance and policy indicators Table C.6:Green growth LIST OF Graphs Graph 1.1: Output gap, real GDP growth and its components Graph 1.2: Contributions to potential growth Graph 1.3: Household debt evolution Graph 1.4: Labour shortages in the economy Graph 1.5: Unemployment rates of specific groups Graph 1.6: Changes in the income share owned by the highest decile of the country’s population since 1945 Graph 1.7: Net international investment position Graph 2.1: Overall multiannual implementation of 2011-2017 CSRs to date Graph 4.2.1: Common Equity Tier (CET1)-to-total-assets ratio and implied risk weights (%), four major Swedish banks versus sample of 62 large EU banks

Graph 4.2.2: Averages of the annual growth rates of real disposable income and real house prices between 2001-2016 Graph 4.2.3: House prices by market segment (nominal) Graph 4.2.4: Valuation gap based on price-to-income and price-to-rent ratios and fundamental-model-based estimate Graph 4.2.5: Revenues from property taxes Graph 4.2.6: Residential construction investment Graph 4.2.7: Housing starts, including net conversions, versus projected need Graph 4.2.8: Price level index for residential construction costs for selected EU countries and Norway Graph 4.2.9: Labour productivity in construction sector, Sweden and selected EU countries Graph 4.2.10: Cumulative change in rental versus tenant-owned housing stock in Greater Stockholm Graph 4.2.11: Debt-to-income ratios for selected groups of mortgage borrowers (as of September 2017) Graph 4.2.12: Estimated monthly income surplus for newly mortgaged households in different income deciles, by year of origination Graph 4.2.13: Share of households with different debt-to-income ratios, new loans Graph 4.2.14: Rate of amortisation given the debt-to-income ratio and loan-to-value ratio (2016) Graph 4.2.15: Breakdown of corporate debt by funding source Graph 4.2.16: Drivers of year-on-year changes in corporate debt to GDP ratios Graph 4.2.17: Leverage indicators for non-financial corporations Graph 4.3.1: Employment rate by educational attainment Graph 4.3.2: Beveridge curve, 2000-2016 Graph 4.3.3: Employment rate by country of birth Graph 4.3.4: Gap in predicted employment rate for non-EU born and second generation (by gender and educational attainment)

Graph 4.3.5: Risk of poverty or social exclusion Graph 4.3.6: Proportion of low achievers in science by immigrant background in 2015 Graph 4.4.1: Yearly changes in export market share: contribution of world trade versus growth in Swedish exports Graph 4.4.2: Gross investment 44 Graph 4.4.3: Breakdown of investment by sector in 2016 Graph 4.4.4: Gross fixed capital formation, dwellings versus other investment, comparison with EU average Graph 4.5.1: Change in business R&D intensity and public R&D intensity Graph 4.5.2: Tax revenues from environmental taxes LIST OF Boxes Box 2.1: Tangible results delivered through EU support for structural change in Sweden Box 4.1.1: Effects of a tax shift from labour to property Box 4.3.1: Monitoring performance in light of the European Pillar of Social Rights Box 4.3.2: Policy highlight - Inclusive processes in Sweden Box 4.4.1: Investment challenges and reforms in Sweden Executive summary Sweden's buoyant economic performance represents an excellent foundation to address structural weaknesses in relation to the housing market and household debt. Further boosting new construction in appropriate locations and market segments could help alleviate a long-standing housing shortage. A more market-oriented rental housing sector could contribute to this as well, and would also support mobility and flexibility in the labour market. Tax incentives for property ownership and mortgage debt still support household debt growth and overvalued house prices. Addressing these issues would make the Swedish economy more resilient. ( ) After recording an estimated 2.7 % growth in 2017, the Commission’s winter 2018 interim forecast projects real GDP to increase by 2.7 % and 2.0 % in 2018 and 2019, respectively. Robust export growth and a moderate increase in domestic demand are expected to support economic activity in the coming years.

Sweden’s external position remains strong. Goods and services exports benefitted from the global upswing in 2017. As import growth remained solid, the current account surplus hovered around 5 % in 2016-2017. Underpinned by strong growth in Sweden's main trading partners, the outlook for exports will remain favourable, in particular for investment goods. Investment surged due to buoyant construction activity. After expanding at a rate of above 5 % per year in 2015-2017, investment is expected to continue increasing at a slower pace in the coming years. Partly thanks to reforms to building regulations and the planning process, investment in housing in particular has rebounded strongly since mid-2013. However, this new supply is insufficient to match estimated housing needs. The labour market continues to perform well. In 2016 Sweden had one of the highest employment rates in the EU at 81.2 %, and overall unemployment was below the EU average at 6.9 %. Labour shortages emerged in sectors such as construction, education, health, science, engineering and ICT. A major challenge for the labour market now is the integration of people with a migrant background, including those with relatively low levels of education and skills. The fiscal position has remained strong. Robust revenue collection and lower-than-expected expenditure for migration and integration should result in a fiscal surplus in 2018 and 2019. Government debt stood at about 39 % of GDP in 2017, well below the reference value of 60 % of GDP agreed in the Treaty, and is projected to decline in coming years. The outlook for Sweden’s fiscal sustainability is sound in the short, medium and long term. Inflation is expected to stay broadly stable. Sweden’s central bank has continued its expansionary monetary policy to support a sustainable rise in the rate of inflation to its 2 % target. It has kept repo rates at negative levels. Financial conditions support the economy, but also contribute to imbalances. The central bank’s monetary policy stance has resulted in very low mortgage interest rates. In turn, low rates have further boosted private indebtedness and to a lesser extent supported house prices. Sweden has made limited ( ) progress in addressing the 2017 country-specific recommendation. As regards policies relevant to macroeconomic imbalances, the government approved a strengthened amortisation requirement ( ) for high-debt-to-income mortgages; thus achieving substantial progress in this area. Some progress has been made on fostering investment in housing and improving the efficiency of the housing market. In particular, the authorities are continuing to gradually implement the 22-point plan to increase residential construction and improve the efficiency of the housing market. The government has also launched a new initiative for more participation by foreign firms in the Swedish construction sector. No significant policy action has been taken to introduce more flexibility in setting rental prices. Finally, there are key parts of the recommendation that have not been met by any policy action, notably on reforming the favourable tax treatment of mortgage debt and home ownership. On these aspects of the recommendation, no progress has been made. Regarding progress in reaching the national targets under the Europe 2020 strategy, indicators where Sweden continues to perform well are the employment rate, greenhouse gas emissions, the share of renewable energy, the rate of early school leaving, tertiary education attainment and poverty risks. Areas where progress remains relatively weak are energy efficiency and R&D targets. Sweden performs well on the indicators of the Social Scoreboard supporting the European Pillar of Social Rights. The employment rate is high, while the gender employment gap and the share of young people not in employment, education or training rate are at low levels. Positive outcomes, also on participation in active labour market policies and of children in formal childcare, reflect an advanced welfare model, strong social dialogue and a high level of gender equality. The main findings of the in-depth review contained in this report and the related policy challenges are as follows: ·While banks are healthy, there are vulnerabilities linked to their growing exposure to household mortgages. Banks remain profitable. The regulatory capital adequacy ratios are high, but as a share of total (unweighted) assets, capital has remained stable at lower levels. Considering the steadily increasing mortgage-related lending on their balance sheets, the risk of a rapid decline in house prices represents a significant vulnerability for the stability of the banking system. Moreover, since Swedish banking groups are of systemic importance for all countries in the Nordic-Baltic financial market, any shock to the banking sector could have a wider impact on neighbouring countries. ·Household indebtedness has continued to rise from already elevated levels. Household debt grew by 7.0 % in 2017, reaching about 86 % of GDP and 184 % of disposable income – among the highest levels in the EU. This is driven mainly by higher mortgage borrowing, linked to high house prices and rising new construction volumes, coupled with structural distortions favouring mortgage-financed property investment. Debt levels are unevenly distributed, with lower-income and younger households facing particularly high debt loads relative to their incomes. Sweden has implemented several macroprudential measures in recent years, including a mortgage amortisation requirement in 2016. The latter appears to have considerably influenced borrower behaviour, but the overall effect on total debt incurred seems modest. More generally, macroprudential policy steps taken so far appear to have had limited impact on mortgage lending growth. ·After two decades of rapidly rising house prices, the housing market experienced a gradual decline in autumn 2017, before rising somewhat again in January 2018, but prices remain above fundamentals. Key structural issues include tax incentives favouring home ownership and mortgage debt, and continued accommodative credit conditions coupled with still relatively low mortgage amortisation rates. In addition, despite a sharp rise in new construction in recent years, there is still an ongoing supply shortage, particularly of affordable homes around major cities. This shortage in housing supply is linked to structural inefficiencies, including limited competition in the construction sector due to barriers to entry for small and foreign firms and the ability of large developers to control land resources. There are also barriers to efficient usage of the existing housing stock. In the rental market, below-market rents create lock-in and ‘insider/outsider’ effects. In the owner-occupancy market, capital gains taxes reduce homeowner mobility. The housing shortage also hampers labour mobility and can contribute to intergenerational inequality. ·The continued increase in household debt and bank exposure to residential mortgages is a growing risk to macroeconomic stability. Despite gradual policy action, mortgage debt continues to increase further. With the housing market still appearing overvalued, even after recent declines, rising indebtedness means there is the growing risk of a disorderly correction. This could culminate in a rapid deleveraging process, with an adverse impact on the real economy and potentially the banking sector. Other key structural issues analysed in this country report, which point to particular challenges for Sweden's economy, are the following: ·Despite favourable economic conditions, some population groups have difficulties finding a job. Sweden has high employment and low long-term unemployment rates. However, challenges remain, for example integrating low-skilled people and non-EU migrants into the labour market. This challenge is likely to remain in the coming years in light of the magnitude and composition of the arrival of asylum seekers in late 2015. Efforts have been made to improve the employability of recently arrived migrants and a new simplified scheme (introduktionsjobb) is set to begin in spring 2018. ·The educational performance gap between different social groups is large and widening. Despite recent measures, the education system does not appear to promote quality education for all. The integration of newly arrived migrant pupils warrants close monitoring, as does the growing shortage of teachers. ·The economy benefits from a favourable business environment, although barriers to investment and long-term growth remain. Sweden performs well in terms of efficient public administration, access to finance for small and medium-sized enterprises, and innovation and internationalisation by businesses. The public procurement system generally works well, but investment by small and medium-sized enterprises is in some cases constrained by insufficiently transparent public procurement procedures. Finally, there remains scope for closer cooperation between academia and businesses. 1. Economic situation and outlook

GDP growth Economic activity remained strong and balanced. Real GDP grew by 3.2 % in 2016 and is expected to have increased by 2.7 % in 2017, according to the Commission’s winter 2018 interim forecast. Domestic demand and exports benefited from the continued accommodative monetary policy and the pick-up in global demand (Graph 1.1). Investment was pushed up by buoyant construction activity. Investment is set to have contributed to close to 2 percentage points (pps) of GDP growth in 2017. Decades of pent-up demand for housing led to a strong supply response from the construction sector in recent years. In 2017, dwelling starts topped their historically high level of the previous year, and housing investment is projected to have grown by more than 10 %. Other construction, in particular of public buildings and facilities, contributed also to the momentum. However, this new supply is insufficient to match estimated housing needs (see Section 4.2.2). Graph 1.1:Output gap, real GDP growth and its components (1) Source: European Commission The economic outlook is solid. While investment growth is set to decline, the further strengthening of global activity should benefit Sweden’s small, open and competitive economy in the coming years. All in all, real GDP growth is projected to hover around 2.7 % in 2018 and fall to 2.0 % in 2019, with the economy going back to its potential. Investment is expected to grow at a slower pace. As capacity utilisation is high, exporters are likely to invest in additional equipment to respond to the external demand. However, the recent fall in house prices is set to dampen residential investment. Overall, investment is expected to grow at around 2 % in 2019. The growth in public and private consumption is set to moderate. Despite modest wage growth, the increase in employment, low interest rates and additional social transfers and tax cuts are expected to support disposable income and private consumption in 2018. A rise in core inflation and the cost of housing (due to gradually higher interest rates) is not expected to affect significantly private consumption growth in 2019. Public consumption was broadly unchanged in 2017 and is projected to slightly increase as the 2018 budget bill includes additional funding to municipalities for staff and for improving the delivery of welfare services and education. Potential growth The positive economic development is also mirrored in Sweden’s potential growth, which has returned to pre-crisis levels. Following a sharp fall with the onset of the 2009 financial crisis, potential growth has recovered, albeit its composition has changed. The labour contribution increased due to a larger working age population, supported by migration, and rising participation rates. In addition, since 2013 a larger capital stock on the back of investment growth has also supported the economy’s potential (Graph 1.2). However, the contribution from total factor productivity (TFP) — despite an increase since 2009 — remains below the rates seen in the pre-crisis period. This could be an indication of the decreasing impact of ICT adoption and the stagnating levels of investment in R&D in the country (Edquist and Henrekson, 2016). Also, the longer term shift towards a more services-based, labour-intensive economy constitutes a structural, compositional factor that moderates TFP evolution. The outlook for total factor productivity is balanced, possibly with diminishing returns to technological innovation (Konjunkturinstitutet, 2017). Graph 1.2:Contributions to potential growth (1) (2) Source: European Commission (Autumn forecast 2017) Inflation and monetary policy Despite strong economic growth and an accommodative monetary policy, inflation is projected to remain sluggish. For some time during 2017 it seemed that higher import prices resulting from the depreciation of the Swedish krona in 2016 and recovering energy prices were pushing inflation above 2 %. However, at the end of 2017, headline inflation was back to 1.9 %. Although capacity utilisation is high after several years of strong economic growth, cost pressures have not built up yet. The Swedish central bank (the Riksbank) has continuously used its monetary policy toolbox to guide inflation towards its target. ‘Core inflation’, i.e. the underlying long-term inflation excluding volatile items like food and energy prices, is gradually increasing but held back by subdued wage growth. In the coming years, a further tightening of the labour market and economic growth are expected to support core inflation. Overall, the harmonised consumer price index is expected to grow at 1.8 % in 2018 and 1.7 % in 2019. The Riksbank is set to maintain a negative repo rate in 2018 to stabilise inflation around its 2 % target. Since early 2016, the Riksbank had kept its repo rate at -0.5 % and acquired SEK 290 billion (EUR 30.1 billion) in government bonds over the last three years in order to raise inflation and inflation expectations. In December 2017, the Riksbank decided to end the asset purchase programme, albeit with repurchases continuing for six more quarters, and announced that slow increases of the repo rate would begin towards the end of 2018. The low interest rate environment, combined with other structural factors lowering mortgage debt service costs and a continued housing shortage, has been supporting increase in household debt and house prices. These increases have made the financial system and broader economy more vulnerable to external shocks (see Section 4.2). Private indebtedness In 2017, household debt continued to outpace economic growth. Household debt amounted to 184 % of disposable income or about 86 % of GDP in Q3 2017, among the highest levels in the EU (see Section 4.2.3). There have been some positive developments at the margin, in part driven by the adoption of a new mortgage amortisation requirement in 2016. This has helped contain mortgage borrowing at very high debt-to-income levels, leading to a modest drop in the average debt-to-income ratio for new mortgage borrowers after years of steep increases. However, overall, household debt has continued to rise broadly in line with its previous growth trend of 67 % per year (Graph 1.3). Graph 1.3:Household debt evolution Source: Eurostat Labour market Favourable economic conditions are supporting strong improvements in the labour market. In the third quarter of 2017, Sweden had one of the highest employment rates in the EU (81.8 %), above its national target (80 %). Unemployment is lower than the EU average (6.8 % versus 7.5 % in the EU in Q3-2017), and youth unemployment along with the rate of people not in education, employment or training decreased in 2016. However, labour shortages in sectors such as construction, education, health, science, engineering and ICT have been reported. By contrast, the employment rate of low-skilled people is declining, pointing to potential skills mismatches (Graph 1.4). Unemployment is therefore set to stabilise at around 6.5 % in 2018-2019. Graph 1.4:Labour shortages in the economy (1) Source: Public Employment Office Bringing migrants into the workforce remains a challenge (see Section 4.3). The percentage of residents in Sweden not born in the EU is among the highest in the EU as the country has been attracting migrants for humanitarian and family reunification reasons for decades. Since 2008, it has also been taking in non-EU labour migrants. However, the unemployment rate of non-EU-born residents in Sweden stood at 19 % in 2016 (Graph 1.5), which is four times higher than the rate for native-born residents.

In the medium term, the economy could benefit from successfully integrating migrants into the labour market. The gradual increase in the labour force might slow the decrease in the unemployment rate in the short term. However, past experience indicates that over time people granted asylum usually find employment, thus lifting potential growth. Graph 1.5:Unemployment rates of specific groups Source: European Commission Inequality Sweden has one of the lowest levels of income inequality in the EU. Growth is inclusive, with household income per person increasing faster than GDP per person ( ). The distribution of market incomes (i.e. before taxes and transfers and excluding pensions) is more equal than in most EU countries, since wage distribution is quite compressed. In addition, the redistributive power of the tax and benefit system further reduces inequality (in 2014, the Gini coefficient ( ) fell from 45 before taxes and transfers to 25 after taxes and transfers). Nevertheless, income inequality has increased in Sweden over the past decades. The share of the country’s income owned by the top 10 % of the population increased from about 20 % to 30 % between 1982-2014 (Graph 1.6). The distribution of wages has remained broadly stable. Changes appear to be driven by an increase in capital income, a diminishing effect over time of the tax and benefit system to reduce market inequality and structural trends in household composition. The persistent increase in property prices and the absence of a wealth inheritance and gift tax have negatively affected wealth distribution (Lundberg et al., 2018; OECD, 2017b). In addition, the current tax treatment of owner-occupied housing with a mortgage is regressive as a result of the low recurrent property tax, which is generally not aligned with property values. This is combined with full deductibility ( ) of mortgage interest payments (see Demand-side issues in Section 4.3.1). Graph 1.6:Changes in the income share owned by the highest decile of the country’s population since 1945 (1) Source: The World Wealth and Income database Competitiveness Sweden has maintained its cost competitiveness, as wage growth remains subdued despite high economic activity. In the first half of 2017, the exporting industry agreed in its wage bargaining negotiations to a 2.2 % annual rate increase for 2017-2019. This modest outcome was the result of negotiations that started in 2016 in an environment of downward price and wage pressure from major trading partners, intensification of e-commerce and political uncertainty in Europe. Since then, other sectors have closely followed this benchmark agreement, except for some public services professions. While wage growth is projected to positively drift away in the coming years, cost competitiveness developments are expected to remain contained. External position Foreign trade is a key growth driver for Sweden’s economy. The tradable sector accounts for close to half of GDP and a third of employment. The economy has become more service-intensive, and services’ exports have outpaced goods’ export for more than a decade. A pick-up in foreign demand boosted exports in the second half of 2017, and this momentum is expected to gather pace in 2018. Import growth is forecast to moderate slightly in line with domestic demand. Net exports are therefore projected to contribute positively to GDP growth in 2018-2019. The current account balance surplus is primarily driven by high savings. The persistent current account surplus is declining from 8.6 % in 2006 to 5.1 % of GDP in 2016. The surplus is not a reason for concern: close to 40 % is driven by merchanting activities ( ), i.e. multinational enterprises that have moved their production abroad (to gain a competitive edge) but retained their headquarters, research and development and other key functions and assets in Sweden. The surplus also reflects high household savings rather than underinvestment (see Section 4.4.1). However, the net international investment position is only slightly positive, i.e. the accumulated foreign assets exceed liabilities (Graph 1.7). Valuation effects and measurement errors might continue to underestimate the net international investment position (European Commission, 2016a, p. 13-14). Graph 1.7:Net international investment position Source: European Commission Public finances The fiscal position has remained strong. Revenue collection, underpinned by solid economic growth, surprised on the upside. By contrast, expenditure for taking in and integrating of asylum seekers was lower than expected in 2016-2017. As a result, the general government headline surplus is set to have reached 0.9 % of GDP in 2017, well above the initial plan of the 2017 budget, implying a structural surplus of 0.8 % of GDP. However, as the fiscal measures included in the 2018 budget bill are only partially financed by additional revenue growth, the headline surplus is expected to decline to 0.7 % and 0.6 % of GDP respectively in 2018-19. With prudent fiscal management, the general government gross debt has been declining over recent years, a trend that is set to continue with the debt-to-GDP ratio projected to fall further to 34.4 % in 2019, significantly below the reference value of 60 % of GDP agreed in the Treaty (see also Section 4.1).

Table 1.1:Key economic and financial indicators – Sweden (1), (2) Source: Eurostat and ECB as of 30 Jan 2018, where available; European Commission for forecast figures (Winter forecast 2018 for real GDP and HICP, Autumn forecast 2017 otherwise) 2. Progress with country-specific recommendations Progress with implementing the recommendation addressed to Sweden in 2017( ) has to be seen in a longer term perspective since the introduction of the European Semester in 2011. Looking at the multi-annual assessment of the implementation of the CSRs since these were first adopted, 78 % of all the CSRs addressed to Sweden have recorded at least 'some progress'. 22 % of these CSRs recorded 'limited' or 'no progress' (Graph 2.1). Substantial progress and full implementation have been achieved in several policy areas, in particular fiscal governance and research and innovation. Limited progress has been achieved in implementing housing market and household debt related CSRs. Graph 2.1:Overall multiannual implementation of 2011-2017 CSRs to date (1) Source: European Commission Sweden has been able to preserve a sound fiscal position. This has ensured compliance with the medium-term budgetary objective and keeping debt on a declining path well below the Treaty threshold. For the labour market, the government achieved some progress in improving the employment situation of young people. In particular, it has adopted measures to strengthen apprenticeships and other types of work-based vocational education. However, on the recent arrival of asylum seekers, it is too early to assess the outcomes for non-EU-born people, given its magnitude and the considerable time it takes for integration measures to show their full effect. Since 2011, the country has each year received a recommendation related to its high and persistently rising household debt and house prices. The authorities have taken a number of policy steps to help rein in mortgage debt and house price growth, and the associated risk to the broader economy and the financial system. The focus has so far mainly been on macroprudential measures and steps to tackle housing supply bottlenecks. Macroprudential measures include introducing a loan-to-value ceiling of 85 % for mortgages in 2010, gradually raising banks’ risk weight floors for mortgages in 2013 and 2014, and introducing a formal mortgage amortisation requirement in June 2016 (see Section 4.2.3). Additionally, Sweden has adopted legislation to strengthen the macroprudential authority's legal mandate. While these steps have improved the resilience of the banking sector (see Section 4.2.1), they have not been sufficient to rein in household debt growth (see Section 4.2.3). Additionally, the authorities have over time introduced measures to streamline building and planning regulations and have provided some direct budgetary support for municipalities to encourage more construction. This has resulted in a significant pick-up in construction in recent years, but the current level is still insufficient to meet anticipated demand, particularly in major cities (see Section 4.2.2). Table 2.1:Summary table on CSR assessment (1) Source: European Commission Overall, Sweden has made limited ( ) progress in addressing its 2017 country-specific recommendation (CSR). Some policy steps have been taken in response to the recommendation (which is relevant for the macroeconomic imbalance procedure (MIP), see Section 3). However, implementation has been uneven and key areas are left unaddressed. The government has approved a strengthened amortisation requirement for high-debt-to-income mortgages, which will come into force in March 2018. For the housing market, Sweden is moving forward with the gradual implementation of the ‘22-point plan’ to increase residential construction and improve the efficiency of the housing sector (see Section 4.2.3). The authorities have also launched a new initiative to raise participation of foreign firms in the Swedish construction sector. However, no significant policy action has been taken to introduce more flexibility in setting rental prices. No progress has been made on reforming mortgage interest deductibility and recalibrating recurrent property taxes. European Structural and Investment Funds (ESI Funds) address challenges to inclusive growth and convergence in Sweden, and have successfully supported migrants into entrepreneurship or employee positions in various sectors and helped local authorities provide tailor-made training and support for employability. ESI Funds are contributing notably to a strong innovation environment, clusters and accessibility of research resources for industry (Box 2.1). Box 2.1: Tangible results delivered through EU support for structural change in Sweden Sweden is a beneficiary of European Structural and Investment Funds (ESI Funds) support and can receive up to EUR 3.6 billion until 2020. This represents around 3 % of public investment I annually over the period 2014-2018. By 31 December 2017, an estimated EUR 2.1 billion (59 % of the total) was allocated to projects and has paved the way to strengthen the competitive edge of 28 120 companies. Project areas include internationalisation, business development, incubation and new entrepreneurship. Access to risk capital, in particular venture capital has been enhanced and is delivered through one National fund-in-fund (EUR 23.1 million), eight regional venture capital funds (EUR 74 million) and a new National “green fund” with a focus on the transition to a low carbon economy (EUR 38.7 million). ESI Funds help address structural policy challenges. They are used to support strong innovation environments, clusters and accessibility of research resources for industry. Sweden uses the funds to implement smart specialisation strategies in all regions. It will cover over 5 600 enterprises and cooperation with research institutes to bring new products to market. EUR 400 million supports the transition to a low-carbon economy. European Regional Development Fund (ERDF) activity in Sweden shows how to use the funds for integration of third country nationals. The focus has been to support migrants to become entrepreneurs or employees and a dedicated call of proposals was made for innovative solutions. A number of projects has been approved and are well in progress. Strengthening the employability of individuals through skills development and training is also supported by the European Social Fund (ESF) with EUR 808 million. The ESI Funds have helped to develop methods and structures for providing more individually adapted training and support for employability. Nearly 80 000 persons have benefitted from different ESF funded projects. Various reforms were undertaken already as precondition for ESI Funds support II . These were the transposition of the energy efficiency directive and changes for the provision of statistical data on the implementation of ESI Funds. Sweden is advancing the take up of the European Fund for Strategic Investments (EFSI). As of December 2017, overall financing volume of operations approved under the EFSI amounted to EUR 1.7 billion, which is expected to trigger total private and public investment of EUR 6.3 billion. Energy ranks first in terms of operations and volume approved, followed by RDI and digital. Some 805 smaller companies or start-ups will benefit from this support III . Funding under Horizon 2020, the Connecting Europe Facility and other directly managed EU funds is additional to the ESI Funds. By the end of 2017, Sweden has signed agreements for EUR 194 million for projects under the Connecting Europe Facility. https://cohesiondata.ec.europa.eu/countries/SE 3. Summary of the main findings from the Macroeconomic Imbalance Procedure in-depth review The in-depth review for the Swedish economy is presented in this report. In spring 2017, Sweden was identified as having macroeconomic imbalances, in particular relating to persistent house price growth coupled with a continued rise in household debt. The 2018 Alert Mechanism Report concluded that a new in-depth review should be undertaken for Sweden to assess developments relating to identified imbalances (European Commission, 2017h). Analyses relevant for the in-depth review can be found in the following sections: the banking sector in Section 4.2.1; the housing market in Section 4.2.2; and private indebtedness in Section 4.2.3. 3.1.Imbalances and their gravity Private sector debt stands at 188 % of GDP, among the highest in Europe. Both households (85 % of GDP end-2016) and non-financial corporations (103 % of GDP end-2016) have high debt levels compared to other EU countries, which are also above proprietary debt benchmarks developed by the European Commission, Household debt is a particular source of concern. It has risen rapidly and persistently, outpacing GDP growth for over two decades now, driven primarily by mortgage lending. Although households own significant assets, these are generally illiquid and their value is exposed to market risks. Moreover, the distribution of debt across households is uneven, and there is a significant fraction of borrowers with large debt-to-income ratios, particularly among younger households and those buying properties in major cities. Corporate debt, while elevated, is matched by high equity cushions and corporate savings levels. Despite the significant stock of debt, financial risks remain limited thanks to healthy financial positions, in particular a low degree of balance sheet leverage and strong profitability. Moreover, external funding exposure, while growing, remains limited: domestic loans, which have proved resilient during the crisis, constitute the main funding source for non-financial corporations. The Swedish economy has a significant exposure to the housing market, which makes it vulnerable to shocks. Swedish house prices have steadily risen for almost two decades, although in autumn 2017 the market experienced a gradual decline, followed by another month-on-month price increase in January 2018. Strong fundamentals, in particular robust disposable income and population growth, can explain part of Sweden’s historical house price growth, but several indicators such as price-to-income (affordability) and price-to-rent (dividend) ratios suggest that house prices are above their fundamental values. Distortive taxation and structural supply-side inefficiencies in the housing market contribute to this overvaluation (see Section 4.2.2). The risks linked to this scenario have prompted the European Systemic Risk Board to issue a formal warning in 2016.

The banking sector is solid, but it would be only partially shielded against a potential abrupt fall in house prices. So far banks’ assets have performed well and the sector has high profitability compared to its peers in other EU countries. However, banks rely to a large extent on international wholesale funding, giving rise to some degree of maturity mismatch. Risk weights generated by their internal models are low and might not fully reflect the underlying risks in banks’ exposure to household mortgages. Consequently, in a severe housing market slump this vulnerability could have repercussions for the wider economy and the financial system. Due to the importance of Swedish banks in the region, other Nordic economies might also be affected. 3.2.Evolution, prospects, and policy responses While overall private debt has roughly stabilised relative to GDP, household debt remains on an upward trajectory. It grew at 7.0 % year-on-year in nominal terms as of December 2017, continuing to outpace economic and income growth. The increase in mortgage lending is driven by house price rises coupled with structural factors favouring (mortgage-financed) property investment, notably mortgage interest tax deductibility, variable rates and long maturities for mortgages. The authorities have gradually taken some policy action to curb household debt growth. After introducing a mortgage amortisation requirement in 2016, in late 2017 the government approved a stricter amortisation rule specifically targeting borrowing at high-debt-to-income levels, which will come in force in March 2018. In addition, the Swedish parliament adopted legislation to strengthen the legal mandate of the macroprudential authority (Finansinspektionen). The new mandate is operational from February 2018, allowing the authority to respond in a more timely manner with a wider range of potential measures to the risks associated with growing household debt. However, so far, these measures appear to have had limited impact on household debt growth, and key policy gaps remain. While the 2016 amortisation requirement seems to have considerably affected borrower behaviour, the overall impact on total debt incurred appears modest. Sweden has one of the highest tax incentives for home ownership in the EU due to relatively low property taxes and high mortgage interest rate deductibility, while the design of capital gains tax limits a more efficient use of the housing stock. These tax incentives contribute to the problem of persistent household debt growth. Corporations have continued a gradual post-crisis deleveraging process in 2017. Non-financial corporation debt relative to GDP is down by about 25 percentage points since its peak in 2009. This has mostly been the result of ‘passive’ deleveraging, with net credit flows to firms positive but outweighed by growth and inflation. Domestic bank loans remain the main funding source of firms, but large corporations increasingly rely on the bond market as well. While this allows for funding alternatives, a higher share of bond market financing could in some cases expose firms more to volatility and stress in the financial markets. Swedish banking groups have a substantial and growing exposure to household mortgages, but banks’ capital buffers appear sufficient to support this. The near-term risks of household debt service problems seem limited, given low debt service costs and sizeable household budget margins. However, stretched housing market valuations combined with high debt levels make the household sector vulnerable to shocks. If, for instance, mortgage interest rates were to rise significantly, or if incomes were hit due to an external shock to the economy, households could be forced to rapidly reduce consumption levels. Moreover, as Swedish banks are reliant on wholesale funding, a downturn in the housing market could result in a sudden rise in bank funding costs, thus amplifying the impact of any domestic housing market adjustment. Supervisors are mindful of such risks. House prices started gradually falling in autumn 2017, but this follows a long period of virtually uninterrupted strong growth. Real house prices have more than tripled over the past two decades, significantly outpacing income growth. Contrary to most European countries, Sweden experienced no major adjustment in house prices around the 2008-2009 financial crisis. House price growth peaked in 2015 at about 12 % in real terms, but since then there has been a notable loss of momentum: in 2016, real house prices rose by 7.6 %, and in 2017 the market cooled further, culminating in prices seeing outright month-on-month declines throughout the autumn. In January 2018, prices rose again by 3.4 % month-on-month on average, slightly above what could be expected based on seasonal trends. Market segments that had outperformed historically, notably Stockholm apartments, have shown particular weakness since early 2017, with prices in January 2018 close to 10 % below their peak in the spring of 2017. Still, valuation indicators continue to suggest that house prices remain very high relative to fundamentals. A number of policy measures appear to have supported the recent turn in the house prices. The introduction of the 2016 amortisation requirement likely had a modest dampening impact on prices. The gradual simplification of planning and building regulations, combined with rapid house price rises in recent years, encouraged new housing construction. The ongoing implementation of the ‘22-point plan’ for the housing market will likely further support housing supply. It will be important, however, for new construction to be focused on market segments where needs are most pressing, as it is becoming increasingly apparent that specific market sectors (notably luxury apartments) are experiencing a degree of oversaturation. The latter is likely a significant contributing reason for the recent house price correction. Some key structural distortions in the housing market have not been addressed yet. In particular, no policy action has been taken to reform the tax incentives for home ownership and mortgage debt (see above), liberalise tight rental market regulations and revise the capital tax on owner-occupied homes. In addition, there remains scope to further tackle the lack of land available for development, complex planning and building regulations, limited incentives for municipalities to support new construction and limited competition in the construction sector. 3.3.Overall assessment Sweden faces sources of imbalances in the form of high private debt and overvalued house prices. The elevated private indebtedness, in particular of households, makes the economy vulnerable to macroeconomic shocks. Large deleveraging needs may potentially lead to a harmful adjustment, with lower consumption, investment and credit flows. In spite of recent declines, house prices continue to appear overvalued. In the event of a large, disorderly downturn in the housing market, there is a risk of negative spillover effects to other Nordic countries through the financial system. Policy measures to address these imbalances have so far been insufficient. The authorities have gradually taken some policy action to curb household debt growth in recent years, but this appears to have had limited impact on indebtedness growth. In addition, some key structural issues in the housing market have not been addressed. Overall, policy gaps remain for housing-related taxation, the functioning of housing supply and of the rental market.



Table 3.1:MIP assessment matrix (*) — Sweden 2018 (Continued on the next page) Table (continued) Source: European Commission 4. Reform priorities

4.1. Public finances and taxation Public finances remain strong. Sweden is set to have achieved a general government surplus of 0.9 % of GDP and a structural surplus of 0.8% of GDP in 2017. The debt-to-GDP ratio is expected to decline below the new 35 % debt anchor by 2019. The 2018 budget bill includes initiatives to address key objectives while strengthening fiscal soundness. It includes new spending measures of about SEK 40 billion (EUR 4.1 billion), or 0.8 % of GDP centred on labour market and migrant integration, climate and environment, education, health and defence. The bill also provides for amendments to the fiscal framework from 2019 onwards. With prudent fiscal policy in place, Sweden faces low fiscal sustainability risks in the medium to long term. 4.1.1.Fiscal framework The recently revised fiscal framework aims to ensure fiscal sustainability. The Swedish authorities adopted a fiscal governance reform package in late 2017, with effect in 2019. Most notably, the net lending surplus target defined over the cycle is lowered to 0.33 % of GDP from the current 1 % of GDP. The structural balance rule is complemented by a debt anchor set at 35 % of GDP, a new feature serving as a benchmark consistent with the surplus target ( ). The reforms further improve the soundness of the framework. The main conceptual pillars of the framework essentially remained in place. Changes, such as the establishment of a new debt anchor as an explicit multi-annual debt objective, helped to bring the Swedish national regulation in line with the Budgetary Frameworks Directive (2011/85). The Fiscal Policy Council (Finanspolitiska rådet) has received a stronger mandate. It has a more prominent role in assessing compliance with the rules and is tasked with the regular evaluation of the government's economic forecasts.( ) The nomination procedure for the Council's members has been amended. So far, members have been elected at the discretion of the Council itself. Following a broad political agreement, this process will be replaced on 1 July 2018 by a selection process steered by a nomination committee. This committee will include the Chair and Deputy Chair of the Riksdag’s Finance Committee, as well as senior officials knowledgeable in the field of e.g. economic policy or statistics. The inclusion of elected representatives in the nomination procedure for the Fiscal Policy Council was officially motivated by the desire to give the independent body more democratic legitimacy and increase its responsibilities and diversity. However, former and current members of the Council have opposed this change because it may actually decrease the members’ autonomy now that their selection will be more political. 4.1.2.Taxation developments The general level of taxation remains one of the highest among EU countries. In 2017, the total tax burden was 43.5 % of GDP compared to the EU average (39.4 % of GDP). Given the composition of the 2018 budget the level is expected to remain broadly unchanged. The 2018 budget bill has introduced limited changes to the tax system. These include tax reductions for pensioners to gradually close the gap between taxation of income from work and taxation of income from pensions. The budget also raised the income tax rate for non-residents (from 20 % to 25 %). It plans to change corporate taxation, such as a lowered corporate tax rate (from 22 % to 20 %) combined with a restriction of interest deductibility for companies. Other tax measures focus on small and medium-sized businesses and a greener more sustainable economy. To promote job creation and entrepreneurship, the self-employed are given incentives to hire their first staff member, taxes are reduced on stock options used by start-ups as an alternative to a higher salary, and an exemption from value added tax exemption is introduced for small businesses. To make the economy greener, the budget includes tax increases on aviation and a lower electricity tax for certain sectors. Addressing tax incentives could help mitigate the build-up of household indebtedness. There are currently no plans to revise taxation on housing, such as mortgage interest deductions and recurrent property tax. Reforms in this area could contribute to a more favourable development of household debt (see Section 4.2) and would also have a favourable impact on income equality, particularly if the proceeds are used to reduce taxes on labour (Box 4.1.1). 4.1.3.sustainability of public finances Sweden's public debt burden is expected to continue declining over the medium-term. Sound fiscal and strong economic performance is projected to bring government debt close to 20 % in 2028 from 39 % in 2017, well below the 60 % of GDP Treaty reference value. The outlook for Sweden's fiscal sustainability appears sound in the short, medium and long term. ( ) ( ) Debt dynamics appear to be resilient to shocks. In all scenarios public debt remains on a downward trend and the increase in the level of debt compared to the baseline is moderate. In the worst case scenario, based on a shock to the exchange rate (under a cumulative 20.8 % depreciation over 2 years), gross public debt would reach 39.3 % of GDP in 2019 given that over 26 % of public debt is denominated in foreign currency. Public expenditure on long-term care is projected to increase. Demographic changes imply that under current policies spending on long-term care can be expected to increase significantly, from 3.2 % of GDP in 2016 (among the highest in the EU), to 4.9 % of GDP in 2070 (European Commission, 2018b). This corresponds to a 41 % increase, similar to the EU average. The share of the population that receives long-term care benefits is relatively high by EU standards, whereas the underlying level of need ( ) is broadly in line with the EU average. The long-term care sector is not fully efficient. Resources are not always targeted at those who need care the most and can least afford it. Additionally, the proportion of recipients receiving care in an institutional setting (rather than at home) is relatively high. There is room to improve the flexibility of the system. Box 4.1.1: Effects of a tax shift from labour to property Mortgage interest tax deductibility has been a long-standing issue in Sweden. The country is one of the very few EU member states with an uncapped ( ) tax reduction on mortgage interest paid by owner-occupiers. This is widely seen as an incentive for households to take on high levels of debt and as a source of growing imbalances (see Sections 4.2.2 and 4.2.3). In order to address these imbalances, the Council has repeatedly called on Sweden in its country-specific recommendation to gradually limit mortgage interest deductibility (MID). Removing MID would ease housing demand and discourage excessive leverage. The Joint Research Centre of the European Commission has used the EU tax-benefit microsimulation model EUROMOD IV to simulate the effect of a tax shift from labour to property. Results suggest that removing MID has, on average, a small effect on disposable income. If combined with cuts in labour taxes or in-work tax subsidies, it could boost employability and work incentives for those with a lower income, thus further reducing inequality. These simulations are primarily aiming to improve our understanding of the impact various policies could have on individuals and the economy, while identifying possible trade-offs. Simulations inevitably abstract some possible sentiment effects that could result from a significant reform. As a first step, the fiscal and distributional effects of removing MID are considered. Removing the incentive would result in an additional SEK 17 billion (or EUR 1.8 billion) of revenues (0.3 % of GDP). This would decrease household disposable income by a mere 0.8 % in a smooth progressive pattern across the household deciles (see graph 1), thereby reducing income inequality. As a second step, the resulting extra fiscal space is used to reduce labour taxes to support low-skilled and non-EU born people to enter the labour market. Unemployment rates of these groups are relatively high in Sweden. As suggested by economic theory, moving the tax burden from labour to more growth-friendly revenue sources may improve labour market participation. Swedish labour taxation is relatively elevated (25 % of GDP versus 19.6 % on average in the EU), especially for the single worker who earns 50 % of the average wage (tax wedge of 39.2 % versus 32.8 % EU average). For illustration, two policies shifting taxes from labour to property are considered: (1) lifting labour demand by reducing the rate of employers’ social security contributions (SSC) from 33.2 % to 22.3 % for low-wage earners V while ensuring budget neutrality; and (2) lifting labour supply with a targeted increase of the earned income tax credit (EITC) for workers earning less than the average wage while making the tax credit refundable VI . Results show that the rebate of the SSC lowers the implicit tax rates on labour income for all households, and that the impact is particularly significant for wage earners in the first income deciles (i.e. low and middle-income earners – see graph 2). The rebate allows reducing the gap between labour costs and take-home pay and could result in higher employment and/or wages VII . Sweden is using the EITC to ensure appropriate tax incentives for individuals to participate in the labour market. The simulated EITC reform would partially compensate for the decrease in household disposable income caused by the removal of the MID, especially between the first and fifth deciles (see graph 1). As a consequence, distributional effect could be significant (reduction in the Gini coefficient from 0.239 to 0.237). In addition, since this scenario would not use the entire fiscal space, roughly SEK 8 billion (EUR 0.8 billion) could be used to finance, for example, complementary policies like upskilling or integration of vulnerable groups in the labour market. Using the full amount of freed up resources in a broader EITC increase offsets most of the negative impact from the MID reform on disposable income, but leads to a smaller impact on inequality (Gini index moving from 0.239 to 0.238) and a minor employment effect (a slight increase in labour market participation, especially from women) VIII . 4.2. Financial sector 4.2.1.Banking sector (*) ( )

Overview The Swedish banking sector is large and interconnected. The sector’s assets have been around 300 % of Sweden’s GDP in recent years, while its equity has for long remained broadly stable relative to total assets. Given its size and operations in the region, the banking sector plays a key role and is highly interconnected with the Nordic-Baltic financial system. Bank profitability remains among the highest in Europe despite the negative rate environment. Banks’ returns on equity are averaging 12 %. In addition to low funding costs and high cost efficiency, strong economic conditions boosted lending as well as revenue from advisory and transaction fees, thus supporting profits. Banks are increasingly exposed to the real estate market. Loans to households and non-financial corporations holding real estate have increased and constitute about 80 % of the major banks’ total lending. Of this, about 75 % represents housing loans to households and the remaining 25 % lending to corporates holding property assets. Too strong a focus on housing lending in the banks’ portfolios could lead to a misallocation of credit to non-productive uses. Good asset quality has been a major strength of the Swedish banking sector. In 2016 the average non-performing loan ratio stood well below the EU average of 5.2 % and remained one of the lowest in the EU. High repayment capacity due to high savings and a strong repayment culture have helped to limit defaults. Banks’ capital buffers have increased and are above requirements. In response to stability risks stemming from the housing market and high household indebtedness, Finansinspektionen, the Financial Supervisory Authority (FSA), has activated specific sectoral and countercyclical buffers (European Commission, 2017a). The average Tier 1 ratio stood at 22.8 % in June 2017, well above the EU average of 15.9 % (Table 4.2.1). Regulatory capital ratios are high but risk weights are among the lowest in Europe. The average risk weighting of bank assets has fallen, contributing to the rise in capital adequacy ratios, while the ratio of capital to total (non-risk-weighted) assets has been broadly stable over time. Swedish banks have relatively low risk weights and capital levels compared to total assets (Graph 4.2.1). This results from the extensive use of internal rating-based models which incorporate low historical defaults on large portfolios, notably residential mortgages. Because these historical values might underestimate the actual risks, the Financial Supervisory Authority (FSA) (Finansinspektionen) imposed some adjustments such as higher risk weights for residential mortgages, whereas the Riksbank has argued for a leverage ratio requirement as a complement to risk-weighted capital requirements. Graph 4.2.1:Common Equity Tier (CET1)-to-total-assets ratio and implied risk weights (%), four major Swedish banks versus sample of 62 large EU banks (1), (2) Source: Riksbank, Bankscope Key risks The banks’ high exposure to the housing market remains a key risk. Households remain vulnerable to an adjustment in the housing market with substantial repercussions for the overall economy and the financial system (see Risks in Section 4.2.3). This is highlighted in the European Systemic Risk Board warning to Sweden issued in November 2016. Commercial real estate (CRE) markets have been buoyant, driven by a search for yield. Investment in CRE has been growing fast, supported by bank lending but also by an increasing share of market-based funding. While the associated risk does not appear to be of the same order as for residential property, CRE is sensitive to economic downturns. There is the potential of negative spillovers, given the connections to the financial system and the real economy (Finansinspektionen, 2017c). A downturn in housing markets could result in higher funding costs with implications for the region. Banks are reliant on wholesale funding as domestic deposits fund only around half of the banks’ loan portfolio. To cover this funding gap banks issue covered bonds that are held by other domestic and foreign financial institutions. Against this backdrop, a change in risk perception could result in a sudden rise in bank funding costs, thus amplifying the impact of any domestic housing market adjustment. To contain associated liquidity risks, the Riksbank urges banks to have enough liquidity reserves and maintain sufficiently stable funding in foreign currency. Macroprudential policy Macroprudential measures have been adopted to mitigate the risks posed by the housing market. The FSA has introduced a number of specific capital buffers for banks, a 25 % risk weight floor on residential mortgages for banks applying the internal rating-based approach, specific amortisation requirements for households with mortgage loan-to-value ratios over 50 or 70 %, and the imposition of a 100 % risk-weight on mortgages for real estate (as of 2007). In addition, the government approved a strengthened amortisation requirement that enters into force in March 2018 (see Section 4.2.3). In December 2017, parliament adopted legislation to strengthen the legal framework for the macroprudential authority. The new legislation was introduced to give a clear mandate to the FSA to introduce macroprudential measures that may be required in a timely and effective manner and using a wider range of tools. Importantly, a formal public consultation process, which is standard procedure before introducing any new regulations, and government approval will still be required for any proposed measures. It is the government’s intention to use this approval requirement as an ‘emergency brake’ (IMF, 2017). Nordea’s planned move to Finland will have significant implications for the Swedish banking sector. Subject to shareholder approval, Nordea, a globally systemically-important institution, will relocate its headquarters to Finland by end-2018. The move would reduce the asset-to-GDP ratio of the Swedish banking sector by over 100 % of GDP. While Nordea’s operations in Sweden are not expected to markedly change in terms of size and interconnectedness, the move will also have implications for the supervisory and resolution framework.( ) This concerns not only liquidity management in the event of cross-border financial stress and possible resolution issues, but also how macroprudential measures will be applied to branches of foreign banks active in Sweden. Some progress has been made to reduce vulnerabilities due to regional spillovers. Mindful of the interconnectedness of the financial system in the Nordic-Baltic region, supervisors and national central banks together with the European Central Bank have signed memoranda of understanding to strengthen coordination among countries. However, this arrangement has yet to be tested in a distress situation. In addition, the Swedish government set up an inquiry to analyse the consequences of Sweden's possible participation in the EU Banking Union, with reporting expected by November 2019. Table 4.2.1:Financial soundness indicators Source: ECB 4.2.2.Housing market (*)

Housing market developments While the Swedish housing market appears to be undergoing a correction, this follows a two-decade period of strong price growth. Since bottoming out after the banking crisis in the early 1990s, real house prices have more than tripled, significantly outpacing income growth as well as house price rises in other EU countries (Graph 4.2.2). In addition, whereas most EU countries experienced significant property market adjustments over the past decade, the house price upswing in Sweden has continued virtually uninterrupted until recently, aside from a short-lived and relatively mild dip around the 2008 financial crisis. This steep and broadly persistent growth in house prices poses risks to financial stability (see Sections 3, 4.2.1 and 4.2.3) and also has implications for social equality (see Inequality in Section 1). Graph 4.2.2:Averages of the annual growth rates of real disposable income and real house prices between 2001-2016 Source: European Commission

House price momentum has decelerated notably since mid-2016, albeit with significant differences between regions and market segments. On average, real house price growth slowed from 12 % year-on-year in 2015 to 7.6 % in 2016, as a combination of steep price rises in prior years, the introduction of a formal amortisation requirement in June 2016 (see Section 4.2.3), and a sharp rise in new supply appeared to weigh on the market, notably in Stockholm. In 2017, house price inflation cooled further, accompanied by a slowdown in transaction volumes. In autumn 2017, the housing market started experiencing outright month-on-month declines, culminating in an overall average price fall of 2.5 % ( ) over 2017. This was driven mainly by weakness in the tenant-owned apartment ( ) market, with prices of Stockholm apartments in particular continuing their underperformance relative to the national average and falling by 9 % over the year (Graph 4.2.3). Single-family homes, on the other hand, which until 2015 had lagged the apartment market, still registered a minor overall price rise (about 0.2 %) in 2017. In January 2018, prices rose again by 3.4 % month-on-month on average for the overall housing market, slightly above what could be expected based on seasonal trends. Graph 4.2.3:House prices by market segment (nominal) Source: NASDAQ OMX Valueguard-KTH Housing Index In spite of recent declines, valuation indicators suggest that house prices remain higher than seems justified based on fundamentals. Fundamental drivers, in particular strong population and income growth and increasing urbanisation, have supported house price growth (European Commission, 2016a). Nevertheless, over time valuations appear to have become disconnected from fundamentals. In particular, price-to-income and price-to-rent ratios (measures of affordability and return-on-investment of owner-occupied houses) are respectively about 40 % and 60 % above their long-term averages, and fundamental-model-based estimates suggest that the housing market is overvalued by around 8 % ( ) as of end-2016 (Graph 4.2.4). These estimated valuation gaps are among the highest in the EU (European Commission, 2017a). While such indicators are inevitably subject to some modelling uncertainty, they do underscore the vulnerabilities linked to the Swedish housing market. Graph 4.2.4:Valuation gap based on price-to-income and price-to-rent ratios and fundamental-model-based estimate (1), (2) Source: European Commission Demand-side issues The impact of low mortgage rates on housing demand has been amplified by a number of specific structural features of the Swedish mortgage market. Monetary policy in Sweden has remained highly accommodative, with benchmark interest rates entrenched in negative territory for over 2 years now (see Section 1). While falling interest rates naturally act as a tailwind for the property market, in Sweden this effect has been magnified by a high share of variable-rate mortgages, long contract maturities and still generally low amortisation rates (see Section 4.2.3 for details). As a result, debt service costs relative to incomes have steadily fallen to reach post-crisis lows in 2015, even as house prices and debt levels have continued to climb. In 2016, the introduction of the new amortisation requirement has raised average debt service costs for new borrowers somewhat (further discussed in Section 4.2.3). The Swedish tax system provides some of the strongest incentives for home ownership in the EU. The overall tax take from property taxes in Sweden is about 1 % of GDP, just over half the EU average (Graph 4.2.5). This is partly due to a ceiling on annual property taxes, resulting in most owner-occupiers effectively paying a relatively modest fixed fee that does not scale with property values. Consequently, imputed rents are significantly undertaxed compared to other capital income, particularly for higher-value properties (European Commission, 2017a). Additionally, Sweden is one of the very few EU countries where an uncapped ( ) tax reduction is granted on mortgage interest paid by owner-occupiers. This provides an effective subsidy for funding a property purchase using mortgage debt, and further favours (debt-financed) home ownership — both over other investment opportunities and over rental housing, for which the overall tax burden is considerably higher (SOU, 2014). Graph 4.2.5:Revenues from property taxes Source: OECD Reforming the tax incentives for home ownership and mortgages could also benefit job creation and income equality. By design, phasing out tax reductions for mortgage interest and raising recurrent property taxes would dampen demand for housing and mortgages and thus help contain imbalances in these areas. In addition, these tax reforms could bring about broader economic and social benefits as well. Analysis by the Swedish Fiscal Policy Council (Finanspolitiska rådet) has shown that reducing mortgage interest deductibility and abolishing the ceiling on recurrent property taxes would have a broadly progressive impact, as these tax incentives tend to be largest for higher-income households (Finanspolitiska rådet, 2016). This potential inequality-reducing effect could be further enhanced by using the fiscal room created by such reforms to reduce taxes on income from labour. Microsimulations using the Commission’s EUROMOD model suggest that eliminating mortgage interest deductibility could free up an estimated SEK 17 billion (EUR 1.8 billion) to ease the labour tax burden, with a broadly progressive distributional impact (Box 4.1.1). Supply-side issues Investment in residential construction has been subdued compared to peer countries for a prolonged period of time. While rising house prices have spurred sizable investment in housing in other EU countries (particularly before the 2008 financial crisis), new construction in Sweden has remained muted historically (Graph 4.2.6). This is partially explained by a steep fall in residential investment in the wake of the early-1990s banking crisis. However, new construction activity in Sweden continued to lag behind the EU average until 2013, in spite of comparatively high population growth and house price rises. Direct measures of the effect of house price growth on construction output also point to a relatively weak supply response in that period (European Commission, 2017a; IMF, 2015). Graph 4.2.6:Residential construction investment Source: European Commission Building activity has picked up sharply in recent years, but still falls short of near-term demand. After experiencing a protracted post-crisis ‘double dip’, new construction has seen a notable upswing, with annual housing starts more than tripling from their 2012 nadir (Graph 4.2.7). However, this still remains somewhat below projected near-term needs, and growth in construction output appears likely to gradually taper off as capacity constraints in the sector become increasingly binding. Graph 4.2.7:Housing starts, including net conversions, versus projected need Source: Statistics Sweden (historical data until 2016); Boverket (estimated starts for 2017-2018, and projected need) Moreover, while aggregate construction growth seems encouraging, it is unclear if it is focused on the regions and market segments where shortages are most pressing. While hard data are limited, it appears that the recent surge in construction activity may be overly skewed towards high-end developments (Riksbank, 2017b), including in some regional markets where end-user demand for such properties tends to be especially limited. As a result, there is a risk of oversupply in specific segments of the housing market, while a chronic shortage of affordable housing near major economic hubs remains. A number of structural bottlenecks are constraining housing supply and raising construction costs. A first key issue is lack of developable land, partly driven by the fact that a large share of buildable land is owned by municipalities, who can have financial incentives for making it available in a piecemeal fashion over time rather than when it is needed most (European Commission, 2015). Secondly, while reforms have been introduced to simplify zoning and building regulations, overall they remain relatively cumbersome and complex. In particular, local standards tend to vary between different municipalities in some areas, creating a fragmented market that reduces efficiency and raises uncertainty for construction companies (European Commission, 2016). Also, the timeline to obtain planning permission can be considerably longer than in other countries (Emanuelsson, 2015). This raises financial risks for construction projects and causes delays in new supply coming online. Finally, rigidities in the construction sector have weighed on productivity growth and limited competition among developers, raising construction costs in Sweden to among the highest in the EU (Graph 4.2.8). Graph 4.2.8:Price level index for residential construction costs for selected EU countries and Norway Source: European Commission

Productivity in the construction sector has started to recover, but remains well below its mid-2000s peak. While construction productivity growth has been lacklustre in many countries, it has performed particularly poorly in Sweden (Graph 4.2.9). This is partly due to the broader housing supply cycle: housing construction, which accounts for a large part of value added in the construction sector, plunged after 2007 and did not recover meaningfully until 2013. However, structural factors likely also play a significant role, including fragmented planning regulations constraining potential economies of scale and relatively limited competition among construction firms. It remains to be seen if the recent positive trend will be lasting. Graph 4.2.9:Labour productivity in construction sector, Sweden and selected EU countries (1) Source: European Commission Competition in the residential construction sector remains limited. Barriers to entry for small and foreign firms, like complex planning regulations that favour well-connected established companies, and the ability of large developers to control land resources, hamper competition (European Commission 2017a). Market concentration in the construction sector remains high, in spite of a modest decrease recently. Among the 30 largest construction companies, the share in turnover of the four leading ones dropped from 73 to 65 % over the past 5 years (Sveriges Byggindustrier 2012 and 2017). Barriers to efficient usage of the existing housing stock Sweden’s unique rent-setting framework leads to below-market rents in major cities. Rent levels for most residential tenancies are set in negotiations between the Swedish Union of Tenants (Hyresgästföreningen) and housing companies using a collective bargain approach. These are in turn based on a ‘utility value’ (bruksvärde) determination, intended to reflect the quality of accommodations and tenant preferences in the negotiated rent level. In practice, however, this system tends to result in rents that are well below market levels, particularly in urban areas. In the Stockholm metropolitan area, for instance, model-based estimates suggest that negotiated rents are on average roughly 25-30 % below market rents, and considerably more so in the most attractive central-city locations (Donner et al., 2017). While the Swedish system does not involve direct rent control regulations, the overall impact is thus essentially the same. Cross-country analysis shows that the effective degree of rent control and overall tenant protections in Sweden is among the highest in the EU (European Commission, 2017a; Cuerpo et al., 2014). Below-market rents result in poor access to rental accommodation and create lock-in and ‘insider-outsider’ effects. The rent-setting system is highly favourable for ‘insiders’ who have been able to obtain a primary tenancy and thus enjoy low rents and effectively permanent security of tenure. Conversely, ‘outsiders’ — mainly newcomers to the rental market, such as students, recent immigrants and younger households — face great difficulty accessing rental housing, as the large demand/supply imbalances resulting from below-market rents lead to long waiting lists (e.g. on average over 9 years in greater Stockholm). In addition, the favourable conditions enjoyed by sitting tenants incentivises them not to move, even if their accommodation is no longer fully suited to their needs, thus creating lock-in effects in the rental housing market.( ) The disconnect between actual rents and market rents has also impaired the supply of rental housing. Below-market rents combined with high land prices incentivise developers to favour construction of owner-occupancy housing over rental units ( ). The situation also encourages the conversion of rental units into owner-occupied homes, thus further aggravating the rental housing shortage. This has been particularly problematic in major metropolitan areas: in greater Stockholm, since the early 2000s the total rental housing stock has steadily fallen (Graph 4.2.10), in spite of strong underlying demand. In contrast, the stock of tenant-owned apartments, the nearest owner-occupancy equivalent to rental apartments, has seen comparatively strong (albeit still insufficient) growth. Graph 4.2.10:Cumulative change in rental versus tenant-owned housing stock in Greater Stockholm Source: Boverket, Statistics Sweden In addition, there are negative knock-on effects on labour mobility and social equality. The lock-in and insider/outsider effects in the rental market can prevent workers from moving to locations with the best job opportunities, thus hampering labour market dynamism. Furthermore, tight rental regulations combined with a severe shortage of affordable rental housing can exacerbate inequality and social problems. This particularly affects lower-income households who cannot afford to buy their own home and for whom access to affordable, entry-level rental housing is thus especially important ( ). This may force them to resort to the growing shadow rental market, which can involve sizeable payments for unauthorised sublets without security of tenure. Sweden’s tight rental regulations also contribute to a relatively high degree of overcrowding among socially vulnerable groups, including non-EU migrants (OECD, 2017). While reforming Sweden’s rental market may have significant redistributive and social consequences as well, this could be managed by a combination of tax measures and targeted subsidies for vulnerable households (Donner et al., 2017). Capital gains taxes on property sales can make moving costly for homeowners, thus creating lock-in effects in the owner-occupier market. Sweden applies a 22 % capital gains tax on property sales, even when a homeowner is selling to buy another property of similar value elsewhere (meaning no actual economic gain is realised). In light of the steep house price rises over the past two decades, this implies that households who have owned their home for a long time can face prohibitively high moving costs ( ). In practice, this tends to particularly affect elderly households living in a large single-family house looking to relocate to a conveniently-located apartment. Reforming capital gains taxation to eliminate this lock-in effect could help free up underused family dwellings from the existing housing stock and improve overall liquidity and supply-demand matching in the owner-occupier market. The latter will become especially important as the aggregate supply-demand gap in the housing market continues to gradually shrink thanks to the strong rise in construction output, while imbalances remain within market segments (see above). Policy developments Demand-side policy action in the housing market has been focused on curbing mortgage lending via macroprudential measures. Since 2010, Sweden has gradually introduced a number of measures to contain mortgage debt growth (and thus housing demand). Steps taken include setting loan-to-value limits, adjusting banks’ risk weight floors, and introducing a formal mortgage amortisation rule in June 2016 (see Section 4.2.3 for details). In addition, an enhanced amortisation requirement for borrowers with high debt-to-income ratios is set to come in force in March 2018 (also discussed in Section 4.2.3). While earlier measures largely failed to make a dent in house price momentum, the 2016 amortisation requirement appears to have had some modest impact. Analysis based on the macroprudential authority’s annual mortgage market survey suggests that households affected by the new rule are buying somewhat less expensive properties on average, with the overall effect on purchase prices( ) estimated at about 3 % (Finansinspektionen, 2017a). While this should not be interpreted as a direct measure of overall market impact ( ), it indicates that the 2016 amortisation requirement likely contributed to the recent slowdown in house price growth. Sweden has gradually implemented a range of measures to improve new housing supply in recent years. Policy action has mainly focused on streamlining the planning and appeals processes to make lead times shorter and more predictable, simplifying building and zoning regulations and more generally reducing red tape for new construction (European Commission, 2015a and 2016a; Emanuelsson, 2015). There has also been some modest budgetary support for new construction, either in the form of investment subsidies for specific types of housing (e.g. for students or the elderly) or as general construction bonuses to incentivise municipalities to promote more building activity. The authorities are proceeding with the implementation of the 22-point plan for the housing market launched in mid-2016. The plan contains a range of measures aimed at making more land available for development, reducing construction costs, shortening planning process lead times and addressing some specific rental market inefficiencies. Significant parts of the plan have been largely implemented over the course of 2017, particularly with regard to reducing construction costs and lead times. Other key reforms under the plan, including a comprehensive review of building and planning regulations and measures for more developable land, involve significant preparatory work and stakeholder consultation processes. It will therefore take more time before these proposals are finalised and they remain subject to implementation uncertainty. Nevertheless, overall, the 22-point plan and similar new initiatives will likely provide further support for the strong ongoing construction upswing. Sweden is taking steps to raise participation of foreign companies in the construction industry. In July 2017, the government announced a plan to facilitate entry of foreign construction firms in order to increase competition and lower residential construction costs. The National Board of Housing, Building and Planning (Boverket) will set up a website with translations of the building regulations into other languages (initially just English) which should be operational by mid-2018. In addition, it will report on possible further measures to address obstacles foreign operators encounter. 4.2.3.Private indebtedness (*) Household debt In spite of a modest slowdown since mid-2016, Swedish household debt continues to grow at one of the fastest rates in the EU. Household debt has been on a steep and persistent upward trajectory, outstripping GDP growth for over two decades now. In nominal terms, it increased by 7.0 % ( ) in 2017, continuing a gradual deceleration from its recent peak year-on-year rise of 7.8 % in May 2016. However, its current growth rate remains among the highest in the EU, even though Swedish household debt levels already appear elevated compared to peer countries (European Commission, 2017a). Household debt is unevenly distributed. The aggregate debt level across all Swedish households (including those without any debt) amounts to about 184 % ( ) of disposable income as of Q3 2017. While an estimated 57 % of the adult population are tenants or mortgage-free home-owners (Ölcer et al., 2017), households who do have a mortgage have an average debt-to-income (DTI) ratio approaching 340 % (Blom et al., 2017). Among mortgaged households, DTI ratios tend to be highest for lower-income households (Graph 4.2.11), although this trend appears to be gradually reversing (Finansinspektionen, 2017b) — possibly driven by increasing difficulties faced by lower-income households to obtain a mortgage at all. Younger mortgage borrowers also tend to have higher debt loads relative to income than older households, and are more likely to have unsecured loans in addition to their mortgage (Finansinspektionen, 2017b). DTI ratios are also higher on average for those living in major cities, particularly Stockholm.

Graph 4.2.11:Debt-to-income ratios for selected groups of mortgage borrowers (as of September 2017),

(1), (2) Source: Blom et al., 2017 Drivers for household debt growth Household debt growth has been driven by house price rises coupled with structural factors favouring (mortgage-financed) property investment. The steady increase in Swedish household debt stems almost entirely from growth in loans for property acquisition (European Commission, 2017a). The latter is interlinked with rapid house price rises (see Section 4.2.1) in a mutually reinforcing way: higher house prices enable larger mortgage loans by increasing the value of the underlying collateral, and growing mortgage debt levels raise the total investment amount flowing into a limited supply of houses, thus putting upwards pressure on prices. In Sweden, this dynamic is further exacerbated by the following structural factors that act to lower debt service costs: ·Favourable tax treatment of owner-occupied housing and mortgages (see Section 4.2.2 for details). ·Mortgages are mostly variable-rate: about 73 % of new and 68 % of all outstanding mortgages are linked to short-term interest rates (European Mortgage Federation, 2017). This has reduced debt service costs as interest rates have fallen to historically low levels in recent years, but it also shifts risks related to future rate rises to the household sector. ·Swedish mortgage contracts have historically been characterised by long maturities compared to other EU countries, generally accompanied by low amortisation (i.e. capital repayment) requirements. This further amplifies the relative impact of lower interest rates on monthly mortgage payments (European Commission, 2017a). Risks Steadily growing household leverage coupled with elevated house prices makes the economy vulnerable to shocks. If mortgage interest rates were to rise – either driven by a gradual normalisation in monetary policy or by wider risk premiums ( ) – highly-indebted households may need to rapidly reduce consumption to meet rising mortgage payments. This would reduce demand and raise uncertainty, potentially weighing on growth and employment and thus further decreasing households’ ability to service their mortgages. Ultimately, this could lead to a disorderly deleveraging process with a significant broader macroeconomic impact, in line with historical developments in some other countries facing a combination of high house prices and household debt (OECD, 2017a). These vulnerabilities are also confirmed by proprietary debt benchmarks developed by the European Commission based on empirical cross-country evidence, which suggest that Sweden’s household debt load is higher than can be justified by fundamental drivers, and above levels at which the risk of crisis becomes elevated. Risks are partly mitigated by households’ robust payment ability and financial wealth. Households with a mortgage generally have relatively high income surpluses (roughly 40 % of disposable income on average) after mortgage service costs and day-to-day expenses (Finansinspektionen, 2017b). Households’ strong payment ability is also reflected in a very low share of non-performing household loans (see Section 4.2.1). Additionally, households have a high savings rate and significant financial wealth, estimated at roughly 3 times their liabilities. However, this relatively strong overall financial position would likely provide only limited cushioning in a significant housing market downturn. While income surpluses are high on average, they are heavily skewed towards higher-income households (Graph 4.2.12). Moreover, while significant income surpluses imply that most households would likely be able to continue servicing their debt even in a downturn, there could still be a considerable consumption reduction as households may wish to maintain or even raise their savings rate in light of increased economic uncertainty. As for financial wealth, close to 50 % of non-housing assets owned by Swedish households are invested in pension fund or life insurance instruments and can therefore only be accessed upon retirement. A large portion of the remainder — particularly equity investments, which account for about a third of total household wealth — is exposed to market risks, and would likely fall in value in an economic downturn. Consequently, rather than cushioning the impact of a housing market fall, this could further amplify it, by weighing on consumption via wealth effects. Graph 4.2.12:Estimated monthly income surplus (1) for newly mortgaged households in different income deciles, by year of origination Source: Finansinspektionen Policy developments The authorities have gradually taken some policy action to curb household debt growth in recent years, relying mainly on macroprudential measures. These include the setting of a loan-to-value (LTV) ceiling of 85 % for mortgages in 2010 and the gradual raising of banks’ risk weight floors for mortgages in 2013 and 2014. In June 2016, the authorities implemented a formal mortgage amortisation rule, requiring new mortgages to be paid down by a minimum of 2 % per year until the LTV drops below 70 %, and by 1 % afterwards until the LTV drops below 50 %. In December 2017, Sweden also adopted an expanded legal mandate for the macroprudential authority (see Section 4.2.1). The 2016 amortisation requirement has had a considerable impact on borrower behaviour, but the effect on total debt incurred appears modest. Estimates based on the macroprudential authority’s mortgage market survey indicate that the measure led affected borrowers to reduce their mortgage borrowings by 9-14 % (Finansinspektionen, 2017a). However, the impact on borrowers’ overall debt levels appears much smaller (up to 4 %, and only for the most strongly affected borrowers). This suggests that the amortisation rule may have prompted some households to resort to unsecured borrowing to replace part of their mortgage financing, although further investigation will be required before firm conclusions can be drawn. Despite this possible undesirable side effect, the overall impact of the amortisation requirement appears broadly positive. It has led to a modest fall in the average debt-to-income ratios for new mortgage borrowers (to 402% in 2016 from 406% in 2015) after years of steep increases, and prompted a small reduction in the share of households borrowing at the highest debt-to-income levels (Graph 4.2.13). By design, it also raised amortisation rates: on average across all borrowers, mortgages obtained in 2016 are amortised at a rate that is close to 50 % higher than for those originated in 2015. While this still leaves overall amortisation levels quite low by international standards, it nevertheless represents a meaningful step forward that will, at the margin, contribute to the financial resilience of the household sector. Graph 4.2.13:Share of households with different debt-to-income ratios, new loans Source: Finansinspektionen A strengthened amortisation rule for new mortgage borrowers with high debt-to-income (DTI) levels will come into force in March 2018. This new macroprudential measure will require households obtaining a mortgage with an overall debt level over 450% of gross income (roughly equivalent to 630 % of after-tax disposable income) to amortise by an additional 1 percentage point per annum. Combined with the existing amortisation rule introduced in 2016, this would bring the overall amortisation rate to a maximum of 3 % per annum (Graph 4.2.14). This represents an additional step towards reining in lending at excessive DTI levels. Given the recent cooling in the housing market, this measure seems to be balanced. It is projected to affect only about 14 % of new mortgages issued by raising the debt service cost (in cash flow terms) for high-DTI borrowing, as opposed to imposing an actual DTI limit. Graph 4.2.14:Rate of amortisation given the debt-to-income ratio and loan-to-value ratio (2016) Source: Finansinspektioen’s sample from the mortgage survey in 2016 and own calculations. Figures on percentages of affected households may not add up due to rounding. Corporate debt Swedish non-financial corporations continued a gradual post-crisis deleveraging process in 2017. Consolidated corporate debt fell to about 100 % of GDP as of mid-2017 (Graph 4.2.15). On a non-consolidated basis (including financing flows between domestic companies), corporate debt fell to 141 % of GDP as of Q2-2017, down about 5 pps year-on-year. Since its peak in 2009, the corporate debt-to-GDP ratio has come down by about 25 pps in aggregate. This has mostly been the result of ‘passive’ deleveraging, with net credit flows to Swedish firms positive but outweighed by growth and inflation (Graph 4.2.16). Still, the corporate debt level remains high compared to the euro area average of about 80 % of GDP (on a consolidated basis) at the end of 2016.

Graph 4.2.15:Breakdown of corporate debt by funding source Source: Statistics Sweden Graph 4.2.16:Drivers of year-on-year changes in corporate debt to GDP ratios Source: European Commission Domestic loans remain the main funding source for the corporate sector, with international bond markets gradually seeing increased use as an alternative financing option. Graph 4.2.17 shows that domestic lending (mostly from banks) to firms has been broadly stable at about 60 % of GDP since the financial crisis. However, larger corporations have increasingly come to rely on the bond market as an additional funding source, with its contribution growing from 11 % of GDP pre-crisis to about 16 % end-2016. Lending from abroad contracted from a peak of about 48 % of GDP in 2009 to 26 % of GDP over the same period. However, this change is essentially fully accounted for by intra-group loans from foreign branches, which fell sharply after corporate tax reforms in 2013 (European Commission, 2016a). These foreign intra-group loans were replaced by a larger funding contribution from domestic lending between firms and more bond market funding. While overall corporate debt levels are still high, firms generally seem to have a healthy financial position with limited risks of financial distress. Sweden’s corporate-debt-to-GDP ratio is relatively high compared to other EU countries. However, other leverage indicators demonstrate that financial risks are limited. Corporates have significant equity cushions, as indicated by a debt-to-equity ratio that is already at a quite low level (43 % end-2016, compared to about 60 % on average for EU countries) and that continues to fall (Graph 4.2.17). In addition, gross corporate savings are at a relatively healthy 16 % of GDP (about 12 % EU average), underscoring that the corporate sector is sufficiently profitable to be able to reduce its debt level quickly if needed. Graph 4.2.17:Leverage indicators for non-financial corporations Source: European Commission 4.3. Labour market, education and social policies 4.3.1.Labour market and social policies Labour market Strong economic activity has improved labour market conditions. The labour market is performing well. In the third quarter of 2017, the employment rate was at 81.8 %, and the unemployment rate fell to 6.8 %. Youth unemployment reached the lowest level since 2003. In addition, the percentage of young people not in employment, education or training declined to 6.5 % in 2016, well below the EU average of 11.5 %. Graph 4.3.1:Employment rate by educational attainment Source: Eurostat, LFS However, labour shortages are emerging in certain sectors and a lack of affordable housing is undermining labour mobility. Despite the high employment rate, demand for labour remains strong and firms are reporting difficulties to recruit in certain sectors. The construction, education, health, science, engineering and ICT sectors are among those reporting the largest shortages of labour. Moreover, job creation is mainly concentrated in the major metropolitan areas, where limited availability of affordable housing is undermining labour mobility. The developments on the labour market prove the importance of skills. During the latest economic expansion, the employment rate of low-skilled workers has been decreasing, while the one of medium and high-skilled workers increased (see Graph 4.3.1). Evidence suggests that this is a long-term issue, possibly linked to the fact that Swedish companies have positioned themselves at the high-end of the global value chain, thus reducing their demand for low-skilled labour. At the same time, the demand for highly-skilled workers is not fully matched by supply. The outward shift of the Beveridge curve indicates a higher unemployment rate for a given labour shortage in manufacturing. This suggests a growing skill mismatch (see Graph 4.3.2). Graph 4.3.2:Beveridge curve, 2000-2016 Source: European Commission based on Eurostat data While participation of adults in lifelong learning is generally high, the government has made training of low-skilled people a priority. The percentage of adults in lifelong learning is at 29.6 %, well above the Education and Training target (15 %). Sweden excels on the percentage of unemployed participating in education or training and since 2017 adults over 20 who had already left the formal education system are entitled to start an adult education improving their employability. This is expected to provide about 70 000 adults with a higher level of skills. To make vocational upper secondary education more attractive, vocational education and training courses that prepare for tertiary education are being put into place. Box 4.3.1: Monitoring performance in light of the European Pillar of Social Rights The European Pillar of Social Rights, proclaimed on 17 November 2017 by the European Parliament, the Council and the European Commission, sets out 20 principles and rights to benefit citizens in the EU. In light of the legacy of the crisis and changes in our societies driven by population ageing, digitalisation and new ways of working, the Pillar serves as a compass for a renewed process of convergence towards better working and living conditions. Sweden performs well on th