EUROPEAN COMMISSION Brussels, 22.2.2017 SWD(2017) 92 final COMMISSION STAFF WORKING DOCUMENT Country Report Sweden 2017

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 2017 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(2017) 90 final}

{SWD(2017) 67 final to SWD(2017) 93 final}



Contents Executive summary1 1.Economic situation and outlook4 2.Progress with country-specific recommendations9 3.Summary of the main findings from the MIP in-depth review12 4.Reform priorities17 4.1.Public finances and taxation197 4.2.Financial sector19 4.3.Labour market, education and social policies33 4.4.Investment40 4.5.Sectoral policies46 A.Overview Table50 B.MIP Scoreboard53 C.Standard Tables54 References59 LIST OF Tables 1.1.Key macroeconomic, financial and social indicators8 2.1.Summary table on CSR assessment10 3.1.MIP assessment matrix (*) - Sweden 201715

B.1.The MIP Scoreboard for Sweden53 C.1.Financial market indicators54 C.2.Labour market and social indicators545 C.3.Labour market and social indicators (continued)556 C.4.Product market performance and policy indicators567 C.5.Green growth58 LIST OF Graphs 1.1.Output gap, real GDP growth and its components4 1.2.Contributions to potential growth5 1.3.Unemployment rates of specific groups6 1.4.Asylum seekers by age, 2000-20166 1.5.Net international investment position7 4.2.1.Banking system assets relative to GDP (%)19 4.2.2.Swedish banks CET 1 capital relative to risk-weighted and total assets (%)19 4.2.3.Banking system return on equity (%), Q3 201620 4.2.4.Share of non-performing loans in total loan book (%), Q3 201620 4.2.5.Household interest payments as percentage of income21 4.2.6.Real house price evolution (indexed, 2010=100)22 4.2.7.Valuation gap estimates and recent house price growth: Sweden versus other EU countries23

4.2.8.Housing starts, including net conversions, versus projected need24 4.2.9.Building permits issued per unit of population v house price growth (2011-2015)25 4.2.10.Rent Control Index (1) and Tenant-Landlord Relation Index (2) for Sweden v other EU countries26 4.2.11.Household debt growth (indexed, 2005=100)28 4.2.12.Share of households with different debt-to-income ratios, new loans (share of households in % of total)29 4.2.13.Loans to households: loans for property acquisition and consumption loans in Sweden versus euro area average29 4.2.14.Typical mortgage maturity, 2015 (years)30 4.2.15.Breakdown of corporate debt by funding source31 4.2.16.Drivers of year-on-year changes in corporate debt as % of GDP31 4.2.17.Leverage indicators for non-financial corporations32 4.3.1.Labour market situation, 2001-201633 4.3.2.Employment by skill levels, 2000-201633 4.3.3.Breakdown of unemployment by skill level and country of birth, 201534 4.3.4.Employment rate of native-born and of non-EU-born by reason of migration, 201435 4.3.5.Share of low achievers in 2015 PISA37 4.3.6.Proportion of low achievers in science by immigrant background in 201538 4.4.1.Current account balance40 4.4.2.Gross fixed capital formation, comparison with EU average40 4.4.3.Net lending/borrowing by sector41 4.4.4.Cumulative export market share loss since 2005 for Sweden and selected peer countries41

4.4.5.Competitiveness and dynamism in Sweden’s top-10 goods export destinations, 2011-201542 LIST OF Boxes 2.1.Contribution of the EU budget to structural change in Sweden11 4.3.1.Selected highlight: refugee integration36 4.4.1.Investment challenges and reforms in Sweden45 Executive summary This report assesses Sweden's economy in light of the European Commission's Annual Growth Survey published on 16 November 2016. In the survey the Commission calls on EU Member States to redouble their efforts on the three elements of the virtuous triangle of economic policy – boosting investment, pursuing structural reforms and ensuring responsible fiscal policies. In so doing, Member States should put the focus on enhancing social fairness in order to deliver more inclusive growth. At the same time, the Commission published the Alert Mechanism Report (AMR) that initiated the sixth annual round of the macroeconomic imbalance procedure. The in-depth review, which the 2017 AMR concluded should be undertaken for the Swedish economy, is presented in this report. The Swedish economy is continuing to perform well. Growth was 3.3 % in 2016 – among the highest in the EU. It is forecast to slow somewhat to the economy's potential growth rate, to 2.4 % in 2017 and 2.1 % in 2018, in line with the Commission 2017 winter forecast. Solid investment growth and increasing household and government consumption are expected to support growth in the coming years. Exports have been weak, while imports have increased, reducing the current account surplus. As a result of sluggish trade performance, the export-oriented industrial sectors were rather weak, while domestically-oriented service sectors grew strongly. As import growth accelerated, the current account surplus is set to have decreased to 4.8 % of GDP in 2016 compared with its peak of 8.2 % in 2008. A gradual recovery in Sweden's main trading partners and a relatively weak Swedish krona is projected to improve the outlook for exports, in particular for investment goods. Investment growth surged due to buoyant construction activity. After expanding at a rate of close to 7 % per year in 2015-2016, investment is expected to keep increasing at a solid pace of around 3 % in the coming years. Partly thanks to reforms to building regulations and the planning process, housing investment in particular has rebounded strongly since mid-2013 from relatively low levels, although it remains insufficient to meet pent-up demand. Public investment growth is expected to accelerate in 2017, with infrastructure renovation and construction a key underlying driver. The labour market is performing well. In 2016 Sweden had one of the highest employment rates in the EU at 81.2 % (first three quarters), and overall unemployment was below the EU average at 6.9 %. While employment growth has been high in recent years, the labour force has also increased, thus slowing the decrease in unemployment. A major challenge for the labour market is the integration of people with a migrant background, including those with relatively weak education and skill levels. Fiscal policies remain in line with previous years. Despite a significant increase in expenditure related to migration and integration, the general government budget is expected to remain broadly balanced in the coming years. Inflation has started to resume and is expected to gradually reach 1.8 % by 2018. Sweden's central bank has continued its expansionary monetary policy to support the gradual rise of inflation. It has kept repo rates at negative levels, which has resulted in very low mortgage interest rates, further boosting house prices and private indebtedness. Overall, Sweden has made limited progress in addressing the 2016 country-specific recommendation. As regards policies relevant to macroeconomic imbalances, the authorities have achieved cross-party agreement on enhancing the macroprudential authority's mandate, but concrete proposals are still to be published. Accordingly, progress on this aspect is currently assessed as limited. Some progress has been made on fostering investment in housing and improving the efficiency of the housing market. In particular In particular, the government put forward a 22-point housing market plan, including proposals to increase construction, but generally the timeline and form of implementation remain uncertain. This plan also includes a reform of the rules on the deferral of capital gains tax for housing transactions, but its impact is likely to remain modest. 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 was relatively weak in 2016 are energy efficiency and R&D targets. The main findings of the in-depth review contained in this report, and the related policy challenges, are as follows: While banks are profitable and well-capitalised, there are vulnerabilities linked to their growing household mortgage exposure. The regulatory capital adequacy ratios are high, but as a share of total (unweighted) assets, capital cushions have remained at a relatively low level in recent years. In addition, household mortgages constitute a substantial and growing component of bank assets. Accordingly, the risk of a rapid house price correction represents an increasingly significant vulnerability. 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 high levels. Household debt grew by 7.1 % in 2016, approaching 86% of GDP and about 180 % of disposable income, driven mainly by higher mortgage borrowing linked to continued house price rises. The distribution of debt levels is becoming increasingly uneven, with a growing fraction of newly mortgaged households borrowing as much as 600 % of their disposable income. The authorities have taken some relevant macroprudential measures – including the introduction of a new mortgage amortisation requirement in 2016 – but these appear to have had limited impact on mortgage lending growth so far.

Even though house prices are well above their fundamental levels, they have continued to grow rapidly and persistently. Key drivers include generous tax treatment of home ownership and mortgage debt, accommodative credit conditions coupled with relatively low mortgage amortisation rates, and an ongoing supply shortage. This shortage is linked to structural inefficiencies in the housing market, including limited competition in the construction sector. There are also barriers to efficient usage of the existing housing stock. In the rental market, the unique negotiation-based rent-setting system contributes to lock-in and ‘insider/outsider’ effects. In the owner-occupancy market, relatively high capital gains taxes reduce homeowner mobility. The housing shortage can also hampers labour mobility and can contribute to intergenerational inequality. The continued increase in house prices, household debt and bank exposure to residential mortgages is a growing risk to macroeconomic stability. Despite gradual policy action, existing macroeconomic imbalances deepened further. An increasingly overvalued housing market coupled with rising indebtedness entails growing risks 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. The persistent current account surplus is driven primarily by high savings, not underinvestment, and has limited outward spillover effects. Sweden's investment rate is well above the EU average, and compares favourably to that of peer countries with similar current account surpluses. The surplus is linked to an even higher savings rate, driven in particular by gradually growing household net savings. In addition, while Sweden is an important trading partner for several countries, the impact of its demand on neighbouring EU countries is relatively contained. As a result, its surplus does not give rise to significant external risks for other economies. Other key economic issues analysed in this report which point to particular challenges facing Sweden's economy are as follows: In the short and medium term, the country faces low risks in terms of fiscal sustainability. Government debt stood at 41.0 % of GDP in 2016, well below the 60 % of GDP Treaty reference value, and is projected to decline in coming years. Past pension reforms are helping to contain pension expenditure. Still, in the medium-term the projected public expenditure on long-term care is set to increase significantly and there could be scope to improve efficiency. The strength of the labour market continues to grow. Sweden is a top performer in the EU in terms of employment and long-term unemployment rates. However, challenges remain, for example integrating low-skilled people and non-EU migrants into the labour market and reducing the substantial employment gap for non-EU-born women. The integration challenge is likely to remain in the coming years in light of the magnitude and composition of the recent inflows of asylum seekers. Several efforts have been made to improve the human capital and the employability of migrants, and more measures are being considered. School education outcomes have somewhat improved after years of deteriorating performance. Basic skills of the younger generation have improved, reversing previous negative trends according to the PISA 2015 survey but levels are only around the EU average. Moreover, the performance gap between different social groups has widened. Despite recent measures, the education system does not appear to promote quality for all. The integration of newly-arrived migrant pupils warrants close monitoring. The economy benefits from a broadly favourable business environment, although issues remain in a few specific areas. The country 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 is generally efficient and well-functioning, although in specific instances it is not fully transparent. Despite general success in promoting digitisation as well as research and innovation, some indicators point to a slowdown in recent years. Some barriers to investment and long-term growth remain. In particular, construction investment is held back by several interlinked housing supply bottlenecks. Investment by small and medium-sized enterprises is in some cases constrained by insufficiently transparent public procurement procedures. Finally, while the cooperation between academia and large businesses seems to work quite well, collaboration with small and medium-sized enterprises is not at the same level, thus inhibiting optimal use of their innovative potential and weighing on their R&D investments. 1. Economic situation and outlook GDP growth After a strong performance in 2015 and 2016, economic growth is expected to slow down. Real GDP growth expanded by 4.1 % in 2015 and 3.3 % in 2016, according to the European Commission winter 2017 forecast. A combination of factors spurred economic activity, in particular domestic demand: an expansionary monetary policy, additional public expenditure to cope with the influx of asylum seekers and strong household income. For 2017 and 2018, real GDP growth is projected to decrease to around 2 % with most components of growth shifting into a lower gear as the economy is at its potential (Graph 1.1). Graph 1.1:Output gap, real GDP growth and its components Source: European Commission

* Forecasts for 2016-2018 based on a no-policy-change assumption Private consumption is projected to support the economy in the coming years. It is set to slow but still contribute to more than 1 percentage point (pp.) of GDP growth in 2017-2018. Rising real disposable incomes on the back of strong employment growth and increasing wealth are expected to keep consumption growth up. Household savings are projected to remain high (around 19 % of disposable income, albeit slightly declining), due to structural factors such as increasing life expectancy and past pension reforms (see 4.4.1). Pent-up demand for housing combined with low interest rates is supporting housing investment. There was a significant increase in the number of new dwellings built, pushing housing investment growth into double-digit rates in 2015 and 2016. However, according to the National Board of Housing, Building and Planning (Boverket), this new supply remains insufficient to match estimated housing needs to respond to a growing population. Thus, housing investment is set to remain robust in 2017 and 2018, albeit growing at a slower pace as the construction sector is likely to face shortages of buildable land and skilled labour (see 4.2.2 and Box 4.4.1). The high influx of asylum seekers in 2015 led to more spending on providing public services. This reflected spending to provide shelter, food and basic allowances for asylum seekers while increasing the responsibilities and administrative capacity of the Swedish Migration Agency (Migrationsverket). Government consumption expenditure therefore surged in 2015 and 2016. Additional public consumption and investment is expected to support economic growth in the years to come. Local authorities will play a key role in the integration of refugees. They have been granted extra funding, some of which is earmarked for accommodating refugees, but have also received a general grant from the central government. This grant is intended to be spent on staff, welfare services and infrastructure, e.g. childcare facilities and hospitals. Potential growth Although real GDP growth is set to slow down, potential growth has improved and is back at pre-crisis levels. Following the 2009 financial crisis and the subsequent euro area sovereign debt crisis, the economy’s potential output grew at less than 2 % until 2014. Since then strong employment growth and rising total factor productivity have lifted the potential growth rate to pre-crisis levels of 2 % to 3 %. Graph 1.2:Contributions to potential growth Source: European Commission

*Forecasts for 2016-2018 based on a no-policy-change assumption

TFP: total factor productivity Inflation and monetary policy

Inflation showed signs of picking up in early 2016 and is projected to gradually reach 1.8 % by 2018. Increased import prices as a result of the Swedish krona depreciation in 2014-2015, recovering energy prices and tax increases supported the pick-up. However, ‘core inflation’, i.e. the underlying long-term inflation excluding volatile items like food and energy prices, was lower in 2016 compared with 2015. This reflected a modest increase in rent prices and wages as an outcome of the 2016 negotiations. In 2017 and 2018, the harmonised consumer price index is expected to grow at 1.7 % and 1.8 % respectively as high capacity utilisation rates and tighter labour market conditions are set to increase domestic cost pressures. Since exchange rate developments usually affect prices with some time lag, the depreciation of the Swedish krona against the euro and US dollar towards the second half of 2016 could provide an additional impetus to inflation in years to come. Sweden’s central bank (the Riksbank) maintains an accommodative monetary policy stance to support a rise in inflation to its target level. Between January 2015 and February 2016, the Riksbank gradually cut the repo rate from 0.0 % to -0.5 % in order to boost inflation from its very low level of 0.2 % in 2014 and signalled its readiness to cut further to anchor inflation expectations. This has been complemented by unconventional monetary policy measures, such as asset purchases. The Riksbank has purchased SEK 245 billion (EUR 25.9 billion) of government bonds over the last two years. In December 2016, the Riksbank decided to extend the asset purchase programme until mid-2017 and announced that slow increases of the repo rate will not begin until early 2018. The resulting low interest rate environment, combined with other structural factors lowering mortgage debt service costs and a continued housing shortage, supports further household debt and house price increases. Ultimately, these increases are likely to make the financial system and broader economy more vulnerable to external shocks (see 4.2). For example, an abrupt correction of house prices could dampen business confidence, household consumption and construction investment. Private indebtedness In 2016, household debt growth stood at 7.1 % year-on-year in nominal terms, continuing to outpace economic growth. As a result, household debt is approaching 86% of GDP, among the highest levels in the EU (see 4.2.3). Relative to incomes, household debt stood at 179 % of disposable income in mid-2016, up about 10 pp. over the past two years. If one considers only households with a mortgage, the average debt-to-income ratio rises to 343 % (Sveriges Riksbank, 2016; Ölcer and van Santen, 2016). Labour market The strength of the labour market continues to grow. In 2016 Sweden had one of the highest employment rates in the EU (81.2 % v 70.9 % in the first three quarters), while the overall unemployment rate was below the EU average (6.9 % v 8.5 %). The long-term unemployment rate estimated at about 1.3 % was one of the lowest in the EU. Unemployment declined further supported by increasing economic activity, notably in the construction and public service sectors. The unemployment rate is projected to fall from 6.9 % in 2016 to 6.5 % in 2017 and broadly stabilise as labour supply is increasing. However, integration remains a challenge for people born outside the EU. Although their employment rate is somewhat above the EU average for the non-EU-born, their unemployment rate stood at 19.2 % in 2015 (Graph 1.3), which is three times as high as the rate for native-born Swedes. The authorities have undertaken sizeable efforts to integrate the large inflows of more than 300 000 asylum seekers since 2013. Around 40 % of these asylum seekers are minors, of which about half are unaccompanied ( ). This group is particularly vulnerable and requires additional protection and integration assistance. This is a change compared with previous inflows of asylum seekers, which were smaller (around 30 000 per year) and had fewer unaccompanied minors (Graph 1.4). Since 2000, most migrants who arrived have left their home countries for humanitarian and family reunion reasons and are on average less successful in finding a job than migrants who come to work and study (see 4.3). 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 1.3:Unemployment rates of specific groups Source: European Commission Graph 1.4:Asylum seekers by age, 2000-2016 Source: European Commission computations from Swedish Migration Agency Social developments Income inequalities remain low, but wealth inequalities are growing, driven in particular by housing prices and the tax system. Standard inequality measures with a focus on income distribution show that Sweden performs well compared to the EU average. In 2015, only four countries had more equal income distributions ( ). However, the persistent increase in property prices and the absence of an inheritance and gift tax have negatively affected wealth distribution (Lundberg et al, 2016; OECD, 2017). In addition, the current tax treatment of owner-occupied housing with a mortgage is regressive; this is driven by a low recurrent property tax that is generally not aligned with property values, combined with full deductibility of mortgage interest payments (see Demand-side issues under 4.3.1). Competitiveness Sweden has improved its cost competitiveness. While it has been losing export market shares for a long period, this primarily reflects broader trends faced by many export-focused industrialised economies, and driven by developing economies’ growing contribution to world trade along with the sectoral and geographical composition of exports (see 4.4.1). The depreciation of the Swedish krona in 2014-2015 and towards the second half of 2016 translated into the depreciation of the real effective exchange rate. Since the exporting industry sets the benchmark in the wage bargaining negotiations, cost competitiveness developments are expected to remain contained. Wages are projected to increase at a slightly higher pace than last year’s agreement of a modest 2.2 % rate. Deviation of domestic sectors from the wage benchmark could provide a further boost to household consumption. External position Services exports are playing a key role in the economy. Since 2006, the positive trade balance in goods decreased, from 6.9 % to 2.7 % of GDP in 2015, while the one in services grew from 0.2 % to 2.2 % of GDP. Exports of services only account for about a third of total exports but have grown faster than exports of goods in recent years. Norway, the US, the UK and Germany are major recipients of Swedish services such as computer consultancy, sales of other services between headquarters and subsidiaries, and compensation for intellectual property rights. Additionally, expenditure made by foreigners (travel expenditure from tourists but also e-commerce, border trade and consumption from foreign nationals) in Sweden accounts for close to 20 % of exports of services. Slower growth in major trading partners weakened exports in 2016 but net exports are set to make a positive contribution to growth in 2017. As a small open economy, a further weakening of world trade could weigh on Sweden's export sector and its overall economic activity. The current account balance is in surplus and the net international investment position has turned positive. From a saving-investment perspective, the current account surplus is not a reason for concern since it is driven by high savings and not underinvestment (see 4.4.1). As a consequence, since 2015, Sweden has had a slightly positive net international investment position, i.e. the accumulated foreign assets exceed its liabilities (Graph 1.5). Valuation effects and measurement errors might however underestimate the net international investment position (European Commission, 2016a, p. 13-14). Graph 1.5:Net international investment position Source: European Commission

*2016 is based on Q1-Q3 Public finances

The general government balance is expected to have achieved a surplus again in 2016. While economic activity was somewhat weaker, strong tax payments on production and lower expenditure following from the regulation of the rebate on the EU contribution helped to off-set the higher spending on the reception and integration of refugees. In 2017-2018, the general government balance is expected to remain broadly stable between -0.2 % and 0.2 % of GDP with some additional welfare spending but still helped by a robust economy. Public debt stood at a relatively low level of around 41.0 % of GDP in 2016, below the 60 % of GDP Treaty reference value and is projected to fall gradually in the coming years (see also 4.1). Table 1.1:Key macroeconomic, financial and social indicators Source: European Commission, ECB 2. Progress with country-specific recommendations Progress with implementing the recommendation addressed to Sweden in 2016 ( ) has to be seen as part of a process which started with the introduction of the European Semester in 2011. Sweden has been able to preserve a sound fiscal position since 2011 ensuring compliance with the medium-term budgetary objective and keeping debt on a declining path well below the Treaty threshold. Concerning the labour market, the government took action and achieved some progress in improving the employment situation of young people, with measures to strengthen apprenticeships and other types of work-based vocational education. However, it is too early to assess the outcomes for non-EU-born people, given the magnitude of the recent influx of refugees, and the usual time span of integration measures. 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 the introduction of a loan-to-value ceiling of 85 % for mortgages in 2010, the gradual raising of banks' risk weight floors for mortgages in 2013 and 2014, and the introduction of a formal mortgage amortisation requirement in June 2016 (see 4.2.3). While these steps have improved the resilience of the banking sector (see 4.2.1), they have not been sufficient to rein in household debt growth (see 4.2.3). Additionally, the authorities have gradually 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, albeit to a level that is still insufficient to meet anticipated demand (see 4.2.2). Overall, Sweden has made limited ( ) progress in addressing its 2016 country-specific recommendation (CSR). Some policy steps have been taken in response to the recommendation (which is MIP-relevant, see Section 3), but implementation has been uneven and key areas left unaddressed. The authorities intend to enhance the macroprudential authority's legal mandate in 2017, with full implementation likely to follow in 2018. Regarding the housing market, a 22-point plan has been put forward including a range of proposals to increase residential construction and improve the efficiency of the housing sector. However, the timeline and precise form of implementation often remain uncertain 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 introducing properly-sized recurrent property taxes.

Table 2.1:Summary table on CSR assessment ( ) Source: European Commission 3. Summary of the main findings from the MIP in-depth review The 2017 Alert Mechanism Report called for further in-depth analysis to monitor progress in the unwinding of the imbalances identified in the 2016 MIP cycle. Because in spring 2016 Sweden was identified as having macroeconomic imbalances in the form of high household debt associated with high house prices, a new in-depth review is needed to assess how these imbalances are evolving. This report provides an in-depth review of how the imbalances identified have developed. In particular, analysis relevant to the review can be found in the following sections: the banking sector in Section 4.2.1; developments and drivers of the housing market in Section 4.2.2; and developments in private indebtedness, mainly households, in Section 4.2.3. In addition, in Section 4.4.1 the report confirms last year's finding that external balance and competitiveness are not an imbalance. 3.1. Imbalances and their gravity Private sector debt has increased further to about 190 % of GDP, among the highest levels in Europe. Stocks of both household (88 %) and non-financial corporations (105 %) debt are significant. In particular, household debt is historically high, primarily due to mortgage lending. Potential deleveraging needs are estimated at more than 20 % of GDP for households. 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 becoming increasingly uneven: the fraction of borrowers with large debt-to-income ratios is sizeable and increasing, particularly among younger households and those buying properties in major cities. Corporate debt, while elevated, is matched by the high value of equity. Despite the significant stock of debt, financial risks remain limited due to healthy financial positions, in particular a low degree of leverage and strong profitability. Moreover, external funding exposure, while increasing, 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. While most European countries experienced a significant adjustment in real estate prices during the last decade, in Sweden house prices have continued to rise. Strong fundamentals, such as disposable income and population growth can explain part of the increase, 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 inefficiencies in the housing market contribute to this overvaluation. Overvalued house prices entail risks of a disorderly correction, which could become more pronounced if interest rates were to rise faster than expected. A sudden house price correction would have adverse implications on household consumption, growth, employment and ultimately the banking sector, with mutually reinforcing dynamics. The risks linked to this scenario have prompted the European Systemic Risk Board to issue a formal warning.

The banking sector is solid, but it is only partially shielded against an abrupt change in house prices. So far banks' assets have performed well and the sector has high profitability compared to its peers. 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 cater for the risks entailed in the banks' strong exposure to household mortgages in case of a sizeable house price correction. In a severe housing market slump, this vulnerability would likely have repercussions for the overall economy and the financial system. Due to the importance of Swedish banks in the region, the Danish, Finnish and Norwegian economies might also be affected. The persistent current account surplus does not reflect significant macro stability concerns due to its drivers, its moderate size and its limited spillovers. With overall investment being relatively high and supporting future potential growth, the surplus mainly stems from low household consumption which reflects private pension savings and the situation on the housing market. While the surplus remains relatively stable at around 5 % of GDP, it increasingly reflects the activities of Swedish multinationals abroad, with limited ties to domestic investment and savings decisions. The outward spillovers from the surplus via the trade and financial channels also seem limited at the current stage (see European Commission, 2016a, p.35-37). 3.2. Evolution, prospects, and policy responses While overall private debt is slowly decreasing, household debt remains on an upward trajectory: household debt growth stood at 7.1 % year-on-year in nominal terms as of December 2016, continuing to outpace economic and income growth. The increase in mortgage lending is driven by persistent house price rises coupled with structural factors favouring (mortgage-financed) property investment, notably mortgage interest tax deductibility, variable rates and long maturities for mortgages. This development makes the economy vulnerable to shocks: highly leveraged households may need to rapidly reduce consumption to meet rising mortgage payments. The authorities have gradually taken some policy action aimed at curbing household debt growth in recent years. In 2016 they introduced a mortgage amortisation requirement. In addition, the government has announced plans to enhance the legal mandate of the macroprudential authority (Finansinspektionen). This would allow the authority to respond in a timely manner with a wider range of potential measures to the risks associated with growing household debt. So far, these measures appear to have little discernible impact on household debt growth. 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 2016, albeit from a high level. Non-financial corporation debt relative to GDP is down by about 20 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 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 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 short term risks of household debt service problems seem limited, given the low interest expenditure. At the same time, the stretched housing market valuations and high debt levels compared to income make the household sector vulnerable to shocks. However, the 2016 EU-wide European Banking Authority stress tests showed that banks' capital buffers were more than sufficient to absorb losses under such an adverse scenario. House prices have grown almost continuously in the last 20 years, and have been accelerating since 2012: real house price growth reached 12 % in 2015, among the highest in Europe. Contrary to most European countries, Sweden experienced no major correction in house prices during the crisis, and shows no sign of a correction in the short term. House price increases have been particularly steep in the Stockholm and Gothenburg areas. This persistent price growth is partly the result of a structural undersupply of houses: housing construction has continued to increase, but remains insufficient to address the sharply rising housing demand. Policy measures implemented so far have not curbed house price increases. In particular, a new mortgage amortisation requirement for new loans with a loan-to-value ratio above 50 % came into force in June 2016, but this does not appear to have had a significant impact on price growth yet. In addition, a reform of the capital gains tax deferral rules for housing transactions has recently been adopted, with a view to improving housing market liquidity and owner-occupier mobility. The authorities have also put forward a 22-point plan with measures to increase developable land availability, reduce construction costs and shorten planning process lead times, as well as some specific rental market reforms. However, there are still policy gaps. The availability of land, complex planning, building regulations, lack of municipalities' incentives to support new construction, public infrastructure design, weak competition in the construction sector and the high level of rent control have not yet been addressed. 3.3. Overall assessment Sweden faces significant sources of imbalances in the form of high private debt and overvalued and still rising house prices. The elevated private indebtedness, in particular of households, increases the vulnerability of the economy to macroeconomic shocks. Large deleveraging needs may potentially lead to a harmful correction in consumption, investment and credit flows. House prices appear to be significantly overvalued, entailing risks of a disorderly correction. A large correction may have negative spill over effects on other Nordic countries through the financial system. While corporates are slowly deleveraging, surging house prices have led to increased household indebtedness. Household debt is continuing to grow rapidly from a level that is historically elevated, driven by persistent house price rises coupled with structural factors favouring (mortgage-financed) property investment. The current drivers of house price growth are projected to remain in place in the short and medium term in the absence of a policy intervention. Overvalued house prices entail risks of a disorderly correction. The overall shortage of housing supply can also hamper labour mobility and is further exacerbated by the large recent inflow of migrants in need of affordable housing. The policy measures taken to address these imbalances have so far been insufficient. The authorities have gradually taken some policy action aimed at curbing household debt growth in recent years, but these policy measures appear to have had little discernible impact on house price and indebtedness growth. Overall, policy gaps remain in the areas of housing-related taxation, the macroprudential framework, the functioning of housing supply and of the rental market. Table 3.1:MIP assessment matrix (*) - Sweden 2017 (Continued on the next page) Table (continued) Source: European Commission 4. Reform priorities 4.1. Public finances and taxation

Public finances are robust. Sweden is set to have achieved a surplus in 2016, in spite of spending increases related to migration. The debt-to-GDP ratio is expected to continue to fall well below 40 % in 2018. Recent amendments to the fiscal framework are expected to further strengthen public finances. They aim to provide the necessary margin for automatic stabilisers to play their role in a context of a somewhat weaker economic activity in the coming years. The country appears to face no major fiscal sustainability risks in the medium term. However, some minor long-term risks remain, mainly linked to the projected impact of age-related public spending. 4.1.1.Fiscal framework Building on its strong institutional set-up and extensive track record of fiscal soundness, the authorities recently announced some fiscal governance reform. After more than a year of deliberation, a dedicated parliamentary committee (Surplus Target Committee) presented its final report in September 2016 (SOU, 2016a) ( ) with the agreement of seven out of eight represented political parties. Given the broad political consensus, it is now expected that the reform proposals will be included in an updated government communication on the fiscal policy framework. The main conceptual pillars of the framework would essentially remain in place, with some numerical modifications and clarifications. One of the main proposed reforms is the lowering of the 1 % of GDP surplus target defined over the cycle (in place since 2007) to 0.33 % of GDP from 2019 onwards. This reduction will continue to allow Sweden to partially accommodate the projected increase in the costs of the pensions system while maintaining adequate safety margins for economic fluctuations ( ). The authorities explained that the rationale behind this decision lies in the fact that the country's fiscal position is robust enough. In parallel, the mechanism for monitoring the revised surplus target would be clarified, thereby addressing shortcomings identified, inter alia, by the European Commission and adding credibility to the new target. So far the fulfilment of the target has been measured by a number of indicators (including 7- and 10-year averages) without specifying the relative weights assigned to each of them. It is now proposed to use the structural balances in the current and the subsequent year to establish whether a deviation from the surplus target had taken place. If in these two years the structural balance clearly deviated from the surplus target, the government must adopt an adjustment plan with a specified end date for public finances to return to the target. The reform proposes to complement the reduction of the surplus target with additional amendments to the framework. These include a new debt anchor, a reinforcement of the role and the independence of the Fiscal Policy Council (Finanspolitiska rådet), and regular comprehensive reviews: The debt anchor, set at 35 % of GDP for the general government debt aims to better link the conduct of fiscal policy to the objective of long-term sustainability. Should the public debt ratio differ from the anchor by more than 5 pps, the government would be required to explain the reasons for the deviation and present corrective steps in a special written communication to Parliament. The Fiscal Policy Council will be reinforced by (i) assigning to it a more prominent role in the monitoring of the surplus target; (ii) making the nomination procedure of the Council's members more independent; and (iii) mandating the Council with the regular evaluation of the official macro-fiscal forecasts. Regular reviews of the Swedish fiscal governance framework are planned every 8 years, and focus on the adequacy of the numerical targets in the light of economic and demographic trends. 4.1.2.Taxation developments Sweden’s general level of taxation is relatively high compared with other EU countries. The tax burden is 44.2 % of GDP compared with 40.0 % at EU level. Given the authorities’ intention to prioritise public investments related to the integration and reception of refugees, climate transition and gender equality over tax cuts, the level is expected to remain broadly unchanged. The 2017 budget bill has introduced limited changes to the tax regime. The country has one of the highest ratios in the EU of taxes relative to GDP on production and imports and on income and wealth. The new budget bill has only included some limited adjustments to the lower and upper brackets of the national personal income tax. The relatively high level of household indebtedness is a key challenge and tax measures could play a role in mitigating it. A revision of taxation related to housing, such as interest deductions and recurrent property tax, is not envisaged. The lack of reforms in this area risks contributing to a further increase in household debt (see Section 4.2). While recurrent property taxes are considered to be among the most growth-friendly and least distortive taxes, revising the generous interest deductions could increase tax revenues when interest rates start rising from the currently very low level. Tax reforms also intend to further increase employment and promote a greener and more sustainable economy. To promote job creation and entrepreneurship, the 2017 budget includes a few changes to the tax system, namely incentives for the self-employed to hire new staff and the introduction of a value added tax exemption for small enterprises. To make the economy greener, the budget includes some proposals in the field of energy taxation: to gradually phase out the tax on thermal effect of nuclear power plants and to lower the property tax on hydro power plants. 4.1.3.Public debt sustainability Sweden appears to face low fiscal sustainability risks in the medium to long term. Government debt stood at 41.0 % of GDP in 2016, well below the 60 % of GDP Treaty reference value, and is expected to decrease to 37.6 % of GDP by 2018. In the longer run, pension reforms implemented in the past are projected to contain pension expenditure. Public expenditure on long-term care (LTC) is projected to increase at the same rate as the EU average. Demographic changes mean LTC spending can be expected to increase significantly, from 3.6 % of GDP in 2013 (among the highest in the EU) to 5.1 % of GDP in 2060 (European Commission, 2015b). This corresponds to a 41 % increase, similar to the EU average. The share of the population that receives LTC benefits is relatively high by EU standards, whereas the underlying level of need suggested by indicators ( ) is broadly in line with the EU average. The LTC sector is not fully efficient. Resources are not always targeted at those that need care the most and can least afford to pay for it. Additionally, the proportion of recipients receiving care in an institutional setting (rather than at home) and the role of in-kind benefits (rather than cash) to support LTC recipients are relatively high and reduce the flexibility of the system.

4.2. Financial sector 4.2.1.Banking Sector (*) ( ) Overview In recent decades the Swedish banking sector has grown significantly and now dominates the Nordic-Baltic financial markets. Its assets are three times as large as Sweden’s GDP, while its equity has remained broadly stable relative to assets (Graph 4.2.1). Graph 4.2.1:Banking system assets relative to GDP (%) Source: Riksbank Bank capital adequacy ratios — measured relative to risk-weighted assets — have also increased over time. The average Common Equity Tier 1 (CET 1) ratio was at 19.2 % at end September 2016, among the highest in the EU (Graph 4.2.2). However, this capital ratio strengthening is mainly due to the progressive lowering of banks’ risk-weighted assets density. Partly due to the removal of Basel I risk weight floors from exposure calculations ( ), the average risk weighting of bank assets has fallen in recent years, mechanically leading to a rise in capital adequacy ratios. Conversely, capital adequacy measures in relation to total (non-risk-weighted) assets have remained essentially stable over time (Graph 4.2.2). On average, total CET 1 capital accounted for about 3.8 % of banks’ balance sheets at end September 2016, while the average leverage ratio of the four main Swedish banks was 4.4 %. Graph 4.2.2:Swedish banks CET 1 capital relative to risk-weighted and total assets (%) Source: Riksbank Improving capital ratios are also linked to the introduction of special capital buffers by the macroprudential authority. Sweden is the only EU country that has a non-zero countercyclical capital buffer (CCB) rate. The CCB was already activated at 1 % in 2014, and has been increased to 1.5 % (applicable from 27 June 2016) and further to 2 % (from 19 March 2017). Its aim is to avoid the build-up of financial imbalances given the present phase of its macroeconomic and financial cycle. The requirement on CET 1 for large banks is also higher than in other EU countries. It amounts to at least 12 % (versus a 7 % minimum requirement for all EU banks) due to the identification of the four largest banks as ‘systemically important institutions’ (SII), reflecting their structural systemic risks ( ). Bank profitability is among the highest in Europe. According to the European Banking Authority (EBA), the sector’s return on equity as of September 2016 was 13 % on average (Graph 4.2.3), more than double the 5.4 % EU average. However, these positive results are largely dependent on the low risk-weighted assets density of banks and, consequently, on their low equity base relative to their total balance sheet size. Graph 4.2.3:Banking system return on equity (%), Q3 2016 Source: European Banking Authority Good asset quality has so far been a major strength of the banking sector, also in comparison with other EU countries (Graph 4.2.4). According to the EBA, in September 2016 the average non-performing loanratio was around 1.0 %, one of the lowest in the EU and well below the EU average of 5.4 %. High payment capacity and discipline of borrowers contribute to this low level. In addition, the very efficient public framework for debt collection also plays a substantial role. The average coverage ratio of non-performing loans is 28.6 %, lower than the EU average of 43.9 %. Graph 4.2.4:Share of non-performing loans in total loan book (%), Q3 2016 Source: European Banking Authority Key risks and stress test results The exposure of Swedish banking groups to household mortgages has grown substantially in recent years. This increase happened against a background of rising mortgage demand driven by falling interest rates and steep house price inflation (see 4.2.3). While household debt levels are becoming increasingly stretched compared to incomes, expenditure on interest by households is at historical lows (Graph 4.2.5). This suggests that there is limited immediate risk of debt service problems. Nevertheless, the combination of ever higher housing market valuations (Graph 4.2.7) and high debt levels makes the household sector vulnerable to shocks (see ‘Risks and policy response’ under 4.2.3). In a severe housing market slump, it is likely that this vulnerability would have repercussions for the overall economy and the financial system. Due to the importance of Swedish banks in the region, the Danish, Finnish and Norwegian economies might also be affected. Graph 4.2.5:Household interest payments as percentage of income Source: Riksbank A housing market downturn could result in rising funding costs for Swedish banks, given their reliance on international financial markets. The loan-to-deposit ratio stood at 213 % in September 2016, showing that domestic deposits fund less than half of the banks’ loan portfolio. To cover this funding gap, banks issue debt securities, which are largely purchased by foreign investors. Therefore, if foreign investors’ perception of risks in the banking sector were to deteriorate, this could result in a sudden rise in bank funding costs, thus amplifying the impact of any domestic house market fall. The 2016 EU-wide EBA stress test suggests that the four major Swedish banks are at little risk of a capital shortfall. Their capital buffers were found to be more than sufficient to absorb losses under the adverse scenario. The decline in the fully loaded CET 1 (i.e., net of transitional effects) ratios in this scenario ranged from 187 basis points (bps) for Swedbank to 270 bps for Svenska Handelsbanken (around 234 bps on average), bringing them across the sample to an average CET 1 ratio of 16.6 % at the end of 2018, which is much higher than the 9.2 % average for the entire sample of EU banks. Nonetheless, due to the low risk weights generated by Swedish banks’ internal models, some concerns remain about the vulnerability of the banking sector. The Riksbank has recently flagged the importance of introducing a leverage ratio requirement as a complement to the risk-weighted capital requirements, pointing to shortcomings in the latter that could lead to banks holding insufficient capital. For the same reason, the Riksbank has also suggested that there are grounds to consider a further tightening of the existing risk-weighted capital requirements (Sveriges Riksbank, 2016). Macroprudential policy steps

Sweden has implemented a range of macroprudential measures to rein in the risks associated with growing mortgage debt and house prices. As mentioned above (see ‘Overview’), the Financial Supervisory Authority (FSA) (Finansinspektionen) has gradually introduced a number of special capital buffers for banks. In addition, since 2007 the FSA applies stricter requirements (100 %) for the risk weighting on exposures secured by mortgages on commercial real estate, and in September 2014 it introduced a risk weight floor increase from 15 % to 25 % on residential mortgages for banks applying the internal rating-based approach. Furthermore, it also introduced a number of specific macroprudential measures to curb the trend of rising house prices coupled with growing household indebtedness, such as the new amortisation requirement for residential mortgages (see ‘Risks and policy response’ under 4.2.3). As these macroprudential measures have shown little impact, concerns related to macroeconomic and financial stability have been raised. Mortgage debt has continued to outpace income growth, and property prices continue to climb from already elevated levels. For this reason, several Swedish and international institutions (Sveriges Riksbank, 2016; Finansinspektionen, 2016a; IMF, 2016; European Commission, 2016a) have flagged the increasing macroeconomic and financial stability risks. In addition, the European Systemic Risk Board (ESRB) — which in 2016 conducted an EU-wide forward-looking assessment of the residential real estate sector in EU countries — issued a formal warning to Sweden (as well as to seven other Member States) on the existence of vulnerabilities in the residential real estate sector. This warning was made public on 28 November 2016. Following changes in the legal structure of the Nordea group, the FSA’s responsibilities for the Nordic region have become substantially larger, stressing the importance of a flexible and effective macroprudential mandate for the FSA ( ). On 1 January 2017 the Nordea group, which is active across all Nordic and Baltic countries, turned most of its subsidiaries into branches. Before this legal change the subsidiaries in Finland, Denmark and Norway were supervised by the respective national competent authorities (the ECB in Finland). In compliance with the Capital Requirements Directive IV (CRD IV), which assigns the supervision of foreign branches to the home competent authority, the FSA is now responsible for supervising these former foreign subsidiaries. As almost two-thirds of Nordea’s lending takes place outside Sweden, this allocates a sizeable additional responsibility to the FSA and also has resource implications. To deal with the new situation, the Nordic financial supervision authorities and the ECB have established framework arrangements ( ) concerning information sharing, supervisory responsibility and cooperation, macroprudential policy, depositor protection and recovery and resolution planning. In the ongoing review of the FSA’s mandate (see ‘Risks and policy response’ under 4.2.3), it would be desirable to take proper account of its wider responsibility for the financial system in the Nordic region. 4.2.2.Housing market (*) Housing market developments Sweden has experienced rapid and persistent house price growth since the mid-1990s. This is in part driven by global economic trends, notably falling interest rates and generally favourable credit conditions. Nevertheless, the country stands out as one of the very few European countries that have experienced strong house price inflation both before and after the financial crisis, without any significant corrections (Graph 4.2.6). In 2015, real house prices rose by 12 % year-on-year (13.1 % in nominal terms) — among the highest growth rates in the EU. Over the course of 2016, price inflation cooled somewhat compared to 2015, but remained well above income growth: it stood at 8.6% year-on-year (in nominal terms) as of December 2016 ( ). Graph 4.2.6:Real house price evolution (indexed, 2010=100) Source: European Commission While this rapid house price growth is partly driven by strong fundamentals, indicators point to valuations becoming increasingly overstretched. Population and income growth levels have been well above the EU average over the past decade and there has been a trend towards increasing urbanisation, suggesting some fundamental justification for relatively strong house price rises. Nevertheless, there appears to be a significant and growing disconnect between price levels and fundamentals (European Commission, 2016a). As of end-2015, a combination of valuation indicators suggests that house prices are overvalued by about 35 % — among the highest levels in the EU (Graph 4.2.7). While such valuation estimates should be interpreted with care, they do highlight the potential vulnerabilities linked to the housing market. They are also consistent with the observation that house price growth has been boosted by a number of well-known structural issues distorting demand, supply and allocative efficiency in the housing market. Graph 4.2.7:Valuation gap estimates and recent house price growth: Sweden versus other EU countries Source: European Commission, Bank of International Settlements Demand-side issues The impact of falling mortgage rates on housing demand has been amplified by several specific structural features of the Swedish mortgage market. Monetary policy in Sweden has become increasingly accommodative in recent years against a backdrop of muted global growth and inflation (see Section 1). While a continued fall in interest rates inevitably acts as a natural tailwind for the property market, long contract maturities, low amortisation (i.e. capital repayment) requirements and a high share of variable-rate mortgages (see 4.2.3 for details) have augmented this effect. As a result, debt service costs relative to incomes have fallen to post-crisis lows even as house prices and debt levels have continued to climb (Finansinspektionen, 2016b). This mutually reinforcing dynamic of rising house prices and rapid indebtedness growth is a major vulnerability for Sweden, and triggered a formal warning by the European Systemic Risk Board (see 4.2.1). The tax system favours owner-occupied housing over other investments, particularly when financed by mortgage debt. Under the dual income tax system, returns from financial investments are normally taxed at a flat capital income rate of 30 %. However, imputed rents (the effective return to a homeowner on his housing investment) are not subject to taxation. This is to some extent compensated by taxation of property ownership. Because this annual property tax is subject to a low ceiling( ), the outcome is a highly favourable tax treatment of owner-occupied housing compared to other investments, and a low overall tax take from property by international standards (European Commission, 2016a, p. 30). Additionally, interest paid on mortgages is generally deductible at the 30 % capital income rate( ), providing an effective subsidy for funding a property purchase using mortgage debt. From a household’s perspective, this further favours (debt-financed) home ownership both over other investment opportunities (which typically cannot easily be used as collateral for loans) and over rental housing. Reforming the favourable tax treatment of home ownership and mortgages could help curb house price and household debt growth, while simultaneously promoting employment and consumption. A gradual phasing out of mortgage interest tax relief and/or introduction of properly-sized recurrent property taxes would create fiscal room to reduce taxes on labour income, among the most distortive for growth (European Commission, 2014). Additionally, such reforms would, by design, reduce demand for housing and mortgages. Simulations using the European Commission’s QUEST model indicate that a complete phasing out of mortgage interest tax deductibility, with the tax savings used to reduce the labour tax wedge, could boost long-term employment and consumption levels by 0.20.3 %, while reducing household debt growth by about 1.2 % of GDP (Burgert et al., 2016). Similar effects could be achieved by raising recurrent property taxes to enable a comparable tax shift away from labour income. Importantly, the simulations suggest that these policy options would not cause a ‘hard landing’ in house prices. Moreover, reforming recurrent property taxation and mortgage interest deductibility could contribute to reducing inequality. Analysis by the Swedish Fiscal Policy Council (Finanspolitiska rådet) has demonstrated that the impact of such tax reforms would be broadly progressive, as households that currently benefit the most from the favourable tax treatment of home ownership and mortgage debt tend to be the higher-income ones (Finanspolitiska rådet, 2016). Simulations conducted by the Joint Research Centre of the European Commission using the EUROMOD microsimulations model have further confirmed the progressive impact of mortgage tax relief reforms. Supply-side issues A key driver of Sweden’s persistent house price inflation is a structural undersupply of dwellings. New construction has picked up strongly in recent years (albeit from low levels) and is projected to grow further in 2017. However, it remains well below new construction needs (Graph 4.2.8). While the shortage is geographically fairly widespread, it tends to be especially severe in the major urban centres. There is a particular shortage of rental apartments in larger cities; this, in turn, pushes households who might otherwise wish to rent into home ownership, thus exacerbating the shortage (and upwards price pressure) in the owner-occupied market as well. Graph 4.2.8:Housing starts, including net conversions, versus projected need Source: Statistics Sweden (historical data); Boverket (estimates for 2016, 2017 and projected need) While building activity has increased significantly in recent years, relative to the rapid house price growth the construction supply response remains rather weak. In spite of the rapid growth in house prices (and high absolute price levels) by international standards, residential investment as a share of GDP remains somewhat below the EU average. Direct measures of the supply response to house price rises also show that Sweden has significantly underperformed peer countries in this respect (Graph 4.2.9). This is further confirmed by supply elasticity analysis for different regions within Sweden (IMF, 2015). Graph 4.2.9:Building permits issued per unit of population v house price growth (2011-2015) Source: European Mortgage Federation, European Commission

Structural bottlenecks for new construction are constraining housing supply. There is lack of developable land, partly driven by a large share of buildable land owned by municipalities, who can have financial incentives for making it available for construction in a piecemeal fashion over time rather than when it is needed most (European Commission, 2015a). Zoning and building regulations are relatively cumbersome and complex, and standards vary between different municipalities, creating a fragmented market that reduces efficiency and raises uncertainty for construction companies (European Commission, 2016a). In addition, the timeline to obtain planning permission can be considerably longer than in other countries (Emanuelsson, 2015), raising financial risks for construction projects and causing delays in new supply coming online. Finally, the construction sector is characterised by rigidities that have weighed on productivity growth and have limited competition among developers, making construction costs in Sweden among the highest in the OECD. Market concentration in the construction sector remains high, pointing to relatively weak competition. Among the 50 largest construction companies, the three leading ones account for almost 60 % of turnover (Sveriges Byggindustrier, 2016). In 2009-2013, these three companies also won 40 % of all municipal housing procurement contracts (SOU, 2015, p. 173). Competition among developers for such major public housing projects seems already limited at the tendering stage: in almost 45 % of municipal procurements, the number of companies is limited to three or less, and for a sizeable minority (about 10 %) only one developer is tendering. The three largest construction companies also show notably higher operating margins than the sector average, which is primarily driven by their project development activities. These observations are consistent with prior analysis pointing to weak competition in the Swedish construction sector, mainly owing to barriers to entry for larger-scale development projects against small and foreign firms (European Commission, 2015a and 2016a; Emanuelsson, 2015). Vertical integration of project development and construction can hamper competition. The Swedish Competition Authority (Konkurrensverket) has highlighted that construction companies without their own project development activities may depend on larger, vertically integrated competitors, e.g. through subcontracting (Konkurrensverket, 2015). Moreover, partly as a result of the hard-to-navigate planning system, well-connected established companies with land resources and large project portfolios can control housing supply and keep prices high (SOU, 2015). Municipalities can play a role in enhancing competition among developers and more generally in speeding up the building process, but appear to neglect using some of their relevant powers. Land allocation and sales by municipalities are a key enabling factor for construction activity. However, an inquiry by the Swedish Competition Authority found that several municipalities seem to lack sufficient resources for land use and planning, and in particular, that they generally do not fully use their powers to demand that housing is actually built (Konkurrensverket, 2015). Municipalities could counteract the negative impact on competition resulting from established developers’ control of land resources by making land sales conditional on actual building. Since rapidly expanding construction is not always in the interest of the municipalities (for example due to required infrastructure investments) appropriate state support may be required. Barriers to efficient usage of the existing housing stock Sweden’s tightly regulated rental market creates lock-in and ‘insider/outsider’ effects. The rental market has some of the strongest tenant protection rules and the highest degree of rent control ( ) in the EU (Graph 4.2.10). There is a growing divergence between market and negotiated rents, particularly in major cities, creating large demand/supply imbalances and long waiting lists to obtain rental accommodation (e.g. on average over 8 years in Stockholm). As a result, sitting tenants have a strong financial incentive not to move, even if their rental accommodation is no longer fully suited to their needs ( ). Residential mobility statistics show that tenants renting at below-market prices tend to move at roughly half the rate of the minority renting at full market prices (European Commission, 2015c). Conversely, new entrants — such as students, young households and recent immigrants — have great difficulty in obtaining access to the rental market, thus creating an insider/outsider effect. The disconnect between negotiated rental prices and market rents has hindered rental housing supply, particularly in major cities. Below-market rent levels combined with high land prices create financial incentives to favour the construction of owner-occupancy housing over rental units ( ). They also incentivise the conversion of rental units into owner-occupied homes, thus further aggravating the rental housing shortage (European Commission, 2015a). This has been particularly problematic in urban areas: for example, in the Stockholm region, for every new rental unit built, three were converted into owner-occupied homes over the 1990s and 2000s (Emanuelsson, 2015). Graph 4.2.10:Rent Control Index (1) and Tenant-Landlord Relation Index (2) for Sweden v other EU countries Source: Cuerpo et al. (2014) In addition to the direct welfare loss associated with suboptimal use of the rental stock, 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. Furthermore, tight rental regulations combined with a severe shortage of affordable rental housing can exacerbate inequality and social problems. They particularly affect lower-income households which cannot afford to buy their own home, and contribute to a relatively high degree of overcrowding among socially vulnerable groups, including non-EU migrants (OECD, 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 in situations where a homeowner is selling to buy another home of similar value elsewhere (so that no actual economic gain is realised). The steep house price rises over the past two decades mean 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 large family dwellings looking to relocate to a smaller apartment, often in a convenient city-centre location. This issue is somewhat mitigated by the ability to defer (part of) the capital gains tax liability, but not fully (see Policy developments). Reforming capital gains taxation to eliminate this lock-in effect could help free up underused family dwellings and improve overall liquidity in the owner-occupier market. Policy developments Demand-side policy action in the housing market has focused on curbing mortgage lending via macroprudential measures. Since 2010, Sweden has gradually introduced a number of measures aimed at containing mortgage debt growth (and thus housing demand). Steps taken include setting loan-to-value limits, adjusting banks’ risk weight floors, and most recently in June 2016, a formal amortisation rule that requires most new mortgages to be paid down by a minimum of 1 % per year (see 4.2.3 for details on the new amortisation requirement and other macroprudential measures). The new mortgage amortisation requirement appears to have had limited impact on house price growth so far. While it is difficult to gauge the precise effect of the amortisation rule ( ), it seems that in most areas there was a brief levelling off in house price growth around the time the rule was introduced (particularly in Stockholm, where flat prices actually fell somewhat over the summer months). However, the market generally recovered swiftly in the autumn. For 2016 as a whole, house price inflation slowed significantly in some locations and segments — for instance, Stockholm flat prices rose by about 5 % over 2016, versus 18 % in 2015 ( ) — but in other cities such as Malmö, price growth actually accelerated compared to 2015. Overall, the housing market did cool down somewhat in 2016, but price growth is still well above income growth and remains high by international standards. Sweden has gradually implemented a range of measures to raise new housing supply in recent years. Policy action has mainly been focused on streamlining the planning and appeals processes to make lead times shorter and more predictable, on simplifying building and zoning regulations and more generally on reducing red tape for new construction (European Commission, 2015a and 2016a; Emanuelsson, 2015). Additionally, there has been some modest budgetary support for new construction, either in the form of investment subsidies for specific types of rental housing (e.g. for students or the elderly) or of general construction bonuses to encourage municipalities to promote more building activity. In June 2016, the authorities put forward a 22-point plan aimed at tackling a number of supply bottlenecks and improving the overall efficiency of the housing sector. This plan emerged after cross-party talks about a more wide-reaching reform to address both demand-side issues (including taxation) and supply inefficiencies ended without comprehensive agreement. Instead, the 22-point plan contains a collection of more limited, incremental proposals which have broad support across political parties and key stakeholder organisations. The objective is to increase the amount of land available for development; to reduce construction costs by further streamlining building regulations and shortening planning process lead times; and to address a number of specific inefficiencies in the rental market ( ). Since most of the underlying reforms involve broad review and stakeholder consultation processes, it will take some time before these proposals are finalised and there is some uncertainty on how they will ultimately be implemented. As a result, it is difficult to assess their impact at this juncture. As part of the 22-point plan, the deferral rules for capital gains taxes on property transactions have been adjusted, but this is likely only to have a modest impact on owner-occupier mobility. Specifically, for property sales between June 2016 and June 2020, the full capital gains tax liability will be deferrable if a homeowner sells up to purchase a similarly-valued home (whereas before, the deferrable amount was subject to a ceiling). This reform is intended to address the lock-in effects in the owner-occupier market resulting from relatively high capital gains taxes. Some improvement in mobility in the owner-occupancy market can indeed be expected as a result of this measure. However, its impact will likely fall short of a more comprehensive reform of transaction costs that tackles the actual wealth reduction represented by the capital gains tax liability, and not just its immediate cash flow effect. 4.2.3.Private indebtedness (*) Household debt developments Household debt has continued to grow rapidly from a level that is already historically elevated. It has been on a persistent upward trajectory over the past decade, outpacing the EU average and key peer countries, with only Finland experiencing debt growth at a level approaching Sweden’s (Graph 4.2.11). While in most economies with relatively high household debt levels (such as the Netherlands, Denmark and the UK), debt growth tapered out after the financial crisis as households started a gradual deleveraging process, in Sweden there was no significant slowdown. In 2016, household debt grew by 7.1 % ( ), approaching 86% of GDP. Graph 4.2.11:Household debt growth (indexed, 2005=100) Source: European Commission

The distribution of debt levels across households is becoming increasingly uneven.

Among mortgaged households, those who took on their mortgage more recently tend to have higher debt levels: the debt-to-income ratio for new borrowers was estimated at 406 % in 2015, up from 387 % in 2014 and 325 % in 2011 (Finansinspektionen, 2016b). Furthermore, the fraction of borrowers with very high debt-to-income ratios has been steadily growing: about 17 % had debt-to-income ratios above 600 % in 2015, up from 14.8 % in 2014 and about 10 % in 2011 (Graph 4.2.12). Younger and lower-income households tend to be particularly highly indebted (Ölcer and van Santen, 2016; European Commission, 2016a). Graph 4.2.12:Share of households with different debt-to-income ratios, new loans (share of households in % of total) Source: Finansinspektionen Drivers for household debt growth Household debt growth is primarily due to rising mortgage lending. The increase in household debt is almost entirely due to loans for property acquisition. Consumption loans form a relatively small share of total lending that is roughly the same size (relative to GDP) as in other European economies (Graph 4.2.13). Mortgage lending growth is driven by persistent house price rises coupled with structural factors favouring (mortgage-financed) property investment. Rapid house price rises (see 4.2.1) and mortgage debt growth tend to be mutually reinforcing: 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 reinforced by steadily falling mortgage rates and structural factors that act to lower debt service costs: Favourable tax treatment of owner-occupied housing and mortgages (see 4.2.2 for details). Mortgages are mostly variable-rate: about 70 % of new and 64 % of all outstanding mortgages are linked to short-term interest rates (European Mortgage Federation, 2016), thus reducing debt service costs in an environment of falling interest rates. Graph 4.2.13:Loans to households: loans for property acquisition and consumption loans in Sweden versus euro area average Source: ECB, European Commission Swedish mortgage contracts have historically been characterised by long maturities compared to other EU countries (Graph 4.2.14), generally accompanied by low amortisation (i.e. capital repayment) requirements. This further amplifies the relative impact of lower interest rates on monthly mortgage payments ( ). Graph 4.2.14:Typical mortgage maturity, 2015 (years) Source: European Systemic Risk Board (ESRB) report on residential real estate and financial stability in the EU (2015) Risks and policy response Steadily increasing household leverage coupled with rapidly rising property prices makes the Swedish economy vulnerable to shocks. If there was a significant rise in mortgage risk premiums — perhaps triggered by a house price correction, a wider economic slowdown or higher funding costs for banks as market perceptions about their riskiness worsen — highly-leveraged 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. The latter could potentially lead to further increases in mortgage risk premiums and a broader disorderly deleveraging process. In this scenario, non-housing assets owned by households — notably equity investments, which account for about a third of total household wealth — would also probably fall, further weighing on consumption via wealth effects. More generally, Swedish households’ relatively large financial wealth — estimated at about three times their liabilities — would likely provide only limited cushioning in a significant housing market slump. Close to 50 % of non-housing assets owned by households are invested in pension fund or life insurance instruments and can thus only be accessed upon retirement, and a large share of the remainder is exposed to market risks. In addition, financial wealth is unevenly distributed; while limited hard data are available on this, it is likely that key segments of mortgage borrowers — notably newer borrowers and younger households — will tend to have relatively modest non-housing assets relative to their debt level. ( ) Empirical evidence from other countries confirms that high household debt levels tend to foreshadow deeper economic downturns and weaker recoveries following a housing market slump (Crowe et al., 2011). Even in the absence of any acute threat of large-scale house price falls, it may therefore be important to address the macroeconomic stability risks associated with Sweden’s house price / indebtedness dynamics. The authorities have gradually taken some policy action to curb household debt growth in recent years, relying mainly on macroprudential measures. These include the introduction 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. More recently, the authorities proceeded with the implementation of a long-awaited mortgage amortisation requirement: since June 2016, most new mortgages must be amortised by a minimum of 2 % per year until the LTV drops below 70 %, and by 1 % afterwards until the LTV drops below 50 %. While this is an important step forward, it still leaves Swedish amortisation requirements significantly softer than in other EU countries, where full repayment of the loan over time is the norm for owner-occupier mortgages. Despite these policy measures house prices and indebtedness continued to grow. As mentioned earlier (see 4.2.1 and 4.2.2) there has been no significant slowdown in household debt or house price growth in recent years. Reform of the tax incentives combined with further macroprudential measures could help curb household debt growth. As discussed in 4.2.2, raising recurrent property taxes or phasing out mortgage interest deductibility could help contain the house price / mortgage debt dynamic, while also positively impacting long-term output and employment growth. In addition, there may be scope for further macroprudential measures. This could potentially include further steps to align mortgage amortisation rates with those common in other EU countries and/or a form of debt-to-income limits for new borrowers. The Swedish macroprudential authority (FSA) has suggested that the latter in particular may be an appropriate policy option (Finansinspektionen, 2016a). The current legal framework for the macroprudential authority (FSA) does not appear sufficiently robust to appropriately address the risks associated with growing household debt, as illustrated by the significant delays incurred with the introduction of the new amortisation requirement. The FSA originally proposed this measure in late 2014, but it became the subject of legal challenges concerning the FSA’s ability to impose mandatory amortisation rates, and ultimately could only be implemented via a legislative initiative by the government (see European Commission, 2016a, p. 22 for further background). In response to this, the authorities have recently announced that they have advanced plans to revise the FSA’s legal mandate, with a view to ensuring that it can introduce potential macroprudential measures that may be required in future in a timely manner and using a wider range of tools. The precise form of the new legal framework, which is expected to be made public later in 2017, will be of key importance to ensure that this reform is successful. Corporate debt developments Swedish non-financial corporations continued a gradual post-crisis deleveraging process in 2016. Consolidated corporate debt fell to 104.6 % of GDP at the end of 2015 (Graph 4.2.15). On a non-consolidated basis (including financing flows between domestic companies), corporate debt fell to 144 % of GDP as of Q1-2016, down about 10 pps year-on-year. Since its peak in 2009, the corporate debt-to-GDP ratio has come down by about 20 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 77 % of GDP (on a consolidated basis) at the end of 2015.

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 as % of GDP 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 4.2.15 shows that domestic lending (mostly from banks) to firms has remained 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 18 % as of mid-2015. Lending from abroad contracted from a peak of about 48 % of GDP in 2009 to 28 % of GDP as of Q2-2015, but 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, p. 23). These foreign intra-group loans were replaced by a larger funding contribution from domestic lending between firms and by the trend towards more bond market funding. While overall corporate debt levels remain high, firms generally seem to have a healthy financial position with limited risks of financial distress. Sweden’s corporate-debt-to-GDP ratio is well above the euro area average. However, other leverage indicators demonstrate that financial risks are limited. In particular, corporates have a significant equity cushion, as indicated by a debt-to-equity ratio that is already at a quite low level (43 % as of 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 15 % of GDP (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: Statistics Sweden 4.3. Labour market, education and social policies 4.3.1.Labour market and social policies The labour market is performing well. Sweden had one of the highest employment rates in the EU (81.2 % in the first three quarters of 2016, while recording one of the lowest long-term unemployment rates. Unemployment fell to 6.9 % in 2016, below the EU average. Similarly, youth unemployment decreased (Graph 4.3.1) and the rate of people not in education, employment or training (NEETs) is lower than the EU average. Graph 4.3.1:Labour market situation, 2001-2016 Source: European Commission, Eurostat, Labour Force Survey

* Activity rate and long- term unemployment rate for 2016 are based on Q1-Q3.

**NEET refers to people aged 15-24 being ‘not in employment, education or training’. Despite positive overall developments, challenges persist for low-skilled people. While the employment rate of high and medium-skilled people has been broadly stable, that of the low-skilled has been declining (Graph 4.3.2). In parallel, their unemployment rate (19.5 % in the first three quarters of 2016) has increased and is significantly higher than the EU average (16.3 %). To improve outcomes for the low-skilled, access to adult education and vocational education and training (VET) is being improved. A right for adults over 20 who had already left the (ordinary) education system came into force in 2017, allowing them to complement their previous studies and obtain an upper secondary qualification. This is a significant extension of the previous entitlement to complete compulsory schooling, and is expected to help 70 000 adults to upgrade their skills. Graph 4.3.2:Employment by skill levels, 2000-2016 Source: European Commission, Labour Force Survey. Note: age group 20-64 The government is also strengthening the attractiveness of vocational upper secondary education. Once approved by Parliament, all corresponding ‘national’ programmes ( ), including VET programmes, are expected to grant eligibility to tertiary education, as was the case before the 2010 Education Act. This may make VET programmes more attractive in particular for those still in education (but also for the above-mentioned adults): until 2009, at upper secondary level there were as many students attending vocational programmes as academic programmes. Despite a slight upward trend in certain areas such as the retail and hotel sector where apprenticeship programmes appear successful, the increase in the number of apprenticeships in upper secondary school remains limited. Overall, in autumn 2015 the number of apprentices was 8 400, up from 6 000 in autumn 2013 (Skolverket, 2016a). An inquiry into the numerous wage subsidy schemes has been launched. Some of these schemes are not targeted at individuals with lower productivity, and the whole system suffers from limited take-up by employers. Therefore, streamlining and better administration might be necessary (OECD, 2016a; Almega, 2016). The outcome of the investigation is expected by 31 August 2017. The low-skilled population includes many refugees, and their integration remains a major social and labour market challenge (Graph 4.3.3). The share of non-EU-born residents in Sweden (11.1 % in 2015) is among the highest in the EU. It has doubled since 2000 due to an increase of 500 000 people. The non-EU-born residents have a lower activity rate, which at 78.1 % for the age class 20-64, is 9.9 pps. below the activity rate of native-born residents. Those available for work had an unemployment rate of 19.2 % in 2015, three times as high as for native-born residents. A gap also exists for young foreign-born people, who are more likely not to be in education, employment or training (9.8 % v 6.2 % for native-born), and even more so for women. The magnitude and composition of the recent migration flow adds to the integration challenge. Before 2013 roughly 30 000 asylum seekers arrived in Sweden each year, mostly from Iraq, Somalia, Serbia and Afghanistan. However, the magnitude and composition of the arrivals have changed in 2013-2015, with about 300 000 asylum requests made. Close to half of these requests were made between July and December 2015. Around 40 % of asylum seekers are children of school age, and almost half of them are unaccompanied minors. In 2015, 50 % of non-EU-born people residing in Sweden were refugees or their family members and 30 % were other family migrants (coming to join family members who are not refugees). These two groups have on average low qualifications (see 4.3.2) and weaker labour market outcomes than migrants who come for work or study (Graph 4.3.4). Graph 4.3.3:Breakdown of unemployment by skill level and country of birth, 2015 Source: European Commission, extraction based on Labour Force Survey

Note: Age group 20-64

Migrants, and in particular asylum seekers, face various barriers to labour market participation and social inclusion when they arrive in Sweden. These include limited language proficiency (see 4.3.2), difficult access to adequate housing (see 4.2.2), lack of a personal network and contacts, limited institutional knowledge of the labour market and social systems, or the absence of appropriate validation or recognition procedures for skills and education acquired abroad. Even when transferable, these skills may not correspond to the needs on the Swedish labour market (skills mismatches), hence the importance of (re)training or upskilling policies. Moreover, migrant women from countries with low female employment tend to show larger gaps in labour market participation. Although employment rates are increasing with time spent in Sweden, children of non-EU-born parents still face barriers. Even accounting for differences in individual characteristics (age, gender, education and literacy level), their likelihood of being employed remains 13.3 pps. lower than native-born residents without a migrant background (OECD, 2014a). This indicates discriminative hiring practices as evidenced by field experiments and other recent studies (see the review in OECD, 2016a). Direct discrimination remains nevertheless difficult to prove (Council of Europe, 2012). While the employment gap affecting the non-EU-born in Sweden is significant, their employment rate is still better than the EU average. In spite of a challenging immigration profile, with a low share of labour migration and not many immigrants speaking Swedish when entering the country, the employment rate of non-EU-born is 63.7 %, 3.4 pps. above the EU average. However, it is 20.3 pps. below the employment rate of native-born Swedes (Graph 4.3.4). The gap is particularly high for non-EU-born women (23.3 pps.). All in all, the magnitude and profile of immigration resulted in a marked increase in the share of foreign-born people among all unemployed from 24 % to 42 % between 2005 and 2015. Graph 4.3.4:Employment rate of native-born and of non-EU-born by reason of migration, 2014 Source: European Commission, Eurostat Labour Force Survey, 2014 ad hoc module on migrants. Note: Age group 15-64. The Introduction Programme for new refugees and their families has been enhanced, yet challenges remain. Since 2010, this Programme has provided refugees and their families with intensive support. It covers a period of 24 months and includes language, education and training measures. Results have improved over time, nevertheless in 2016 only 32.6 % of participants were in work or education 90 days after having completed the programme. Women are underrepresented among the participants and those who participate have worse outcomes than men (21 % v 39 %). The government has proposed a regulatory reform (as of 2018) to enhance results which aim to simplify the Programme and streamline it with other labour market activation measures. This would enable the Public Employment Service (Arbetsförmedlingen) to refer a newly-arrived migrant to any programme or measure, not limited in time and content to the Introduction Programme. This broadened scope would in turn allow more individualised and longer-term strategies, based on early competence mapping and assessment. In the same vein, given the increased awareness that ‘one size does not fit all’, additional flexibility is offered in education and training pathways. The possibility to combine Swedish for Immigrants language training with vocational education or studies and work on a part-time basis has been strengthened. More generally, many of the government’s recent initiatives, e.g. trainee jobs and education contracts (European Commission, 2016a, p. 44-45), have the potential to reach more beneficiaries by taking into consideration both local conditions as well as the individual’s needs. This is expected to help curb skills mismatches among refugees. ‘Fast Track’ initiatives have been started to help the newly-arrived to enter the labour market faster. These are targeted at sectors with labour shortages and established in cooperation with the social partners (see Box 4.3.1). Some professions such as healthcare and teaching proved to be more successful than others (Arbetsförmedlingen, 2016) as they had less teething problems, for example regarding the coordination with relevant stakeholders (such as social partners and municipalities). Sweden is also strengthening early intervention measures for asylum seekers who are waiting for a residence permit. Immediate language training is provided mainly by civil society organisations. After a pilot phase, the public employment service is going to offer a tool for self-assessment based on mapping of skills and experiences. Despite ongoing work, a comprehensive approach and governance on how to recognise the qualifications of migrants are still missing. The Swedish Council for Higher Education has been tasked with coordinating a pilot project to establish a structure for support to the recognition of prior learning and cooperation between universities. Due to a lack of common standards, many municipalities are carrying out their own validation as part of their adult education and training set-up. Vocational and informal skills are also validated at sectoral and branch level. The new residency law may have mixed effects on labour market integration. This measure, granting 13 months of temporary residency permits to people with subsidiary protection ( ) and 3 years for recognised refugees, incentivises the take up of employment, and overall may reduce the number of jobless migrants. On the other hand, making the renewal of residency permits conditional on immediate self-sufficiency may act as a disincentive to upgrade education and develop sustainable labour market integration strategies. Therefore, the law does not appear fully in line with the long-term investment and broader inclusion approach embedded in longer term measures such as the two year Introduction Programme or the ‘Fast track’ initiatives. Social policy Lower labour market integration of the non-EU-born results in lower incomes, but severe material deprivation is not widespread. Non-EU-born people are much more at risk of po