Growing investor concern about Sweden

Economic policy, both fiscal and monetary, is an often-overlooked factor in investment forecasts. The role of government, even when not openly mismanaged, can easily make life more complicated for entrepreneurs and investors. But even worse are the occasions when politicians, through arrogance or ignorance, add insult to injury and aggravate economic downturns.

There are many examples around the world of how politicians have made life difficult for the private sector. Sweden, often seen as a place for profit-making, is now high on the list of countries where government can make a difference for the worse.

While having done some things right, such as creating a relatively favourable tax environment for corporations, the Swedish government also has a track record of clumsy fiscal policy stretching back some 30 years. It is this track record that now causes concern as the country approaches a new recession.

The economic crisis of 1992-94 was aggravated by a badly timed tax reform. On top of that, as the economy began recovering, the social-democrat government launched a destructive fiscal-policy campaign against the budget deficit. Consisting primarily of tax hikes, it almost killed the recovery and permanently lowered the growth potential in the private sector.

That history is about to repeat itself, as several signs point to trouble in the Swedish economy.

On March 29, the OECD reported that it has lowered its GDP growth outlook for Sweden. Their predicted 1.6 percent for 2019 would be a reduction by one third compared to 2018. However, their analysis does not factor in the negative repercussions of a government trying to balance its budget in the midst of a recession.

History and conventional political wisdom in Sweden suggest that government will disregard the consequences of higher taxes on an economy in decline. If higher taxes are combined with cuts in spending that benefit low- and middle-income households – a scenario also supported by previous experience – the macroeconomic deceleration in the OECD outlook could become serious.

However, there are yet more reasons for investors to be on the alert regarding the Swedish economy.

To start with, the Swedish krona is currently at a 15-year high vs. the U.S. dollar, trading at SEK9.26 on April 12. Notably, so far this year it has also fallen against the euro, despite the fact that the euro has weakened against the dollar. This suggests that Sweden is suffering an outflow of foreign capital.

According to, the stock market has remained in the 1550-1650 index bracket for two years, but with added volatility in the past six months. However, household indebtedness in general, and in particular mortgage debt, is potentially a more serious source of problems for the Swedish economy.

Generally, lending to households has slowed down since early 2018, from seven percent annual growth early last year to just over five percent in February 2019. This should be viewed in the context of the country’s high real-estate inflation: according to the Bank for International Settlements, since 2010 – the bottom of the last global recession – Sweden has had the 15th fastest growing housing prices in the world. Only three European countries, Estonia, Latvia and Austria, have seen stronger price increases.

As an early sign of a turn in the debt-growth trend, Statistics Sweden reports that the country’s banks have reduced their balance of outstanding debt by 22.5 percent in one year.

In and of itself, this is not an alarming number. If it correlated with rising interest rates there is an apparent, conventional explanation. However, the Riksbank – the Swedish central bank – has almost entirely refrained from raising interest rates. Its deposit rate, negative for almost five years, rose only marginally late last year from -1.25% to -1%. It was neither sized nor timed to explain the deceleration in household credit.

Another variable that could have explained debt deceleration is household earnings. If households were doing better, they would have chosen to finance more spending upfront, and put down larger down payments on homes. However, that would have shown up in a decline in private debt vs. GDP and household income – and no such trend is visible.

On the contrary, and again according to, the private debt-to-GDP ratio remains high. Having risen sharply ten years ago it has hovered around 270 percent since then. For comparison, the US ratio is around 200% while in Germany the same ratio has declined steadily for at least a decade, now being below 150%.

Specifically, the ratio of household debt to private income has been on a steady rise for a long time in Sweden. It passed 100% in 1997 and exceeded 186% in 2017. There is no sign of it tapering off.

When very low interest rates are combined with a slowdown in new debt and a sustained high debt-to-income ratio, the only explanation is rising concerns among lenders that debtors will not be able to make their payments. Factoring in the unusually strong inflation in Swedish real-estate prices, the possibility of a housing bubble becomes apparent. There is no reason to believe a mortgage-bubble burst is imminent, but what seemed a remote scenario a year ago is now reason for investor caution. In addition to the aforementioned variables, it is also important to note the reversal of the price trend in some key areas, such as Stockholm’s posh downtown. This shift has begun spreading geographically; should price deflation become the prevailing trend in the Swedish housing market, the case for a mortgage bubble will rapidly grow stronger.

A macroeconomic slowdown, as suggested by the OECD, could quickly reinforce a negative real-estate outlook.

What makes the Swedish situation worrisome is the fiscal-policy history of the Swedish government. Without it, the situation in Sweden would be one of normal concern in a recession, in other words not beyond what would generally be advisable for global investors.

However, the experience from the 1990s, and its consequences for Swedish economic policies since then, makes Sweden a particularly difficult place to predict.

There are two reasons to expect badly timed fiscal measures, the first of which is an interesting relationship between household debt and government debt. Before the mid-1990s the two types of debt essentially grew together. Since then, however, as Figure 1 reports the relationship has been reversed, almost perfectly mimicking what the classical Ricardian-equivalence theory predicts. See figure 1

There is an important reason why this relationship shifted in the 1990s, a reason that has strong bearing on what may happen in the Swedish economy in the next year or two. The shift has its origin in the economic downturn of the early ‘90s, when an unprecedented budget-deficit crisis hit the Swedish government. Its cause was trifold:

  • A global recession hit this export-dependent country hard, causing a rapid macroeconomic swing from growth to recession;
  • A supposedly revenue-neutral tax reform had shifted the bulk of the tax burden from personal income to consumption, making tax revenue even more vulnerable to the business cycle;
  • Very expansive welfare-state entitlement programmes, closely tied to the egalitarian principle of benefitting low-income families, led to sharp increases in government spending as unemployment exploded from 2% to more than 15% in a year and a half.

The political reaction to this downturn was at first neutral, with the incumbent centre-right administration under Prime Minister Bildt doing little in terms of anti-deficit policies. Their passive attitude had an alleviating effect on the economy, especially by keeping taxes stable and predictable. However, the large deficit was used by the social-democrat opposition to stir up worries about future debt costs and rising interest rates.

Consequently, after winning the 1994 election the new left-wing government launched an anti-deficit campaign to reduce the deficit. However, this was not done through promoting growth-oriented policies, but through sharp tax increases and unpredictable, disruptive cuts in entitlement programs that benefited low-income families. As I explained in detail in my book Industrial Poverty (Gower, 2014), two thirds of the fiscal value of their anti-deficit policies was accounted for by higher taxes.

Private businesses and households paid the price; household incomes have never quite recovered, despite at times reasonably strong economic growth. This is statistically visible in steadily growing household debt: borrowed money has supplanted growth in disposable income as a means of maintaining standard of living.

It is here that the fiscal-policy experience from the 1990s comes into play. The change in government vs. private debt was due to an institutional change in fiscal policy. As a result of mid-‘90s constitutional reforms, the Swedish parliament has to put its budget balance above all other fiscal-policy concerns. In a conflict between promoting growth and jobs creation on the one hand, and budget balancing on the other, constitutional and statutory features mandate that the parliament prioritize the latter.

As a consequence, government inevitably reinforces a recession, and its effect grows exponentially with its size. If government were small, higher taxes and spending cuts would have negligible effects on the rest of the economy; when government is large, its efforts to balance the budget in a recession have strong negative effects on the private sector.

Government spending and taxes are close to 50% of the Swedish economy. A full 70% of that spending is redistributive, in other words providing cash and in-kind entitlements through the welfare state. Cuts in spending therefore hit hard in income segments of the population where a recession has already made life tougher.

On the tax side, married couples face average income tax rates in the 38-39% bracket.

Together with a value-added tax of 25% on large segments of household spending, as well as other taxes (which, e.g., account for two thirds of gasoline prices), Swedish families already shoulder a heavy burden. Higher taxes to counter a deficit in the government budget would quickly translate into lower consumer spending.

As the icing on the cake, higher taxes could quickly conspire with rising unemployment to trigger mortgage defaults. Keeping in mind the high indebtedness of Swedish households and the aforementioned indicators that their finances are already stretched by their debt obligations, it is fair to say that the difference between a manageable economic downturn and financial calamity is in the hands of the country’s finance minister, Magdalena Andersson.
Again, the outlook on the Swedish economy does not yet merit the term ‘imminent crisis’.

However, anyone looking for reasons to be optimistic may be looking in vain. It is considered a political virtue in Sweden to balance the government budget at all times, and a sign of political ‘manliness’ to do it regardless of the consequences for the rest of the economy.
In short: this is a year of high risk for investors with assets in Sweden.