Recent Monetary Trends

This review covers the period from May to August 1998.

In recent years Denmark has enjoyed a high level of economic activity, which has reduced unemployment and increased business enterprises' capacity utilization. Growth has been high, also when compared to Denmark's most important trading partners. The current-account balance has therefore deteriorated, so that Denmark's still considerable foreign debt cannot be repaid as quickly as planned. Furthermore, the high level of activity has led to a shortage of skilled manpower, particularly in the building and construction sector. Against this background the Folketing (Parliament) in June adopted the government's "Whitsun package" of measures, which included reduction of the tax-deductibility of interest payments. The measures are designed to dampen price increases in the housing market and to strengthen private savings.

Available forecasts indicate that demand is rising in a number of trading-partner countries. This may contribute to reversing the current account's development. However, increased demand from abroad for Danish products may also aggravate the tensions in the Danish labour market, thereby pushing the already considerable wage increases even higher.

So far, the crisis in Asia and Russia and further deterioration in the Japanese economy have had no significant adverse impact on the economies of the industrialized countries, although a certain decline in exports to the affected countries can be seen. Falling long-term interest rates and lower energy prices as a consequence of the crisis have had a counteracting effect. It is difficult to assess the significance of the most recent development in Russia and Asia to the global economy.

International background

From January until the end of August the Japanese yen weakened by around 10 per cent vis-ā-vis the US dollar, the D-mark and the pound sterling. The bilateral positions of the latter three currencies have thus been almost constant. Evaluated on the basis of fluctuations in recent years the dollar is therefore still strong, since it has strengthened by respectively 70 and 25 per cent against the yen and the D-mark since mid-1995. The pound sterling has by and large followed the dollar during this period.

The boom in the US economy has continued in 1998, driven primarily by domestic demand. However, during the year year-on-year growth in GDP has subsided to a degree, to 3.5 per cent in the 2nd quarter, due to such factors as a direct drop in exports and a strike at General Motors in June. The decline in exports is due particularly to a slump in exports to Asia. The US labour market continues to be tight, with unemployment at less than 5 per cent of the workforce. The stable price development is partly a consequence of external factors such as a rising dollar rate and falling energy prices. However, in recent years wage costs have risen steadily.

Japan has succumbed to a profound economic crisis with obvious problems in the banking sector. The Japanese government has introduced yet another package of measures, including more lenient taxation of businesses and private individuals. The aim is to create more confidence in the future development and thereby stimulate the falling domestic demand. Inflation is close to 0 per cent. In the event of actual deflation it will be even more difficult to recover from the crisis since in that case the value of the debt in real terms will increase. Net exports are one of the few remaining positive growth factors, but are not sufficient to pull Japan out of the crisis.

The crisis in Japan and the weakening of the yen against the dollar have reduced opportunities for the problem-ridden Asian countries to export their way out of the crisis. As a consequence of this and other factors there was renewed currency unrest in Asia. Against rumours of devaluation of the Chinese currency several currencies in the region have weakened. Uncertainty and rumours of a new round of competing devaluations are in themselves enough to prolong the crisis in Asia. This crisis and Japan's problems have led to lower bond yields in the West and continued dampened development in raw material prices. Most recently the crisis in Russia, cf. p. 6ff, has amplified this general trend. The upswing in the USA and Europe is thus taking place at relatively stable prices, whereas exports to Asia are decreasing.

The economies of the future euro countries are growing by around 3 per cent on average, while the current rate of inflation for the entire area is below 1.5 per cent. Unemployment is falling and was in May 11 per cent of the workforce. A number of the minor economies are furthest into the business cycle, while the larger economies are gaining ground. In both Germany and France the export-driven upswing thus appears to be spreading to domestic demand, thereby becoming self-sustaining. Unemployment in Germany has dropped after peaking at almost 12 per cent of the workforce at end-1997 to less than 11 per cent in July. However, a considerable proportion of this decline can be attributed to job-creation measures. In France too there are indications of favourable development in employment, but so far mostly as an increase in the number of temporary employees.

This may be attributable to uncertainty, since in France it is relatively difficult and expensive to lay off permanent employees. As an element of the introduction of a 35-hour week the French government has decided to reward creation of any full-time job. This may have caused employers to refrain from creating full-time positions beforehand.

Up to the final nomination of the future EMU countries in May several former high-interest countries experienced a considerable narrowing of their interest-rate differentials to Germany, cf. Chart 1. The most significant factor behind the convergence of interest rates is clearly the transition to the single currency as from January 1999, which will eliminate exchange-rate uncertainties among the participating countries. Since May the interest-rate differentials for both the previous high-interest countries and for certain core countries have widened. Towards the end of August this trend became stronger. The widening can be attributed particularly to the drop in long-term interest rates in Germany as a consequence of the turbulence in the capital and foreign-exchange markets which among other things arose in reaction to the aggravated situation in Russia. In such cases investors will usually take refuge in German central-government securities which are found to be particularly safe. The uncertainty which suddenly arose concerning Norway's exchange-rate policy, giving rising long-term interest rates in Norway, Sweden and Denmark among other countries, also played a role.

On August 24, in connection with a raising of the current-account rate to 8 per cent, Norges Bank announced that until further notice it would hold the official interest rates and discontinue intervention in support of the Norwegian krone. Official interest rates had been raised 7 times since March, of which 3 in August alone. The decision to cease further support of the Norwegian krone caused the currency to weaken considerably on the following days vis-ā-vis the ECU index used by Norges Bank to manage the krone rate, cf. Chart 2.

The objective was to keep the index at between 103 and 105, where a high value represents a weak Norwegian krone. At end-August the index was 110.

The Norwegian krone has been subject to downward pressure for some time. Falling oil prices since the autumn of 1997 are a significant factor behind the current weakening of the krone, which tends to follow oil prices. At the same time the Norwegian economy is in danger of overheating. The growth is driven by private consumption and investments. Unemployment has dropped to the lowest level for 10 years and wage increases are excessive.

For some time Norges Bank, the IMF and the OECD have recommended a tightening of economic policy, but fiscal policy has been too relaxed and thus not fulfilled the necessary role of sharing the burden with monetary policy, in order to maintain a fixed exchange rate. In the absence of a sufficiently tight fiscal policy monetary policy is now being used to dampen

demand in Norway. The raising of interest rates immediately affects Norwegian home owners whose purchases of owner-occupied homes are mainly financed with variable-interest loans. However, the weakening of the krone has the opposite effect.

In recent years consumption in Sweden has been sustained by a significant decrease in the savings ratio since disposable incomes have declined. However, in 1998 disposable incomes appear to be rising for the first time in many years. Concurrently investments, particularly in construction, have at last begun to rise, stimulated by the low Swedish interest rates. Against the background of such factors as continued low inflation Sveriges Riksbank in June lowered the repo rate by 1/4 per cent. The Riksbank expects inflation at 1/2 per cent in 1998 and 0.9 per cent in 1999, which is below the inflation target of 2 per cent with a tolerance of 1 per cent. The krona was affected by the fluctuation of the Norwegian krone at the end of August.

The crisis in Asia made share prices plummet, particularly in the affected countries, but the falling trend has also spread to share prices in the USA and Europe. In the light of the very considerable increases in recent years the present falling share prices in the USA and Europe can be considered partly as a correction, cf. Chart 3.

Japanese banks

The crisis in the Japanese banking sector originated as early as the beginning of the 1990s. The strong decline in the value of real property and shares eroded the collateral furnished for a large proportion of the banks' lending, while the banks themselves suffered losses in these markets.

The Japanese banking crisis has worsened over the last 12 months. The current more intense phase was triggered in the autumn of 1997 when the crisis in Asia coincided with the collapse of three domestic financial institutions: Sanyo Securities, Yamaichi Securities and Hokkaido Takushoku Bank. Since then the situation has deteriorated in view of the continued weakening of the domestic and Asian economies, leading to an increase in the proportion of distressed loans. In addition, share prices have fallen, thereby reducing considerably the value of the banks' "hidden" reserve in the form of their share portfolios. Combined with stricter requirements concerning identification of bad loans and the introduction of an international solvency standard Japanese banks thus need to strengthen their capital base and solvency. In their efforts to achieve this the Japanese banks have scaled down lending activities, in some cases creating financial problems for business enterprises, which may contribute to pressure on the domestic economy.

The Japanese government has made available a package of 30 trillion yen (approximately kr. 1,400 billion, or 6 per cent of Japan's GDP) to stabilize the financial sector. The package includes a plan to establish "bridge banks" which for a period of up to two years will take over the defaulting banks' exposures with healthy debtors until such exposures can be transferred to private financial institutions. On the other hand the defaulting banks' bad loans are transferred to a public winding-up company established for the purpose.

The Russian economy

On August 17 Russia's exchange-rate policy was adjusted when a new fluctuation band of 6.0 to 9.15 roubles per dollar was fixed for the rest of the year. The Russian central bank also declared that it would no longer announce a narrow day-to-day fluctuation band for the rouble against the dollar. In future the Bank of Russia would intervene only to cushion significant exchange-rate fluctuations.

A 90-day moratorium for payments on Russia's foreign debt was introduced simultaneously with the adjustment of the exchange-rate policy. Exempt from this moratorium are interest payments, trade credits and payments of both interest and instalments on the general-government foreign debt. Regarding the central-government's domestic debt a (mandatory) conversion of maturities was announced for the period up to end-1999. At the end of the month the details of this conversion had not been published.

Finally, certain control measures were introduced concerning capital flows between Russia and abroad. It was also announced that the central bank and the major banks together would enter into a liquidity arrangement to support the settlement of payments in the banking sector.

At the time of the change of the exchange-rate policy the rouble stood at 6.31 per dollar, but weakened considerably on the following days, cf. Chart 4. The Bank of Russia then suspended trading in roubles. When official trading was resumed on September 3 the official exchange rate was 12.82 roubles per dollar. The rouble had thus lost more than half its value in the course of two weeks.

The background to the change of the exchange-rate policy was the renewed pressure on the Russian currency during August. The markets had been relatively stable since July when an IMF loan to Russia was finalized, cf. the Box. The loan was granted because the Russian central bank had used such vast amounts of foreign currency to defend the rouble that external assistance was required.

The development in Russia in August aggravated the financial and economic crisis in the country. Russia suffers from a large budget deficit and lacks both the political will and the administrative structures required to achieve the economic-policy measures needed to put the Russian economy back on course. One of the quite obvious unsolved problems is that on the one hand no salaries have been paid to public-sector employees and that on the other no taxes have been paid in. The IMF programme was thus not able to create the necessary confidence in the Russian economy.

Economic activity in Russia began to decline in the first half of 1998. In 1997 output rose for the first time since the transition from a planned to a market economy. Among the reasons for the decline are unrest in the Russian money and capital markets, higher interest rates, lower oil and raw material prices (oil and gas account for 40 per cent of Russia's exports) and weak domestic demand. As a consequence of this downturn, in the first half of 1998 Russia for the first time had a current-account deficit.

The unrest on the money and capital markets was manifested as resale from abroad of Russian central-government securities, of which around

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