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Norway risks ‘Dutch disease’ as opposition set for big election win

A poster of the Norwegian leader of the opposition party is seen on September 9, 2013 in downtown Oslo.
Daniel Sannum Lauten | AFP | Getty Images
A poster of the Norwegian leader of the opposition party is seen on September 9, 2013 in downtown Oslo.

As Norway's opposition Conservatives swept to power in elections on Monday, analysts warn the country's economy is at risk of overheating, due to rising oil prices and a debt-fueled housing boom.

An official projection of the result late Monday showed the opposition Conservative Party and its allies would win a majority with 96 seats in the 169-member parliament. That's 11 more seats than needed for the majority.

While the Conservative party has campaigned on its ability to keep the public purse in order, economists said that fiscal policy was likely to become more expansionary in the country, irrespective of who gained power.

While Labour has made new welfare spending commitments, the Conservatives have promised to cut income and wealth taxes, as well as increase spending on infrastructure. Research firm Capital Economics warned that the Conservatives' proposals could undermine Norway's economic competitiveness, if they were funded through the selling of foreign holdings from its $778 billion sovereign wealth fund, the largest in the world.

"Selling foreign assets from the sovereign wealth fund to pay for these policies would increase capital inflows, which risks strengthening the krone and, with unemployment already low, inflating high labor costs," said Capital Economics' James Howat in a research note.

"Overall, under a Conservative-led government, Norway would be unlikely to move any closer to a sustainable long-term growth model. Indeed, it may be pushed a little further away," he added.

Howat said that a Conservative-majority might exacerbate both Norway's housing boom and its reliance on the energy sector.

"A Conservative-led government would be more likely to allow oil-drilling off the Lofoten coast. Given that the region is estimated to hold around 10 percent of Norway's undiscovered oil and gas reserves, this would significantly increase Norway's dependence on the energy sector," Howat said.

Norway's economy is highly dependent on its housing market, mining and fishing industries, and — most importantly — oil. The country exports five times more oil per capita than Russia, and is Europe's largest holder of natural gas and oil reserves. Its economy accelerated in the second quarter of this year to grow by 0.8 percent. However, mainland GDP (gross domestic product) growth, which excludes the oil and shipping sectors, slowed from 0.6 percent growth to 0.2 percent, as household spending faltered.

Another concern for economists is Conservative Leader Erna Soldberg's argument that Norway's banks should loosen credit standards, potentially exacerbating the country's housing boom. In contrast, Norway's regulatory bodies have urged banks to cap loan-to-value ratios, and to triple the risk-weights they assign to mortgage assets.

Saxo Bank Chief Economist Steen Jakobsen told CNBC that Norway's "hugely overpriced" housing market was clearly indicative of an economy that needed slowing down.

"The Norwegians are certainly at risk of catching the Dutch disease," he said. "This creates the political issue of finding the right balance between 'helping the economy' – read: stimulating – and keeping bubbles from bursting."

(Read more: Norway's Economic Star Begins to Lose Its Shine)

The so-called Dutch disease is the negative impact of sudden, large increases in a country's income – for example, a boom in natural resources exploitation – which causes the currency to appreciate, making the country's exports less competitive. The term was coined in the 1970s to describe the decline of Dutch manufacturing after the Netherlands discovered a large natural gas field.

Jakobsen added that high oil prices had helped fuel Norway's boom, by generating strong public pressure for the resulting oil wealth to be spent domestically. This was a view corroborated by the chief economist of Norway's largest bank, DNB, at the weekend, when he said that the country's greatest challenge was deciding how to spend its "huge" oil wealth.

"All countries around us are forced to reduce their spending," DNB's Oeystein Doerum told AFP news agency. "Our biggest challenge is that our oil wealth is so huge we run the risk of wasting it on substandard projects that are not profitable enough."

(Read more: How Norway Could Become a Victim of Its Own Success)

While acknowledging the debate about how to use the oil revenue, Swedbank First Securities' Harald Magnus Andreassen said that irrespective of who gained power on Tuesday, fiscal policy was not about to be revolutionized.

"The ups and downs in private sector demand are far larger and far more important than any likely change in the fiscal stance, for interest rates and the krone exchange rate," he told CNBC.

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