Boston, MA -- (ReleaseWire) -- 04/10/2014 -- Although Denmark is not part of the eurozone monetary union, its deep financial and trade links have been strengthened by its pegged exchange rate regime, leaving the economy significantly exposed to spill over effects of the eurozone debt crisis.
A burst housing bubble and subsequent bank failures have made Denmark the hardest hit Scandinavian economy, and its after-effects will continue to weigh on growth in the medium term. Although Denmark is in the process of staging an economic recovery, the outlook remains dependent on improving external demand and a sustained recovery in house prices.
Denmark has been singled out as a relative safe haven given its favourable public debt dynamics and fixed currency regime. However, this inflow of capital has masked structural economic problems, and should investors start leaving the country it could expose an array of problems, most problematic of which could be a drop in house prices.
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The government of Denmark has repeatedly expressed its commitment to its pegged currency regime, confirming our view that the country will not join the eurozone in the next decade.
The public sector will remain one of the largest in Europe for the foreseeable future, as Denmark's deeply ingrained welfare model remains broadly popular. However, gradual reforms are likely to continue in the coming years that scale back benefit programs.
A lthough we expect public expenditure to remain elevated, the government's substantial tax revenues will enable it to keep deficit and debt levels on a sustainable trajectory.
Key Risks To Outlook
A major risk to Denmark's medium-term macroeconomic trajectory stems from ongoing economic and financial developments within the eurozone. Denmark has sizeable trade and investment linkages with the common currency bloc, and a major deterioration in growth in the core countries, or renewed flare up of the sovereign debt crisis, could push Denmark back into recessionary territory.
In light of growing disillusionment with the current government and inter-coalition tensions over the recent passing of tax legislation and social benefit reform, there is potential for strains on the government's political cohesion to continue building. In turn, this could raise the potential for a break-up of the government and early elections being called further down the line.
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