Soaring rates threaten Scandinavia

SCANDINAVIA'S economic gloom darkened yesterday as interest rates rose rapidly in Sweden, Finland and Norway.

Turmoil in Europe's financial markets has hit the three countries badly when they already face serious problems in restructuring their economies.

Sweden's central bank raised its key lending rate yesterday morning from 13 to 16 per cent after pressure on the currency.

'We can see that the market is very nervous. We have currency outflows, we have to defend the crown, the fixed exchange rate, and this is our only tool,' Bengt Dennis, the central bank governor, said.

Within minutes, Finland responded by raising its key money market rate from 15.5 to 17 per cent. Norway took no official action in response, but money market rates surged.

All three countries have linked their currencies informally to the European Monetary System, and Helsinki and Stockholm are preparing for membership negotiations with the European Community. But foreign investors are retreating from Europe's more peripheral currencies as uncertainty increases over the forthcoming referendum in France on the Maastricht treaty on European Union. Since Sweden and Finland have inflation rates between 2 and 3 per cent, this means real interest rates are placing a crushing burden on domestic economic activity, and both countries will see their economies shrink this year by up to a percentage point.

There was a rebound in Swedish share values after the decision, though dealers were uncertain whether it could continue. Poor first-half profits have depressed the market and uncertainty still hangs over the Conservative government's plans to keep the budget deficit in order.

The outlook should be brighter in Finland, which suffered a 6 per cent fall in GDP last year as a result of lost markets in the former Soviet Union. Last November the country was forced to devalue by 12 per cent, which boosted its competitivity. An agreement with trade unions has kept wage growth to zero, and the centre- right government of Esko Aho has put forward proposals to cut back government spending.

The Norwegian government will be wary of risking further disruptions to its hard-pressed financial sector, rocked by Tuesday's decision to put the country's biggest insurer into administration. The crisis in Scandinavia's financial sector claimed its latest victim when UNI Storebrand finally succumbed to a liquidity crunch. This followed the decision by Hafnia, Denmark's second-largest insurer, to seek refuge from its creditors last week.

The economic crisis is putting severe pressure on societies where low unemployment is the norm. Unemployment hit a post-war high in Sweden in July of 307,000, equivalent to 6.5 per cent of the workforce. In Norway it was 6.1 per cent in July and rising fast, and it is about 13 per cent in Finland.

Though Finland and Sweden have right-wing governments committed to revamping the welfare state and switching to more free-market policies, there is concern that, if the situation does not improve, these will be toppled, reversing reforms and undermining commitment to join the EC.