Sept. 21 (Bloomberg) -- Sweden predicted a smaller budget gap than it forecast earlier as resurgent trade demand aids an export-led recovery and lifts revenue, even after the government raised spending and cut taxes ahead of 2010’s election.

The deficit of the Nordic region’s largest economy will widen to 3.4 percent of gross domestic product in 2010 from 2.2 percent this year. That compares with an August forecast for a 3.7 percent gap in 2010 and a 2.4 percent shortfall this year. The deficit will shrink to 2.1 percent in 2011 and 1.1 percent in 2012.

“We’re surprised by the positive development of government finances,” said Robert Bergqvist, chief economist at SEB AB in Stockholm. “The stimulus measures that we will now get and stable government finances mean that the economic outlook for Sweden looks pretty good.”

Sweden’s export-oriented economy, with half of total output stemming from sales abroad, will benefit from a revival of demand in Europe and Asia. Germany and France both emerged from recession last quarter, contributing to a 0.2 percent expansion in Sweden in the three months through June. Government stimulus measures have also underpinned growth, jolting the economy out of recession and limiting joblessness.

Tax Cuts

“It should pay to work. It should pay to hire,” Finance Minister Anders Borg said today as he presented the budget to parliament. “That’s the most effective measure to boost employment.”

Prime Minister Fredrik Reinfeldt’s government will cut taxes and raise spending on schools, hospitals and measures to support the unemployed before the elections next September. A package of new and previously announced stimulus measures will contribute 1.7 percentage points to economic growth next year, the budget forecasts, after Sweden’s worst economic decline in at least 15 years in the first half of 2009.

“The public finances have developed somewhat better than forecast in the 2009 economic spring budget both because of higher income and lower expenses,” Borg said. “Expectations of stronger export orders, a more positive purchase managers index, further improvements on the financial markets” and a global upturn “may make the recovery faster than expected.”

Sweden has suffered a deeper economic decline than neighbors Norway and Denmark after a slump in global trade undermined demand for its exports.

The krona lost 0.4 percent against the euro to trade at 10.1383 at 10:35 a.m. in Stockholm. Against the dollar, the krona lost 0.8 percent.

Economy

Borg yesterday reiterated forecasts from last month that the economy will return to growth of 0.6 percent in 2010 and 3.1 percent in 2011 after shrinking 5.2 percent this year.

Prices will rise 0.4 percent in 2010 after falling 0.4 percent this year and unemployment will peak at 11.6 percent in 2011 from 8.8 percent this year.

“The predictions are somewhat more pessimistic than those from other forecasters including ourselves,” said Cecilia Hermansson, chief economist at Swedbank AB. This is partly to restrain expectations of a quick recovery, she said.

The government had already announced plans to cut income taxes for a fourth time since it came to power in 2006. Yesterday, it announced higher spending on new stimulus measures, including more spending on schools and hospitals, of 32 billion kronor next year and 24 billion kronor for 2011. The tax cuts will boost economic growth, Hermansson said.

“It’s definitely an election year budget,” said Stefan Hoernell, senior economist at Svenska Handelsbanken AB.

Election

The government trails the three-party opposition bloc of Social Democrats, the Left Party and the Greens by 3.4 percentage points, according to an opinion poll by Sifo Research International published last week.

The Social Democrats want to raise income taxes and re- introduce the country’s wealth tax in a different shape to create more jobs and invest in hospitals and schools.

“Three’s no room for reckless tax cuts,” said the party’s economic spokesman, Thomas Oestros, economic spokesman for the Social Democrats told parliament. “We want to prioritize welfare, our children’s school and our hospitals.”

The “most serious risk” to the economic forecasts and budget stems from the Baltic countries of Estonia, Latvia and Lithuania, where Sweden’s Swedbank AB and SEB AB are the biggest lenders, Borg said. A deepening of the crisis in the Baltics will “affect the entire Nordic region,” he said.

Estonia, Latvia and Lithuania, the European Union’s fastest-growing economies from 2004 through 2006, have since toppled into the bloc’s deepest recessions. Property-investment and spending booms, financed mainly by bank lending, turned to bust as inflation soared, cheap credit evaporated and demand for exports ebbed.

To contact the reporters on this story: Johan Carlstrom in Stockholm at jcarlstrom@bloomberg.netNiklas Magnusson at nmagnusson1@bloomberg.net

Last Updated: September 21, 2009 04:41 EDT