Trouble in paradise? Sweden risks deadlock in tight election race

STOCKHOLM (Reuters) - Sweden, seen for years as a beacon of stability and reforms in a crisis-ridden Europe, may be heading for political deadlock after Sunday's general election, with polls suggesting that both right and left might be unable to form a stable government.

Prime Minister Fredrik Reinfeldt's centre-right coalition is battling an opposition alliance led by the Social Democrats. But neither group looks set to win a majority - putting them at the mercy of more radical leftist or far-right parties.

The Social Democrats, campaigning to spend more money on a welfare state that they founded in the last century, were the election favourites for months. But some polls suggest a once seemingly unassailable lead has narrowed, unsettling businesses and investors and even raising the prospect of a new vote.

"It could be an Italian situation, something we've hardly ever experienced in Sweden," said Magnus Henrekson, Director of the Research Institute of Industrial Economics.

An increasingly likely scenario is that Social Democrat leader Stefan Lofven will head the biggest party but struggle to cobble together a majority. Even if he won the support of a former communist party, he could still be in a minority against the far right and Reinfeldt's coalition.

Under eight years of Reinfeldt, the government slashed taxes by 130 billion Swedish crowns (11.4 billion pounds) and trimmed welfare spending. The tax burden fell by about four percentage points to around 45 percent of GDP - less than that of France.

Despite recovering from the global financial crisis better than most - with more Michelin star restaurants than ever sprouting in the capital and house prices booming - many voters are increasingly concerned over poor education standards and the growing role of private equity firms in running healthcare.

With youth unemployment high and a general sense that the government was stale after two terms in power, it seemed voters wanted a change. But that political backlash has split between social democrats, the far right and far left.

LEADING, BUT NOT BY MUCH

Most analysts say it is too late for Reinfeldt's Alliance to complete a shock comeback after trailing in every major poll since February 2013.

But the frontrunning Social Democrats - for decades Sweden's dominant party - still appear to be heading for their worst result since universal suffrage was introduced in 1921, while the upstart anti-immigrant Sweden Democrats look set for their best, at about 10 percent.

"I don't think it will be obvious what government will take office after the election is over," said Bengt Westerberg, former leader of the Liberal Party and deputy prime minister from 1991 to 1994.

A survey published on Monday gave the Social Democrats 30.6 percent and the Greens - their most likely coalition partner - 8.6 percent, with the Left Party having a further 7.1 percent.

That would give the combined centre-left 46.3 percent or around 167 seats, eight short of a majority. The ruling four-party Alliance, with a combined 41.3 percent, would get around 148 seats if the outcome were repeated on Sunday.While Sweden is used to minority governments, the current situation is unusually complex. If the Red-Greens - the Social Democrats and Green Party - are short of a majority, they are likely to reach out to the Left for support.

But while the Social Democrats and Greens are wary of scaring off middle-class voters, the Left Party, the former Communist party, wants to end the role of private firms in running hospitals and schools, and pile on taxes for richer Swedes and businesses.

PRICE OF SUPPORT

Left Party leader Jonas Sjostedt told Reuters the party could back budget bills put forward by the Social Democrats and Greens from outside a coalition, but would still demand a heavy price - probably much tighter regulation of for-profit companies in the welfare system.

Even with Left Party support, the centre-left might not be able to pass its budget, which has to be presented by Nov. 17.

The Alliance has threatened to put forward a joint finance bill even it if loses the election. If that were backed by the unaligned Sweden Democrats, whom the centre-right has pledged not to cooperate with, it would bring down the centre-left government and trigger a new election.

"It is a completely new parliamentary situation, and we don't know how the Sweden Democrats will handle it, nor how the other parties will respond," said Gothenburg University political scientist Mikael Gilljam.

To avoid this, Lofven, who wants to invest 40 billion Swedish crowns in welfare and job creation, has courted the Liberal and Centre parties.

So far, they have remained loyal to the current coalition. But if either or both changed leader after the election, an alliance with Lofven could conceivably even free him of the need to win the support of the Left Party.

With polls showing the race getting tighter, most analysts expect forming a government to take time, leaving scope for market jitters, even though Sweden's robust public finances and rigid fiscal framework should offer support in the long term.

"The worst thing from a financial market perspective would be a very weak, Red-Green minority government," said Roger Josefsson, chief economist at Danske Markets.

(Additional reporting by Johan Ahlander, Daniel Dickson and Anna Ringstrom; Editing by Alistair Scrutton and Kevin Liffey)

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