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16. febrúar 2001 Fjármála- og efnahagsráðuneytiðGeir H. Haarde, fjármálaráðherra 1998-2005

Ræða fjármálaráðherra á ensku á fundi Bresk-íslenska verslunarráðsins í London. Recent developments and future prospects for the Icelandic economy.

Geir H. Haarde
Minister of Finance

Recent developments and future prospects for the Icelandic economy
Address at a meeting of the British-Icelandic Chamber of Commerce in London
February 16, 2001
(Check against delivery)

Ladies and Gentlemen,

It is with great pleasure that I address this meeting of the British-Icelandic Chamber of Commerce. There is a long history of trade and investment between the two countries and it is interesting to see from the list of members how diverse the business has become. There are of course the more traditional seafood, transportation and export/import companies who have been doing business for many decades, but the more recent increase in all sorts of financial companies, accounting firms, consultants and law firms is a clear sign of the much discussed internationalisation and globalisation that is taking place. Not to mention the rapidly increasing export product, which is the Icelandic football player. The whole nation closely follows the English football league every week and cheers for "Icelandic" teams such as Chelsea, Ipswich, Leicester, Bolton and Watford – not to mention Stoke City, which happens to be my personal favourite.

Iceland may not be the largest market or the biggest economy in the world, but there are interesting developments currently taking place and attractive investment opportunities arising. I will take a few minutes to discuss the current economic situation and the financial environment in Iceland and conclude with the newest developments in the Government's privatisation policy.

The Icelandic economic situation

The Icelandic economy is basically sound at present. This is both the result of a sensible fiscal and monetary policy, as well as the other various structural measures undertaken in recent years to improve economic conditions both of industry and households. Tax reforms have been enacted in order to improve the competitive position of industry by reducing marginal tax rates. The financial market has been deregulated and liberalised to increase the freedom of capital movements within the country as well as to and from abroad, thus strengthening the domestic financial market. The pension fund sector has been reorganised with the aim of strengthening the financial position of the funds and thereby of future pensioners in addition to strengthening financial savings.

These measures have helped strengthen Icelandic industry and paved the way for new sectors such as information technology, software, telecommunications and biotechnology. As a result, productivity has increased and economic growth has been higher in Iceland in recent years than in most neighbouring countries. The purchasing power of households has also increased rapidly and unemployment has been all but wiped out. Stability in the labour market has been ensured by the conclusion of private sector wage agreements for the next three to four years which will contribute to a better operating environment for enterprises and wage earners as well as the economy as a whole. The wage agreements for the public sector are currently being negotiated and they will take notice of the policy that has been made in the private sector.

The unusually strong economic upswing has, however, been accompanied by a rapidly growing domestic demand, a temporary hike in inflation and a widening current account deficit. This trend has now been reversed. The latest indicators point towards a considerable slowdown in domestic demand. Thus, import demand has been levelling off, especially that of consumer durables.

This has also been reflected on the revenue side of the fiscal budget which records a much lower year-on-year increase than in the two preceding years. Although total tax revenue, in relation to GDP, has increased somewhat since 1998, the ratio has been more or less stable since 1999, at about 30 per cent.

The expenditure side shows broadly the same picture with total expenditures recording a fall in relation to GDP. In fact, expenditure growth has been below the estimated national expenditure growth between 1998 and 2001.

The current slowdown in domestic demand has also been reflected in the trade deficit which appears to have peaked. The comparison between 1999 and 2000 is striking in this respect. In 1999, the increase in import demand was almost exclusively accounted for by a surge in consumer goods whereas last year consumer goods were more or less stagnant, with the surge in oil imports and investment goods leading the way.

In this context, it is also important to note that the current account deficit is not due to central government indebtedness but exclusively the result of increased private sector borrowing. This reflects the private sector's confidence in the Government's economic policy and continued economic stability. The strength of Treasury finances represents a significant counterbalance against the impact of private sector indebtedness upon domestic demand and the current account and the overall public sector saving accounts for 40-45 per cent of total saving.

Increased foreign assets

It should also be borne in mind that the foreign assets of Icelanders, particularly in stocks, have increased rapidly in recent years. In 1994 there was practically no investment in foreign stocks, whereas at the end of 1999 it amounted to 124 billion krónur, increasing to 155 billion, or close to a quarter of GDP, by the middle of 2000. The dividends from these investments are to an increasing extent being reflected on the revenue side of the current account and thereby mitigate the interest cost of foreign debt. It should also be noticed that the economy is gradually moving away from the "old economy" production phase towards the "new economy" era of high-tech, information and service sectors, a development which calls for substantial investments, not only in the new sectors but also in traditional sectors which are rapidly acquiring the new technology. These investments will yield ever-increasing returns to the economy in the future and in turn further reduce the current account deficit.

Inflation on the decline

Finally, inflationary pressures have been declining. The doubling of the price of oil and the rapid increase in housing prices, following the stagnation of recent years, led to a rise in the consumer price index from about 2 per cent on average in 1994-1996 to 5-6 per cent in the latter half of 1999 and the first half of 2000. There is a strong indication that property prices have all ready peaked and the same seems to be true for oil prices. As a result, the twelve-month increase in the consumer price index has declined from a 5S-6 per cent annual rate in the early part of the year 2000 to 3S per cent in recent months and a further decline in inflation is expected in coming months. For the 2001 budget, the Ministry of Finance has assumed a 4S per cent average consumer price increase between 2000 and 2001 and a somewhat lower increase over the year.

Strong fiscal outcome

The strength of fiscal developments in the past few years has served to curb domestic demand and thereby significantly contribute towards stability in the Icelandic economy. The revenue surplus of the public sector is one of the highest in the OECD area and the same applies to the net financial surplus. This favourable development is not, however, attributable solely to the strong economic upswing since the structural surplus has been growing and accounts for almost two-thirds of the total revenue surplus.

The main emphasis of the Government's economic policy is to continue along the same path and pursue a tight fiscal policy in the medium-term. The Government has recently announced its next steps in privatising government stakes in various enterprises, most significantly in the telecommunications and banking sectors, which will render considerable proceeds to the Treasury as well as fostering increased competition and productivity gains. In recent years, proceeds from the sale of government assets have been used to reduce Treasury debt as well as future government pension commitments by raising the equity of the Government Employees Pension Fund. This policy will be continued.

A number of tax measures have in recent years strengthened Icelandic industry, particularly new economy sectors, and additional reforms are underway. This applies i.a. to a further lowering of corporate income taxes. In this respect, we generally favour going for a general lowering of the corporate income tax rather than granting specific tax benefits in special areas.

The new economy

The sharp turnaround of the stockmarket last year and the dramatic fall in share prices, especially in the ITC-sector, have called the "new economy" effects into question in many countries. Since I disagree with these sentiments, I would like to make a few comments on whether we feel the "new economy" effects in Iceland as, perhaps most noticeably, has been the case in the US. The most direct answer is "yes"; we have definitely felt the effects of the new economy in Iceland. The "new economy" sectors like the IT, the High-Tech, Bio-Tech and the Telecommunication sectors have, indeed, been moving fast.

And has this development made a noticeable impact on the Icelandic economy? Yes, it has. Not only because of a rapid development in the so-called "new economy" sectors and their contribution to export growth, but also because of the catalytic effect on the development of the "old economy" sectors. The fact is that the new economy does not replace the old economy nor does it solve all the problems of the old economy. What I believe is the major contribution of the "new economy" effect in Iceland, however, is the fact that the IT-process has not only been felt in the "new" industries but also, and perhaps more significantly, in the more traditional "old" industries. I believe, these "second-round effects" if you like, will be even more important for the future development of the Icelandic economy than the first-round effects. Also, I would like to underline the importance of a flexible labour market and a highly skilled and educated labour force. In this era of ever increasing globalisation and increased competition these factors will be of growing importance.

Privatisation policy in Iceland

Let me now turn to the privatisation process in Iceland and current developments in that area. Since 1991 the Government has followed a clear privatisation policy with four main objectives:

  1. To increase private saving. This is accomplished by selling the shares in public offerings and by continuing to offer individuals a tax reduction if they invest in listed shares.
  2. To increase economic efficiency by eliminating the distortions inherent in state-ownership.
  3. To broaden share ownership and continue to encourage the development of the Icelandic stock market.
  4. To raise capital in order to decrease Treasury debt. One of the main goals of the privatisation program is to use the income from privatisation to reduce Treasury debt and reduce the debt burden of future generations.

Organised privatisation in Iceland began in 1991-1992 although there had been individual sell-offs earlier. The first steps entailed disentangling the State from operations where it had no business being as there was a competitive market in the given field. The operation of a travel agency, a fertiliser plant, fish processing plants, a machine shop, a print shop, and alcohol production are clear examples of this. You can see from that list that the Icelandic state was involved in a wide array of activities behind each of which there usually were particular, political circumstances.

In the last three years, a new and long-desired chapter in privatisation opened when the State began to systematically withdraw from the financial market. Investment loan funds of the State had been merged into one limited liability bank in 1997, the FBA, or the Icelandic Investment Bank Ltd., which was later sold in two stages in 1998-1999. The newly privatised FBA then merged last year with Islandsbanki Ltd., thus becoming the largest bank in Iceland.

The most interesting privatisation project at present is no doubt the Icelandic Telecom Company. The Post and Telecommunications Administration was converted to a limited liability company in 1997 and then split into two companies a year later. Iceland Telecom Ltd. is not only by far the biggest telecommunications company in Iceland, but also one of the most profitable enterprises in the country, with its market value estimated around 340-500 million GBP. A few weeks ago the Government announced the privatisation of the company and the way it will be organised. This decision not only reflects the strong commitment of the Government to continue on the path of privatisation but also to attract foreign capital and ownership. I personally think it is very important to fully privatise the company as soon as possible, hopefully with the participation of a foreign investor as a strategic partner.

The two state-owned commercial banks, the National Bank of Iceland and the Agricultural Bank of Iceland, were converted into limited liability companies, and the sale of their shares also began in 1998. Share sales continued in 1999, and the State now owns about two-thirds of the share capital in each bank. A few weeks ago the Government decided to investigate the feasibility of merging these two banks, and planned on their privatisation to continue following the possible merger. Those plans were set back due to a ruling of the Competition Authority, which prohibited their merger. This does not mean, however, that the privatisation is off, only that it is likely to be postponed a bit. Their full privatisation is expected to be completed during the term of the present Government, which extends until 2003. It is my belief that it would be highly beneficial for the Icelandic economy if at least some part of these banks were sold to foreign investors, to diversify the Icelandic market and enhance competition. The combined market value of these two companies on the Icelandic Stock Exchange is about 50 billion ISK, or roughly 400 hundred million GBP.

Concluding remarks

As I have already mentioned, there are many interesting projects currently under way in Iceland. Iceland has joined the ranks of those nations that have been most successful in their economic and fiscal developments in recent years. Remarkable success has been achieved, as is attested to both in the assessment of the OECD and the IMF. The same verdict comes from international credit rating agencies that have assessed Iceland's credit rating, including Standard & Poor's, Fitch IBCA and, most recently, Moody's. The positive verdicts of these rating agencies have yielded tangible results for the Republic of Iceland in the form of lower interest rates on foreign credits, as well as for other Icelandic borrowers since the credit rating on government debt serves as a benchmark for other Icelandic debt issuers.


So what is the conclusion of this little overview of the small Icelandic economy? You don't have to be big to be successful in today's globalised economy. You only have to do the right things!


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