In a new economic outlook for Iceland released yesterday, OECD voiced several concerns about the state of economic affairs in Iceland. It claimed that the economy was overheating and warned against inflation and “huge external deficits and debt levels”.
As the capital inflows from the ongoing, large-scale investment projects slow down, the substantial appreciation of the Icelandic Króna experienced in the past two years could “go into reverse” warned the OECD.
Moreover, the current economic conditions could lead to “a full-blown recession, as happened following the previous overheating period in 2002.”
As remedy, OECD prescribes a mix of policies, including a continued course of interest rate increases. “The government should aim at budget surpluses higher than those currently planned”, said OECD in the report. It should also exercise “spending restraint” and reduce tax expenditures favoring the booming housing sector.
But finance minister Geir H. Haarde is sanguine. According to Morgunblaðið and Iceland State Radio, RUV, the finance minister claims that the report contains no new information, and he does not foresee any specific measures in response to the criticism outlined in the report. Geir says that fiscal policy is a “matter of debate” and that the government is “working to extend the current period of economic growth” by exploring further opportunities for investment projects. He claims that there is substantial interest among foreign companies for investing in Iceland, especially in heavy-industry.
Birgir Ísleifur Gunnarsson, managing director of the central bank Seðlabanki, sounded more cautious. “We have been saying for quite some time now that the Icelandic economy was at risk of overheating” he said to Morgunblaðið “and we still hold that view.” If Seðlabanki hadn’t raised interest rates over the past year, he says, inflation would now be “much higher”.