Special IR Supplement on Banking in Iceland Released Skip to content

Special IR Supplement on Banking in Iceland Released

A special supplement entitled “Banking and Finance in the Icelandic Economy” accompanying the first issue of Iceland Review this year has been released and is available for free download.

The supplement contains an interview with Prime Minister Geir H. Haarde as well as features on investment bank Straumur, the Iceland Stock Exchange becoming a part of NASDAQ OMX Group, Icebank’s mission and the operating results for the commercial banks in 2007.

Click here to download your free copy of “Banking and Finance in the Icelandic Economy.” Below is the interview with Prime Minister Haarde.

Geir H. Haarde, Prime Minister of Iceland: Flexible and Resilient Economy

In its February 2008 economic survey of Iceland, the Organization for Economic Co-operation and Development (OECD) states that the Ice-landic economy is both resilient and quite flexible. It points out that per capita income has grown twice as fast as the OECD average since the mid-1990s and that the country had the fifth highest gross domestic product (GDP) per capita among OECD member countries in 2007. And in the last few years the country has repeatedly scored high on internationally recognized league-tables, most recently topping the United Nations Human Development Index 2007 which measures life expectancy, literacy, education, standard of living and GDP per capita for countries worldwide.

Geir H. Haarde, prime minister of Iceland.

Liberalization, privatization, globalization and tax cuts

Mr. Geir H. Haarde, prime minister of Iceland since June 2006, minister for foreign affairs the year before and minister of finance 1998-2005, says the OECD’s positive judgment of the Icelandic economy does not come as a surprise.

“The underlying themes of the economic policy of successive governments for nearly two decades have been liberalization, privatization, globalization and tax cuts. Iceland was a founding member of the European Economic Area in the early 1990s, whereby the EU countries and the EFTA countries, including Iceland, created the world’s largest single market for capital, goods, services and labor. For Iceland, this meant significant liberal-ization in many areas of the economy.”

Mr. Haarde speaks passionately about the nation’s success in privatizing key state-owned enterprises between 1991 and 2005. He points to the two commercial banks Landsbanki Íslands and Búnadarbanki Íslands (which later merged with Kaupthing Bank), privatized in 2001-2003 and Iceland Telecom in 2005, as the most significant in terms of revenues for the treasury. The effects of privatization on these three companies and their respective sectors have been felt around the world.

After privatization, globalization has been the main characteristic of the Icelandic economy since the turn of this century. “Icelandic businesses have only limited growth opportunities in this country,” says Mr. Haarde. “And it is only natural for them to expand overseas.” He adds that successive govern–ments have emphasized foreign investment in Iceland. “Iceland has vast environmentally-friendly hydro and geothermal energy resources, which have attracted power-intensive industries to the country, like aluminum smelting. These are industries that have been instrumental in broadening the export base of the country and have good future prospects.”

Various international economic institutions and international ratings agencies have highlighted the internal and external imbalances in the vibrant Ice-landic economy over the last few years. The current account deficit, boom-ing labor market, high inflation rate and high interest rates have been of particular concern.

“Yes,” admits Mr. Haarde, “the last few years have put strains on the economy but not all the symptoms should be regarded as entirely negative. Take the current account deficit as an example. A large part of the deficit in recent years can be explained by imports related to the construction of huge power plants and aluminum smelters. This is an investment, which will generate future export earnings. Similarly, imports that have gone hand in hand with the booming residential and commercial property market should not be viewed the same way as imported consumption items.”

Mr. Haarde also points out that the current build-up of production capacity in the energy sector and power-intensive industries is more or less completed—at least for the time being. This, as well as the cooling-off in the construction sector, will contribute significantly to the slow-down in economic activity expected in 2008 and 2009. “We will see economic growth this year and next that is significantly below the long-term average. This will ease conditions in the labor market, inflationary pressures should abate and the current account deficit will shrink significantly,” the prime minister says.

Strong public finances, further tax cuts

Rapid economic growth in recent years, and proceeds from privatization have boosted public finances. Budget surpluses have been used to reduce the public debt, build up assets in the public sector pension funds and reduce taxes. It is expected that at the end of this year, the net public sector debt will have fallen to 6.3% of GDP as compared with close to 40% in the mid-1990s. The combined state and local income tax rate stands at 35.7% and the corporate income tax rate at 18%. In February 2008, the government announced that corporate income tax would be cut further, to 15% as of this year. “This strong fiscal position is not least the result of a built-in counter-cyclical tax and expenditure structure,” says Mr. Haarde, adding that strong government finances and a fully funded pension system are two vital pillars of the strengths of the Icelandic economy.

The Icelandic financial sector

One of the most noticeable factors in Iceland’s recent economic develop-ment has been the growth of the financial sector, which now accounts for about 10% of GDP compared to 6% in the year 2000; and the industry’s assets have grown to about eight times Iceland’s GDP.

“Privatization of state-owned banks and mergers among Iceland’s largest banks released new energy in the sector. The banks have found growth opportunities abroad and transformed themselves from purely local banks to truly inter-national banks,” says Mr. Haarde.

The Icelandic banks have felt the effects of the current turmoil in international financial markets, which has made access to funding more difficult and costly for most international banks. However, the Icelandic banks remain strong according to the Icelandic Financial Super-visory Authority (FME), which points to their relatively high capital adequacy ratios, good liquidity position, increased proportion of deposits in their funding profile and their ability to withstand severe stress tests that the FME performs regularly.

“The Icelandic banks are healthy and I am confident that they will weather the storm in international financial markets,” says Mr. Haarde. “There are those who argue that the banks have become too big for the country and that the current turmoil could bring down the banks and cause severe economic conditions in Iceland, but this is totally unfounded in my view.”

The international ratings agency Moody’s decided to assign a negative outlook to Iceland’s sovereign Aaa ratings in early March 2008 citing its recent one-notch downgrades of the country’s main commercial banks’ financial strength ratings. Nevertheless, Moody’s emphasizes that the banks are sound, with strong franchises, healthy capital adequacy and good liquidity and that the risk of disruptive systemic stress in the banking sector is very low.

Furthermore, Moody’s applauds the country for its advanced economic structure, low government debt, high per capita incomes and nearly fully-funded pension system, stating that it is a highly creditworthy, developed country whose public finances and wealth compare very favorably even against many of its Aaa peers. “I couldn’t agree more,” says Mr. Haarde.

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