by Prime Minister Halldór Ásgrímsson at
First Iceland Business and Investment Roundtable
in Reykjavík, May 15 2006
Real storm or storm in a tea cup?
Ladies and gentlemen.
It is a pleasure for me to be here today and have the opportunity to address this distinguished audience. I have been a regular reader of the Economist for many years and consider it one of the best, most trustworthy and most reliable magazine in the world.
These three concepts, one of the best, trustworthy and reliability, are in fact keywords in the discussion about the Icelandic economy today. I note that this conference is held under the label of: Real storm or storm in a tea cup?
Although Iceland has had its fair deal of stormy weather during the centuries due to its geographical location, I would like to throw the ball back and ask: Why is one of the richest economies in the world, one of the most competitive economies in the world and one of the fastest growing economies in the world going through such turbulent times as has been the case in the past few weeks?
The answer is not obvious but one thing seems quite clear, namely that there is a widespread lack of knowledge about the Icelandic economy abroad. This is one of the most important lessons that the recent turbulence has taught us and it is a lesson that we do not take lightly.
Let me say that we have already at this stage taken significant steps towards increasing the flow of information about the Icelandic economy abroad. This applies both to Icelandic firms engaged on the international scene, especially the banks, and the authorities. Everywhere you look, you see an Icelandic banker presenting and explaining our case on the major television channels, be it the BBC, CNBC, Bloomberg or others networks. The same applies to central bankers and ministers who have been racing between London, Copenhagen and New York, to name but a few examples.
I have lost count of the interviews I have given to foreign reporters in recent weeks, explaining the main characteristics of our economy and why we are confident that, when the dust settles, the Icelandic economy will still be one of the richest, most competitive and fastest growing economies in the world.
I would like to explain why we feel confident that the economic policy of the Icelandic Government will continue to be as successful as it has been for the past 10 years or so. Afterwards, I will be glad to respond to your questions and comments in the hope that you can leave this conference with a clearer picture of the fundamentals of our economy, which we believe are quite sound.
The events of recent weeks and the turbulence in the Icelandic financial market show that Iceland is no longer an isolated island far away in the north Atlantic. The disturbances in our foreign exchange market reverberated throughout the world in an instant, in much bigger economies such as Brasil, New Zealand and some Asian countries. To some extent this shows how integrated into the world economy Iceland has become. This has both its advantages and disadvantages. Our task is to see to it that the disadvantages be kept to a minimum.
Many of you know that Iceland has been the European growth tiger in the past few years, second only to Ireland. In the past 10 years, the economy has grown by more than 50% in real terms and since 2003, economic growth has averaged at or above 5% annually. Unemployment is non-existing, in fact, we have to import labour from other countries in order to fulfil demands in certain sectors, such as the construction industry. Iceland also enjoys one of the highest standards of living in the world. The fiscal situation is sound and the level of public debt is amongst the lowest in the world.
This favourable description of the economic situation in Iceland is recognised by distinguished international organisations such as the OECD and the IMF, as well as the major international rating companies, Moody’s and Standard & Poor’s. Furthermore, Iceland tops the league of European nations when it comes to competitiveness, and comes fourth worldwide according to the most recent study by the IMD Business School in Switzerland. Obviously we have our problems, but as a nation we cannot complain when we compare our situation with that of many others.
How did our isolated island develop into the modern Iceland of today? The answer lies in wide-ranging structural changes that have been implemented in the past 10-15 years. Let me mention the most important ones.
First, since the early 1990s, Iceland has actively sold its state assets. The largest privatization in Iceland´s history was successfully executed last year when Iceland Telecom was sold. The privatization of the three state-owned banks a few years ago has resulted in much stronger banks, that are more willing and more capable to take part in entrepreneurial activities and large-scale investments, domestically and internationally.
Second, the market and tax structure has been modernised allowing businesses and competition to thrive. Here, the EEA agreement, between the European Union and the EFTA countries, has served Icelandic interests well and provided Icelandic businesses and entrepreneurs with good access to European markets. Furthermore, the tax system has gone through a complete overhaul resulting in a much more favourable business climate. Both personal income and corporate taxes have been cut by a large margin. Today, the marginal rate of the personal income tax is 36,7% while the average rate is much lower, or about 23%. The corporate tax has been lowered from 51% to 18%, and is now amongst the lowest in Europe. Last but not least the capital income tax, levied on all types of capital income, is 10%.
Third, and closely related to the above-mentioned changes, asset prices have risen dramatically as witnessed by the Iceland Stock Exchange index, which has more than tripled in the last three years and increased by about 40% over the last 12 months. Also, the equity market capitalization as a percentage of GDP in 2005 was significantly higher in Iceland than in many other countries, including the UK, the US, Sweden and Norway, to name but a few examples. Although market prices have fallen recently, they still remain at 2005 year-end levels.
Fourth, the financial position of the Icelandic pension funds is extremely strong and growing stronger every day. Their total assets amount to more than 1.200 billion ISK, which constitutes 20% more than Iceland´s national income. This means that there is a lot of capital available for investment purposes.
Finally, let me mention important structural reforms in the fishing industry by introducing a quota system which has helped us manage our very important fish resources in a sustainable way. We have also introduced various other reforms in the fishing sector that have contributed to a stronger and a more efficient industry.
All these changes have played a major role in transforming the Iceland economy and contributed to create a sound and stable economic situation after decades of instability. Furthermore, and no less important, is the fact that we have had a very stable political situation during this period.
What does this mean in economic terms? Let me first look at the business sector. In a relatively short time span, the Icelandic economy has evolved from being a primary goods producer, where fish products constituted the bulk of our exports, to a diversified and high-technology production and services economy where new industries and services play an ever bigger role. I am not simply referring to large scale power-intensive industries utilising our valuable and sustainable energy resources but also to numerous companies in other sectors such as software development, pharmaceutical production and distribution, medical equipment production, biotechnology research and development, expansion of the telecom industry and other high-tech industries.
At the same time, Icelandic firms have expanded into foreign markets which has furthermore strengthened the foundations of the economy. They have been investing in the banking sector in the Nordic countries, Switzerland and the UK while the Icelandic banks have been setting up subsidiaries in these countries as well as others such as Luxemburg. The same applies to the pharmaceutical sector and telecommunications where the activity has stretched to Eastern Europe, the Balkans and even to Asia.
But there have been interesting developments in other sectors as well, for instance in aviation, where Icelandic investors have been investing in foreign airline companies. Finally, let me mention the flourishing investment activity of Icelandic firms in the food market, especially in the UK but also in France. The same applies to other markets such as real estate, clothing, toys and jewellery stores.
It is also important to note that the Government’s economic policy has been guided by the need to enhance long-term economic growth. Most significant in this respect is the emphasis on sound public finances. This policy has been highly successful as witnessed by large surpluses on the central government accounts for the most part of the last 10 years. This has, in turn, created scope for a sharp reduction in government debt which by now has been all but eliminated.
Given these favourable developments, it is no wonder that the recent turmoil in the financial market in Iceland has raised a few eyebrows in our country. We fully accept that in a world of free capital movements speculation can lead to sudden changes and even turbulence in financial markets. This lies in the nature of things. We even accept that every now and then such a behaviour may be based on misconceptions about the true state of the Icelandic economy. This is something that we have to live with and try to learn our lessons from what has happened.
We must therefore further improve our presentation of these facts abroad in order to reduce the risks that these misconceptions create unnecessary disturbance in view of the small size of our economy. We can, however, never escape the fact that the Icelandic economy will always be a small pawn by international comparison and, therefore, exposed to external disturbances, no matter how poorly supported they are with facts.
It does not come as a surprise to anyone who knows the Icelandic economy that the króna exchange rate has declined. This has been expected for a long time as it has been clear that the high exchange rate could not be sustainable in the long run. It came, however, as a surprise that this correction of the exchange rate came so suddenly.
It is a well known fact that economic growth has, even by Icelandic standards, been extremely strong in the past few years, mostly driven by the large-scale investments in the energy and aluminum sectors. This has inevitably fuelled strong domestic demand and created imbalances as witnessed by the large current account deficit.
I am confident that the present imbalances in the Icelandic economy will be relatively short-lived. The current account deficit is to a large extent caused by the investment projects in the energy and aluminum sectors and will therefore be sharply reduced after their completion. The lower exchange rate of the króna will also contribute to a better balance in the economy by reducing demand pressures and lower the current account deficit even further.
Also, I believe that the present inflationary hike is temporary and that we will already in the latter half of next year see inflation figures close to the inflation target of the Central Bank. This is supported by recent forecasts by the Ministry of Finance and the Icelandic banks.
There are already some indications that the worst is now behind us. The exchange rate has gradually recovered and is now close to a long-term balance. This reflects the effect of an intensive publicity campaign by the banks and the authorities in recent weeks with the result that more and more foreign observers have become better informed about the sound fundamentals of the Icelandic economy. The rating companies, Moody’s and Standard & Poor’s, have also recently emphasized their firm belief in the soundness of both the economy as a whole and the financial position of the banks.
And, most recently, two reports have given the same positive picture of the economic situation. One report was issued by the Central Bank of Iceland which concludes that the financial stability of the Icelandic banking system is sound. The other report was written by the distinguished professor Frederic Mishkin and Professor Tryggvi Thor Herbertsson, Director of the Institute of Economic Studies with the University of Iceland.
The main conclusion of this report is, and I quote: “Iceland is unique in that it is the smallest economy in the world to have its own currency and a flexible exchange rate. It has experienced high current account deficits before, but rapid adjustment has taken place in the past without significantly stressing the Icelandic financial system. Iceland is also an advanced country with excellent institutions (low corruption, rule of law, high education, and freedom of the press). In addition, its financial regulation and supervision is considered to be of high quality. Iceland also has a strong fiscal position that is far superior to what is seen in the United States, Japan and Europe. Iceland's financial sector has undergone a substantial liberalization, which was complete over a decade ago, and its banking sector has been transformed from one focused mainly on domestic markets to one providing financial intermediation services to the rest of the world, particularly Scandinavia and the UK.”
The authors recognise that Iceland is running a large current account deficit, but add that current account deficits by themselves do not lead to financial instability. They also point out that the sources of financial instability that triggered financial crises in emerging market countries in recent years are just not present in Iceland, so that comparisons of Iceland with emerging market countries are misguided. Therefore, they see no reason to expect financial instability in Iceland.
I fully agree with these conclusions and I note that there are others that do the same. Only last Friday, Morgan Stanley issued a new report on the Icelandic banks saying that the Mishkin report had convinced them that the likelihood of a financial crisis in Iceland is extremely limited and urged investors to buy bonds from the banks.
Another important player in this field is the IMF. They have just concluded one of their regular missions in Iceland and will present their main conclusions about the state of the Icelandic economy tomorrow. I had the opportunity to hear their views last Friday and I am convinced that their report will be helpful in further stabilising the financial markets in Iceland.
Ladies and gentlemen.
Let me conclude by saying that our main task over the past decade has been to build a strong, modern society that can take on the future with a powerful market economy, a strong business climate, an ambitious cultural and educational environment along with a resilient social and welfare system in the spirit of a liberal democratic social policy that preserves our national heritage.
The policy of the present Government is based on the same fundamentals. This policy has until now contributed towards making the Icelandic economy the most competitive in Europe and the fourth in the world, after the US, Hong Kong and Singapore. This is no small feat and places us in front of our Nordic neighbours as well as the larger European countries such as the UK, Germany and France.
Our task in the future is to make the Icelandic economy even more competitive than it is today and thus continue to improve the living standards of the Icelandic people. This is indeed quite a challenge but it is a challenge that I will gladly take on.