I welcome this opportunity for an organised discussion of the economy and employment so soon after parliament has reconvened following its Christmas recess.
There is no denying that at the moment the economic outlook in the country is dark – as we have discussed often enough here in parliament and as is attested to by the recently published forecast from the Ministry of Finance. We Icelanders, however, are far from the only ones in this situation. The situation in neighbouring countries is also extremely difficult, as the global economy wrestles with one of the toughest crises it has confronted since the time of the Great Depression of the 1930s.
In its macroeconomic forecast, the Ministry of Finance predicts a GDP contraction of 9.6% this year, which is a dramatic reversal from the trend of recent years, together with a drop in private consumption as high as 24% in real terms. Purchasing power of disposable income should fall considerably less, or by around 13%, after taking into consideration the impact of rising unemployment, which according to the forecast will be 7.8% in 2009.
Inflation has been difficult to control in recent months, as we know, not least due to the major depreciation of the króna last year. On the other hand, there is widespread agreement that the prospects are good for a rapid drop in inflation in the latter half of this year, bringing it close to the Central Bank's target by year-end.
There has been a dramatic turnaround in foreign trade, with imports now falling sharply while exports are growing. The additional 30,000 tonne cod catch quota for the current fishing year naturally will boost exports of marine products, reinforce the fisheries sector and further boost export production. A positive balance of balance of trade in goods of over 14% of GDP is forecast for this year, an overwhelmingly positive transformation from the situation of the past few years.
The prospects for GDP growth next year are minimal, since the economy is not likely to have fully recovered following the shock of the banks' collapse. But GDP is not expected to drop further after the contraction forecast this year. The prospects are good that, as early as the latter half of next year, an economic turnaround will become visible, where the wheels of our economy will begin to turn at full speed once more.
Employment issues have been in the spotlight recently, as few matters are of greater importance for households than secure employment, ensuring families’ living security. Although achieving a positive outcome here requires taking specific action where this is necessary, in the end it is the success of overall economic policy which will result in an optimal outcome for everyone.
If we start by looking at the big picture, it was of crucial importance for the Icelandic economy that the government has, since November, been implementing the clear economic programme drafted in co-operation with International Monetary Fund experts. This forms the basis for co-operation between Iceland and IMF for the next two years. The programme is ambitious and clear – and naturally it takes into consideration the unprecedented setback suffered by the Icelandic financial system and the stark contraction which our economy will undergo as a result over the next two years. The programme follows a specific time schedule, but will be adjusted as the situation unfolds and reviewed by IMF experts at three-month intervals.
It has been claimed that the government has done nothing to respond to the enormous difficulties which the Icelandic economy is currently experiencing. This is, of course, anything but the truth, as I hope to show by summarising the actions taken by the government in recent weeks and months to extend assistance to individuals and families.
- The debt service of households with indexed loans has been reduced by applying an adjustment index, i.e. a wage index corrected for the employment level.
- Additional remedies have been made available to the Housing Financing Fund (HFF) to assist persons with difficulties in meeting their payments, such as extending loan terms and refinancing debt and increasing the flexibility of the collection regime.
- HFF has been provided with legal authority to rent out housing it acquires, in order to provide additional options for individuals with difficulties in meeting their payments. Agreements can be reached on co-operation with municipalities or other operators to handle such activities.
- The required provisional amendments have been made to Acts and Regulations to allow cancellation of various charges for modifying loan terms, such as stamp duties and registration fees, which made it difficult to refinance or repay loans.
- Provisions for netting child allowances against taxes and levies have been repealed.
- Provisions for netting interest benefits against payments on HFF mortgages have been repealed.
- Child allowances are now paid monthly, on request, rather than at three-month intervals.
- Public authorities responsible for collection of taxes and duties have been granted provisional authority to show flexibility in negotiating payment of overdue claims, to take into account individuals’ varying situations.
- Authorities responsible for collection of taxes and levies owed to the treasury have been granted provisional authority to cancel penalty interest, collection costs and charges in certain clearly specified instances.
- All ministries and state institutions have been instructed to show consideration wherever possible in collection actions towards individuals, including limiting to the extent possible the proportion of an individual’s wages which the state can appropriate for payment of debt.
- The Act on Penalty Interest has been reviewed, with the aim of reducing the rate of penalty interest.
- An authorisation to issue a Regulation setting a ceiling on collection cost has been availed of.
- In December, Althingi adopted amendments allowing for payment of partial unemployment benefits to encourage employers to offer full-time employees part-time work instead of laying off workers. Self-employed persons can now also undertake occasional work without losing their rights to benefits.
- Enterprises and institutions have also been offered assistance in hiring persons seeking work on a temporary basis, by paying the unemployment benefits to subsidise these workers' wages. The rights of unemployed workers have also been increased to facilitate their re-entry into the labour market, e.g. by providing moving grants.
- Actions have been taken to encourage start-up companies and more are to follow. Last November the New Business Venture Fund was a prime actor in establishing the powerful, new investment fund Frumtak to support such important growth endeavours in coming years. It is also significant that construction of the new aluminium smelter in Helguvík is proceeding well. The government has made every effort to ensure this project continues, for instance, with a special agreement on the investment last month.
- Various actions in the area of education have also been taken. Unemployed persons can receive the unemployment benefits they are entitled to while pursuing certain studies or attending courses. In addition, the Ministry of Education has sought to extend financial allocations to schools to ensure that practically everyone who applied for admission to upper secondary schools in the spring term of 2009 could be accepted.
As the above list clearly demonstrates, it is anything but correct to maintain that the government has failed to act. This is more than evident from the work carried out here in the Althingi, as many of these issues have been dealt with by the parliament in recent weeks. On the contrary, determined and diligent efforts have been made on all fronts to reduce the negative impact of economic distress on households.
In addition, it could be pointed out that a large number of measures to improve the corporate operating environment have either been implemented by the government or are in their final stages of preparation.
- In the first place, the banks were instructed to adopt clear guidelines on the financial assistance extended to Icelandic companies, with the aim of preserving jobs and encouraging the continuing operation of viable companies. The rules are to cover, for instance, extension of loan terms, debt reduction, conversion of debt to equity and mergers. Rules will be set to ensure transparency and objectivity in banks’ decision making, providing for consistent procedures in financial assistance to corporates while at the same time strengthening the banks’ internal supervision.
- The banks either already have set up or are in the process of establishing separate asset holding companies, to handle their holdings in companies where it has been decided to convert debt into equity.
- Support will be provided for the establishment of a reconstruction fund, a strong industrial investment fund backed by pension funds, banks and other investors. The government encourages this reconstruction fund to have regard for good corporate governance and corporate social responsibility in its investment policy, including emphasis by companies on preserving or creating jobs. Furthermore, close attention will be paid to companies’ compensation policy, gender policy, environmental strategy, contributions to R&D, importance for basic community services, etc.
- Companies who fulfil in other respects the requisite legal provisions are allowed to prepare their accounts in foreign currencies under legislation retroactive to 1 January 2008. A number of companies have already taken advantage of this move, which clearly is to the advantage of various enterprises.
- A proposal has been made to appoint an independent customer ombudsman for each bank and at least two of the commercial banks have advertised such a position. The ombudsman’s task will be to ensure that the bank in question does not discriminate between customers, that the process of corporate restructuring and other major measures taken are transparent and documented, and that the bank shows due regard for competition concerns. The Board of Directors of each bank is to select its ombudsman and ensure he/she can perform the supervisory role properly.
- In restructuring companies, the routes chosen must reinforce competition and take care to restrict it as little as possible. Similarly, opportunities to alleviate oligopoly or dominant market positions will be availed of wherever possible. The Boards of the banks have been instructed to have regard for the competition principles set out in a recent opinion from the Icelandic Competition Authority.
- The government declares its support for efforts to facilitate settlement with foreign creditors by offering them equity in the new banks, for instance, to help ensure their refinancing, the diversity of the banking system and the normal functioning of credit transactions between domestic parties and foreign banks.
- The government intends to adopt legislation facilitating long-term ownership by pension funds of real estate for which they have provided mortgage financing. In this manner, households and businesses whose properties are appropriated can be offered the option of continuing to live in or operate on the premises by renting them from the pension funds.
- Special emphasis will be placed on labour-intensive, job-creating state works projects, with the timing of undertakings harmonised with that of municipal projects in order to maintain employment and boost cost-efficiency. The Minister of Transport is concentrating especially on this matter.
- The government will promote a review of provisions of the Act on Public Companies, Acts on Taxation and other legislation to facilitate corporate managers in steering their companies through temporary difficulties resulting from the economic situation.
- In co-operation with the social partners, the government will review rules on currency controls intended to strengthen the ISK exchange rate in order to minimise their negative impact.
This list of actions hopefully attests to the very diligent efforts made by the government to respond to the economic difficulties while at the same time laying the groundwork for economic reconstruction. To the list of actions taken for the benefit of households it could be added, as has previously been mentioned here in the Althingi, that the Ministry of Justice has been preparing amendments to the Insolvency Act to facilitate so-called "payment adjustment for individuals". A bill to this effect will hopefully be placed before parliament in the very near future.
I would like next to turn to the economic recovery programme drafted by the government in co-operation with the International Monetary Fund and currently being implemented. The programme reflects clearly the economic and financial situation currently facing the nation. It has three primary objectives, all of which aim basically at restoring confidence in the Icelandic economy and preparing the way towards improving the financial position of Icelandic households and corporates as rapidly as possible.
Monetary and exchange rate policy
The first objective of the programme is to stabilise the ISK and ensure a rapid reduction in inflation. This is important not least due to the high foreign-denominated or inflation-indexed debt of corporates and households. Few developments can provide greater benefit to Icelandic households and corporates than ISK appreciation and increased price stability. Loans extended by the IMF and friendly countries are aimed at helping to achieve this objective - by providing the currency reserves needed on the FX market.
Althingi passed legislation on currency controls at the end of November which, as far as can be determined, has in most respects achieved its intended purpose. The ISK strengthened somewhat immediately afterwards, although it has weakened again to some extent since then. This is somewhat of a surprise in view of the record surplus in foreign goods trade in December, and the increase in the foreign-domestic exchange rate differential. Efforts are underway to fine tune the rules further and enforce their implementation to ensure that the turnaround in foreign trade results in ISK strengthening, which would be to the decided advantage of the general public and the vast majority of Icelandic companies.
Despite the important milestones achieved in foreign currency and price levels, major tasks still await resolution. The next steps will be to finalise a strategy for when and how currency controls will be relaxed and the policy rate lowered. The sooner the positive foreign trade balance is visible in ISK appreciation, the sooner interest rates can begin to drop.
There is no question that the intent is to relax and eventually remove currency controls as soon as the opportunity presents itself. Such restrictions generally have a negative impact on an economy in the longer term and are conceived only as a short-term measure, in fact an emergency action, as everyone is aware. On the other hand, it will take some time before the flow of capital will become completely unrestricted and obviously these controls cannot be relaxed until the exchange rate has stabilised and it is clear how effective the Central Bank’s management tools are under new circumstances. It will also be necessary to follow a tight monetary policy while the controls are relaxed, but we can expect the Central Bank to cut its policy rate rapidly as soon as this is possible.
The second objective of the economic recovery programme is to restore fiscal sustainability, in view of the major burdens assumed by the Treasury for recapitalising the banking system and the huge deficit foreseeable in coming years. Debt service on borrowing will also be high in coming years as a result of high gross public debt. This is offset, however, by substantial assets, making net debt considerably lower, conceivably close to 70% of GDP. Under the current circumstances, these estimates are naturally subject to high uncertainty. If they prove correct, the government’s net debt position will not differ greatly from the eurozone average. I want to emphasise this point especially, since unfortunately there has been substantial misinterpretation in this respect.
Efforts on behalf of the government concerning fiscal policy have been directed especially at amendments to the 2009 budget in view of the altered situation since the economic recovery programme was adopted. It proved necessary to adjust the Treasury balance by reducing spending and increasing income by ISK 45 billion from what was originally planned for 2009. According to the new budget, the fiscal deficit this year will be close to ISK 154 billion, or equivalent to 10% of GDP. Priority was given to maintaining basic state services in education, health, social affairs and law enforcement. In view of the above the government has, as previously mentioned, announced action plans for households and businesses, although the financial situation of the Treasury naturally sets limits for such measures.
In the current situation, there are only two ways to finance the budget deficit. On the one hand, the Treasury will use its credit balance with the Central Bank, which fortunately is very sizeable after budget surpluses of recent years. As much as ISK 100 billion will be withdrawn from the treasury’s account to cover this year’s budget deficit. Further withdrawals, however, could risk sending inflation soaring once more. The other means of financing the budget deficit is to issue government bonds. A major increase in such debt issuance could result in boosting interest rates. Neither route is therefore without certain cost to Icelandic households and businesses, who will eventually have to repay the Treasury debt resulting from the deficit.
Work is also underway on the fiscal framework over the next three to four years. The intention is to make the completed proposal public in the first half of this year, as it is important that ministries and institutions have a clear picture of their budget allocations in coming years in order to take appropriate cost-cutting measures. Clear objectives for the coming years should lay the foundation for restructuring.
Rebuilding the banking system
The third government objective is to rebuild an Icelandic banking system that will provide households and corporates with responsible and efficient service. An effective financial system is a pre-requisite for economic reconstruction and for successful corporate operations.
This is an enormous task, however, as around 85% of the banking system has collapsed - which is the most extensive shock ever suffered by any financial system in the world. The Treasury is expected to provide the three state banks with as much as ISK 400 billion in equity. This arrangement was adopted as part of the 2009 budget. As it will not require special debt issuance, recapitalising the system in this respect should not affect the domestic interest rate level. Efforts are also underway to strengthen the foundations of savings banks and other smaller financial institutions, many of which have suffered setbacks resulting from the credit crunch. A decision has also been taken to refinance the Central Bank in part through bond issuance, as previously announced and this action is being finalised.
In order to ensure the progress of banking reconstruction and to make proposals for further actions in this regard, a special commission has been set up, led by a respected Swedish banking expert, who also spent many years in the service of the International Monetary Fund. A Finnish financial expert has also been engaged to review the regulatory framework of the financial system. Finally, it should be mentioned that a contract has been concluded with a leading global financial consultancy, Oliver Wyman, to supervise the valuation of both the new and the old banks.
All of this is aimed at rebuilding the Icelandic banking system and restoring confidence. To achieve this, all procedures must be transparent and carried out professionally and responsibly.