Growth and opportunities
By Bjarni Benediktsson, Minister of Finance and Economic Affairs
celand’s real economy has made increased improvements over the past few years and the country is again one of the fastest growing advanced economies. Investment is picking up again, inflation is now below the Central Bank’s target of 2.5% and government finances have moved back into positive territory. In July the Treasury and Central Bank of Iceland prepaid the remainder of the Nordic loans taken in connection with the IMF-lead Stand-By Arrangement in 2008. One of the government´s priorities is to bring down debt and at the end of 2014 an important milestone will be reached when the debt to GDP ratio will fall below 80%, down to 78%.
GDP growth is outperforming most of Iceland’s European peers; it has been positive since 2011 and is projected at 3.1% in 2014 and 3.4% in 2015.
Historically, the Icelandic economy has stood on two main pillars, fishing and energy intensive industry. The third pillar, tourism, has been growing fast, with its share in total export income rising from 20% to 27% in just four years. Tourism is the fastest growing sector at the moment and moving away from being generally a seasonal industry. There are now clear signs that the peak season is lengthening in both directions.
The Icelandic economy is firmly based on its rich natural resources and the maximization of their long-term utilization. Investment is taking hold again and the international interest in the development of Iceland‘s green energy is rising again as the world economy rebounds. According to the Central Bank’s macroeconomic forecast, the outlook for investment is good; it is expected to grow by 16.9% in 2014, 15.7% in 2015, and 12.5% in 2016, bolstered by increased investment in the energy-intensive sector. The outlook is therefore bright from 2014 onwards, with growing GDP driven by investment and private consumption.
Prudent economic policy
Improvements in the real economy are being supported by prudent economic policy. Government finances have moved back into positive territory with a sizeable surplus expected for 2014 and a budget proposal for continued restraint and surplus in 2015. Continued fiscal prudence and lowering of government debt levels are among the government‘s main priorities. To this end, the framework for fiscal policymaking is to be completely revised through a new Organic Budget Law currently before parliament. A thorough review of the tax system is also taking place. The aim is to rebuild a simple, fair and effective tax system with positive incentives for jobs, investment and growth. The first steps have already been presented, with broadening of the VAT base, rationalization of tax rates and elimination of commodity taxes.
The removal of capital controls imposed following the collapse of the banking sector in 2008 remains one of the main challenges facing economic policymaking in Iceland. The controls need to be unwound without risking economic and financial stability. Good progress is being made in preparing the ground for important steps in this regard. New capital inflows are not subject to the controls, and investors are permitted to export returns (earned interest) within six months of the interest payment. The Central Bank has been able to increase its non-borrowed reserves on the back of sizeable capital inflows. This has been done whilst the exchange rate has remained stable and inflation benign.
As the estates of the fallen banks are wound up and the controls eased the financial sector framework will continue to be based on strong capital and liquidity ratios, with the experience of the 2008 crisis in mind. The framework for the financial system is being improved with the incorporation of the CRD IV package, strengthened financial supervision and a newly established Financial Stability Council that is to bridge gaps between micro- and macro-supervision.
Structural reforms are being implemented to improve productivity and strengthen the economy’s growth potential. The number of years pupils spend in secondary schools is being shortened towards peer-country averages without affecting the quality of education. At the same time, increased funding is being directed towards R&D according to an ambitious research and innovation strategy that aims to raise R&D funding to 3% of GDP.
As a small economy, Iceland bases its prosperity on access to international markets. Membership to the European internal market forms the backbone for international trade for Iceland, as well as a successful, well-established trading partnership with the USA. The free-trade agreement with China that came into effect on July 1 opens up enormous opportunities for Iceland. Good access to these markets, as well as a swath of other free-trade agreements through Iceland’s membership to EFTA, situates Icelandic industries in a prime position to take advantage of the opportunities granted by expansion of the world economy. These opportunities are not only important for Iceland’s traditional resources sectors but also for new rapidly expanding knowledge based industries.
A successful Eurobond issuance of €750m in July was yet another positive step for the sovereign. Iceland opened up the access to international capital markets in wake of the crisis with two US dollar bond issuances in 2011 and 2012. The July issuance was the sovereign´s first issuance in euros since 2006. The proceeds were used to prepay what was remaining of the loans from the Nordic countries that were taken as part of the Economic programme in 2008. Iceland´s continued recovery story, strong economic fundamentals and outperformance of many of its peers, certainly attracted investors both from Europe and the US.
With good open access to major international markets, very favourable demographics, highly skilled labour force, a strong pension system and a strong resource base, the Icelandic economy is well situated to continue to face the challenges ahead and take advantage of improved economic conditions amongst its main trading partners and stronger world growth.