Economy of Iceland

Economy of Iceland

Iceland
Currency	Icelandic krona (ISK)
Fiscal year	calendar year
Trade organisations	WTO, EFTA, OECD, EEA
Statistics
GDP	$12.144 billion (2007 est.)
GDP per capita	$63,830 (2007 est. nom.) (4th)
Inflation (CPI)	11,8% (2008 est.)
Population below poverty line	no data
Labour force	173,000 (2006 est.)
Labour force by occupation	agriculture: 5.1%, industry: 23%, services: 76% (2006)
Unemployment	~1% (2007 est.)
Main industries	fish processing; aluminum smelting, ferrosilicon production; geothermal power, tourism
External
Exports	$3.587 billion f.o.b (2006 est.)
Export goods	fish and fish products 70%, aluminum, animal products, ferrosilicon, diatomite.
Main export partners	UK 17.9%, Germany 16.4%, Netherlands 13%, US 8.1%, Spain 7.7%, Denmark 4.3% (2005)
Imports	$5.189 billion (2006 est.)
Import goods	machinery and equipment, petroleum products, foodstuffs, textiles
Main import partners	Germany 13.4%, US 9.1%, Sweden 8.6%, Denmark 7.3%, Norway 7.2%, UK 5.9%, China 5.3%, Netherlands 5%, Japan 4.7% (2005)
Public finances
Government debt	$3.073 billion (2002)
Revenues	$7.345 billion
Expenses	$6.655 billion; including capital expenditures of $467 million (2006 est.)
Economic aid	no data
All values, unless otherwise stated, are in US dollars.

The economy of Iceland is small but well-developed, with a gross domestic product estimated at US $ 12.172 billion (132nd of 227 countries) in 2005 (and a per capita GDP of $40,277, which is among the world's highest).

In 1990s, Iceland commenced extensive free market reforms and growth has been strong. Iceland has a mixed economy with high levels of free trade and government intervention. However, government consumption is less than in other Nordic countries. Today, Iceland has some of the world's highest levels of economic freedoms as well as civil freedoms. As of 2007, Iceland is the most developed country in the world, according to the Human Development Index and one of the most egalitarian, according to the calculation provided by the Gini coefficient. It is also the fourth most productive country per capita.

More recently, the economy of Iceland has suffered severe setbacks due to the financial crisis of 2007-2008.

History

In 1991, the Independence Party, led by Davíð Oddsson, formed a coalition government with the Social Democrats. This government set in motion market liberalisation policies, privatising a number of small and large companies. At the same time economic stability increased and previously chronic inflation was drastically reduced. Iceland became a member of the European Economic Area in 1994

In 1995, the Independence Party formed a coalition government with the Progressive Party. This government continued with the free market policies, privatising two commercial banks and the state-owned telecom Siminn. Corporate incomes tax was reduced to 18% (from around 50% at the beginning of the decade), inheritance tax was greatly reduced and the net wealth tax abolished. A system of individual transferable quotas in the Icelandic fisheries, first introduced in the late 1970s, was further developed. The coalition government remained in power after relatively successful elections in 1999 and 2003. In 2004, Davíð Oddsson stepped down as Prime Minister after 13 years in office. Halldór Ásgrímsson, leader of the Progressive Party, took over as Prime Minister from 2004 to 2006, followed by Geir H. Haarde, Davíð Oddsson’s successor as leader of the Independence Party.

After a temporary recession in the early 1990s, economic growth has been considerable, about 4% per year on average from 1994, and Iceland is now one of the wealthiest countries in the world according to OECD statistics.

"Nordic Tiger" was a term used to refer to the period of economic prosperity in Iceland that began in the post-Cold War 1990s and ended in a national financial crisis in 2008, when the country's major banks failed and were taken over by the country's government.

The country's prosperity had been attributed to several factors, including: high interest rates, which led to the inflow of foreign capital; a rapid expansion of the nation's banks into foreign markets; and the economically liberal policies pursued by the government of Davíð Oddsson, which included deregulation, privatising the banking sector and lowering taxes.

2008 financial crisis

Further information: 2008 Icelandic financial crisis

The Icelandic Central Bank approached the Bank of England in March 2008 for assistance to support its currency as confidence in its heavily-indebted banking began to ebb away

Following sharp inflation in the Icelandic króna during 2008, the three major banks in Iceland, Glitnir, Landsbanki and Kaupthing were put into control of the government. A subsidiary of Landsbanki, Icesave, which operated in the UK and the Netherlands, was declared insolvent, putting the savings of thousands of UK and Dutch customers at risk. It also transpired that over 70 local authorities in the UK hold more than £550 million of cash in Icelandic banks, and councils are concerned that their money may be lost, as their accounts are not guaranteed in the same way as consumer accounts.

On October 7, 2008, it was reported that the Russian ambassador to Iceland had announced a €4 billion loan to the Central Bank of Iceland, however the Russian ministry of finance stated no decision on such a loan had been made. Later however, Russian finance minister Alexei Kudrin admitted that such a loan request did occur and Russia was reviewing its position. On BBC2’s The Daily Politics television programme of October 7 presenter Andrew Neil suggested this loan could be tied to Russian access to military or naval bases in Iceland formerly occupied by the United States of America.
Iceland later turned to IMF
On October 24, 2008 IMF Announces Staff Level Agreement with Iceland on US$2.1 Billion Loan
On October 28, 2008 Iceland interest rate raised up to 18% to fight inflation

Geography and resources

Iceland occupies a land area of 103,000 square kilometers. It has a 4,790 kilometer coastline and a 200 nautical mile (370.4 km) exclusive economic zone extending over 758,000 square kilometers of water. Approximately 20% of Iceland's land is arable, since the island's terrain is mostly mountainous and volcanic.

Iceland has few proven mineral resources. In the past, deposits of sulphur have been mined, and diatomite (skeletal algae) was extracted from lake Mývatn until recently. That plant has now been closed for environmental reasons. The only natural resource conversion in Iceland is the manufacture of cement. Concrete is widely used as building material, including for all types of residential housing.

By harnessing the abundant hydroelectric and geothermal power sources, Iceland's renewable energy industry provides over 70% of all the nation's primary energy - proportionally more than any other country - with 99.9% of Iceland's electricity being generated from renewables. The Icelandic Parliament decided in 1998 to convert vehicle and fishing fleets to hydrogen fuel and consequently Iceland expects to be energy-independent, using 100% renewable energy, by 2050. As part of this program, the country opened the world's first public hydrogen filling station in 2003. As of 2007, it has about 40 hydrogen-powered vehicles on the road, second only to the U.S. state of California.

By far the largest of the many Icelandic hydroelectric power stations is Kárahnjúkavirkjun (690 MW), which is being constructed in the area north of Vatnajökull. Other stations include Búrfell (270 MW), Hrauneyjarfoss (210 MW), Sigalda (150 MW), Blanda (150 MW), and more. Iceland has explored the feasibility of exporting hydroelectric energy via submarine cable to mainland Europe and also actively seeks to expand its power-intensive industries, including aluminium and ferro-silicon smelting plants.

Currency and monetary policy

Main article: Icelandic króna

The currency of Iceland is the króna (plural: krónur), issued exclusively by the Central Bank of Iceland since the bank's founding in 1961. The exchange rate in 2008 was 78. krónur to the United States dollar, down from 97.43 in 2001.

Monetary policy is carried out by the Central Bank of Iceland, which maintains a 2.5% inflation target rate, adopted in March 2001.

Iceland's economy is prone to inflation but remains rather broad-based and highly export-driven. During the 1970s the oil shocks hit Iceland hard. Inflation rose to 43% in 1974 and 59% in 1980, falling to 15% in 1987 but rising to 30% in 1988. Since then, inflation has dramatically fallen, and the current government is committed to tight fiscal measures. The current unemployment rate stands at a record low 1%. Iceland experienced moderately strong GDP growth (3% on average) from 1995 to 2004. Growth slowed between 2000 and 2002, but the economy expanded by 4.3% in 2003 and grew by 6.2% in 2004. Growth in 2005 exceeded 6%. Inflation averaged merely 1.5% from 1993-94, and only 1.7% from 1994-95. Inflation over 2006 topped at 8.6%, with a rate of 6.9% as of January 2007. Standard & Poor's reduced their rating for Iceland to AA- from A+ (long term) in December 2006, following a loosening of fiscal policy by the Icelandic government ahead of the 2007 elections. Foreign debt has risen to more than five times the value of its GDP, and Iceland's Central Bank has raised short-term interest rates to nearly 15% in 2007. Due to the plunging currency against the euro and dollar, in 2008 inflation is speculated to currently be at 20-25%.

Imports and exports

Iceland's economy is highly export-driven. Marine products account for the majority of goods exports. Other important exports include aluminum, ferro-silicon alloys, machinery and electronic equipment for the fishing industry, software, and woollen goods. Most of Iceland's exports go to the European Union (EU) and European Free Trade Association (EFTA) countries, the United States, and Japan. The 2005 value of Iceland's exports was $3.215 billion f.o.b.

The main imports are machinery and equipment, petroleum products, foodstuffs and textiles. Cement is Iceland's most imported product. The total 2005 value of imports was $4.582 billion. Iceland's primary import partner is Germany, with 12.6%, followed by the United States, Norway, and Denmark. Most agricultural products are subject to high tariffs; the import of some products, such as uncooked meat, is greatly restricted for phyto-sanitary reasons.

Iceland's relatively liberal trading policy has been strengthened by accession to the European Economic Area in 1993 and by the Uruguay Round, which also brought significantly improved market access for Iceland's exports, particularly seafood products. However, the agricultural sector remains heavily subsidized and protected; some tariffs range as high as 700%.

Fishing industry is one important industry, which provides 70% of export income and employs 6.0% of the workforce; therefore, the state of the economy remains sensitive to world prices for fish products.

Transportation

Main article: Transport in Iceland

The main form of transportation in Iceland is the national road system, connecting most of the population centers. Organized road building began in the 1900s and has greatly expanded since 1980. The main highway, Þjóðvegur 1, is a circular road that runs along the coast almost completely around Iceland, leaving out only Vestfirðir. Þjóðvegur 1 lies through most of the main urban centers in Iceland, but there are also many smaller roads to smaller towns and villages, including some mountain roads in the Icelandic Highlands.

Regular air and sea service connects Reykjavík with the other main urban centers. In addition, airlines schedule flights from Iceland to Europe and North America. The national airline, Icelandair, is one of the country's largest employers. In 2000 a new low cost carrier Iceland Express started connections to Copenhagen and London, which meant cheaper airfare to and from Iceland. Domestic air travel remains important for those that need to travel frequently between different parts of the country, but coastal sea travel is reserved only for transportation of goods and even so, it is giving way to transportation by trucks. In 2005, transportation of goods got almost completely off the sea and on the roads when Iceland's shipping companies quit their scheduled cargo-ship transportation around Iceland from Reykjavik and emphasized on truck transportation of goods.

Iceland has no railroads.

In 1998 the Icelandic Parliament committed to convert the national vehicle and fishing fleets to hydrogen fuel in order to become a virtually energy-independent zero-carbon economy. It is expected that this will be accomplished by 2050, and a number of Icelandic hydrogen demonstration and development projects are in progress.

Economic agreements and policies

Iceland became a full European Free Trade Association member in 1970 and entered into a free trade agreement with the European Community in 1973. Under the agreement on a European Economic Area, effective January 1, 1994, there is basically free cross-border movement of capital, labor, goods, and services between Iceland, Norway, and the EU countries. However, the government of Iceland remains opposed to EU membership, primarily because of Icelanders' concern about losing control over their fishing resources. Iceland also has bilateral free trade agreements with several countries outside the EEA. The most extensive of these is the Hoyvík Agreement between Iceland and the Faroe Islands, this agreement goes even further than the EEA agreement by establishing free trade in agricultural products between the nations. Iceland has a free trade agreement with Mexico on November 27, 2000.

The center-right government plans to continue its generally neo-liberal policies of reducing the budget and current account deficits, limiting foreign borrowing, containing inflation, revising agricultural and fishing policies, diversifying the economy, and privatising state-owned industries.

Manufacturing

The presence of abundant electrical power due to Iceland's geothermal energy sources has led to the growth of the manufacturing sector. Power-intensive industries, which are the largest components of the manufacturing sector, produce mainly for export. Manufactured products constituted 36% of all merchandise exports, an increase from the 1997 figure of 22%. Power-intensive products's share of merchandise exports is 21%, compared to 12% in 1997.

Aluminium

Aluminium smelting is the most important power-intensive industry in Iceland. There are currently two plants in operation, with one under construction and two in the planning stage.

Alcan owns a plant in Straumsvík near the town of Hafnarfjörður which has been in operation since 1969. Its initial capacity was 33,000 metric tons per year (mtpy) but has since been expanded several times and now has a capacity of 180,000 mtpy. Alcan is studying the feasibiliy of expanding the plant to a capacity of 460,000 mtpy; negotiations are already underway with the power companies Landsvirkjun (the national power company) and Orkuveita Reykjavíkur, although it is yet unclear if the municipality of Hafnarfjörður will allow such an expansion, but the inhabitants of Hafnafjörður are going to vote whether they want to expand the alminunum smelting or not.

The second plant started operations in 1998 and is operated by Norðurál, a wholly owned subsidiary of U.S.-based Century Aluminium Company. It is located in Grundartangi in Western Iceland near the town of Akranes. Its current capacity is 220,000 mtpy but an expansion to 260,000 mtpy is already underway and is expected to be completed in the last quarter of 2007.

United States-based aluminum manufacturer Alcoa has become a major investor in Iceland and has a major plant under construction near the town of Reyðarfjördur. The plant, known as Fjarðaál (or "aluminum of the fjords") will have a capacity of 322,000 mtpy and is anticipated to be completed in 2007. To power the plant, Landsvirkjun will construct Kárahnjukar, a 630-megawatt hydropower station.

According to Alcoa, construction of Fjarðaál will entail no human displacement, no impact on endangered species, and no danger to commercial fisheries; there will also be no significant effect on reindeer, bird and seal populations. However, the project has drawn considerable opposition from environmentalist groups such as the World Wide Fund for Nature, which called on Alcoa to abandon the plan to build Fjarðaál. In addition, Icelandic singer Björk was a notable early opponent to the plan; protesting the proposed construction, the singer's mother, Hildur Rúna Hauksdóttir, went on a hunger strike in 2002.

Alcoa is also conducting a feasibility study on the possibility of building a second plant in Iceland near Húsavík. That plant would have a 250,000 mtpy capacity and be powered entirely by geothermal power. If the decision will be made to build the plant, construction would not start before 2010.

Norðurál has signed a memorandum of understanding to purchase electricity for its own aluminum reduction project in Helguvík. The agreement was reached between Norðurál and two Icelandic geothermal power producers, Hitaveita Suðurnesja and Orkuveita Reykjavíkur. The power supplied will initially support aluminum production of 150,000 mtpy, which will eventually grow to support 250,000 mtpy.

If all of the currently proposed expansions and new plants are constructed, the total production capacity of the Icelandic aluminum industry will rise to 1,542,000 mtpy, compared to the current capacity of 400,000 mtpy.

Medical products and pharmaceuticals

Iceland is an exporter of medical products, including prosthetics, diagnostic equipment, and medical software; the 2003 value of these exports was 13.5 billion krónur.

Actavis, a generic drug manufacturer, purchased U.S.-based Amide Pharmaceuticals in 2005 for between $500 and $600 million, as well as the generics business of Alpharma Inc.; Actavis had 2005 sales of €551 million and a net profit of €81 million. Its shares are traded on the Icelandic Stock Exchange and the company is part of the ICEX-15 index.

deCODE genetics, a worldwide leader in the field of biotechnology is also based in Iceland.

Finance

Banks

Main article: Banks of Iceland

Iceland currently has two major commercial banks – Landsbanki and Kaupþing Bank – and a third, Icebank, which serves as the clearinghouse for the 29 locally run savings banks. One of the single most important and historic days in Icelandic economy history happened on 29 September 2008, when the government announced it would be taking over one of the country's biggest commercial banks, Glitnir. In addition, Iceland used emergency powers adopted on 6th October 2008 to dismiss the board of directors of Landsbanki and put the bank in receivership. The Althing granted the Icelandic Financial Supervisory Authority sweeping powers over banks as its financial system tottered and its currency plunged. Speculation continues about the financial health of the other banks. All of the major banks were publicly listed on Kauphöll Íslands (the Iceland Stock Exchange), though each was either wholly state-owned or merged with previously state-owned banks in the past.

The banks are competitive and each has branches and ATMs across Iceland. Each of the three major banks usually holds about a quarter of the total deposits, with the remaining share held by the savings banks and a small Postal Giro system. Because of the persistence of high inflation, most deposits are held in time (savings) deposits and currency-linked accounts rather than demand (checking) deposits.

Each of the major Icelandic commercial banks has offices in various American and European banking centers, but no foreign bank currently operates in Iceland due to the long distances and small market. The commercial banks have become much more aggressive in their lending since the liberalization of interest rates in 1986.

Stock market

Because of the persistent inflation, historical reliance on fish production and the long-standing public ownership of the commercial banks, equity markets were slow to develop. Kauphöll Íslands, the Iceland Stock Exchange (better known as ICEX), was created in 1985. Trading in Icelandic T-Bonds began in 1986 and trading in equities commenced in 1990. All domestic trading in Icelandic equities, bonds and mutual funds takes place on the ICEX.

The ICEX has used electronic trading systems since its creation. Since 2000, SAXESS, the joint trading system of the NOREX alliance, has been used. There are currently two equities markets on the ICEX. The Main Market is the larger and better known of the two. The Alternative Market is a less regulated over-the-counter market. Because of the small size of the market, trading is illiquid in comparison with larger markets. A variety of firms across all sectors of the Icelandic economy are listed on the ICEX.

The most important stock market index is the ICEX 15.

Other financial markets

Historically, investors tended to be reticent to hold Icelandic bonds because of the persistence of high inflation and the volatility of the Króna. What did exist was largely limited to bonds offered by the central government. The bond market on the ICEX has boomed in recent years, however, largely because of the resale of mortgages as housing bonds.

A mutual fund market exists on the ICEX in theory, but no funds are currently listed. A small derivatives market formerly existed, but was closed in 1999 because of illiquidity.

Growth

Iceland's economy had been diversifying into manufacturing and service industries in the 1990s, and new developments in software production, biotechnology, and financial services were taking place. The tourism sector was also expanding, with the recent trends in ecotourism and whale-watching. However, in 2008, the Icelandic economy entered a deep recession in correspondence to the 2008 Credit Crunch. There is even speculation that Iceland is now entering an economic depression, making it the first economy of the developed world to plunge into depression due to the Global recession of 2008

See also

• OECD's Iceland country Web site and OECD Economic Survey of Iceland
• 2008 Icelandic financial crisis
• Economy of Europe

External links

• Economic figures updated regularly can be found on the official website of the Icelandic Bureau of Statistics - http://www.statice.is
• Kauphöll Íslands (Iceland Stock Exchange - ICEX) - http://www.icex.is
• Integrated financial services in Iceland - http://www.kaupthing.com
• Iceland Country Profile on the link2exports website