Q: What is your general assessment of Iceland’s economy and what is your outlook?
A: The Icelandic economy is recovering well from a deep recession following the 2008 financial crisis, with growth of 3.5% in 2014 and average growth of about 3% forecast over the coming years. Public finances are back on a sustainable path, with the general government expecting to show a sizeable surplus in 2014. The financial system is growing healthier and the legal framework is strengthened through new legislation based on the Capital Requirements Directive [CRD] IV/Capital Requirements Regulation [CRR] framework.
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In the short term, the removal of capital controls remains the most salient challenge to economic policy-making. Private consumption and investment are again the main drivers of growth after the strong net export growth of 2013. Lower household and corporate debt play an important role in this shift.
The low inflation of recent months is also a welcome development for the Icelandic economy, which has long struggled with price stability. With inflation well below the central bank’s 2.5% target, unemployment falling to about 5% and a solid underlying current account surplus, the economy appears well balanced for strong growth going forward.
Q: What measures have been taken to regulate and stabilise Iceland’s banking sector since the crisis?
A: A new domestically oriented banking sector was established on the core foundations of the international banking sector that collapsed in 2008. The new banks are focused on servicing the domestic real economy and were established with very healthy capital and liquidity ratios. Numerous amendments were enacted to the law on financial undertakings following the crisis, including important amendments regarding large exposures, disclosure and notification of bank holding/ownership, connected lending and holdings in own shares. The authorities are moving towards implementing the CRD IV/CRR package and Basel III. The first enacting legislation was presented to Parliament in November 2014.
The supervisory framework has also been improved with a much-strengthened Financial Supervisory Authority, which has doubled in size, and a framework to analyse and react to macrofinancial risks through the establishment of the Financial Stability Council.
The banking sector enjoys healthy capital and liquidity positions, and has been profitable in recent years, even though too large a share of the sector’s income has come from irregular items. Importantly, the banking sector has managed to reduce the elevated share of non-performing loans and is moving ahead to clean its balance sheets in order to be actively involved in the relatively strong rebound of Iceland’s economy. Going forward, the banking sector needs to strengthen the profitability of its core business.
Q: The capital controls of 2008 are still in place and calls are being spurred for it to be lifted. What is your position on this?
A: The enactment of capital controls played an important role in stabilising Iceland’s economy following the collapse of the banks in 2008 and safeguarding it from crisis-related legacy issues. Since then, the Icelandic economy has made steady progress on its road to recovery. As time passes, however, the costs of these controls will rise and it is the expressed objective of this administration to bring about the abolition of capital controls and to promote the free movement of capital while safeguarding the economy through our strengthened prudential regulatory frameworks.
We are seeking a comprehensive solution to capital controls. While the interests of the domestic population are our primary responsibility, we duly respect our international obligations and our commitment to ensure equality under the rule of law regarding any potential solution. It is of fundamental importance for all concerned to understand that the comprehensive solution we are seeking must be compatible with Iceland’s future economic stability, growth and prosperity. To this end, our balance of payments and real exchange developments should not be governed by crisis-related legacy issues but reflect both current and future real economic prospects and developments.
Q: What is the strategy behind your fiscal policy?
A: The central objective of the fiscal plan is to achieve surplus in the overall balance of the Treasury and lower the debt to a sustainable level. After six years of persistent deficits since 2008, the prospects for this year are that this objective will be reached with a surplus. As the public finances are stabilising, the Treasury debt accumulation is being brought to a halt in nominal terms, with the central government gross debt expected to fall from 90% of gross domestic product [GDP] in 2011 to 78% of GDP in the year-end of 2014, eventually declining to 60% in 2018. This will provide a foothold for a gradually growing surplus in the coming years.
The main reasons for this trend is the growth in GDP, the better outcome on the fiscal side, as well as proceeds from asset sales, which will be used to pay down debt. Net debt levels are much lower at about 43% of GDP as domestic and foreign deposits have been held at very high levels for the past few years. A large buffer in domestic deposits has been important to be able to meet large fluctuations and the majority of the foreign reserves of the central bank have been funded by the Treasury. It is assumed that important steps will be taken in the next few months to lift the capital controls that reduce the need for substantial foreign reserves. This again enables the Treasury to pay down debt with foreign exchange deposits.
The government has submitted a new bill on fiscal planning and budget execution to the Parliament – an organic budget law bill that contains both a generic fiscal rule and numerical fiscal targets. The objective is to enhance stability and focus on longer term planning. In terms of debt targets, the overall debt ceiling established for the general government is set at 45% of GDP and while it is above that level, consistent steps will be required to lower debt to the established target. This new bill will assumingly be adopted within a few months and the aim is to be in compliance with the set fiscal objectives within a few years.
Iceland’s medium-term debt management strategy is updated and revised annually. The fiscal plan for the years 2015 to 2018 estimates a small fiscal surplus in 2015 and 2016 (0.2% and 0.3% of GDP). The plan for 2017 and 2018 is for running a larger surplus of 1.1% and 1.5% of GDP, respectively. The main goal is to lower debt to a sustainable level.
Economic policies and the design of the tax system need to provide a favourable setting for business sector investments and economic expansion that generate public revenues. To that end the tax system needs to be designed in a way that promotes rather than hampers economic growth. The government aims to simplify the tax system. For instance, the efficiency of Iceland’s value-added tax [VAT] system is below average compared with other Organisation for Economic Co-operation and Development countries. The first steps of simplification will be taken in the 2015 budget by abolishing the general commodity tax and significantly reducing the gap between the upper and lower brackets of VAT. Simplification of the VAT system will be ensued by a simplification of personal income tax. Social security tax on wages has been set on a declining path.
Q: Iceland started talks to join the EU in 2009 but has since suspended its application. Where are you with this and what is the reasoning behind it?
A: The current government is against joining the EU and that was manifestly stated in the 2013 general elections by both parties in the coalition government. Being a member of the European Economic Area, Iceland already enjoys important benefits from working with the EU and full access to the internal EU market.
Iceland started EU membership talks in 2009, however, the membership bid ran until January 2013, when the former government suspended talks. The talks therefore remain on hold and there will be no further accession talks with the EU in the near future.
