Iceland: Risk Assessment
Business Climate Rating1
Continuation of positive growth in 2012
After a growth shock of over 10% between 2007 and 2010, the economy grew 2.3% last year but is expected to decelerate significantly in 2012 (up 0.4%) with several factors likely to prompt households to limit spending: high unemployment (between 7 and 8%) by Icelandic standards, resurgent inflation, income tax hikes budgeted for 2012; and gradual withdrawal of measures in support of consumption, like the restructuring, even cancelling of part of the debt of some borrowers. Although many beneficiaries of those measures will nonetheless remain burdened by heavy debt, wage increases negotiated in the framework of a three-year plan in May 2011 and the growth of asset values, especially housing prices, mitigate such negative effects. GDP growth will moreover derive support from corporate investment, particularly by smaller companies that have also benefited from debt restructuring. While very ambitious projects may be postponed this year, the start-up of work on the enlargement of the Staumsvik aluminum factory should enable investment to maintain a good growth rate, up about 9%. Exports have already suffered from several factors: the slowdown in demand from the main trading partners including the Netherlands (31% of sales abroad), United Kingdom (13%), and Germany (11%), the constraints of quotas imposed on the fishing industry, and the stagnation of aluminum production.
Public and external accounts will continue to improve
In 2008, after the credit bubble burst and the property market collapsed, Iceland became the first advanced country to solicit aid from the IMF. The agreement ultimately signed with the Fund expired 31 August 2011. It was an acknowledged success: the objective of consolidating public finances was met with the public deficit reduced by five points in three years albeit still remaining substantial. Although public sector debt remains high, it should begin to decline significantly this year. External debt was cut in half since 2008, down to a still massive 250% of GDP last year. Thanks to capital controls, the Icelandic krona exchange rate has been stabilized. But on the flip side, the controls have impeded the inflows of foreign capital that might otherwise have contributed to financing economic development. They are moreover unlikely to be lifted in 2012. The growth of inflation fueled by the rise of prices for imported raw materials is expected to be held to 4.5%. After raising its key rate twice in four months (in August and then November 2011), up to 4.75%, the Central Bank should tighten monetary policy further in 2012, albeit moderately so as to avoid unduly increasing the household debt service burden.
Companies still very vulnerable
The three main banks - Glitnir, Kaupthing, and Landsbanki - have been restructured and recapitalized: the first two, renamed Islandsbanki and Arion, are owned by their creditors, while the third is 80% state-owned. Meanwhile, the litigation over the digital bank Icesave (Landsbanki subsidiary) has been resolved with the reimbursement of the deposits of Dutch and British nationals handled by the parent company without calling on public finances. The banking sector remains nonetheless vulnerable and the extension of credit to companies and household will remain flat. And that contributes to further undermining the position of Icelandic companies while bankruptcies have soared again with a spectacular surge of nearly 73% in the second half of 2011. The sectors affected mainly include those focusing on the domestic market: wholesalers and retailers, garages, and construction. In view of the moderation expected in foreign demand, it would be advisable to give particular attention to export sectors.
- Abundant thermal and hydroelectric energy
- High tourist potential
- Proportion of youth in the total population above average for Western Europe
- High level of education
- Cleaned-up banking system
- Restructured household debt
- Successful IMF agreement
- Small economy
- Concentration of production and exports (aluminum and seafood)
- Foreign debt and current account deficit still large despite improvement
- Erosion of investment (13% of GDP)