Introduction  

Following the currency and banking crisis that led to the collapse of the banking system in October 2008, economic recovery in Iceland has been slow but has commenced. The most recent statistics indicate that the recovery has been gaining momentum, but the situation is nevertheless fragile. According to preliminary figures from Statistics Iceland, GDP growth measured 3.7% for the first nine months of 2011. The Central Bank of Iceland forecast in November 2011 assumed 3.1% output growth in 2011, driven primarily by private consumption and business investment. Further, statistics show that private consumption has continued to grow and the labour market shows signs of recovery, with unemployment measured at 5.9% in the third quarter of 2011.

A work in progress  

In October 2011 the Supreme Court upheld the validity of the so-called “Emergency Act” which served as legal basis for taking over the collapsed banks and gave deposits priority over general claims. This verdict was considered a crucial milestone on the road towards stable economic recovery.

The banking system has now been restructured. The banks that were established around the domestic operations of the old banks following the collapse of Iceland’s three largest banks have been fully capitalised. In 2011 their funding originated largely from deposits. As a positive step in diversifying the funding of the bank, Islandsbanki hf. completed a listing of covered bonds on the NASDAQ OMX Iceland at the end of 2011, when the bank issued asset based covered bonds. The underlying assets are mortgage loans. The transaction marked the first listing of a bond by an Icelandic financial undertaking since the collapse in October 2008.

Debt restructuring is well under way, both on household debt and on company debt. Private sector indebtedness is declining in the wake of restructuring and debt relief measures. In the years leading up to the financial crisis, Icelandic companies were funded, as a general rule, with loans in foreign currencies. When the Icelandic krona plummeted in October 2008 it had severe consequences for the balance sheets of many of these companies as many of them generated revenue in the Icelandic krona. This resulted in many of them being taken over by the banks through enforcement of security. In order to expedite the restructuring process legislative reforms were made on the Act on Financial Undertakings under which banks’ ownership of companies in unrelated operations was limited to a period of twelve months. The Icelandic Financial Supervisory Authority (FME) can authorise an extension of this time-limit. A number of such extensions have been granted but they are nevertheless considered undesirable by the FME. Further, according to a report published in June 2011 by the Icelandic Competition Authority, companies directly owned by banks had a market share of around 46% in the largest competitive markets. The banks are in general aiming at divesting these assets and a number of smaller companies have already been sold. Two listings on the NASDAQ OMX Iceland have taken place post-crisis, the latter was completed successfully in December 2011 when the retail chain Hagar hf. was listed. Further, five companies have announced publicly that they have plans for listing. The companies were all taken over by banks in the wake of the crisis.

Capital controls were implemented in Iceland in November 2008. Controls were deemed necessary to stabilise the Icelandic economy following the financial crisis. The years prior to the financial crisis saw significant inflow of capital into Iceland for a number of reasons, e.g. through borrowing by Icelandic companies and through instruments constructed to benefit from the combination of interest rate differentials and an appreciating currency (carry-trade). The banking crisis and the resulting lack of confidence threatened to trigger large capital outflows with the ensuing adverse effects on the value of the Icelandic currency. The controls are applied universally, but banks and major companies with operations which are largely international and fulfil certain criteria, have received full or partial exemption from the controls. The Central Bank of Iceland is implementing, in steps, a strategy for liberalisation of the capital controls. As part of the liberalisation, foreign investors that have invested with foreign currency in Iceland after 30 October 2009 are allowed to freely transfer their investment from Iceland as they see fit, provided that they follow a simple procedure set up by the Central Bank.

The Outlook  

In the World Bank report “Doing Business 2011,” Iceland is ranked number 9 out of 183 economies for ease of doing business. As a party to the European Economic Area and the Schengen Area the country has implemented a vast part of the EU directives and regulations. Iceland has now applied for membership of the EU. The negotiations for accession have only just been opened and only time can tell how long the negotiation will take and what support the Icelandic population will grant the outcome of the accession agreement.

Export related business activities have flourished following the depreciation of the Icelandic currency in 2008. Export of marine products and aluminium and ferrosilicon remain the sectors generating the highest revenue. Tourism is a growing sector and despite repeated volcano eruptions in the past couple of years figures show a steady increase in visitors. The economic volatility of the global markets has had little direct impact in Iceland for now, largely because of the capital controls, but also due to the fact that domestic entities are relatively independent of foreign credit markets at the present time. The overall economic outlook for Iceland is, however, uncertain, due to the global economic developments and possible effect on exports and tourism. However, although Iceland still faces challenges in its economic recovery the country seems to be recuperating.