Iceland review - 2006, Síða 110

108 BUSINESS SUPPLEMENT
Iceland is a wealthy industrial country with
one of the highest levels of GDP per capita
in the world. It is a member of the OECD
and, together with the European Union (EU)
countries and Norway and Liechtenstein,
a member of the European Economic Area
(EEA). Under the EEA Agreement, Iceland is
a part of the EU’s single market and is obliged
to transpose various Community legislation
into Icelandic law – for example, its financial
market legislation. Consequently, Iceland’s
financial market regulatory framework and
financial supervision are based on best
industrial country practice.
Deregulation and liberalization of the economy
entered full swing in the 1990s, culminating
in the full privatization of commercial banks
and, most recently, Iceland Telecom. Since the
end of the 1990s, two waves of foreign direct
investment have added large-scale production
capacity to Iceland’s long-established
aluminum sector. In tandem, liberalization and
heavy foreign investment have been the main
drivers of robust economic growth in recent
years.
LOW PUBLIC SECTOR DEBT
The treasury has produced an almost unbroken
fiscal surplus for the past ten years. Along
with proceeds from privatization, this has
allowed the government to repay debt on an
unprecedented scale. The treasury’s overall
domestic and foreign debt had fallen to below
20 percent of GDP at the end of 2005. External
treasury debt was below ten percent and, after
allowance for its deposits in the Central Bank,
so was net treasury debt. Debt reduction is set
to continue in 2006.
The pension fund system in Iceland is unique in
the sense that it is to a large extent fully funded.
Unlike most other industrial countries, Iceland
does not face a future public finance burden
stemming from the aging of the population –
which is relatively young anyway. Total assets
of pension funds were equivalent to about 120
percent of GDP at the end of 2005.
In 2001, the Central Bank of Iceland adopted an
inflation target as the framework for monetary
policy. This means that the exchange rate is
freely floating and the Bank seeks to maintain
inflation as close as possible to two and a half
percent as measured by the CPI.
An important characteristic of the Icelandic
economy is its resilience and adaptability.
This was recently demonstrated in a quick
adjustment to internal and external balance
after the overheating of the economy around
the turn of the century. After reaching ten
percent of GDP in 2000, the deficit on the
current account had disappeared by 2002,
and inflation was quickly brought to target
following a temporary surge. The exchange
rate played an important role in bringing about
the correction of the external imbalance.
THE CENTRAL BANK’S CHALLENGE
BALANCING STABILITY & GROWTH: