The OECD on Iceland

Further to Toby’s excellent post on Iceland.

Here are some extracts from OECD Country Reviews – courtesy of Roland Schneider of TUAC – which show gross disregard for the risks as they were building.

Economic Survey of Iceland 2006
Published on 9 August 2006
Chapter 1: Policy challenges in sustaining improved economic performance

Iceland’s growth performance has considerably improved since the mid-1990s thanks to the widespread implementation of structural reforms. Financialmarket liberalisation and privatisation, for example, have fostered entrepreneurship and investment. As a result, part of the previous relative decline in per capita GDP has been reversed over the past decade, and the country’s standard of living has remained among the highest in the OECD area. However growth has been volatile and accompanied by recurrent sizeable economic imbalances and tensions, only partly reflecting major aluminium-related investment projects. Consequently, a key challenge for policy is to enhance macroeconomic stability by ensuring an orderly unwinding of current imbalances and inflation pressures and avoiding their re-emergence in the future.

(……..)

Chapter 4: Building on the success of financial liberalization

This chapter discusses recent developments and policy issues relating to financial markets in Iceland. Overall, the sector is thriving, both relative to history and to conditions in other countries. This bodes well not only for those directly involved in the industry but for the country as a whole, as financial development is an important source of economic growth. Recently concerns have been expressed about the stability of the financial system; however the guarded assessment of financial supervisors and ratings agencies is that the system is broadly sound. A significant part of the credit for the vitality of the financial sector probably lies with government policy – in particular, the opening of the sector to international markets and the privatisation of the banks. Market liberalisation has been successful so far and should continue. In this respect a policy priority is to remove distortions in the market for home mortgage lending. In particular, the government guarantee for the Housing Financing Fund should be removed or neutralised; for example, by charging a fee. Iceland’s unusual reliance on indexation of loans is generally sensible for the borrowers and lenders involved and may have wider benefits. So restrictions on indexation of bank deposits and loans should be repealed. The financing of innovative start-ups is a difficult issue, where “best practice” guidelines are not obvious. Consideration should be given to use of less bureaucratic means of financing start-ups.

OECD Economic Survey of Iceland, 2008
Published on 28 February 2008
Excerpt from the Policy Brief
What are the main challenges?
The Icelandic economy is prosperous and flexible. With its per-capita income growing at double the OECD rate since the mid-1990s, it is now the fifth-highest among member countries and more than a quarter above the OECD average. This impressive performance is attributable to extensive structural reforms that deregulated and opened up the economy, thereby unleashing entrepreneurial dynamism, as evidenced by an aggressive expansion of Icelandic companies abroad. Improved growth performance has been accompanied, however, by mounting tensions and imbalances in the economy. With financial-market liberalisation facilitating access to credit, and reducing its cost, aggregate demand has increasingly outstripped potential output, despite a substantial inflow of foreign workers. As a result, inflation and the external deficit have soared. Foreign indebtedness is the highest among OECD countries.

(….)

Financial-market conditions worsened again following the international turmoil in August 2007 and the monetary stance was tightened further in the autumn in response to a deteriorating inflation outlook. As a result, economic activity is expected to weaken again in the period ahead and to remain sluggish through
2009. By then, the emergence of a negative output gap should bring inflation down to near the official target while the current account deficit should narrow gradually.

(…)

What needs to be done in the area of monetary policy?
So far, Iceland’s financial institutions have weathered the storm well, although increased risk aversion has led to higher borrowing cost for Icelandic banks. While their rapid expansion has raised concerns about financial stability, supervisory and rating agencies consider that the financial system is broadly sound. Stress tests suggest that banks have adequate capital to withstand large credit and market shocks. However, these scenarios do not account for the secondround effects of such shocks. Hence, the authorities should continue efforts aimed at improving the risk assessment and supervision of the financial system