On Dec 16, 2003, Standard & Poor's Ratings Services revised its foreign currency outlook on the Republic of Iceland to positive from stable. At the same time, all the ratings on Iceland were affirmed, including the 'A+/A-1+' foreign currency and 'AA+/A-1+' local currency sovereign credit ratings. The local currency outlook remains stable.
The revision of the foreign currency outlook reflects Standard & Poor's positive reappraisal of developments in the financial sector, as well as the beneficial impact of large-scale investments on the structure of the economy and its growth prospects.
The ratings on Iceland are supported by its stable political institutions, a wealthy and flexible economy, and healthy public finances. The ratings remain constrained by very high levels of external debt throughout the economy, and the off-budget and contingent liabilities of the government.
Iceland boasts stable and flexible political institutions, enjoying broad public backing and a long tradition of stable coalition governments.
Iceland's wealthy and flexible economy generates one of the highest per capita GDPs in the world. The flexibility of the economy was highlighted by the swift unwinding of imbalances that had mounted during the credit-fuelled boom of 1996-2000. Credit growth slowed to virtually zero in 2002 from 44% in 2000, and the current account returned to balance from a deficit of 10.1% in 2000, without major economic repercussions. Economic growth has since accelerated again, to reach 5.5% in 2005, following 1.7% in 2003 and a slight contraction in 2002.
Public finances are healthy. The general government balance will be slightly negative in 2003, at 1.1% of GDP, partly as a result of the economic downturn and discretionary measures on both the expenditure and revenue sides. Going forward, the general government balance is expected to return to a slight surplus until at least 2006. General government debt will resume its decline, to reach 32.9% of GDP in 2006, down from 46.2% in 2002.
Levels of net external debt are very high throughout the economy, at an overall 272% of current account receipts (CARs) in 2003. Capital outflows from Icelandic pension funds diversifying abroad put additional structural pressure on the balance of payments. Despite the rapid reduction of the current account deficit and a very strong increase in foreign exchange reserves, external liquidity has improved only slightly and will remain one of the weakest among rated sovereigns for the foreseeable future.
The off-budget and contingent liabilities of the government are subsiding. Imbalances in the financial sector had been significant as a result of the credit boom, and downside risks remain due to the large external leverage of the sector and a volatile exchange rate. However, tighter regulation and supervision, improved prudential indicators and increased profitability leave the sector in a better position than at the beginning of the decade.
Outlook
The positive outlook on the foreign currency ratings reflects the
expectation that the stability of the financial sector will continue to improve,
owing to tighter regulation and supervision, the recent privatization of two of
the largest banks, and the merger between the third- and fourth-largest banks.
Large-scale investment projects in aluminum smelting and power generation, set to be carried out during 2004-2010, will lead to significant net foreign direct investment (FDI) inflows over the coming years, precipitating strong economic growth and strengthening Iceland's economic structure.
Since the investments pose important challenges for economic policy, the government and the central bank are expected to maintain a tight fiscal and monetary stance, to prevent the recurrence of macroeconomic imbalances, which could exacerbate the country's large net debtor position.
A potential upgrade of Iceland's foreign currency ratings hinges on further strengthening of the financial sector, as well as a prudent macroeconomic policy stance over the period ahead. Conversely, any significant increase in external leverage or a recurrence of macroeconomic imbalances on the back of the country's large investment projects could lead to a downward revision of the outlook.
Ratings List
To From
- Foreign currency sovereign credit
ratings
A+/Positive/A-1+ A+/Stable/A-1+ - Local currency sovereign credit
ratings
AA+/Stable/A-1+ AA+/Stable/A-1+ - Foreign currency senior unsecured
debt
A+ A+ - Local currency senior unsecured debt
- AA+ AA+
- Short-term debt
A-1+ A-1+
© by Standard & Poor's, A Division of the MacGraw-Hill Companies, Inc. Reproduced with permission of Standard & Poor's.
2003
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No. 30/2003
December 17,
2003