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Moody's affirms Iceland's rating of Aaa/P-1

NOTE: This article is from 08. June 2004 and is therefore more than 5 years old.

Moody's Investors Service has affirmed Iceland's credit rating of Aaa/P-1 with a stable outlook. Please see the following press announcement released on June 7, 2004.

No. 17/2004
June 8, 2004

 

 

MOODY'S REPORTS: ICELAND'S Aaa REFLECTS GREATER DIVERSIFICATION AND ECONOMIC FLEXIBILITY

New York, June 07, 2004 -- In its annual report on Iceland, Moody's Investors Service points to the increased diversification and proven flexibility of the island nation's economy as being among the main factors that support its Aaa/P-1 country ceilings.

Moody's notes that the Icelandic economy stands out among its Western European peers because of its small size, its volatile history, and its large foreign indebtedness. "Still, Iceland's top ratings and stable outlook are justified in light of the nation's strong government finances, relatively favorable demographics, and healthy economic growth," emphasizes Moody's analyst Kristin Lindow, one of the authors of the report.

Ms. Lindow says that last year's growth at 4% far exceeded expectations, yet unemployment failed to budge and inflation dropped below the Central Bank's 2.5% target. The analyst expresses concern, however, that the Icelandic economy is already manifesting macroeconomic imbalances, which mostly derive from a massive new foreign investment-led cycle that began last year.

For example, the current account shifted from a modest surplus in 2002 into a deficit equivalent to 5.6% of GDP in 2003, and a further widening is suggested by new figures for the first quarter of 2004. External debt for the US$10.5 billion economy climbed by $5 billion to $16 billion last year, driven by commercial bank foreign borrowing that funded a rapid rise in domestic credit as well as a mergers and acquisitions boom.

Moody's also mentions that consumer prices have edged up in recent months. The latest Central Bank forecast expressed worries that inflation would indefinitely exceed its target, perhaps by a considerable margin, without policy tightening. Accordingly, the monetary authorities increased interest rates twice for a total of 45 basis points during the past month, and more hikes are likely should inflation fail to come back into line.

Moody's emphasizes that the government has also committed to a more restrictive fiscal stance for several years. The agency says that Iceland's policymakers appear determined to avoid the serious economic overheating that occurred during the last foreign investment cycle in the late 1990's -- a cycle that was abetted by a rapid rise in public and private consumption.

Indeed, Moody's remains cautiously optimistic that the government's commitment to tightened fiscal policy will be fulfilled, regardless of the upcoming switch in prime ministers between the heads of the two parties in the three-term ruling coalition. Nevertheless, the agency predicts that the current account deficit will swell substantially further during the next several years as a result of buoyant economic conditions and heavy import requirements for the aluminum smelters and power projects.

Moody's says that Iceland's economic situation could be aggravated in the event of a large devaluation or a sudden and severe economic slowdown, which increases the importance of continuing to lengthen the foreign debt maturity structure. It will also be vital for policymakers to follow through with a restrictive fiscal and monetary stance and to promote a balanced sequencing of any future investment projects under consideration.

In the absence of such adjustments, Moody's is concerned that the eventual correction needed to reestablish macroeconomic equilibrium could be more painful than the soft landing of 2001-2002. Moody's reiterates, however, that the Icelandic economy has proven itself to be "unusually flexible in response to its historic fluctuations," and the rating agency believes that this pattern should repeat itself.

The Moody's report, "Iceland: Global Credit Research" is a yearly update to the markets and is not a formal action to alter the credit rating of the issuer.