The Icelandic economy– spring

forecast 2008National economic forecast for 2008-2013

Is a hard landing imminent?

Thorsteinn Thorgeirsson,Director-General, Economic Department

21 May 2008

Main conclusions

• Despite growing turbulence in financial markets in 2007, GDP growth amounted to 3.8 per cent for that year. Investment, private consumption as well as exports exceeded expectations.

• For this year, GDP growth is forecast at 0.5 per cent, mainly based on a sharp increase in aluminium exports and a decline in imports.

• GDP is forecast to contract 0.7 per cent in 2009, in part because of an expected decline in private consumption and housing investment. Business investment is forecast to continue to decline despite the construction of another aluminium plant.

• For 2010, GDP is forecast to increase by 0.8 per cent as private consumption revives as well as business investment.

Main conclusions, cont’d

• The external balance is improving rapidly. After peaking at 26% of GDP in 2006, the current account deficit reached 15.5 per cent in 2007. In 2008, it is expected to decline to 13.2 per cent, before reaching 7,7% in 2009 and 6.6 per cent of GDP in 2010.

• Unemployment is forecast to increase to 1.9 per cent of the labour force this year and to 3.8% in 2009, but to decline to 3.5 per cent in 2010.

• Inflation is expected to average 8.3 per cent this year and to decline to 3.9 per cent in 2009 and to 2.5 per cent in 2010.

Main conclusions, cont’d

• There are numerous plans for further energy-intensive investments including related power project construction. Should these plans be carried out, annual GDP growth would be up to 1.5 per cent higher in the years 2009-2011.

•The increase in activity would be accommodated by slack projected to develop in the economy in coming years.

• Main elements of uncertainty are i) the exchange rate, ii) conditions in international financial markets, iii) further large scale investment projects and iv) civil servant wage agreements later this year.

GDP, domestic demand & current account, 1995-2010

In per cent of GDP

MÁNUDAGSKVÖLD!

-30

-25

-20

-15

-10

-5

0

5

10

15

20

1995 1997 1999 2001 2003 2005 2007 2009

% Current account balance, % of GDP

Economic growth

National expenditure

Output gap, labour market gap & inflation 1998–2010

%

-4

-2

0

2

4

6

8

10

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Output gap Labour market gap Inflation

Real estate market in metropolitan area 2005 - 2008

-30

-15

0

15

30

45

60

75

90

105

120

2005 2006 2007 2008

%

-10

-5

0

5

10

15

20

25

30

35

40

Turnover (left-hand axis)

Price in real terms (right-hand axis) %

Growth in private consumption per capita, real estate prices and stock market prices

-10

-5

0510

15

20

25

30

35

40

45

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

12-mo.change (%)

12-mo.change (%)

-40

-25

-10

5

20

35

50

65

80

95

110

125

Private consumption (left-hand axis)

Housing prices (left-hand axis)OMXI -15 (right-hand axis)

New auto registrations

0.2

0.6

1.0

1.4

1.8

2.2

2.6

J an.98 J an.99 J an.00 J an.01 Jan.02 J an.03 J an.04 Jan.05 J an.06 J an.07 J an.080.6

0.7

0.8

0.9

1.0

1.1

1.2

Autos (left-hand axis)

Auto trends (left-hand axis)Exchange (right-hand axis)

Exchange trends (right-hand axis)

average1998 = 1.0

average1998 = 1.0

Private consumption & real disposable income, 1995-2010

Disposable income per capitaPrivate consumptionPrivate consumption per capita

Change onprevious year (%)

-9

-6

-3

0

3

6

9

12

15

1995 1997 1999 2001 2003 2005 2007 2009

-2

0

2

4

2006 2008 2010 2012 2014

Grunnspá Frávikspá

-2

0

2

4

2006 2008 2010 2012 2014

Grunnspá Frávikspá

2

4

6

8

2006 2008 2010 2012 2014

Grunnspá Frávikspá

IMF alternative scenarios

USA Euro-zone

World, other

Further large scale investments 2008-2015

0

20

40

60

80

100

120

2008 2009 2010 2011 2012 2013 2014 2015

B.kr. at current prices

0.0

1.0

2.0

3.0

4.0

5.0

6.0

%

B.kr. (left axis)

% of GDP (right axis)

Alternative scenario: further large scale investments

-1

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

2008 2009 2010 2011 2012 2013 2014 2015

Baseline forecast Alternative scenarioGDP growth (%)

Current account 2000-2010

-30

-25

-20

-15

-10

-5

0

5

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Trade balance Services balanceBalance on income Current account balance% of GDP

Unemployment rate & wage index 2001-2010

Wage index (left-hand axis)Wage index, forecast (between annual averages)Unemployment rate (right-hand axis)Unemployment rate (annual average)

12-mo.change (%)

% oflabour force

3

4

5

6

7

8

9

10

11

12

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Exchange rate & currency market turnover 1999-2008

0

200

400

600

800

1 000

1 200

1 400

jan.99jan.00jan.01jan.02jan.03jan.04jan.05jan.06jan.07jan.08jan.09jan.10100

110

120

130

140

150

160

B.kr. 1991=100

Total turnover (left-hand axis)Exchange rate index (right-hand axis)Exchange rate index, forecast (annual average)

Exchange rate & inflation 2000-2010

-20

-15

-10

-5

0

5

10

15

20

25

30

jan.00 jan.01 jan.02 jan.03 jan.04 jan.05 jan.06 jan.07 jan.08 jan.09 jan.10

CPI ForecastInflation target

CPICPI excl. housing componentExchange rate index, annual change%

Interest rate development 2001-2008

2

4

6

8

10

12

14

16

18

2001 2002 2003 2004 2005 2006 2007 2008

3-mo. REIBOR Policy rateNon-indexed interest rate Indexed interest rate

%

Bank lending to domestic & foreign parties 2003-2008

-20

0

20

40

60

80

100

120

140

160

180

jan.03 júl.03 jan.04 júl.04 jan.05 júl.05 jan.06 júl.06 jan.07 júl.07 jan.08

Lending to domestic sector

Lending to foreign sector

12-monthchange (%)

Public investment 1998-2010

0

1

2

3

4

5

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

General government

Central government Local governments% of GDP

Central government revenue balance 1998-2010Financial balance (right-hand axis)Revenue (left-hand axis)Expenditure (left-hand axis)

29

30

31

32

33

34

35

36

37

1998 2000 2002 2004 2006 2008 2010

-2

-1

0

1

2

3

4

5

6

% of GDP % of GDP

Risk premia in European money marketspread between 3 mo. EURIBOR & EONIA swap index

-0,2

0

0,2

0,4

0,6

0,8

1

1,2

J an.07 Mar.07 May.07 J ul.07 Sep.07 Nov.07 J an.08 Mar.08 May.08

%

CDS spreads for the Icelandic banks

0

200

400

600

800

1000

1200

Mar.06 J ul.06 Sep.06 Nov.06 Jan.07 Mar.07 J ul.07 Sep.07 Nov.07 Jan.08 Mar.08May.06 May.08May.07

Basispoints Glitnir Kaupthing Landsbanki iTraxx Europe

The Icelandic Economy Is a hard landing imminent?

• The profile of the projections suggests a downturn similar to that seen in 2001-2002.

• The economy is expected to enter a moderate recession in 2009 but a recovery in 2010.

• A hard landing is therefore not expected.

• Areas of uncertainty include conditions in international financial markets, the exchange rate and further large-scale investment projects.

• The strong position of the Treasury and the pension fund system along with flexibility and resilience of the economy make it better able to handle present conditions and restore balance.

Mange tak!

The Icelandic Economy Is a hard landing imminent?