Economy

The economy of Iceland is small but well-developed, with a gross domestic product estimated at US $11.38 billion in 2006 and a per capita GDP of $38,000, which is among the world's highest.

Like the other Nordic countries, Iceland has a mixed economy that is mainly capitalistic but supports an extensive welfare state. Social expenditure is, however, below that of mainland Scandinavia and most of western Europe.

The Icelandic economy is highly dependent on the fishing industry, which provides 70% of export income and employs 4% of the workforce; therefore, the state of the economy remains sensitive to world prices for fish products.

Resources

Iceland occupies a land area of 103,000 square kilometres. It has a 4,790 kilometre coastline and a 200 nautical mile (370.4 km) exclusive economic zone extending over 758,000 square kilometres of water. Approximately 20% of Iceland's land is arable, since the island's terrain is mostly mountainous and volcanic.

Iceland has few proven mineral resources. In the past, deposits of sulphur have been mined, and diatomite (skeletal algae) was extracted from Lake Myvatn until recently. That plant has now been closed for environmental reasons. The only natural resource conversion in Iceland is the manufacture of cement. Concrete is widely used as building material, including for all types of residential housing.

By harnessing the abundant hydroelectric and geothermal power sources, Iceland's renewable energy industry provides over 70% of all the nation's primary energy - proportionally more than any other country - with 99.9% of Iceland's electricity being generated from renewables. The Icelandic Parliament decided in 1998 to convert vehicle and fishing fleets to hydrogen fuel and consequently Iceland expects to be energy-independent, using 100% renewable energy, by 2050.

By far the largest of the many Icelandic hydroelectric power stations is Karahnjukavirkjun (690 MW), which is being constructed in the area north of Vatnajokull. Other stations include Burfell (270 MW), Hrauneyjarfoss (210 MW), Sigalda (150 MW), Blanda (150 MW), and more. Iceland has explored the feasibility of exporting hydroelectric energy via submarine cable to mainland Europe and also actively seeks to expand its power-intensive industries, including aluminium and ferro-silicon smelting plants.

Currency

The currency of Iceland is the krona (plural: kronur), issued exclusively by the Central Bank of Iceland since the bank's founding in 1961. The exchange rate in 2005 was 62.98 kronur to the United States dollar, down from 97.43 in 2001.

Monetary Policy

Monetary policy is carried out by the Central Bank of Iceland, which maintains a 2.5% inflation target rate, adopted in March 2001.

Iceland's economy is prone to inflation but remains rather broad-based and highly export-driven. During the 1970s the oil shocks hit Iceland hard. Inflation rose to 43% in 1974 and 59% in 1980, falling to 15% in 1987 but rising to 30% in 1988. Since then, inflation has dramatically fallen, and the current government is committed to tight fiscal measures. The current (2006) unemployment rate stands 1.3%. Iceland experienced moderately strong GDP growth (3% on average) from 1995 to 2004. Growth in 2005 exceeded 6%. Inflation averaged merely 1.5% from 1993-94, and only 1.7% from 1994-95. Inflation over 2006 topped at 8.6%, with a rate of 6.9% as of January 2007. Standard & Poor's reduced their rating for Iceland from AA- to A+ (long term) in December 2006, following a loosening of fiscal policy by the Icelandic government ahead of the 2007 elections. Foreign debt has especially risen, after a depreciation of the krona, and the possibilities are real for an economic recession.

Growth

Iceland's economy has been diversifying into manufacturing and service industries in the last decade, and new developments in software production, biotechnology and financial services are taking place. The tourism sector is also expanding, with the recent trends in ecotourism and whale-watching.

Imports and Exports

Iceland's economy is highly export-driven. Marine products account for the majority of goods exports. Other important exports include aluminium, ferro-silicon alloys, machinery and electronic equipment for the fishing industry, software, and woollen goods. Most of Iceland's exports go to the European Union (EU) and European Free Trade Association (EFTA) countries, the United States, and Japan. The 2006 value of Iceland's exports was $3.587 billion f.o.b.

The main imports are machinery and equipment, petroleum products, foodstuffs and textiles. Cement is Iceland's most imported natural resource. The total 2006 value of imports was $5.189 billion. Iceland's primary import partner is Germany, with 13%, followed by the United States, Norway and Sweden. Most agricultural products are subject to high tariffs; the import of some products, such as uncooked meat, is greatly restricted for phyto-sanitary reasons.

Iceland's relatively liberal trading policy has been strengthened by accession to the European Economic Area in 1993 and by the Uruguay Round agreement, which also brought significantly improved market access for Iceland's exports, particularly seafood products. However, the agricultural sector remains heavily subsidized and protected; some tariffs range as high as 700%.

Economic Agreements and Policies

Iceland became a full European Free Trade Association member in 1970 and entered into a free trade agreement with the European Community in 1973. Under the agreement on a European Economic Area, effective January 1, 1994, there is basically free cross-border movement of capital, labour, goods and services between Iceland, Norway, and the EU countries. However, the government of Iceland remains opposed to EU membership, primarily because of Icelanders' concern about losing control over their fishing resources. Iceland also has bilateral free trade agreements with several countries outside the EEA. The most extensive of these is the Hoyvik Agreement between Iceland and the Faroe Islands, this agreement goes even further than the EEA agreement by establishing free trade in agricultural products between the nations. Iceland has a free trade agreement with Mexico, November 27, 2000.

The centre-right government of Iceland plans to continue its policies of reducing the budget and current account deficits, limiting foreign borrowing, containing inflation, revising agricultural and fishing policies, diversifying the economy, and privatizing state-owned industries.

Manufacturing

The presence of abundant electrical power due to Iceland's geothermal energy sources has led to the growth of the manufacturing sector. Power-intensive industries, which are the largest components of the manufacturing sector, produce mainly for export. Manufactured products constituted 36% of all merchandise exports, an increase from the 1997 figure of 22%. Power-intensive products share of merchandise exports is 21%, compared to 12% in 1997.

Aluminium

Aluminium smelting is the most important power-intensive industry in Iceland. There are currently two plants in operation, with one under construction and two in the planning stage.

Alcan owns a plant in Straumsvik near the town of Hafnarfjordur which has been in operation since 1969. Its initial capacity was 33,000 metric tons per year (mtpy) but has since been expanded several times and now has a capacity of 180,000 mtpy. Alcan is studying the feasibility of expanding the plant to a capacity of 460,000 mtpy; negotiations are already underway with the power companies Landsvirkjun (the national power company) and Orkuveita Reykjavikur, although it is yet unclear if the municipality of Hafnarfjordur will allow such an expansion, but the inhabitants of Hafnafjordur are going to vote whether they want to expand the aluminium smelting or not.

The second plant started operations in 1998 and is operated by Nordural, a wholly owned subsidiary of U.S.-based Century Aluminum Company. It is located in Grundartangi in Western Iceland near the town of Akranes. Its current capacity is 220,000 mtpy but an expansion to 260,000 mtpy is already underway and is expected to be completed in the last quarter of 2007.

United States-based aluminium manufacturer Alcoa has become a major investor in Iceland and has a major plant under construction near the town of Reydarfjordur. The plant, known as Fjardaal (or "aluminium of the fjords") will have a capacity of 322,000 mtpy and is anticipated to be completed in 2007. To power the plant, Landsvirkjun will construct Karahnjukar, a 630-megawatt hydropower station.

According to Alcoa, construction of Fjardaal will entail no human displacement, no impact on endangered species, and no danger to commercial fisheries; there will also be no significant effect on reindeer, bird and seal populations. However, the project has drawn considerable opposition from environmentalist groups such as the World Wide Fund for Nature, which called on Alcoa to abandon the plan to build Fjardaal. In addition, Icelandic singer Bjork was a notable early opponent to the plan; protesting the proposed construction, the singer's mother, Hildur Runa Hauksdottir, went on a hunger strike in 2002.

Alcoa is also conducting a feasibility study on the possibility of building a second plant in Iceland near Husavik. That plant would have a 250,000 mtpy capacity and be powered entirely by geothermal power. If the decision will be made to build the plant, construction would not start before 2010.

Nordural has signed a memorandum of understanding to purchase electricity for its own aluminium reduction project in Helguvik. The agreement was reached between Nordural and two Icelandic geothermal power producers, Hitaveita Sudurnesja and Orkuveita Reykjavikur. The power supplied will initially support aluminium production of 150,000 mtpy, which will eventually grow to support 250,000 mtpy.

If all of the currently proposed expansions and new plants are constructed, the total production capacity of the Icelandic aluminium industry will rise to 1,542,000 mtpy, compared to the current capacity of 400,000 mtpy.

Medical Products and Pharmaceuticals

Iceland is an exporter of medical products, including prosthetics, diagnostic equipment, and medical software; the 2003 value of these exports was 13.5 billion kronur.

Actavis, a generic drug manufacturer, purchased U.S.-based Amide Pharmaceuticals in 2005 for between $500 and $600 million, as well as the generics business of Alpharma Inc.; Actavis had 2005 sales of €51 million and a net profit of €81 million. Its shares are traded on the Icelandic Stock Exchange and the company is part of the ICEX-15 index.

Finance

Banks

Iceland currently has three major commercial banks - Glitnir, Landsbanki and Kaupthing Bank - and a fourth, Icebank, which serves as the clearinghouse for the 29 locally run savings banks. All of the major banks are publicly listed on Kaupholl Islands (the Iceland Stock Exchange), though each was either wholly state-owned or merged with previously state-owned banks in the past.

The banks are competitive and each has branches and ATMs across Iceland. Each of the three major banks usually holds about a quarter of the total deposits, with the remaining share held by the savings banks and a small Postal Giro system. Because of the persistence of high inflation, most deposits are held in time (savings) deposits and currency-linked accounts rather than demand (checking) deposits.

Each of the major Icelandic commercial banks has offices in various American and European banking centres, but no foreign bank currently operates in Iceland due to the long distances and small market. The commercial banks have become much more aggressive in their lending since the liberalization of interest rates in 1986.

Stock Market

Because of the persistent inflation, historical reliance on fish production and the long-standing public ownership of the commercial banks, equity markets were slow to develop. Kaupholl Islands, the Iceland Stock Exchange (better known as ICEX), was created in 1985. Trading in Icelandic T-Bonds began in 1986 and trading in equities commenced in 1990. All domestic trading in Icelandic equities, bonds and mutual funds takes place on the ICEX.

The ICEX has used electronic trading systems since its creation. Since 2000, SAXESS, the joint trading system of the NOREX alliance, has been used. There are currently two equities markets on the ICEX. The Main Market is the larger and better known of the two. The Alternative Market is a less regulated over-the-counter market. Because of the small size of the market, trading is illiquid in comparison with larger markets. A variety of firms across all sectors of the Icelandic economy are listed on the ICEX.

The most important stock market index is the ICEX 15.

Other Financial Markets

Historically, investors tended to be reticent to hold Icelandic bonds because of the persistence of high inflation and the volatility of the Krona. What did exist was largely limited to bonds offered by the central government. The bond market on the ICEX has boomed in recent years, however, largely because of the resale of mortgages as housing bonds.

A mutual fund market exists on the ICEX in theory, but no funds are currently listed. A small derivatives market formerly existed, but was closed in 1999 because of illiquidity.