Country Report Iceland July 1998 Main report

Outlook for 1998-99: Economic growth will remain strong --

The economy, which has been growing strongly, will continue to boom with growth reaching 4.5% in 1998 and 3.7% in 1999, down slightly from 5% in 1997. There is, however, a distinct possibility that an upward revision of these forecasts will be necessary, particularly if appropriate policy responses are not forthcoming. Continued buoyant private consumption growth, matching the rate of increase in 1997 of 6%, and double-digit rates of investment growth, picking up from the already high 9.9% in 1997 to 11% in 1998 before slowing to 5.5% in 1999, will drive the economy over the outlook period. The external sector will be the main drag on growth, as net exports decline significantly.

-- pushing the current account further into the red

The result of these high growth levels, driven by domestic demand, will be higher levels of imports, having an adverse effect on the current account which will move further into deficit in 1998, reaching 2.6% of GDP, before moving back towards equilibrium in 1999. The possibility of an upward revision of GDP growth is of particular relevance to the forecasting of the current-account position. Higher than anticipated domestic demand will suck in higher levels of imports, thus worsening the deficit position on the current account.

-- but price inflation will be kept in check --

Despite the above-trend growth and high levels of capacity utilisation, inflation is likely to remain subdued, rising to 2.4% in 1998 and 2.6% in 1999 from 1.8% in 1997. These forecasts are based on the assumption of an appropriate fiscal policy response should inflation shows signs of accelerating. However, such an assumption may prove erroneous. While the Central Bank of Iceland has stated publicly that fiscal policy remains too loose, the government will be reticent to cut expenditure and/or raise revenue with an election pending, particularly as the first budget surplus since 1984 was recorded in 1997.

Forecast summary (% change year on year unless otherwise indicated) 1996(a) 1997(a) 1998(b) 1999(b) Real GDP 5.5 5.0 4.5 3.7 Cod catch in volume 6.3 11.0 7.0 9.0 Consumer price inflation (av) 2.3 1.8 2.4 2.6 90-day Treasury-bill rate (%) 7.0 7.0 7.5 7.8 Unemployment rate (% of labour force) 4.3 3.9 3.2 3.4 Current-account balance ($ m) -133.7 -114.8 -194.9 -138.9 % of GDP -1.7 -1.6 -2.6 -1.7 Average exchange rates Ikr:$ 66.5 70.9 71.6 72.0 Ikr:DM 44.3 40.8 39.3 41.9 (a) Actual. (b) EIU forecasts.

-- as wage inflation accelerates

The average monthly wage index has continued its rapid rate of increase, up by 12.9% in the first three months of 1998 and rising by a further 9.8% in April. While much of the increase was the result of the implementation of wage rates agreed in 1997, the momentum gathered will be difficult to slow. A recent strike by nurses resulted in the government conceding to a 20% pay increase, something that is likely to lead to higher wage demands, especially in other areas of the public sector. Attempts at wage constraint will be further hindered by near full employment for the remainder of the outlook period.

© 1998 The Economist lntelligence Unit Ltd. All rights reserved
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