-->Iceland's economy heats up

Wednesday, June 29, 2005 Posted: 0228 GMT (1028 HKT)


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Manage Alerts | What Is This? REYKJAVIK, Iceland (Reuters) -- A gleaming new bank building, just a step away from the house where Cold War leaders Ronald Reagan and Mikhail Gorbachev met in 1986, is one of the most visible signs of Iceland's economic transformation.

Better known for fish and geysers, the island which is home to just under 300,000 people is taking great strides to widen its economic base, backed by billions of dollars of foreign investment in aluminium smelters, deregulation and tourism.

A wave of corporate activity has been unleashed, with local firms expanding aggressively into Europe, buying up businesses in Britain and the Nordic countries.

A new generation is becoming rich -- Iceland this year got its first representative on the Forbes list of the world's wealthiest, an investment firm magnate coming in at number 488, valued at $1.4 billion.

"We have been able to move this economy into a different league, making it more comparable with what you see elsewhere," Finance Minister Geir Haarde told Reuters.

Fish now accounts for under 10 percent of gross domestic product, but around 60 percent of exports. Its share of trade has decreased as Iceland revved up its tourism market.

The country expects to start soon shipping aluminium made at new smelters which are being built to take advantage of the volcanic island's abundant and cheap geo-thermal energy.

Domestically, demand has been sparked by liberalization of local financial markets, with commercial banks first being privatized and then being allowed to offer mortgages for the first time in competition to a state-owned housing fund.

This has sparked a boom in house prices and consumer demand.

The finance ministry forecasts that by 2007 fish exports will account for half of foreign trade, with the rest coming from aluminium exports and other products.

End of the octopus
With the economic changes have come new names -- Kaupthing Bank, which owns the modern building of stone and glass just next to the white clapboard house where Reagan and Gorbachev met, is one of them.

Islandsbanki, Landsbanki and investment firms Baugur and Burdaras are others leading a wave of expansion outside Iceland.

The man on the Forbes list, Bjorgolfur Thor Bjorgolfsson, 38, heads Burdaras, which owns stakes in Swedish investment bank Carnegie and Finnair and has bid for Finnish mobile phone operator Saunalahti.

Baugur, headed by another young entrepreneur, Jon Johannesson, has bought Hamley's toy store in London, the Iceland frozen food chain and several retail chains in Britain.

"If you want to grow, you fairly quickly realise you have go outside the country," Islandsbanki CEO Bjarni Armansson told Reuters. His group has just bought two banks in Norway, meaning most of its revenues now come from outside Iceland.

Kaupthing itself doubled in size after buying a Danish corporate bank in Denmark.

The new business generation has displaced the old system of family-controlled businesses, often with political alliances, which was known as the"Octopus" by locals.

Significantly, shipping group Eimskip, one of the old dominant forces of the business scene, was swallowed up in a reverse takeover by Burdaras.

Iceland too hot?
With growth of more than 5 percent last year, expected to be higher this year and next, and inflation going over the official tolerance limit of 4 percent, the central bank has been faced with the challenge of ensuring the boom does not end in a bust.

Central bank chief Birgir Gunnarsson has said he expected to have to raise interest rates again this year to ensure the cooling down was orderly.

"Although we have an overheating problem, we think we can handle it," he told Reuters.

Prime Minister Halldor Asgrimsson said he was not worried about a meltdown.

"We are not going to have any crash," he told Reuters.

The central bank has increased interest rates steadily since May last year to a current level of 9 percent.

Gunnarsson said the rate rises were already beginning to dampen inflation, helped by a strong exchange rate, which makes imports more expensive for Icelanders and reduces demand.

Despite the economic changes, Icelanders have retained their fiercely independent nature, which led them to defy international opinion and resume whaling.

The country also went ahead with a project to build a dam in eastern Iceland, which sparked protests from green groups, as part of power projects for the smelters.

Asgrimsson said Iceland has to use its natural resources in the same way that any other country would.

"Maybe it would be better not to drill for oil in the North Sea," he said.