June 29, 2005

Wave of change rolls over Icelandic economy

By Patrick Lannin

REYKJAVIK (Reuters) - A gleaming new bank building, just astep away from the house where Cold War leaders Ronald Reaganand Mikhail Gorbachev met in 1986, is one of the most visiblesigns of Iceland's economic transformation.

Better known for fish and geysers, the island which is hometo just under 300,000 people is taking great strides to widenits economic base, backed by billions of dollars of foreigninvestment in aluminum smelters, deregulation and tourism.

A wave of corporate activity has been unleashed, with localfirms expanding aggressively into Europe, buying up businessesin Britain and the Nordic countries.

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

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

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

The country expects to start soon shipping aluminum made atnew smelters which are being built to take advantage of thevolcanic island's abundant and cheap geo-thermal energy.

Domestically, demand has been sparked by liberalisation oflocal financial markets, with commercial banks first beingprivatized and then being allowed to offer mortgages for thefirst time in competition to a state-owned housing fund.

This has sparked a boom in house prices and consumerdemand.

The finance ministry forecasts that by 2007 fish exportswill account for half of foreign trade, with the rest comingfrom aluminum exports and other products.


With the economic changes have come new names -- KaupthingBank, which owns the modern building of stone and glass justnext to the white clapboard house where Reagan and Gorbachevmet, is one of them.

Islandsbanki, Landsbanki and investment firms Baugur andBurdaras are others leading a wave of expansion outsideIceland.

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

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

"If you want to grow, you fairly quickly realize you havego outside the country," Islandsbanki CEO Bjarni Armansson toldReuters. His group has just bought two banks in Norway, meaningmost of its revenues now come from outside Iceland.

Kaupthing itself doubled in size after buying a Danishcorporate bank in Denmark.

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

Significantly, shipping group Eimskip, one of the olddominant forces of the business scene, was swallowed up in areverse takeover by Burdaras.


With growth of more than 5 percent last year, expected tobe higher this year and next, and inflation going over theofficial tolerance limit of 4 percent, the central bank hasbeen faced with the challenge of ensuring the boom does not endin a bust.

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

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

Prime Minister Halldor Asgrimsson said he was not worriedabout a meltdown.

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

The central bank has increased interest rates steadilysince May last year to a current level of 9.0 percent.

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

Despite the economic changes, Icelanders have retainedtheir fiercely independent nature, which led them to defyinternational opinion and resume whaling.

The country also went ahead with a project to build a damin 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 inthe same way that any other country would.

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