The privatisation process is under way and there is room for considerable improvements in efficiency in the financial sector. One should expect mergers of individual institutions to take place in the period ahead. Competition among domestic financial institutions is fierce. In the rest of the economy, significant efficiency gains have been realised through privatisation of state enterprises and mergers of companies into larger and more efficient units. BIS Review 117/1999  2  Our experience since capital movements were fully liberalised shows us clearly that foreign exchange flows are very sensitive to changes in the short-term interest rate differential between Iceland and other countries. More generally, the volume of capital flows between Iceland and other countries has grown substantially. It has mainly been a one-way street, though, as domestic portfolio investors have been much more keen to invest abroad than foreign investors to invest in Iceland. On the domestic side, the pension funds have, since capital movements were liberalised, invested substantial amounts in foreign securities. Foreign assets of pension funds now exceed 15% of their total assets as compared with virtually nothing only five years ago. These assets are now yielding noticeable returns in our balance of payments. There are undoubtedly several reasons why foreign portfolio investors have only shown limited interest in Iceland. These include the relatively limited size and depth of the market and the fact that securities are not yet electronically registered. This will change in a few months’ time when a central electronic securities registry will commence operations.

Two years ago the fiscal budget turned into surplus. That surplus has risen and in the budget proposal for the year 2000, which was submitted to Parliament at the beginning of this month, the envisaged revenue surplus is equal to 2.2% of GDP. In the view of the Central Bank, it is essential that the targeted budget surplus be realised. It is important for the credibility of the overall policy of the government and because it will have dampening effects on domestic demand and thus reduce the current account deficit. The foundations of the Icelandic economy have strengthened in recent years through effective natural resource management and increased diversification, including the expansion of services exports. Iceland has made great strides in economic management as indicated by the stability and favourable economic developments that have characterised the economy for much of this decade. Instrumental in the changes that have taken place has been the liberalisation, and I might say marketisation, of the economy. In our present situation it is of paramount importance to safeguard the stability of the economy and quickly reduce inflation again. The Central Bank will continue to pursue a monetary policy geared to that end. Credit rating The success in economic management did not escape the attention of the rating agencies. The Republic of Iceland was first assigned a rating by Standard & Poor’s and Moody’s in the late 1980s. The initial long-term rating from both agencies was in the middle of the single A category.