the treasury ’ s finances appear to have been close to balance in 1997. the treasury repaid debt during the year. amortization of foreign debt exceeded new borrowing by 6. 5 billion kronur, or the equivalent of 5 percent of the treasury ’ s foreign debt ; this marked the first time since 1986 that amortization of foreign debt exceeded new borrowing. domestically, new borrowing exceeded amortization by 3. 4 billion kronur. while this turnaround in the treasury ’ s finances is certainly to be welcomed, it is, nonetheless, a somewhat mixed blessing. it is a matter of concern that the budgeted improvement in the treasury ’ s finances in 1998 is less than warranted by the automatic stabilizers alone and that, all other things equal, the degree of fiscal restraint on domestic demand in 1998 will be less than last year. in preparations for the 1999 budget it is therefore of paramount importance, in light of economic conditions, to aim for a substantial treasury surplus. the same considerations, of course, apply to the implementation of the 1998 budget, and any excess revenue should be used to improve the financial balance rather then end up as extra spending. i say this because there are limits on what monetary policy can accomplish to restrain domestic demand in the current circumstances. local government finances deteriorated somewhat in 1997. the combined revenue deficit of the 14 largest municipalities was 2. 9 billion kronur. it is estimated that local government debt increased from 36 billion kronur to 42 billion kronur in 1997. general government debt in relation to gdp declined from 56 percent in 1996 to 52. 7 percent in 1997, which, in light of the maastricht limit on government debt of 60 percent of gdp, is a fairly good debt position. monetary developments the central bank ’ s principal target remains price stability. the bank ’ s monetary instruments primarily influence inflation in the long run, and it is generally accepted that price stability is an important precondition for economic growth and improved living standards. domestically there is a good consensus about this goal, as is the case in most countries where central banks pursue the same or a similar objective. in an open economy such as the icelandic one a stable exchange rate is necessary for favourable price developments. a stable exchange rate has, therefore, been an intermediate target for monetary policy. the central bank implements monetary policy mainly by setting its own interest rates and by intervening on the money market. in the short run the bank can also influence the exchange rate

the risk of erosion of asset quality. the report included a detailed analysis of the quality of the banks ’ loan portfolios. although the conclusion was that the banks were well prepared to face rising defaults and loan losses at that time, particular attention was drawn to the fact that the previous year had seen increases in the ratio of large exposures to capital and in the proportion of holding companies among borrowers. the report emphasised that there was good reason to scrutinise this development closely. the central bank had actually noted this in earlier publications as well. for the near term, the banks ’ most critical task was to guarantee access to foreign credit and reduce their borrowing requirement. furthermore, confidence among investors and depositors was of vital importance. it was deemed unlikely that conditions in the international markets would improve to any dramatic extent in the near future, and when they did, investors would undoubtedly demonstrate more caution and conservatism than they had previously. in addition to this, the report shed light on the banks ’ very large re - financing needs in the next few years : they would need to re - finance 35 billion euros in foreign bonds through 2012, including 17 billion in 2009 and 2010. some critics have maintained that, in the may 2008 issue of financial stability, the central bank contradicted its own knowledge of the state of the banks – or even that it did not know any better. this is untrue. the report examined in a transparent manner the financial system ’ s weaknesses, as well as its strengths. the developments in the global arena since the spring of 2008 rendered the risks mentioned in financial stability far more serious than was foreseen. in its monetary policy statement in july 2008, the board of governors said inter alia that “ iceland ’ s commercial banks play an important role in maintaining confidence in the financial system. under the current global financial market conditions, they must protect their liquidity and capital position, seek all possible ways to reduce their need for foreign credit, and adapt the scope of their operations to dramatically changed circumstances. ” throughout 2008, the central bank of iceland focused increasing attention on the developments and operational outlook at the nation ’ s financial institutions – particularly its large banks. among other things, it monitored their liquidity much more closely and frequently than is stipulated in the bank ’ s rules on liquidity requirements, and considerably more than had been customary. the central bank met with leaders from the large commercial banks and reviewed various aspects of their operations, requesting information