Although traditionally better known for its hot springs, fishing and whaling industries, Iceland has steadily transformed itself into a financial powerhouse in the last 20 years. Icelandic investment firms have continued to buy up, for example, significant tranches of the UK retail High Street. Icelandic investment firm Baugur and FL Group now own House of Fraser and MK One, for example and is now tipped to buy Debenhams.
Iceland’s business turn-around is reflected in the former state-run banks which have all been privatised. Prosperous, well-run Icelandic businesses have increasingly been forced to look overseas for M&A targets, given the lack of appropriate targets at home. Hence the slew of Icelandic companies and investment houses chasing cross-border deals.
The UK, unsurprisingly, has been a target for much of the cross-border interest: many Icelanders speak English and the UK economy is one of the most open and dynamic in the world. So Icelandic-Brit deals look unlikely to abate, especially if UK interest rates continue to slip, as looks likely. According to a recent survey by M&A intelligence and research service Mergermarket, more than half of senior Icelandic managers are considering a deal in the next 12 months.
Iceland’s economy though is one that’s increasingly highly leveraged with significant levels of external debt thanks to the large amounts of M&A and private equity activity. Which means the economy has, to say the least, sizeable imbalances and therefore remains vulnerable to economic crisis. The diminutive population means that the financial players generally are likely to know each other and there’s an abundance of cross-company ownership.
Iceland’s racy makeover
So, what is behind Iceland’s makeover from grey, dull fish exporter to hot tourist spot and international financial mover and shaker? At first glance, Iceland remains a country riddled with contradictions. It is not a low tax economy. Its aggregate tax burden is roughly 40 percent of GDP, significantly higher than the UK and the US, though lower than many other European countries. More revealingly however is Iceland’s corporate tax rates are low at 18 percent. Although this is not quite Ireland or Hungary territory (12.5 and 16 percent respectively), it’s still impressive.
Former Icelandic prime minister David Oddsson, who oversaw much of Icelandic’s key economic reforms in the 1990’s, has to take much of the credit for Iceland’s economic rejuvenation. Corporate rate reductions were slashed in order to promote a pro-growth economy; wealth taxes were abolished and a flat tax rate was also forced through. Widespread financial de-regulation followed.
Domestic investment firms have been astute in making the most of Iceland’s economic comeback, embracing cross-border opportunities. Despite high interest rates, many Icelandic investment companies in the 1990’s were able to borrow money from countries with lower interest rates before depositing this cash on home ground, allowing them to quickly build up reserves. Meanwhile, old state-run industries were also being privatised, with new property rights created.
Iceland’s re-vamp has also been helped by environmental issues and concerns. Blessed with a super-abundance of hydroelectricity and geothermal power sources, Iceland is now actively looking at ways it can export hydroelectric energy to mainland Europe. Icelanders themselves are early adopters of mobile technology and broadband penetration is amongst the highest within the OECD.
Still fiercely independent
Today, Iceland’s economy looks generally highly robust: unemployment rates are one of the lowest in the world. Oddities remain though: Iceland is not a member of the European Union, nor does it seem much interested in joining. This is premised on the concern that Iceland would have to give up control over much of its natural resources, including fishing grounds, were it to join. Given Iceland’s booming economy and high growth curve, there seems no pressing urgency – at least for the moment – for it to join, so say Iceland’s powerful anti-EU lobby.
On the other hand, pro-EU Icelanders point to Iceland’s formidably high cost of living, even by central London or Scandinavian standards. Rising Icelandic inflation continues to make imports expensive. However, Iceland is a member of the European Free Trade Association and in 1992 Iceland became a member of the European Economic Area, allowing Iceland – and other countries including Norway – to join in the EU single market without formally having to join the EU.
Another hot issue is the unwillingness by Icelanders to give up sovereignty to Brussels. It remains a fiercely independent nation as well as an increasingly wealthy one: according to the Organisation for Economic Cooperation and Development (OECD) and the International Monetary Fund, Iceland now ranks as the world’s fifth-richest nation.
FDI remains patchy
Iceland’s own internal FDI – most of it from Europe and the US – is rather muted in comparison with its strenuous investment efforts overseas. However, plenty of FDI has been channelled towards Iceland’s own IT and software industry. It’s estimated since 2003 around $800 million has been invested. Some significant FDI investment in Iceland’s aluminium industry has also taken place.
Supporters of Icelandic FDI point to its strong levels of efficiency and productivity (amongst the highest in the world) and one of the lowest corporate tax rates in the world (18 percent), as well as its strategic location as a bridge between the US and Europe. Tax benefits to overseas investors includes no net wealth tax, no legislation on thin capitalisation; there’s also no branch profits taxes on repatriated profits.
Iceland’s legal market remains small. There are no large international legal players based in the capital Reykjavik and most domestic law firms focus on dispute resolution and family law. However, specialty legal work is booming, helped by the buoyant corporate M&A market.
Tourism ramping up
Away from the business news headlines however, Iceland’s economy – an odd mixture of capitalistic market economy supporting an extensive welfare state – is still strongly dependent on the fishing industry. In recent years, Iceland though has cottoned on increasingly as a tourist destination, particularly with eco-tourists and whale-watching.
In 2006, Euromonitor estimated tourism accounted for more than six per cent of Iceland’s gross domestic product. The main attraction for tourists is the unspoilt nature of much of its glaciers, lakes and lava field.
Although whale watching has also proved popular, Iceland is increasingly popular with adventure tourist and farm holidays. However, extreme seasonality means the tourist industry has to be flexible and focused. There also remains concern about the possible resumption of commercial whaling – and the impact this could have on Iceland as a green or nature lovers holiday destination. There is also a question mark about just how successful Icelandair is likely to be in developing its network and also being able to maintain growth.
Real estate prospects remain positive
Icelandic real estate roughly doubled between 2001 and 2007. The average price of an apartment ballooned from almost ISK 15 million in 2001 to beyond ISK 30 million by the end of 2007. Recently, as in the US and in some parts of Europe, there has been concern about falling price inflation, however the Icelandic market appears, so far, robust.
House prices are forecast to stay more or less at a standstill in 2008, due to tighter access to loans and a cooling labour market, followed by an uplift in 2009 when interest rates are anticipated to fall again.
Iceland’s mortgage market, like its banking market, has become more liberalised over the years, resulting in wider access to credit and borrowing, stoking demand and prices.
Summing up
Perched at the top of the Atlantic, Iceland is a tricky country to summarise. There are some glaring contradictions: despite relatively high rates of personal taxation, corporate taxation is amongst the lowest anywhere. Despite close ties to Europe and Scandinavia, it is stubbornly independent of Brussels. Although Iceland has an abundance of cheap, green energy, it has few natural resources. And though Iceland can claim a high degree of IT and technological prowess, from biotechnology to financial services, it still relies heavily on its ages-old fishing industry to provide 40 percent of its total exports. It also belongs to NATO, but has no armed forces (it declared itself a nuclear-free zone in 1985).
Meanwhile Iceland’s centre-right government, led by Geir Haarde, head of the Conservative Independence Party, continues to steer a delicate path of avoiding overheating the economy while promoting a high standard of living. Per capita GDP is estimated at more than €25,000 and Iceland’s pension system is well capitalised.
Iceland fact-box
Population: 312,000 people
GDP total: $18.4bn
GDP growth (2007): 2.6 percent
Inflation rate (2007): 4 percent
Budget (2007) $6bn
Unemployment: two percent
Net public debt: 17 percent of GDP
