Transcript Iceland’s Financial Markets and Pension System

Iceland’s Economy, Financial
Markets and Pension System
Már Gudmundsson
Chief Economist, Central Bank of Iceland*
North European Pensions & Investing Summit
Stockholm, May 30-31, 2002
* Views expressed are mine and do not necessarily reflect the views of the CBI
Plan of the presentation
 The
economy and financial markets: A
summary
 The pension system
 Pension fund assets: Developments,
composition and foreign investment
 Current developments
Iceland is small but rich

Iceland has a population under 300 thousand, a
GDP amounting to 8½ b. USD, a foreign
exchange market with a daily turnover of only
50 million USD and a stock market
capitalisation around 1/10 of a moderate size
US company
 GDP per capita (PPP) 2000: around US$ 28
thousand, or eighth among OECD-countries.
Economic structure




Diversified economic structure and foreign trade
Fishing sector: No. 6 in the world in terms of net
exports. 10% of GDP and around half of foreign
exchange earnings
Extensive hydro and geothermal energy
resources
High labour participation rates (77% on average)
and a flexible labour market
Fig u re 4 .2
Break d o w n o f G D P b y i n d u s t ry i n 2 0 0 0
Go v ern men t
serv ices
14
4,3
.3%
%
1
Fin an ce, in su ran ce,
real estate etc.
1
14
4.9
,9%
%
Oth er
,1
%
99
.1
%
Fish in g an d
fish1p
0ro
,1c.
%
1 0 .1 %
Tran sp o rt an d
co mmu n ic.
8 ,9
%%
8 .9
C o mmerce
1 41
,24%
.2 %
Ag ricu
re
1 ltu
,8 %
1 .8 %
C o n stru ctio n
1 2 ,9u%
Man
fact.
8 ,9 %
4 ,9 %
8 .9 %
an d
in d u stries Electricity
water su p p ly
1 2 .9 %
4 .9 %
S o u rce:Natio n al Eco n o mic In stitu te.
A typical industrialised service economy apart from the size
of the fishing sector
Financial markets

Internal capital market liberalisation around
the middle of the 1980s and capital
movements free in the middle of the 1990s
 Traditional markets exist but are small
 Forex: Daily turnover of 50 m. USD (2001)
 Money: Daily turnover of 20 m. USD (2001)
 Bond: 6.2 billion USD (end 2001)
 Equity: 4.1 billion USD (end 2001)
The bond market

Major issues (>5 yrs) are linked to CPI

Majority government guaranteed

Most liquid issues are housing bonds (state guaranteed)

10 liquid bonds - state funded market making agreements
in place to provide liquidity and transparency

Duration between 2 to 13 years – most liquid issues 8 and
13 years dur.
Real yields between 5 and 6%.

The Icelandic bond market at end
of 2001 in millions of USD
Total size: 6.2 b.USD. Thereof government guaranteed 3.7
b.USD
The equity market

Fast growing during the 1990s

Leading index: ICEX 15

5-10 liquid companies

Greatest market value is in financial
institutions
Equity listed on the Iceland Stock Exchange
1991-2001
60
% of GDP
Number of companies
80
Market capitalization % of GDP
Number of companies
45
60
30
40
15
20
0
0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
An organised equity market was born in the 1990s with market
capitalisation going from almost zero to over 50% of GDP (from 2
to 72 companies)
The problem of ageing

Smaller than among most developed
European countries:
 Younger nation
 High labour participation rates of the
elderly
 Mandatory membership of fully funded
pension funds (at least 10% of wages)
The pension system

The Icelandic pension system is developing
according to the three pillar principle:
– A tax financed and means tested public pension,
– A mandatory membership in occupational pension
funds
– A free individual pension saving with tax incentives

43 fully operational pension funds: Thereof 13 with
employer’s guarantee and 30 without, but with a high
degree of risk sharing between members
Net assets of pension funds
100
80
%
Percentage of GDP
Percentage of total assets of the credit system
60
40
20
0
1965
1970
1975
1980
1985
1990
1995
2000
Pension fund assets are predicted to be at least 1½
times GDP in the middle of this century
Pension fund assets ( 2nd pillar) as a percentage of
GDP in EU and EFTA-countries 1998
140
%
120
100
80
60
40
20
0
rg taly ain ay ece ium nce and gal tria any ark and den and UK and nds
u
b I Sp orw re lg ra inl rtu us rm nm rel e el
rl rla
e
c
w
m
F
F Po A Ge De I S I
e
tz the
N G Be
i
x
Lu
Sw Ne
Source: EFRP.
Iceland is fourth among EU and EFTA-countries
Legislation and investments




Total foreign exchange risk: 50% of assets
Ceiling for equity, municipality bonds, bank
bonds and other bonds is 50% for each class of
assets
10% ceiling for unlisted securities (with
conditions)
Individual credit risk: 10% of assets, 15% of
the stock of a single company and 25% of
shares in mutual or equity funds
Composition of pension fund assets 1990 and 2001
1990
Hous ing
(33.9%)
Financial
ins titutions and
mutual funds
(21.2%)
2001
Financial ins titutions
Fund members and mutual funds
(23.6%)
(21.8%)
Hous ing
(22.6%)
Fund members
(11.4%)
Other
(15.1%)
Other
(21.9%)
Equity and equity funds
(1.2%)
Equity and equity funds
(27.3%)
The shares of lending for housing finance and direct lending to
pension fund members have fallen but the share of investment in
equity has increased very significantly ….
Sh are o f fo reig n assets in
p en sio n fu n d p o stfo lio s
25
%
2 1 .2 %
20
15
10
5
1 .9 %
0
1995
2001
… and the share of foreign assets has taken a jump
Net real rate of return on pension assets fund 1991-2001
14
%
12.0
12
12
10
8
6.1
6,1
6
7.0
7
6.7
6,7
6.8
6,8
6.6
6,6
7.9
7,9
7.6
7,6
7.4
7,4
7,6
7
7,4
4
2
0
-0,7
-0.7
-2
-4
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Returns have become more volatile with a bigger share of
equity and foreign assets
?
2001
The pension funds are big players in
domestic financial markets (2001)

P.f. assets equivalent to 34% of the zise of
the credit system (13% in 1980)
 44% of the stock of marketable bonds
 Hold around half the stock of housing bonds
 P.fs. owned domestic equity and shares in
equity funds amounting to 11% of the size
of the organised equity market
Outlook for the pension funds

Reforms in the late 1990s:
– Comprehensive legislation on pension funds
– Reorganisation of public sector pension funds
– Tax incentives for private pension saving

Not major changes ahead:
– The challenge of earning satisfactory return for rapidly
growing funds in a less favourable environment
– Mergers and bigger funds
The economic boom is over and the big current account deficit
is shrinking rapidly
Output gap and inflation 1991-2002
4
3
2
1
0
-1
-2
-3
-4
-5
% of GDP
%
Output gap (left-hand axis)
Inflation (righ-hand axis)
9
8
7
6
5
4
3
2
1
0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
The overheating is turning into a slack, leading to a reduction in
inflationary pressures
General government financial balance
5
% of GDP
4
3
2
Structural
1
0
-1
-2
Actual
-3
-4
-5
-6
1994
1996
1998
2000
2002
2001: Estim ate. 2002: Proj ection.Sources: National Econom ic Institute, Central Bank of Iceland
Government finances were consolidated during the upswing but
a small structural deficit is currently emerging
Monetary policy

Interest rates were increased during the
upswing and the exchange rate appreciated
 The current account deficit, inflationary
pressures and worse growth prospects
created significant pressures on the
exchange rate from the spring of 2000
 Iceland adopted inflation targeting and
floating exchange rate on March 27th 2001
Inflation targeting
 2½%
long run target (2003)
 ±1½% tolerance limits
 Higher tolerance ceilings 2001 and
2002: 6% and 4½%
Th e n o min al effectiv e ex ch an g e rate o f k ró n a
Jan u ary 1 9 9 8 - May 2 0 0 2 (en d o f mo 1n th )
Dec. 3 1 1 9 9 1 = 1 0 0
100
105
110
115
120
125
130
135
140
145
150
In flatio n targ et
F lu ctu atio n limits
(ab o lish ed in M arch 2 0 0 1 )
Ex h an g e rate
J MM J S N J MM J S N J MM J S N J MM J S N J MM J S N
1998
1999
2000
2001
2002
1. Lat est val ue i s May 16 2002.Source: Cent ral Bank of Icel and.
Iceland abandoned exchange rate targeting at the eleventh
hour and went on an inflation target under very difficult
conditions on March 27th 2001
Exchange rate volatility
0,8
%
12-month moving average
%
4
0,7
0,6
3
Daily volatility (left-hand axis)
0,5
0,4
2
0,3
0,2
0,1
1
Monthly volatility
(right-hand axis)
0,0
0
J MM J S N J MM J S N J MM J S N J MM J S N J M
1998
1999
2000
2001
2002
Exchange rate volatility increased considerably
Cen tral Ban k in f latio n fo r ecast
Verðbólguspá Seðlabankans
%
1 010
101 0
5 0 % co n fid en ce in terv al
7 5 % co n fid en ce in terv al
9 0 % co n fid en ce in terv al
88
66
44
Up p er
to leran ce limit
88
66
CP I
44
In flatio n
targ et
22
22
00
00
Lo wer to leran ce limit
-2-2
1998
1998
-2-2
1999
1999
2000
2000
20012 0 0 1 20022 0 0 2 2003 2 0 0 3 2004
2004
Source: Cent ral Bank of Icel and.
But the imbalances were finally contained and inflation is
currently falling rapidly
Cen tral Ban k Rep o - rates
January 5, 1999 - May 22, 2002
12
%
11
10
9
8
7
6
5
4
1999
|
2000
|
2001
|
2002
The CB has therefore started the process of interest rate cuts
Lo n g -term n o min al treasu ry b o n d y ield s
12.0
11.5
11.0
10.5
10.0
9.5
9.0
8.5
8.0
7.5
Daily data
%
Latest: M ay 2 4
1½ yrs. to maturity
5 yrs. to maturity
11 yrs.
11 to
yrs.maturity
to maturity
J
F M A M
J
J
2001
Á
S
O
N D J
F M A M
2002
Nominal bond yields have also fallen along with lower inflationary
expectations and lower CB rates. The slope of the nominal yield curve
reflects confidence in lower inflation.
Yield s o n in d ex ed lo n g -term b o n d s
6.5
%
End of month
Latest: M ay 2 4
6.0
5.5
5.0
4.5
4.0
15 year treas ury bonds
Hous ing bonds
3.5
J M M J S N J M M J S N J M M J S N J M M
1999
2000
2001
2002
But real interest rates have remained high
Th e eq u ity mark et
3 1 /1 2 ’9 7
M onthly
= 1 ,0 0 0
turnover and daily equity prices on ICEX B.kr.
1,900
1,800
1,700
1,600
1,500
1,400
1,300
1,200
1,100
1,000
900
40
ICEX-1 5
35
ICEX-MAIN
30
To tal sh ares
tu rn o v er
25
20
15
10
5
0
2000
|
2001
|
2002
The equity market has recovered. ICEX-15 has inreased by
30% from its low in late summer 2001 and by 11% in 2002.
Some useful websides

The economy:
– Central Bank of Iceland: www.sedlabanki.is
– National Economic Institute: www.ths.is
– Statistics Iceland: www.statice.is

Financial markets:
– For foreign investor: www.bond.is
– Iceland Stock Exchange: www.vi.is
– Financial Supervisory Authority: www.fme.is

Pension funds:
– National Association of Pension Funds: www.ll.is