Address by Prime Minister Geir H. Haarde to the Annual Meeting of the Chamber of Commerce, March 13th 2008

Mr. Chairman, ladies and gentlemen.

In a small, open, globalised and rapidly growing economy such as ours, it is quite necessary that we conduct an open and resourceful debate on our economic situation in general and our exchange rate and currency arrangements in particular.

I therefore wish to thank the Chamber of Commerce for placing these issues on the agenda. It provides us with the opportunity for a review of issues, to listen to different opinions and look towards the future. The foreign speakers have come up with interesting vantage points, and the conclusions of the survey of the Chamber of Commerce on currency issues is certainly of interest. On the other hand, the recent discussion of the weak state of the króna reflects in my view the current conditions in financial markets and the international economy. For that reason allow me to reach a bit back into history and recall some facts.

In May 1997, the Althingi passed a resolution where the Government was to appoint a committee to assess the impact of the European Monetary Union (EMU) upon the Icelandic economy. The EMU was a preparatory stage in the process of adopting a common currency for those European Union member states that fulfilled certain specified economic conditions. The authorities entered into wide-ranging consultations with employers and labour unions and asked the major economic institutes in the country to assess specified aspects of the issue. The committee turned in its report in June 1998 where it was pointed out that the establishment of the EMU would in and of itself have various positive effects upon the Icelandic economy. It was not seen as desirable that Iceland would join the EMU and adopt the euro. The authorities should rather concentrate upon strengthening economic stability.

In the following years, the Icelandic economy went through substantial structural changes, as did the global economy in the wake of increasing liberalisation and the general tendency to do away with restrictions and impediments in world commerce, both in merchandise trade as well as in services and finance.

After careful consideration, the Icelandic Government decided in 2001 to abandon its policy of stabilising the exchange rate, a policy that had been pursued for a number of years, following many years of successive devaluations and concomitant economic instability. The Central Bank was made fully independent and entrusted with the task of containing inflation within defined limits that were agreed upon with the Prime Minister‘s Office.

The next several years were eventful for the economy. The decades of Government interference with the operations of the commercial banks ended with their privatisation in 2003. This turned out to be a fortunate move that not only led to their vigorous growth and entry into foreign markets but also helped in supporting growth in other sectors. These developments resulted in substantial increases in general living standards as well as in business earnings.

These rapid developments prompted a new review of exchange rate arrangements at the request of the Prime Minister that was entrusted to the Economic Institute of the University of Iceland. The Institute turned in its report in December 2005. In the report, two main conclusions were drawn: Either to maintain the current currency arrangement or to join the European Union and adopt the euro. In my view, this conclusion is still fully valid.

In my address to the annual meeting of the Central Bank nearly a year ago, I observed:

„The euro has been the subject of much discussion of late. There are those who have maintained that the adoption of the euro in place of the Icelandic króna would solve all problems of business, households and public entities. This view is illusory. First of all, it is completely unrealistic to contemplate the adoption of the euro without membership in the European Union. All experts agree on this and have pointed out that the unilateral adoption of a foreign currency in place of the domestic one lacks the necessary credibility for economic policy.

The question of formal adoption of the euro in place of the Icelandic króna is therefore a question of whether Iceland should become a member of the European Union. That should be an easy question to answer following the publication of the new report of the Europe

Commission.

Second, it is by no means assured that the adoption of the euro would solve any economic problems in Iceland. On the contrary, new problems would arise in place of old ones. As the Icelandic economy is small and open to outside fluctuations, we must always expect more instability than other nations. We will not solve this problem by replacing the króna with the euro and thereby abandon the possibility of conducting our own monetary policy. This would mean that instead of currency fluctuations we would have labour market instability where changing unemployment would be dominant. Would it be better to have increased unemployment instead of exchange rate fluctuations? This is a question that must be answered. My answer is no.

Third, the misunderstanding has arisen that if companies register their financial accounts in euros that it will signal the demise of the Icelandic króna. Nothing is further from the truth. As Finance Minister, I was responsible for the legislation in 2001 which allowed companies to draw up their annual accounts in currencies other than the króna, subject to certain conditions. This did not signal the end to the króna but was intended to meet the reasonable request of firms to adjust to changing circumstances associated with increased business abroad. Today, Icelandic companies can draw up their accounts in any currency they like, subject to certain conditions. Most companies that have done so have chosen the US dollar.

Let us not forget that a decision to change currencies or become a member of a larger currency area is a very dramatic step to take. Such decisions have been rejected in referendums both in Denmark and Sweden. The currencies of those two countries are a good deal closer to the euro than the Icelandic króna. This is not a question of romantic nationalism in favour of our currency which in any case does not have a long history in its current form. The issue here is to find the most favourable solution for our currency in the context of our small, open economy, at the same time safeguarding our economic independence and making it possible for us to deal with domestic business cycles that, to judge from experience, generally do not coincide with cycles in other larger economies. There is no better alternative today than to keep the Icelandic króna, whatever may turn out later. The Central Bank is entrusted with the task of pursuing its inflation target and safeguarding the value of the currency.

The euro will not perform any miracles for economic policy. The important thing is to conduct a rational and a responsible economic policy.”

Nearly a year has passed since these remarks were made. Since then, no fundamental changes have taken place that call for a change in this position. Still, it appears to me that it has become increasingly clear since then that most people have come to realise that there are only two choices available: To keep the króna or adopt the euro as well as join the European Union. The unilateral adoption of the euro is simply not an option. It would not be credible and would entail a great deal of inconvenience and extra cost. The address of the representative of the European Central Bank that we have heard today confirms this beyond doubt.

As has often been stated before, a membership in the European Union is not on the agenda of this Government nor is the adoption of the euro. We must concentrate on bringing greater stability to the economy after the expansion of recent years, bring down inflation and reduce the current account deficit. These are two, along with the continuing task of strengthening and diversifying the foundations of our economy, represent the major tasks ahead.

Ladies and gentlemen.

Shortly after the middle of last year, conditions in the international economy began to deteriorate. The access to financing became more difficult and stock prices declined. The Icelandic economy and the stock market were also touched by these developments. Stock prices have declined in this country as well as elsewhere. It has helped matters that Icelandic stocks had risen more than in many other markets, and seen over the past two years together, there are not many stock indexes that have declined as little as the Icelandic index. It is necessary to realise that these developments have precisely nothing to do with the state of the króna. There are other forces at work here.

Amongst individual company categories, financial firms have declined most of late. It is therefore not surprising that the Icelandic stock index has declined substantially since financial firms weigh heavily in the index, some 70-80 per cent. This share is considerably higher than in most other countries, a fact that must be borne in mind when the Icelandic index is compared with other indexes where the weight of financial firms is lower.

The CDS premium of Icelandic banks has also risen rapidly in recent weeks, probably in part because of a lack of information of international investors regarding the actual state of the banks. The analysts of the rating firm Credit Sights have for instance stated that the risk associated with the Icelandic banks has been overstated and that the CDS premium does not correctly reflect their actual state. Nevertheless, the premium is a serious matter that impedes normal financing in markets that are already restrained for lack of credit supply.

Moody’s, the credit rating agency, also confirmed this view in its recent review of the Treasury’s credit rating. Moody’s analysts concluded that the banks were sound and in possession of adequate liquidity. They also confirmed that Iceland enjoyed the highest credit rating, primarily due to the strong position of the Treasury, its low debt and the sizeable Treasury surplus. They also observe that the long-term outlook is very good due to the robust pension fund system in our country.

According to the recent assessment of the Financial Supervisory Authority, the Icelandic banks are sound when measured against foreign banks. The analysis points out the healthy profits of the banks in recent years as well as the fact that even if irregular income is subtracted and only the earnings from core activities are counted, the banks compare well with banks in the other Nordic countries. The capital ratios of the banks are strong, stronger in fact that in many foreign banks and the Icelandic banks are thus in a good position to withstand considerable setbacks. The banks have passed a stress test that simulates a large drop in stock prices, a weakening of the króna exchange rate and an increase in loan write-offs. In this connection, it is also being pointed out that the Icelandic banks have turned in profits, whereas many foreign banks, amongst them many of the most respected banks in the world, have suffered losses.

Last week, the Financial Supervisory Authority published its conclusions of its latest stress test conducted on the commercial banks. The test involved the simultaneous simulation of a drop in stock prices, marketable bonds, loans and foreclosure of assets along with the impact of a decline in the exchange rate. In short, all the banks passed this stress test without their capital ratios declining below the limit prescribed by law.

In spite of these favourable conclusions and reports of the Financial Supervisory Authority, Moody’s, Credit Sights and others, certain analysts and media are still voicing negative comments. These commentators have often gotten their facts wrong and their descriptions of the Icelandic

economy are quite overstated. It is a source of concern that these commentators do not take account of the quite detailed information that is available to all and reflects the robust state of the banks and the Treasury. Such commentary appears to be guided by motives other than that of seeking the truth.

In order to meet this, we must all unite and respond. The Government is prepared to work in cooperation with partners in the economy, whether under the auspices of the Chamber of Commerce, the Association of Financial Firms or other associations that supply information and analysis on the Icelandic economy to foreign analysts, investors and the media. I believe it is important to launch such an effort as soon as possible. Ministers will also continue to be prepared along with industry representatives to attend meetings abroad to explain Iceland’s economy and respond to the erroneous statements.

Ladies and gentlemen.

As I have already observed, the recent stress test of the Financial Supervisory Authority has clearly shown that the Icelandic banks are sound and should be able to withstand considerably deteriorating external conditions without reducing their capital ratios below acceptable levels of security. Nonetheless, the Government sees it as prudent to be able to respond quickly and prepare measures in order to mitigate the adverse effects of a possible financing crisis in international markets. Such measures must be prepared in cooperation with market participants. For this purpose, the Government is convening a meeting with financial market participants tomorrow in order to consult on such measures.

In 2006, after consultations between the Government and the Central Bank, it was decided to augment the foreign exchange reserves and the capital of the Central Bank through the issue of foreign debt by the Treasury, the proceeds of which were relent to the Bank. The Government is closely watching developments in the international financial market in order to follow up on this measure as circumstances warrant and market conditions allow.

The Government has emphasised the importance of keeping the headquarters of Icelandic firms in this country, even if they also do business in the international market. The aim of the Government is to create a favourable competitive business environment in Iceland, in part by permitting companies that so wish to keep their books and draw up their annual accounts in foreign currency, provided they fulfil certain legal requirements as I noted earlier. The misunderstanding seems to have arisen that financial firms are at a disadvantage in this respect compared to other businesses. This is not the case and I am taking the opportunity to mention this here.

There are a number of signs indicating that wage agreements in the general labour market are close to being concluded. I hope that their conclusion will have a positive impact on the Icelandic economy and contribute towards improved stability, lower inflation and a reduced current account deficit. The Government is prepared to facilitate wage agreements, and in this regard I specifically wish to refer to the Government’s Policy Statement regarding cuts in taxes on individuals and businesses.

Ladies and gentlemen.

The strong state of the Icelandic economy is beyond doubt. This is highlighted by the strength of Treasury finances, producing a surplus equivalent to 2.5 per cent of GDP and a net Treasury debt of about 5 per cent of GDP. This is almost unique in Europe and reflects a stable and tight fiscal policy. The capital ratios of the banks are also strong, and their strength is confirmed by the fact that they turned in large profits last year in spite of the adversity in financial markets since last autumn.

We Icelanders therefore have a good hand of cards. What is most important is that we play our hand wisely, both in the short and long run.

The spoken word applies.