Icelandic Economy: Is the ISK Overvalued?

According to Kaupthing Research's forecast, the current account deficit in Iceland will persist over the coming years due to the growing factor payment deficit. This imbalance is due first and foremost to the accumulated external debt of Icelandic companies expanding overseas.

(PRWEB) June 14, 2007 -- According to Kaupthing Research's forecast (http://www.kaupthing.com/lisalib/getfile.aspx?itemid=8498), the current account deficit in Iceland will persist over the coming years due to the growing factor payment deficit. This imbalance is due first and foremost to the accumulated external debt of Icelandic companies expanding overseas. It is worth considering whether such an imbalance is a cause for concern, particularly with respect to the ISK since these debts are in fact serviced outside Iceland. The current high real exchange rate of the ISK is primarily due to the overvaluation of the ISK against the dollar.

Prolonged current account deficit - a cause for concern?

The present current account deficit is far from being in line with the external balance of the economy. The part of the deficit that can be described as self-sufficient is the external balance of goods and services, which poses little concern. It seems clear, however, that the factor payment deficit will persist and one should therefore consider whether this is a cause for concern, particularly with respect to the ISK. A large proportion of foreign interest payments comes from Icelandic companies expanding abroad, most of which run their businesses overseas. This type of imbalance should not exert any pressure on the exchange rate of the ISK. Kaupthing Research expects that the current account deficit will persist over the coming years, due to the continued imbalances in factor payments.

Evaluation of the equilibrium real exchange rate:

It is difficult to pinpoint a specific equilibrium for currency markets in terms of the real exchange rates. Development of the main export and import prices of the respective countries would however be sure influencing factors. The determining factor in evaluating the equilibrium real exchange rate of the ISK seems to be the deterioration of the economy's foreign asset position. Kaupthing Research estimates that deterioration in the asset position of 1% of GDP would lead to a 0.2% depreciation of the equilibrium real exchange rate of the ISK. According to this model, the ISK is currently overvalued by about 14%, if the trade-weighted average exchange rate index is taken into account.

ISK overvalued against the dollar:

Looking at specific currencies, the ISK seems to be in good balance with the euro and the British pound at the moment. Therefore the overvaluation of the ISK seems to be first and foremost against the dollar, which weighs 23% in the trade-weighted average exchange rate index of the ISK.

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Manageable current account deficit: Is the ISK overvalued? (http://www.kaupthing.com/lisalib/getfile.aspx?itemid=8498)

About Kaupthing Bank:

Kaupthing (http://www.kaupthing.com) offers comprehensive commercial and investment banking services to individuals, companies and institutional investors. The Bank is a leading player in all the main areas of the Icelandic financial market, and in addition to Iceland, the Bank's key markets are Denmark and the United Kingdom. The Bank focuses on the growth and development of its international activities and aims to be one of the leading investment banks in northern Europe.

Kaupthing Bank operates in ten countries with its headquarters located in Reykjavík. As of 31 December 2006 the number of full-time equivalent positions was 2,719 at Kaupthing Bank and its subsidiaries.

For further information on Kaupthing visit the bank's website, www.kaupthing.com.

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