Given the fact that Iceland is not a member of the European Union, membership in EMU is out of the question. Nevertheless, the establishment of EMU will affect Iceland, particularly in the longer term. A few facts may be mentioned: first, the European Union is an important trading partner, but the absence of Denmark, Sweden and the UK from the EMU means that only about a third of our external trade is with EMU countries at present. Once the three countries join EMU, which we expect them to do, the share of EMU countries in our external trade will rise to above 60%. Second, we expect that our economic performance will be measured by the markets against the criteria developed for the EMU countries. Third, we expect that a successful EMU will bring beneficial effects to Iceland in the form of increased demand for our exports and reduced transaction cost in external trade. Fourth, it might become a greater challenge to operate our own currency. One could, for example, envisage that a currency like ours would be increasingly subjected to pressures from international investors seeking to diversify portfolios, adding currencies on the edge of the euro area and closely linked to it. This could conceivably lead to increased volatility and consequent potential instability down the road. The immediate effects on Iceland of the establishment of the EMU have not been significant. However, the entry of Denmark, the United Kingdom and Sweden into the EMU will markedly change our situation.
In 1996, both agencies raised Iceland’s rating by one notch and in 1997 Moody’s raised Iceland’s rating again and that time into the double A category, to Aa3. The short-term rating is A-1+ and P-1. Both agencies have assigned ratings to the long-term obligations of the Republic of Iceland in domestic currency, Aaa and AA+. The improved rating demonstrated a welcomed recognition of the progress made in Icelandic economic management in recent years. In our own view, the rating improvements were overdue, first because our economic performance was in quantitative terms fully compatible with that of countries with a higher rating than Iceland, and, secondly, because it seemed obvious that the reception of Icelandic borrowing operations in the markets indicated that financial institutions have consistently assessed Icelandic risk differently from, or one might say more favourably than, the rating agencies. Structural changes Other speakers at this conference will touch on structural changes in the economy, particularly in the financial sector. I only wish to emphasise that it is not an overstatement to say that the Icelandic financial system has undergone radical changes since the middle of the 1980s. The market was deregulated, a stock exchange was established, and new institutions and financial services flourished. Last but not least, all restrictions on the movement of portfolio capital between Iceland and other countries were removed as alluded to earlier. The market is now similar to that in other developed countries, except for volume of course, while the role of the government through ownership of financial institutions stands out.