The requirement is primarily prudential in nature. It was among other things aimed at reducing the reliance of domestic credit institutions on foreign short-term capital to finance their domestic lending activities which had risen sharply, but has subsequently diminished markedly. Low inflation and macro-economic stability was only achieved in the early part of this decade. Consequently, it is not at all surprising that we have to maintain interest rates that are significantly higher than among our main trading partners. The required difference is variable over time, depending among other things on the credibility of economic policy, relative cyclical positions and so on. The current differential is the widest since capital movements were liberalised and is of course explained to an important extent by the very different cyclical position of the Icelandic economy from that of most of our trading partners, not the least in Europe. It also entails the cost of maintaining an own currency, i.e. a premium for the availability of the exchange rate as an instrument. 1  BIS Review 117/1999  In this connection, I should also note that since the opening up of the capital account of the balance of payments, long-term interest rates, which used to be very high by any comparison, have been on a downward trend despite repeated increases in short term rates. This is not surprising and reflects a narrowing of long term interest rate differentials between Iceland and other countries towards a much lower level than prevailed before capital movements were liberalised.
Two years ago the fiscal budget turned into surplus. That surplus has risen and in the budget proposal for the year 2000, which was submitted to Parliament at the beginning of this month, the envisaged revenue surplus is equal to 2.2% of GDP. In the view of the Central Bank, it is essential that the targeted budget surplus be realised. It is important for the credibility of the overall policy of the government and because it will have dampening effects on domestic demand and thus reduce the current account deficit. The foundations of the Icelandic economy have strengthened in recent years through effective natural resource management and increased diversification, including the expansion of services exports. Iceland has made great strides in economic management as indicated by the stability and favourable economic developments that have characterised the economy for much of this decade. Instrumental in the changes that have taken place has been the liberalisation, and I might say marketisation, of the economy. In our present situation it is of paramount importance to safeguard the stability of the economy and quickly reduce inflation again. The Central Bank will continue to pursue a monetary policy geared to that end. Credit rating The success in economic management did not escape the attention of the rating agencies. The Republic of Iceland was first assigned a rating by Standard & Poor’s and Moody’s in the late 1980s. The initial long-term rating from both agencies was in the middle of the single A category.