Fitch Affirms Iceland at 'BBB'; Outlook Stable


LONDON/HONG KONG, October 11 (Fitch) Fitch Ratings has affirmedIceland's Long-term foreign and local currency Issuer Default Ratings(IDR) at 'BBB' and at 'BBB+' respectively. The agency has also affirmed theShort-term foreign currency IDR at 'F3' and the Country Ceiling at 'BBB'. TheOutlooks on the Long-term IDRs are Stable. KEY RATING DRIVERS Iceland's ratings are underpinned by high income per capitalevels and by measures of governance, human development, and ease of doingbusiness which are more akin to 'AAA'-rated countries. Furthermore, Iceland'srelative standing according to these indicators has not been affected by theglobal financial crisis. Economic growth has remained steady in the first half of theyear amid a process of debt restructuring in both the household and corporatesectors. Real GDP growth prospects for this year are markedly more positive incomparison with rated peers such as Ireland and Spain. Fitch expects GDP growthto be 1.9% this year before accelerating to an average 2.5% over the next twoyears. A new government took office in May following parliamentaryelections. The new government has signalled its intention to introduce furtherhousehold debt relief measures. At the same time, the new government hassignalled a continuation in the commitment to public debt consolidation. Public finances remain a credit weakness. There has been fiscalslippage in 2013. The general government deficit reached 1.3% of GDP in Q2.Fitch estimates that the deficit for the full year will be 3% of GDP. Grossgovernment debt was 99.5% of GDP in 2012, against a 'BBB' median of 39.3%. At thesame time, due to large government deposits of liquid assets, net public debt ismuch lower than gross debt, at around 70% of GDP.However, the new government has taken steps to address thisslippage through a package of spending and revenue measures worth around ISK30bn(around 1.5% of GDP) for 2014. This reinforces Fitch's view that a strongcross-party consensus exists in Iceland on the need for fiscal consolidation, a factorreflected in the agency's projections. Fitch projects on the basis of therecent budget proposal that the deficit will narrow substantially in 2014, to0.4% of GDP. The agency expects a surplus of 1.3% in 2015. Iceland had alreadyachieved a primary balance in 2012, and large primary surpluses are expected in2014 and 2015. These surpluses would drive the government debt to GDP ratiobelow 90% of GDP by 2015. The country's external finances are a credit weakness. Thelegacy of the financial crisis in 2008/2009 and the winding up proceedings ofthe old banks weigh on the country's external position and the balance ofpayments in the near future. In 2012, the country's net external debt (including theestates of the old banks) was more than five times the size of the economy -peer comparison countries such as Ireland and Spain are both below 100% of GDP.At the same time, the public sector's scheduled foreign loan repayments aresmall against the stock of foreign exchange reserves. The current account isexpected to strengthen over the forecast horizon, but a deficit of around 2%of GDP is still expected in 2015. The presence of capital controls implies that a substantialamount of non-residents claims - estimated to be around ISK341bn (EUR2bn,around 20% of GDP) - are currently 'locked in' krona assets.The Icelandic authorities are not committed to a precise datefor the removal of capital controls, and appear committed to avoid a disorderlyunwinding. Overall, Fitch expects this factor will continue to weigh on Iceland'sfundamental economic and financial stability at least out to 2015, as wellas on the credit profile. RATING SENSITIVITIES The Outlook is Stable. Consequently, Fitch's sensitivityanalysis does not currently anticipate developments with a high likelihood ofleading to a rating change. However, future developments that could, individually orcollectively, result in a downgrade of the ratings include:-A weakening commitment to fiscal consolidation - for example,if election promises on the implementation of further household debt reliefaffect the sovereign balance sheet - resulting in a slower pace ofreduction in the government debt to GDP ratio relative to Fitch's currentprojections-A substantially weaker-than-expected economic performance,resulting in trend growth over the projection horizon falling significantly belowFitch's assumptions, which would in turn weaken public debt dynamics -A crystallisation of contingent liabilities from the bankingsector, and especially the Housing Finance Fund (HFF), over and above theamounts already assumed in Fitch's debt sensitivity analysisThe main factors that could, individually or collectively, leadto a positive rating action are:-Continued reductions in external and public debt ratios-Enduring monetary and exchange rate stability in the context ofcontinued steady economic growth-Evidence of continued and successful debt restructuring in theprivate sector-Greater clarity about the evolution of the process for liftingcapital controls.KEY ASSUMPTIONS The rating and Outlooks are sensitive to a number ofassumptions:Fitch assumes that capital controls will ultimately be unwoundin an orderly manner, beyond the end of the forecast horizon in 2015.Country CeilingsAdditional Disclosure Solicitation StatusALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS ANDDISCLAIMERS. 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