Surplus largely due to contraction in imports
Last year's record trade surplus is due in large part to an abrupt contraction in imports. In volume terms, imports contracted by over 27% from 2008, while exports were up by half a percentage point. The downturn in imports was especially pronounced in investment goods (47%), private motor vehicles (74%), and consumer durables (49%). The small change in export volumes despite an extremely low real exchange rate reflects the constraints placed Iceland's major goods export sectors - fisheries and energy-intensive industry - with regard to expanding output. The fisheries sector is entirely dependent on official decisions concerning allowable catches, irrespective of its competitive position, and the energy-intensive sector can only increase production with a long lag and is dependent on the political will to step up energy utilisation.

The bulk of the contraction in imports stems from the shock sustained by domestic households and businesses in the wake of the banking collapse in 2008. In an international context, substitutability between domestic and imported products is relatively little in Iceland, as there is no manufacturing at all in many product categories that are prominent in private consumption and investment. Domestic manufacturers thus have limited scope to increase their market share at the expense of imported goods, even though their competitive position has improved since the króna collapsed.

Similar trends in crisis-struck fixed exchange rate economies
It is interesting to compare developments in the goods trade balance in Iceland and in countries that have a fixed exchange rate vis-à-vis the majority of trading partners but have suffered as a result of the recent recession. Ireland and Latvia are two telling examples. Like Iceland, both of these countries have seen a significant improvement in their trade balance in the recent term, and as is true of Iceland, that improvement is driven largely by a contraction in imports. For example, imports shrank year-on-year by 23% in Ireland, and 31% in Latvia, in the first 11 months of 2009. On the other hand, the weak króna has had an undeniably positive effect on Iceland's services trade balance in the recent past, unlike countries with a pegged exchange rate.

Outlook for substantial surplus in 2010
Based on the above trade balance figures, we estimate the combined surplus on the merchandise and services accounts at about ISK 120-130 bn for 2009. This is roughly equal to 8-9% of GDP for that year, while the newly published forecast from the Central Bank estimates it at 6.7% for the year. The outlook is for a considerable surplus this year as well. Terms of trade have improved markedly since the first half of 2009 due to strong price rises in aluminium and modest rises in marine products prices. The services sector will presumably continue to reap the benefits of the low real exchange rate. Imports will be at a minimum for the bulk of the year due to a continuing contraction in private consumption and investment, at least in comparison with 2009. Viewed in this light, it would appear that the Central Bank's forecast of a trade surplus amounting to 9.6% of GDP in 2010 is quite likely to materialise.

Contraction deepens in Iceland while growth gains pace abroad

The IMF forecast puts global output growth at 0.8% higher than in the Fund's last forecast, which appeared in October. The IMF now projects 3.9% GDP growth worldwide in 2010, which is quite acceptable. The Fund expects the major industrial economies to grow by some 2.1% this year, also 0.8 percentage points higher than in its October forecast. The increase is due in large part to rising optimism about GDP growth in the US and Germany, both of which are recovering after a difficult contractionary period last year.

The Central Bank of Iceland macroeconomic forecast assumes a deeper contraction in Iceland than in the bank's last forecast, published in November 2009. The CBI now projects the contraction at 3.4%, a full percentage point more than in the previous forecast. The ongoing Icesave dispute about compensation to depositors of Landsbanki's foreign branches has delayed reconstruction and has put a dent in prospects for output growth.

If these forecasts materialise, the gap between 2010 GDP growth in Iceland, on the one hand, and in leading industrial nations, on the other, will be wider than in 2009. IMF estimates put the 2009 contraction at 0.9% worldwide, and 3.2% in industrial economies. The Central Bank estimates a 7.7% contraction in Iceland in 2009. The difference for 2009 is thus 4.5 percentage points vis-à-vis industrial economies, but according to the above-cited forecasts, it will be 5.5 percentage points this year. In other words, the gap in GDP growth domestically and abroad is growing, to Iceland's disadvantage. The financial crisis in Iceland is deeper, more protracted, and more difficult to handle than in most other economies.

2009: a difficult year in building and construction
As has been the case for the past several months, firms in building and construction were most prominent in December bankruptcies, accounting for one-third of the month's total. In 2009, a total of 256 building and construction firms declared bankruptcy, one-fourth of the year's total bankruptcies. In 2008, bankrupt firms in the sector numbered 150, a year-on-year increase of 71%. This should come as no surprise, as external economic conditions have been extremely difficult for the construction sector since the banks collapsed. Roughly 42% of all mass lay-offs in 2009 were in the construction sector, and each month an average of 2,800 unemployed individuals, or one-fifth of those without work, had been employed in that field.

Second in line was the wholesale and retail trade sector, which saw 167 firms declare bankruptcy in 2009, about the same as in 2008. A total of 71 real estate companies were declared bankrupt in 2009, a 27% increase year-on-year. It is likely, however, that bankruptcy figures underestimate the problems faced by firms in the past year. It can be assumed that many of the companies that have been hard hit by the economic crisis in the past several months have been held afloat by the banks, and that the rise in business failures reflects a time lag in the emergence of the after-effects of the crisis. A large number of companies are in serious financial distress, as is revealed by Central Bank figures from end-June, which indicated that about one-fourth of firms were in default on their loans.