Status of the Faroese Economy, Mid-2009

Niels Bartholdy, Economics

SUMMARY

In the wake of the global financial crisis, the economic slowdown that started in 2008 and was initially limited to the fisheries sector has de veloped into a recession in the Faroese economy overall. This is reflected in falling employment in all sectors except the public sector. Unemploy ment is therefore rising rapidly.

Fisheries and the fish-processing industry have been severely affected by lower catches and prices. On the other hand, volumes of farmed sal mon and trout are increasing, and combined with a favourable develop ment in salmon prices this is buoying up export revenue. A drop in im ports means that the trade deficit is likely to be more or less eliminated in 2009.

After having posted large profits in 2007, the Faroese banks taken as one made a loss in 2008, but the impact of the financial crisis on the sec tor has varied considerably.

The economic downturn has led to increasing deficits, and the govern ment has begun to acquire debt.

ECONOMIC ACTIVITY¹

Even before the international financial crisis escalated in the autumn of 2008 and seriously affected economic growth worldwide, the Faroese economy was slowing down after some boom years. Since mid-2008, as the global recession has developed, the slowdown has evolved into a decline in economic activity, as reflected in both employment and total payroll expenditures, cf. Chart 1.

Overall payroll expenditures grew by 1 per cent in 2008. Since in flation, measured by the increase in the consumer price index, was 6.3 per cent in 2008, activity at constant prices dropped considerably. In the first seven months of 2009, payroll expenditures were 5 per cent lower than in the corresponding period of 2008. Employment has reacted with a lag to the economic downturn, and growth was zero in 2008. In the first five months of 2009, total employment was 3 per cent lower than in the corresponding period of 2008.

Employment in both fisheries and the fish-processing industry has fallen substantially in 2009 so far, continuing the strong declining trend seen in 2008, cf. Chart 2. This development reflects the ongoing issue of low stocks of cod and haddock, as well as a clear downward trend in fish prices. Although lower oil prices since the summer of 2008 have reduced costs, profitability has been undermined by the fall in catch prices. The latter is primarily attributable to a general decline in global demand.

Payroll expenditures in the fisheries sector fell by 24 per cent in 2008 and were a full 27 per lower in the first seven months of 2009 than in the corresponding period of 2008. For the fish-processing industry, pay roll expenditures were 10 per cent lower in 2008 than in 2007 and 5 per cent lower in the first seven months of 2009 than in the corresponding period of 2008.

While employment in fisheries still seems to be going down, the last six months or so have seen some degree of stabilisation in the fish-processing industry. From 2005 to 2008, employment in these two sec tors declined from 19 to 14 per cent of total employment in the Faroe Islands.

On the other hand, fish farming has gained considerable ground over the last few years. In 2008, employment in this sector accounted for just over 2 per cent of total employment, having more than doubled since 2005.

All over the world, the building and construction sector has been par ticularly severely hit by the financial crisis. This is also the case in the Faroe Islands. Employment in the building and construction sector has been declining since the 3rd quarter of 2008. In the first five months of 2009, it was almost 13 per cent lower than in the corresponding period of 2008, although it remained somewhat higher than in early 2006 when the boom started in the Faroe Islands and housing prices soared. New public-sector building projects have to some extent made up for the slowdown in private housing construction in the wake of the financial crisis from the autumn of 2008.

Housing prices have been falling since mid-2007, and turnover in the housing market has been very low in 2009 to date. Nevertheless, prices in the Tórshavn area rose slightly in the 2nd quarter of 2009, cf. Chart 3. For the Faroe Islands overall, housing prices are back at the level from the 1st half of 2006, i.e. just after the introduction of new loan types with longer maturities and deferred amortisation had led to a pro nounced upward adjustment of prices.

Following a couple of years with strong expansion, the growth rates of the Faroese banks have slowed since 2008, and both employment and payroll expenditures in this sector have declined recently. The dampened growth in the banking sector was initially attributable to an economic slowdown and falling house prices, but from the autumn of 2008 the trend was exacerbated by the global financial crisis. In the first five months of 2009, employment was a good 2 per cent lower than in the corresponding period of 2008. Payroll expenditures were 5 per cent lower in the period January-July 2009 than in the same period of 2008.

In the other private service sectors, employment was growing up until the end of 2008. From early 2009, however, a decline has also been seen in this sector, and in January-May 2009 employment was 3 per cent lower than in the same period of 2008, while payroll expenditures in the first seven months of 2009 were 6 per cent lower than in the corres ponding period of 2008.

The slowdown has been particularly pronounced in the hotels and res taurants sector. Retail trade has been affected by a moderation in con sumption, which is reflected in import statistics. Employment and payroll expenditures in retail trade have been 3 and 5 per cent, respectively, lower in 2009 to date than in the corresponding period of 2008.

The public sector is unique in that it is the only subsector to register stable positive growth in employment and payroll expenditures in both 2008 and 2009 so far. While there was a widespread shortage of labour in the upswing up to 2008, it has now become much easier to fill va cancies. Presumably this is one of the reasons why public-sector employ ment is growing.

The decline in employment in all sectors except the public sector has led to a surge in unemployment, cf. Chart 4, but from a very low starting point. In July 2009, unemployment was 3.9 per cent. As unemployment has risen, the immigration pattern gradually seems to be changing from net immigration in 2008 to net emigration in 2009. This is in accordance with the pattern usually seen in such situations. Nevertheless, the global economic recession in the wake of the financial crisis, with rapidly rising unemployment worldwide, can make it more difficult to find or retain a job outside the Faroe Islands, and this may dampen net emigration.

Another typical – and positive – consequence of the financial crisis, which also applies to the Faroe Islands, is the strong fall in inflation, cf. Chart 5. The consumer price index rose sharply in 2007 and the 1st half of 2008, primarily reflecting higher oil and food prices, which gradually filtered through to other subcomponents of the index. Conversely, the subsequent fall in oil and food prices has led to lower – in the spring of 2009 even negative – inflation. In the 2nd quarter of 2009, prices were 1 per cent lower than in the 2nd quarter of 2008. The decline in inflation boosts the purchasing power of the households and can be expected to stimulate consumption to a certain extent.

Fisheries
In 2008 and 2009 to date, fishing in waters close to the Faroe Islands, predominantly demersal fishing for cod, haddock and saithe, has been severely affected by problems relating to low stocks and low prices. This is particularly evident for haddock, which is used for traditional British "fish & chips", among other things. Haddock catches dropped by 42 per cent from 2007 to 2008 and the trend is set to continue throughout 2009. At the same time, prices declined from the autumn of 2008 to the spring of 2009 as global demand contracted, reflecting the financial crisis.

For cod, catches were 9 per cent lower in 2008 than in 2007. The average price was also a little lower in 2008 than in 2007 and fell sharply from the end of 2008 and into 2009. By the spring of 2009, cod prices had halved compared to the autumn of 2008. Since catches have also decreased in 2009 to date, the value of cod catches will fall considerably in 2009.

Catches of the low-value fish saithe also declined in volume terms from 2007 to 2008, by 9 per cent, but prices were stable and have re mained so in 2009, while catches have been rising.

The total value of fish caught in Faroese waters fell by 22 per cent from 2007 to 2008 and the outlook for 2009 is a substantial further decline.

In June 2009, the International Council for Exploration of the Seas, ICES, reiterating its 2008 recommendation, proposed a complete ban on all cod and haddock fishing for some time in order for stocks to recover. In August 2009, the Løgting (parliament) opted for a general reduction in the number of fishing days by 5 per cent.

Salmon and trout farming, on the other hand, has grown significantly in recent years following the trough in 2006, when the sector was affect ed by epidemic diseases. The sector now rests on a healthier foundation, and output has increased from 18,000 tonnes in 2006 to 47,000 tonnes in 2008. The fish farming association expects output to be slightly lower in 2009. The price of salmon rose strongly from late 2008 until the summer of 2009, primarily as a market reaction to epidemics in the large Chilean salmon farming sector that caused output to plummet. In July 2009, the price increase to a large extent reversed.

FOREIGN TRADE

The deficit on the trade balance, excluding ships, grew until 2008, cf. Table 1. In the 1st half of 2009, however, foreign trade almost balanced, since increased earnings from salmon exports buoyed up export revenue while imports fell considerably.

Salmon has now overtaken cod as the most important source of export revenue, cf. Chart 6. Salmon accounted for 22 per cent of total export revenue (excluding ships) in 2008 and nearly one third in the 1st half of 2009. Pelagic fishing for herring, mackerel and blue whiting has also yielded higher export revenue in recent years, although catches of blue whiting have decreased in 2008 and 2009 as the Faroese share of the international quotas has diminished.

Excluding ships, exports in the 1st half of 2009 were 4 per cent lower than in the corresponding period of 2008.

Imports fell slightly in 2008, reflecting an accelerating fall from the autumn of 2008, which has continued into 2009 so far. The decline is most pronounced for cars, energy – following a drop in oil prices – and construction materials, cf. Chart 7. Imports of consumer goods and other imports have also declined, but less sharply.

Excluding ships, imports in the 1st half of 2009 were a full 30 per cent lower than in the 1st half of 2008.

The fall in imports and the relatively stable exports entail that in the 1st half of 2009 the trade balance showed only a modest deficit of kr. 93 million (excluding ships, and seasonally adjusted) compared with kr. 804 million in the 1st half of 2008.

If this trend continues throughout 2009, it is likely that there will be a surplus on the current account, which – in addition to the trade balance – also comprises trade in services and transfers to and from abroad. The final figures for 2007 and 2008 are not yet available. At end-2006, the Faroe Islands had accumulated net external assets of kr. 3.7 billion.

THE FINANCIAL SECTOR

In 2008, the Faroese banks realised a total loss before tax of kr. 216 mil lion, compared with a profit of kr. 652 million in 2007. The reversal from a large profit to an aggregate loss is attributable to capital losses on securities, a strong increase in impairment charges and losses in subsid iaries, cf. Table 2.

The impact of the global financial crisis on the financial statements of the Faroese banks does not differ from the pattern seen elsewhere, but the degree of impact varied widely, due to factors such as differences in their expansion outside the Faroe Islands in the preceding years. In 2008, Føroya Banki posted a profit before tax of kr. 200 million, while Eik Bank and Norðoya Sparikassi posted losses before tax of kr. 353 and 63 mil lion, respectively.

Since the financial crisis escalated in September 2008, lending to the corporate sector has shown a slight upward trend, while lending to households has been decreasing. The preceding years had seen very strong growth in lending, culminating at the end of 2007.

PUBLIC FINANCES

After a couple of years with surpluses, the Faroese government had a deficit of kr. 330 million, equivalent to 2.6 per cent of GDP, in 2008, cf. Table 3. This was attributable to the economic slowdown and higher interest rates.

Originally the Finance Act for 2008 operated with a small surplus. Revenue from direct and indirect taxes, including VAT on imports, was approximately kr. 200 million lower than budgeted, while expenses were a good kr. 100 million higher. The latter reflects factors such as in creased interest subsidies for housing and student loans as the financial crisis caused interest rates to rise throughout 2008.

In the 2009 Finance Act, the deficit is expected to increase to approxi mately kr. 500 million, primarily on account of a further decline in rev enue. However, the figure will presumably end up being even higher, particularly since imports, and thus revenue from VAT and other indirect taxes on imports, are set to fall considerably more than predicted when the Act was passed towards the end of 2008. In July 2009, the Faroese government proposed a number of measures, the "Ólav Package", aimed at curbing growth in the government deficit while also stimu lating economic activity. In that connection, the deficit was estimated at kr. 730 million in 2009 and kr. 810 million in 2010.

Even with the 2008 deficit, the government was practically debt-free, but the large deficits in 2009 and 2010 will increase the debt burden.

Local authorities are also saddled with a rapidly increasing debt bur den. According to the latest figures, their aggregate net debt at end-2008 was kr. 394 million. For 2009, the budgeted deficit is kr. 124 mil lion, but in view of the economic slowdown and the decline in tax rev enue, the deficit must be expected to end up being larger.

ECONOMIC OUTLOOK

An economic slowdown that was initially limited to the fisheries sector has now developed into a recession in the Faroese economy overall.

The slowdown and the subsequent downturn has alleviated two of the most urgent problems within the Faroese economy in the preceding two years: shortage of labour and a rapidly growing trade deficit. On the other hand, unemployment is now rising, albeit from a very low level, and the government and local authorities are facing strongly increasing deficits and mounting debts.

A major short-term challenge will be to bring the accumulation of government and local-government debt under control.

An important contribution to reducing the trade deficit comes from the successful re-establishment of salmon and trout farming. However, these farms have now reached their capacity limit, and considerable trade deficits are therefore to be expected when the economy picks up again and imports begin rise from the extraordinarily low level in 2009 so far.