In December 2012 the 12 month inflation was 4.2%. From December 2011 to December 2012 the market price of housing index for the Greater Reykjavik area rose 7.4% for apartments and 4.1% for private houses. The Government bond index increased around 8% in the same period. All indices are therefore increasing quite fast and it might be because there is a lot of money locked in the economy because of the capital controls.
It is estimated that the investment need of the pension funds in Iceland might be around 1 billion dollars per year. There are not many investment opportunities in Iceland at the moment and this money has to go somewhere, and it is difficult the get the money abroad. It is also estimated that foreigners own an equivalent of many billion dollars in the economy. Government bonds have been popular but the stock market is becoming increasingly popular as more firms register to the stock exchange.
The Icelandic pension funds have increased their portfolio of government bonds by a large amount since 2008, which is a concern. Landsvirkjun produces 75% of the electricity in Iceland is 100% owned by the state. It has been suggested to sell around a third of the company to the pension funds to help with their investment needs but these plans have met hard opposition and it is unknown if this will happen. The market value of Landsvirkjun is estimated around 300 billion ISK or around 2.35 billion USD.
It is unclear if there is a bubble in the Icelandic economy but if there is a bubble it is not driven by credit as it was in 2007 but by capital owned by foreigners and by the Icelandic pension system. Some say that a bubble is already in place or that one will emerge very soon. If the capital controls were lifted the bubble could burst, if it is in place, which could be a big problem for the already troubled Icelandic pension funds. Lifting the capital controls without depreciating the Icelandic krona or triggering large stock price decreases is therefore a difficult task and it will be interesting to see what steps will be taken in 2013 to address the problem.