Iceland Source: Danske Bank Markets

Iceland and Ireland had massive booms that ended in spectacular busts and they are now struggling on rocky roads back to fiscal sanity.

On Sept 30, 2008, Ireland issued a blanket guarantee backstopping the debts of its six insolvent domestic banks that had engaged in monumentally reckless lending to fuel an out-of-control property boom; in the same week, Iceland's three main banks collapsed and were nationalised. 

Last Saturday, Icelandic voters in a referendum rejected for the second time, agreements to repay the UK and the Netherlands for compensating depositors in one of the Icelandic banks.

When the Icesave online bank collapsed in 2008, almost €4bn in deposits from 300,000 British and Dutch depositors, including local governments, were at risk.

Iceland was required by EU rules to maintain deposit insurance for its banks and when Landsbanki Íslands bank collapsed, its Icesave unit also crashed.

The deposits were attracted by the highest interest rates in the UK and the Netherlands. The British and the Dutch governments refunded the deposits and Gordon Brown's government used the UK Prevention of Terrorism Act to freeze the transfer of funds from the UK.

The latest agreement cut the average interest rate to 3.2% compared with 5.55% in the first rejected deal; interest payments would commence immediately and principal repayments in 2016, with repayments spread over a maximum of 37 years.

Ólafur Ragnar Grímsson, the Icelandic president, has turned from cheerleader of the buccaneering “Viking capitalists” who ruined the country of 320,000 people, to the people's champion but despite the referendum, Grímsson and the Icelandic government have said the British and Dutch are likely to get most of their money back from the liquidation of Landsbanki Íslands.

Property and land owned by the bankrupt bank would raise over €1bn if sold off, and this would go some way to paying off Iceland’s debt to the Netherlands, finance minister Jan Kees de Jager is quoted as saying by Nos television.

However, Iceland is concerned that the ratings agencies will downgrade the sovereign ratings and on Wednesday, the governor of the Central Bank of Iceland said that Moody’s has confirmed it will hold off on re-evaluating Iceland’s sovereign debt rating following Saturday’s Icesave referendum. He has also asked the other major ratings companies to hold judgment.

Funding from the European Investment Bank of projects including the new Budarhalsvirkjun hydro power station, is at stake.

On Wednesday, Iceland’s Social Democrat-led government survived a parliamentary vote of no confidence, with 32 members in the 63-member Althingi backing the coalition government.

The Independence Party, which misgoverned the country for  18 years until the economic collapse, has 35.8% in a national poll, compared with 22.4%  Prime Minister Jóhanna Sigurðardóttir’s Social Democrats.

Economic Recovery

On Tuesday, Danske Bank Markets issued a report - - Research Iceland: Recovery in uncertain times (pdf) - - on Iceland, which said that the recovery could prove sustainable, as macroeconomic imbalances have been reduced significantly.

The bank says the Icelandic kronúr is 25% undervalued against the euro; a large trade surplus, partly due to a sharp fall in imports; property prices (more or less) back to pre-boom levels (in real terms) and the public finance situation has clearly stabilised, with public debt likely to decline in coming years from the current (high) level of around 100% of GDP (in gross terms, excluding Icesave), will underpin the recovery.

Danske says given Iceland’s significant debt servicing obligations and capital restrictions, the country effectively needs to run current account surpluses. So while Iceland’s external position has improved dramatically, there is no room for slippage on the current account  -- at least not in the present financial environment.

The IMF projects a 2011 budget deficit of 4.6% of GDP compared with Ireland's 10.8%. By 2015, Iceland will have a budget surplus of 2.2% compared with Ireland's deficit of 4.3%.

The IMF says Iceland's public debt/GDP ratio was 30% in 2006 and will be 103% in 2011; Ireland's was 25% and will be 114% in 2011.

Iceland's debt ratio will be 81% in 2015  while Ireland's will be 123.5%.

Iceland currently maintains capital controls and has external funding from the IMF and Nordic neighbours.

Did Devaluation work?

Iceland’s total export value is split about 40% each between marine products and the aluminum industry, linked to its geothermal resources.

The biggest annual changes in exports in recent years have been in 2008. The banking system collapsed early in Q4 2008.

In 2008, marine product exports jumped 33% in value on a volume rise of 13%. This was against a backdrop of global food prices rising to record levels.

Aluminum exports jumped 127% in 2008 and volume increased 71%. US giant, Alcoa, opened a new smelter in East Iceland in mid 2007.

Fish export volume fell 4% in 2009 but the export value jumped 22%; aluminum export volume rose 6% in 2009 but the value of exports fell 6%.

Fish export volume fell 5% in 2010 and the export value rose 5%; aluminum export volume rose 1% in 2010 and the value of exports jumped 30% - - the average aluminum price on the London Metal Exchange in 2010 rose 24%.

As for marine products in 2010, the movement of large shoals of mackerel north to cooler waters off Iceland and the Faroe Islands prompted both countries to unilaterally hike their catch quotas.

Iceland raised its 2010 quota from 2,000 tonnes to 130,000 tonnes and to 147,000 tonnes in 2011.

Without the mackerel windfall, the volume of its fish exports would have fallen more than 5% in 2010.

So the big export volume and value changes happened before the currency collapsed; the price of aluminum fell 40% in Q4 2008.

American economist Paul Krugman identified six ’supertrading’ economies as existing in 1990 - - Belgium, Hong Kong, Ireland, Malaysia, the Netherlands and Singapore and the OECD added six more in 2000.

These economies are dependent on the “slicing up of the value added chain” on an international basis.

US multinationals based in Ireland mainly export to their units in other European countries, Exports to Asia are insignificant and short-term exchange rate movements would not impact supply decisions.

Iceland has an unemployment rate of 9% compared with Ireland's level of almost 15% and about 9,000 are employed directly in the fishing and aluminum industries.

This is only 5% of the total workforce.

The equivalent Irish ratio for the internationally tradeable goods and services sectors is almost 13%.

An Ill Wind...

"What a difference a year makes," says Sif Gustavsson, Area Manager of North America for Visit Iceland.

"This week marks the one year anniversary of the notorious Eyjafjallajokull volcanic eruption that wreaked major havoc on spring travel. Now it turns out the volcano has been a blessing for Iceland in terms of increased tourism. The media attention really put Iceland on the map and now travelers are coming to experience our raw and awesome nature for themselves."

The Eyjafjallajokull eruption drew thousands of volcano-tourists and created an economic windfall for Iceland. At the one-year anniversary of the event on April 14, the island nation is reporting a significant upside to the world-famous, if unpronounceable, natural disaster.

Tourism reaped enormous benefits with a hotbed of new volcano tours, new hotels, and a 33% increase of North American travelers for the first three months of 2011. Escorted tours and guided volcano excursions in specially modified "super jeeps" reveal the eruption's dramatic aftermath in the natural oasis that lies just behind the volcano. Helicopter tours provide a bird's eye view of the volcano and an added thrill for passengers.

Not that Ireland should wish for a disaster...