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News : Global Economy Last Updated: Oct 29, 2013 - 9:10 AM

Iceland's economy is recovering but still in crisis
By Michael Hennigan, Finfacts founder and editor
Oct 25, 2013 - 6:48 AM

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Credit: Gateway to Iceland

Iceland's economy is recovering but it is still in crisis with capital controls reducing the potential for foreign investment and this month the central bank warned that Iceland’s private sector faces the risk of being unable to repay its foreign currency debt.

Iceland has been seen by economists and commentators in Ireland as an example of the flexibility a country with its own currency can have when financial Armageddon strikes.

The headline data looks good: unemployment at 5%; GDP growth this year will be below 2% and a budget deficit of 2.7% is forecast.

Iceland had a gross and net debt as a ratio of GDP in 2007 at 29% and 7%. The IMF forecasts levels of 93% and 66% in 2013.

Unlike Ireland, Iceland with a population of  320,000 in 2012, has a strong base in natural resources: it accounts for one in 84 of fish caught worldwide and it breaks quota agreement fishing limits when it suits. In addition, its hydro power and geothermal resources, enables it to produce electricity five times the requirements of the local population.

Iceland did get a break on Thursday from the EU's Court of Justice when it ruled that Landsbanki Islands hf, an Icelandic bank that collapsed in 2008, is shielded from lawsuits by investors in the European Union after the court ruled that a national law blocking such cases against lenders under reconstruction is also valid outside Iceland.

“The moratorium granted to LBI” is allowed outside the country under EU law, the EU Court of Justice in Luxembourg said.

Landsbanki, Kaupthing Bank hf and Glitnir Bank hf defaulted on a combined $85bn in October 2008 and the country's membership of the European Economic Area, allows it to take part in most of the European Union's internal market.

Bloomberg says the EU court case was triggered by questions from the French Cour de Cassation about the scope of the Icelandic law in a case brought by a creditor in France seeking to seize some of Landsbanki’s assets to cover their losses from the default.

The case is: C-85/12, Landsbanki Islands HF v Kepler Capital Markets SA, Frederic Giraux.

The post crash government led by Jóhanna Sigurðardóttir, was ousted last April after one of the ruling parties of the bubble years, promised mortgage debt relief as many borrowers got foreign-currency loans when the krona was high.

The former prime minister has said that household debt amounted to 135% of Iceland’s GNP when it was highest in 2009, but was down to 108% in early 2013 - - the same as it was fifteen months prior to the banking collapse.

Irish household debt as a ratio of GNP is 155% compared with Greece's ratio of 55% of GDP.

Sigmundur Davíð Gunnlaugsson, now prime minister, promised that foreign creditors - - all termed "hedge funds" or "vulture funds" - - would fund a mortgage relief programme for all homeowners coupled with a series of tax cuts.

The Financial Times says: "About IKr1,800bn of the failed banks’ assets are held in foreign currencies and are relatively unproblematic. The issue is over the IKr957m of assets held in Iceland as the creditors are likely to convert them into foreign currencies immediately, putting pressure on an already hugely weakened krona. Mr Gunnlaugsson appeared to repeat his claims that creditors should give up some of these domestic assets to help with debt relief in Iceland."

“To lift the capital controls, some form of leeway must be created so that not all of this [money] leaves the economy at once,” he said.

The IMF expressed concern over Gunnlaugsson's strategy, soon after Standard & Poor rating agency downgraded the country from a BBB- stable rating to negative.

Jóhanna Sigurðardóttir, the former prime minister wrote last month:

Now that the new coalition government of the Independence and Progressive parties has been in power for five months, it is apparent that those in power are both perplexed and overwhelmed by the tasks at hand. The main emphasis seems to be relieving Ikr20bn krónur worth of taxes from fishery owners and the wealthiest of our community. The current government’s priorities could not be more different from the ones honoured by the last one. Inequality is once again rearing its ugly head, and the sharp knife of austerity has been turned towards the welfare system—all to benefit society’s wealthiest and best-off.

Once more, the wheels of greed are spinning."

Ásgeir Jónsson, an assistant professor of economics at the University of Iceland, the author of "Why Iceland?: How One of the World's Smallest Countries Became the Meltdown's Biggest Casualty, " and a former chief economist at Iceland's Kaupthing bank, wrote this month:.

it is still uncertain whether the Icelandic saga will have a happy ending. As part of the reconstruction efforts, capital controls were implemented, which have virtually unplugged the country from the world economy. Therefore, a 40-50% currency depreciation in 2008, which should have significantly boosted Iceland's competitive position, has not yet led to a significant increase in exports and economic recovery is slow.

As time goes by, the deadweight loss from the controls accumulates and the corporate sector is further drawn away into autarchy. The controls were implemented under the auspices of the IMF and were supposed to be a short-term measure. Five years on and two years after Iceland graduated from the IMF program, the country still lacks a credible plan to abolish the controls. On October 8, 2008, the world closed in on the Icelanders and there they still remain."

The BBC reported last January:

Neil McMahon has been in Iceland for 38 years. He is a teacher, tour guide and translator. Even with 35 years of teaching experience, he only earns £24,000 per annum. That is not enough to afford a comfortable life in Reykjavik.

"I think for an outsider maybe just reading articles in the newspapers or watching brief coverage of Iceland on the TV, they might be fooled in thinking Icelanders have managed to extricate themselves very effectively from this crisis," Mr McMahon says.]

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