Cruising or Crashing? Iceland's Economy in 2019 - The Reykjavik Grapevine

Cruising or Crashing? Iceland’s Economy in 2019

Cruising or Crashing? Iceland’s Economy in 2019

Published December 18, 2018

Photos by
Art Bicnick

This year marked the tenth anniversary of the country’s economic collapse, bringing unprecedented attention to Iceland. The tourist salvation is slowing down and there is a fear among many that this industry’s success will be as fleeting as the banks’ brief boom. The growth of visitors has levelled off, the Icelandic króna (ISK) has lost value and airlines are losing money, with one of them going bankrupt.

Before the banking boom, Icelanders were subject to dramatic economic swings stemming from the fishing market. Fishing was the country’s only large scale export for most of the 20th century, and the largest industry until a few years ago. Apprehension about the economic outlook is understandable. Small, trading states like Iceland are vulnerable to shocks, and global recessions are felt more deeply here.

The double-digit growth rates of the past few years were unsustainable and undesirable. The state and industry have failed to build infrastructure and regulate effectively. This has led to a severe housing shortage, labour abuses and environmental damage. Analyses from the Central Bank, private banks and international organizations all predict a slower but still robust growth rate. The same is true for most of the world. However, there are risks and dissenting voices. Currency fluctuation, contract negotiations and the fate of Icelandic airlines are the main issues for Iceland next year.

We shall see if the island nation has reached cruising altitude or will come crashing down once again.

Currency Crash

Iceland is the smallest economy to have its own floating currency. That gives the country more flexibility but comes at a great cost to most people. The króna has a long history of instability. That instability is felt by residents who have to pay much higher interests than in other developed economies. Many loans are indexed to inflation, meaning if inflation is 5%, the principal loan increases by 5% before interest is calculated. The devaluation of the króna that happened during the financial crisis made Iceland a more affordable destination for tourists, which got the nation out of recession much faster than other economies. Southern Europe, by comparison, did not have independent currencies to value and had to do “internal devaluation,” meaning severe austerity and wage cuts.

“We shall see if the island nation has reached cruising altitude or will come crashing down once again.”

Over the last few months, the ISK has lost value against major world currencies. The troubled airline industry is often blamed for the drop. It is certainly a factor, but it is not the only one. Pension funds and wealthy individuals have taken the opportunity to move money overseas to stronger and more stable currencies. They were not able to invest abroad from 2008 to 2017 because of capital controls that were put in place after the entire banking sector collapsed in October 2008. That capital was invested domestically, most notably in real estate. Average depositors do not have the ability to shift their money overseas and must endure the costs. The Panama Papers showed Iceland to be one of the most offshored countries in the world, with the political and economic elite stashing cash abroad.

Turbulent Industry

The airline market is in a period of intense competition and consolidation. Profitability is down and airlines are going out of business. Icelandic airlines had a difficult year in 2018. Primera Air went bankrupt in October, WOW Air has been near bankruptcy for much of the year, and Icelandair has endured large losses.

After years of astonishing growth and profitability, WOW Air saw losses and did not have enough money in reserve to weather a competitive airline market, slowing tourist growth, and rising fuel costs. The company’s attempted bond offering was a flop, raising much less money than it has hoped. Icelandair announced it was going to buy WOW after a weekend of negotiations. However, Icelandair pulled out of the deal on November 29th because requirements of the deal could not be reached before shareholders voted on the buyout. At the time of this writing, WOW Air announced Wizz Air owners Indigo Partners were going to buy a minority stake in the company, but few details are known about the deal. WOW carries more than a third of travellers to Iceland. If it went bankrupt, it would be a huge loss for the whole economy. Thousands of jobs would be lost and the wider tourist industry would be devastated.

Iceland’s oldest carrier, Icelandair, announced large losses and plans to restructure next year. As a legacy airline, it has huge capital reserves and relationships with banks. If its restructuring plans work as planned, the company will weather the storm. The airline plans to shift its business model to that of WOW Air, focusing on low-prices instead of all-inclusive comfort. Oil prices and stiff competition will continue to be an issue in the new year.

“Class War!”

One of the biggest domestic issues coming next year are the looming labour talks. Minimum wage in Iceland is not set by law, but through collective bargaining. Efling and VR are two of the largest unions in Iceland.They represent many of Iceland’s low-wage workers, and are united in their demand for a significant minimum wage increase to 425,000 ISK, which is about a forty percent increase. Business leaders claim that they cannot afford such an increase and some economists claim it will only increase inflation. However, the labour leaders point to the growing income inequality in the country and the increased cost of living to make their case. Ragnar Þór Ingólfsson, leader of VR, pointed out that an average two-bedroom apartment costs more than the post-tax minimum wage. Many low-wage workers live in precarious housing and homelessness is on the rise, and some workers often live in crowded and costly units without the protections of a rental agreement. The proposed large wage increase would allow workers to live with dignity. The unions are preparing for tough talks in the new year. They have billions in strike funds and can use their pension funds as leverage. They have unabashedly spoken of “class war” in regards to the fight ahead.

Global Downturn?

Mainstream economists see 2019 as the start of a period of slower growth. The Organization for Economic Cooperation and Development (OECD) forecasts a global growth rate of 3.5 percent,and under 2% for most developed countries. They also predict an increase in prices and wages. Their biggest concerns are increasing oil prices and growing trade wars and their assessment for Iceland is broadly in line with the global trend. Some economists see a recession coming in the new year. Public institutions have rosy outlooks, but individual economists are more pessimistic. Analyst Jórg Angele told Market Watch that the US economy is overheating due to stimulating tax cuts. If US President Donald Trump continues to escalate his trade wars, that too could lead to a recession. Former Bill Clinton economic advisor Brunello Rosa is much more pessimistic about the future. In The Guardian recently, he wrote a litany of reasons why the economy will crash, and speculated that it could be worse than the 2008 meltdown. But he gives us another year.

If there is a recession, large or small, Iceland will be hurt severely. Tourism is a luxury good and near the top of the list when it comes to cutting costs.

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