From Iceland — FT: Don't Be Fooled By Iceland's Recovery

FT: Don’t Be Fooled By Iceland’s Recovery

Published July 18, 2014

Nanna Árnadóttir
Photo by
Natsha Nandabhiwat

The Financial Times have published an article detailing the darker side of Iceland’s impressive recovery from the 2008 economic crash.

Unemployment is down as Iceland boasts a growth rate above 3%; tourism, energy and IT businesses picking up pace as the nation’s source of economic development. Last week also marked Iceland’s solid return to the European market when the six-year euro bonds the state put up for sale yielded 2.6%

“This is a testament to what can happen to a post-crisis economy when a resilient population embraces painful restructuring and its currency loses half its value,”  wrote FT’s Gillian Tett. “But there is a problem with this cheering tale. All the laudable growth has not magically removed the cause of Iceland’s crisis: debt.”

According to the IMF, Iceland’s sovereign debt is “just” 84% of gross domestic product. However, adding the remaining liabilities of the banks – which are implicitly owned by the government – the total debt ratio is 221%.

The implementation of capital controls means the government has been able to ignore this problem and keep investors from freely exchanging the ISK for foreign currency. Capital controls has also shielded Iceland and allowed much needed breathing room, giving the country space to recover.

As reported, the six-year bond sale was preparation on the government’s part to begin the process of easing capital controls and to attract more foreign investment.

However, as central bank governor Már Guðmundsson points out, any relaxation will force a new debate about that debt mountain, since the $7.4bn ISK held by foreigners in Iceland’s banks will almost certainly flee if controls are removed without any clarity on how creditors who hold Icelandic bank debt will be treated. And a flight of capital could spark a fresh crisis.

To counter this the Icelandic government has hired external advisors to aid in talks with creditors though the outcome is hard to predict.

“A group that represents about 70% of bond holders wants its claims to be settled by selling the successors to the collapsed Icelandic banks to new foreign owners,” writes Tett. “However, since nationalist sentiment on the island is running high, politicians seem loath to give foreign creditors anything more than a token settlement. So there is every likelihood the country will either end up in a protracted court fight, like the one between Argentina and its “holdout” creditors; or that the government keeps playing for time by extending those supposedly “temporary” controls indefinitely.”

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