Iceland starts to thaw after GFC

Over the last 4 years the Icelandic economy has gone from financial disintegration to an emerging recovery and in doing so has taken a different policy stance than other economies faced with similar economic conditions.

How have they recovered?
1. The government guaranteed the deposits of Icelandic citizens in the banks but this did not apply to foreign investors. The banks that held foreign assets are currently being broken down and assets are being sold to pay off creditors.
2. The weak Krona has been the catalyst to recovery and exports in fish, aluminum, and tourism are up by over 10% from 2010.
3. The IMF and other Nordic countries were forthcoming with loans in order to try and stabilise the already volatile economy.

The table shows the problems that faced the Icelandic economy in 2009. With unemployment on the rise and inflation at 18.6% there was not only stagflation but the government’s debt to GDP ratio has continued to climb as officials protect the social safety net.

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The above is a brief extract from an article published in this month’s econoMAX – click below to subscribe to econoMAX the online magazine of Tutor2u. Each month there are 8 articles of around 600 words on current economic issues.

econoMAX

Iceland starts to thaw

The recent OECD* survey on the Icelandic economy paints a rosey picture when you consider what has happened to its economy over the last 3 years. Iceland’s approach has been different to that of the US and Euro Zone counterparts. Instead of introducing policies of quantitative easing and bailouts of banking institutions the Icelandic authorities allowed its banks to fail. Foreign debt, which totaled US$62 billion, left the country with no real choice but to default on the banks’ creditors. This policy has been called “Bankrupting your way to recovery”. In a recent radio interview on the BBC Iceland’s president Olafur Ragnar Grimsson said that Iceland’s approach is about much more than getting the banking sector operational but affirming the will of the people over the financial institutions. Iceland’s GDP for the last quarter is 2% and unemployment is at 5.8% – the latter being high by Icelandic standards.

Compared with the likes of Greece and Ireland who have gone through similar debt problems the one key option with is not open to its eurozone counterparts is that Iceland had its own currency the Krona. As the economy and banking system collapsed so did its currency which has its advantages and disadvanatges.

* The price of visiting Iceland has effectivley halved – Reykjavik was seen as one of the most expensive places to visit as a tourist
* As most of Iceland’s consumer goods are imported this has meant higher prices of cars, food, electronics etc.

Should Greece and Ireland learn from this? According to Stephanie Flanders – BBC Economics Correspondent – Greece already had huge amounts of debt before the crisis unfolded and it doesn’t hold much relevance as Iceland had no public debt at this time. However Ireland, like Iceland, had handled its public finances well but its financial framework poorly.

*Organisation for Economic Cooperation and Development – The OECD provides a forum in which governments can work together to share experiences and seek solutions to common problems.

Iceland to power Scotland?

Currently Icelandic officials are looking at the possibility of funding a 1,170km power cable to Scotland. Iceland’s has natural endowments which lend itself to huge geothermal and hydropwer potential. Its export value has been put at approximately $1.33bn if priced at today’s spot price which is approximately 10% of Iceland’s $12bn economy.

As the EU tries to increase its use of clean energy (20% by 2020) the cable from Iceland would help considerably in achieving this goal and by about 2030 Iceland’s revenue per capital could rival that of Norway, where oil income has made its $507bn sovereign wealth fund second to that of the UAE on $600bn. This potential earning for the Icelandic government has led to a reduction in the cost of credit default swaps which is insurance on Iceland defaulting. But in order to realise its potential Iceland will have to attract a lot more investment as 75% of its power potential is underdeveloped. Therefore an infrastructure that has the capacity to generate such volumes of electricity is esseential to any further advancement of the Icelandic economy. Alcoa Inc., Rio Tinto Group and Century Aluminium Company have already set up plants in Iceland to take advantage of its cheap energy. Demand is definitely outsripping supply. Click here to see the Bloomberg article on Iceland.