ANALYSIS:A year on from its near collapse, devaluation has returned Iceland from being relatively expensive to being highly competitive, writes MAX DOYLE
ALMOST 12 months ago to the day, Geir Haarde, the then prime minister of Iceland, made an extraordinary televised broadcast to the nation in a short speech.
“There is a very real danger, fellow citizens, that the Icelandic economy, in the worst case, could be sucked with the banks [Landsbanki, Kaupthing & Glitnir] into the whirlpool and the result could be national bankruptcy,” he said.
Kjartan Geirsson was working for Icebank, a subsidiary of Landisbanki, at the time.
“I will never forget it. I was watching with some friends. When he finished, he said ‘God bless Iceland’. I never heard him say that before and for at least 30 seconds there was total silence as we tried to understand what just happened.”
Queues of people formed outside the local banks in Reykjavík, where most of the 320,000 citizens of Iceland live. “People were openly running around with bags of euros and dollars and any foreign bank notes they could find,” says Kjartan.
Twelve months on, Icelanders are coming to terms with their changed circumstances.Thorgen, an electrician working with one of Europe’s largest aluminium smelters in Iceland, offers a succinct summation of the problem.
About 70 per cent of Icelanders have mortgages where the repayments are linked to the rate of Icelandic inflation. Bad luck, as inflation has soared to almost 9 per cent following a near 50 per cent collapse of the Icelandic kronar.
“The last six years of my house repayments have been a waste of time,” says Alex, a German microbiologist based in the University of Iceland. “I have been living here for 10 years and overnight everything changed.”
Groa, a primary school teacher from Keflavik, says she took out a car loan denominated in Japanese yen.
Japanese interest rates were much lower than interest rates in Iceland and besides, the value of the kronar was rising all the time.
“I just didn’t realise that if the kronar collapsed my debt would double. I handed the car keys back to the bank a few months ago and I have not heard from them yet, but I owe about three times the value of the car now.”
It is hard to reconcile these stories and the notion that Iceland is bankrupt with the bustle of Reykjavík, a beautiful, modern city with sophisticated urban living and where everyone is online.
Reykjavík is also home to Europe’s oldest parliament, the Althing, a beautiful and accessible building in the city centre.
It was outside the Althing where sustained and relentless protests lasting almost four months sealed the fate of Mr Haarde’s government. The non-violent protests, which became known as the “utensil revolution”, were noisy affairs involving pots and pans and became part of a national cathartic uprising that forced the government out of office and claimed the scalps of the heads of the Central Bank and the Financial Regulator.
There are many reasons why the banks in Iceland failed but, like the Irish banks, that fateful day came when global liquidity dried up and they were unable to refinance their own borrowings. Asset quality problems came later.
The international lending activities of the Icelandic banks were enormous relative to their domestic operations and a national bailout was ruled out immediately.
Instead, all domestic deposits were transferred into three new banks which then acquired the domestic assets of the failed banks at written-down market value.
“Domestic depositors were the only creditors to get a 100 per cent return, the bond-holders remained with the old banks,” says Agnar Hansson, of HF Securities in Reykjavík.
An entirely new banking system was set up overnight in Iceland.
“There was minimal disruption to the national banking and payments system,” said Finnur Sveinbjornsson, the affable new chief executive of Kaupthing Bank.
The government has capitalised two new banks to date with the equivalent of approximately €675 million. Foreign creditors will be offered up to 90 per cent of the equity in the new banks in settlement of their claims on the failed banks.
Secondary market pricing suggests that creditors of Kaupthing and Glitnir, two of largest failed banks, can expect about 20 per cent recovery, while Landsbanki creditors will get approximately 5 per cent over time.
While Iceland did not default on its debt, it required assistance from the International Monetary Fund to stave off a sustained attack on its currency by the markets. The imposition of old-style currency controls and initial 18 per cent interest rates have contained the devaluation for now.
Tjorvi Olafsson, an economist with the Icelandic Central Bank, explains that a three-point plan is being implemented.
Firstly, stabilise the currency by drawing IMF reserve funds – this would gradually coax interest rates lower from the current 12 per cent and permit the flow of foreign investment. Second, restructure the banks and, thirdly, achieve fiscal sustainability by balancing the budget which projects a deficit of over 12 per cent of gross domestic product in 2009.
“The [new] banks are full of liquidity,” says Dr Egilsson of the Confederation of Icelandic Employers. “There are many investment projects just waiting to start once there is more certainty over the kronar. These will create jobs and exports and they are all from the private sector.”
These projects are based around Iceland’s abundance of natural resources such as hydro power, geothermal energy and fishing.
Unfortunately, the IMF programme has stalled.
“We had hoped for a constructive approach with the IMF, but the reality is that Britain and the Netherlands, our Nato allies and friends, have used their position on the IMF to obstruct IMF staff professionals with the Iceland programme,” says President Ólafur Ragnar Grimsson, who went on to directly criticise Gordon Brown.
He is referring to the Icesave issue where depositors in Britain and the Netherlands were unable to withdraw their cash from their online savings accounts called Icesave Accounts with Landsbanki when it failed.
In Britain, which accounted for most of the deposits, creditors included retail depositors, institutions and local authorities.
Despite being a branch of Landsbanki, the Icesavers have not been made whole by the Government in the same manner as the Icelandic depositors.
On October 8th, 2008, British chancellor Alistair Darling invoked provisions of anti-terrorism legislation against Iceland allowing the seizure of assets belonging to Landsbanki and the Central Bank of Iceland.
“Icesave is poisonous,” says Prof Gylfi Zoega, of the department of economics at the University of Iceland. “In Holland, the accounts were opened only four months before the banks collapsed. The Dutch are really bitter.”
The devaluation of the currency has returned Iceland from being relatively expensive to being highly competitive in a short period, and tourism is booming.
“Iceland is going to be like a natural experiment, the country is getting out cheaply,” adds Prof Zoega. He says that while personal consumption has declined by at least 20 per cent, people are not buying imports of durable goods any more as they are simply too expensive.
However, Iceland’s exports such as fish, aluminium and software have performed strongly. This benefits the tradeable goods sector and ultimately the real economy improves.
“We have lost the financial services and construction sectors but our real output has improved. We will recover quite quickly due to our exports, better competitive position, lower living standards and our natural resources,” he predicts confidentially.
“Ireland has a sound financial system but a rigid real economy which makes it difficult to adjust and be competitive.” Indeed.
Ingibjörg Guðmundsdótti is vice president of ASI, the Icelandic Confederation of Labour, representing about two-thirds of organised labour in the country.
“For 20 years now, we have used the tripartheid agreement system in Iceland – the government, employers and labour, like the three musketeers. We try to negotiate with a win-win mentality.
“If companies don’t make it, there is no employment and you can’t find a solution if you are not on speaking terms.”
She says workers in Iceland “are afraid of losing their jobs”. Unemployment in Iceland is now about 9 per cent. She recounts how the unions sat down every day for one month with the employers’ groups following the collapse of the banks to try to avert job losses.
As part of the country’s Stability Pact, the union agreed specific benchmarks relating to inflation, public deficit and interest rate policy. In addition to a mechanism to adjust the minimum wage (downwards), they have also collectively signed up to the concepts of financial restructuring of household debt, preservation of the education system and reform of corporate governance.
A public investigation is also taking place to establish if any wrongdoing occurred in the banking system.
“I have 22 files on my desk which may be sent to the public prosecutor,” says Gunnar T Andersen, the new head of the Financial Supervisory Authority in Iceland. Not bad considering he has been in the job for only five months.
Many Icelanders are sceptical that prosecutions will take place.
“We are investigating cases of market manipulation amongst other things,” Andersen adds.
However, a Norwegian French prosecutor MEP, Eva Joly, is very popular with Icelanders. She is a special adviser to the government and does not always observe client attorney ceremonial politeness.
“Iceland is a small place,” says Olafur, a former banker with 25 years’ experience. “Introducing a foreign prosecutor allows the investigation to keep going even when members of the same family are on different sides.”
The prosecution hit the headlines last week when the offices of two of the big four accounting firms in Reykjavík were visited by the prosecutors’ office and accompanied by police.
Max Doyle is an investment and restructuring adviser
