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| Iceland holds some key lessons for nations trying to survive bailouts after the island’s approach to its rescue led to a “surprisingly” strong recovery, the International Monetary Fund’s mission chief to the country said. Photographer: Arnaldur Halldorsson/Bloomberg |
Iceland
holds some key lessons for nations trying to survive bailouts after the
island’s approach to its rescue led to a “surprisingly” strong recovery, the
International Monetary Fund’s mission chief to the country said.
Iceland’s
commitment to its program, a decision to push losses on to bondholders instead
of taxpayers and the safeguarding of a welfare system that shielded the
unemployed from penury helped propel the nation from collapse toward recovery,
according to the Washington-based fund.
“Iceland
has made significant achievements since the crisis,” Daria V. Zakharova, IMF
mission chief to the island, said in an interview. “We have a very positive
outlook on growth, especially for this year and next year because it appears to
us that the growth is broad based.”
Iceland
refused to protect creditors in its banks, which failed in 2008 after their
debts bloated to 10 times the size of the economy. The island’s subsequent decision
to shield itself from a capital outflow by restricting currency movements
allowed the government to ward off a speculative attack, cauterizing the
economy’s hemorrhaging. That helped the authorities focus on supporting
households and businesses.
“The fact
that Iceland managed to preserve the social welfare system in the face of a
very sizeable fiscal consolidation is one of the major achievements under the
program and of the Icelandic government,” Zakharova said. The program benefited
from “strong implementation, reflecting ownership on the part of the
authorities,” she said.
Euro Aid
As of March
this year, the IMF had program arrangements with 11 European countries,
representing about 65 percent of its funds, according to its website.
Governments inside the euro zone have struggled to comply with the austerity
terms prescribed in joint aid packages provided by the IMF and the European
Union, leading to revised terms and extended deadlines for nations such as
Greece.
At the same
time, bond markets have reflected a lack of confidence in recovery programs,
sending debt yields higher and adding to pressure on government finances.
Countries inside the euro area or with pegged currencies such as Latvia have
relied on wage cuts and reduced welfare services as a means toward delivering
on bailout goals.
In Iceland,
the krona’s 80 percent plunge against the euro offshore in 2008 helped turn a
trade deficit into a surplus by the end of the same year. Unemployment, which
jumped nine-fold between 2007 and 2010, eased to 4.8 percent in June from a
peak of 9.3 percent two years ago.
Impressive
“Each
program is different and responds to a different situation so one cannot
compare them directly,” Zakharova said. “Of course, considering the depth of
the crisis in late 2008, Iceland’s recovery has been impressive.”
Iceland,
which the IMF estimates was the world’s third- richest nation per capita in
2005 before slumping to rank 20th by 2010, ended its 33-month program in August
last year. The $13 billion economy will expand 2.4 percent this year, the IMF
said April 17. That compares with an estimated 0.3 percent contraction in the
17-member euro area.
Iceland’s
growth “is driven by private consumption, investment has picked up strongly and
even though, when you look at net exports, those have a negative contribution
to growth, it is mainly because imports have been strong, reflecting strong
consumption and an increase in income and the healthy expectations of
households,” Zakharova said. “Still, exports have been increasing very
strongly. Last year was a banner year for tourism. These are all really
positive things.”
‘Key
Challenge’
Iceland,
which started EU membership talks in 2010 with euro-area membership an ultimate
goal, is starting to question whether accession to the trade and currency bloc
is the right way forward as the region’s debt crisis deepens. Thirty-nine of
the Reykjavik-based parliament’s 63 lawmakers oppose continuing EU membership
talks and may push to have the process shelved before elections next year,
newspaper Morgunbladid said today.
The island
still needs to show it can unwind its capital controls successfully, Zakharova
said. About $8 billion in offshore kronur are locked behind the restrictions.
The central bank has said the plan to ease controls is likely to be completed
by the end of 2015. The law allowing the government to maintain the controls
expires next year, requiring a parliamentary extension. Former Economy Minister
Arni Pall Arnason said in a September interview that Iceland has no plans to
return to a free floating currency before entering the euro.
Krona Gains
The krona
has gained about 15 percent against the euro since a March 28 low and was
trading little changed at 147.27 per single currency as of 12 noon in Reykjavik
today.
“The
lifting of the capital controls is a key challenge for Iceland and it’s not an
easy task,” she said. At the same time, “the government has regained access to
international capital markets; the cleaning up of the balance sheet of banks
has been proceeding at good speed. So going forward it’s important that the
gains are sustained and consolidated,” she said.
As the
central bank prepares to ease capital controls, policy makers are also raising
interest rates in part to protect the krona from any weakening that might
ensue. The bank increased its benchmark rate a quarter or a percentage point on
June 13, bringing it to 5.75 percent. It was the fifth interest- rate increase
since August last year.
“Further
monetary tightening is needed, over the next few quarters, in order for Iceland
to get to the target,” Zakharova said. “But we’ve also seen that the central
bank has made strong statements about a hawkish monetary policy stance,
indicating that the monetary policy will be tightened over time. So we think
that the stance is appropriate at this point.”
To contact
the reporter on this story: Omar R. Valdimarsson in Reykjavik
valdimarsson@bloomberg.net
To contact
the editor responsible for this story: Jonas Bergman at jbergman@bloomberg.net
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