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Cautious currency thaw shows Iceland on right track
Breakingviews' Nicholas Paisner writes about Iceland's financial system thawing.
Breakingviews
2 Nov 2009
Cautious currency thaw shows Iceland on right track Iceland : Iceland ’s financial system is slowly thawing. A year after a financial collapse that prompted the British government to freeze Iceland ’s UK financial assets, Reykjavik is feeling confident enough to begin easing restrictions on foreign currency flows.
The moves are limited. The central bank will allow foreign currency to enter and leave the country if it is used to fund appropriately-registered new investments. Iceland is right to be cautious. After seeing its currency decline more than 50% against the euro, the last thing it needs is another bout of currency volatility. Reykjavik hopes its gradual easing will avoid a feared flight of existing foreign currency investments and prevent an influx of yield-hungry speculators.
Iceland is inching slowly to financial rehabilitation. The restructuring of its stricken banking sector is nearing completion. The International Monetary Fund and Nordic and Polish governments have provided $5bn of funding, equivalent to 40% of GDP. That has put an international seal of approval on Iceland ’s recovery plan, while also boosting foreign currency reserves and providing liquidity to service overseas debt.
Still, Iceland and its citizens have a tough time ahead. Icelanders must cope with a swollen foreign debt burden – thanks to the krona’s collapse – and tough fiscal austerity measures. What’s more, Iceland shunned the "bad bank" structure used elsewhere in Europe , so its recapitalised lenders may be weighed down by losses for years to come.
But Iceland is emerging from its financial Armageddon in better shape than might be have expected a year ago. Net public debt has soared as a result of the crisis. But at 67% of 2010 GDP, it will not be too far ahead of the UK ’s. Unemployment of 4.7% does not look disastrous in a European context, even if high by Icelandic standards. Investment in Iceland is still only for the brave – McDonald ' s, for its part, has pulled out. However, the country is starting to look a little less like a stricken banana republic. With a part-nationalized banking sector, an overleveraged consumer and a vulnerable currency, it is increasingly looking like a smaller, colder version of the UK.
nicholas.paisner@breakingviews.com