The financial crisis in Iceland.
Economic and social disaster?
Lilja Mósesdóttir
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The largest bank collapse !
 The profit of the liberalised and privatised banking system was
privatised while the debt will be nationalised.
 The total debt of the central government (sovereign debt):
 A. Pre-crash debt :
653 billion Iskr.
 B. Nationalised debt due to the crash:
ICEsave/Edge:
(secured) loans lost by the Central bank
Recapitalisation of the banks
Short sale losses
Fiscal deficit 2009
FIH bank
695
220
385
35
154
63.6
 Total
2205.6 millj. Iskr.
billion Iskr.
billion Iskr.
billion Iskr.
billion Iskr.
billion Iskr.
billion Iskr.
 National debt becomes 145% of GDP
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3
The economic situation
%
2007
2008
2009
4.9
-0.1
-9.6
Inflation (CPI)
5
12.4
13.1
Budget Balance
(% GDP)
5.5
-1.4
-13,2
Foreign currency
(average price)
change in Iskr)
-2,5
40.1
22.6
Unemployment
2,3
3.0%
10%
Real GDP growth
Sources: Minstry of Finance, (2009) and Statistics Iceland (2008)
Emergency law in October to ensure full access of Icelanders to their bank deposits
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IMF backed program in Iceland
 The loan(s):
 IMF: 2.1 billion US$
 Others: 3 billion US$ (Nordic countries, Russia & Poland)
 Conditions:
1. Implement IFM economic program
2. Demonstrate commitment to solve the dispute around ICEsave/Edge
 IMF program focus on:
 1. Currency stabilisation
Currency stability the goal of monetary policy
• Capital controls
• Central bank interest rate up to 18%
 2. Bank restructuring
New regulatory structure
Recapitalize (The central bank and the 3 state-owned banks)
 3. Fiscal consolidation
Extensive cuts or higher taxes due to large debt-servicing burden
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Criticism of the IMF program
 1. Free floating currency instead of capital controls (right wing)
 2. The program fails to take into account :
 the real economy
The private sector (fishery sector) technically bankrupt
Fish prices are falling due to the global recession
 counter-cyclical measures
Fiscal policy: Fiscal deficit only allowed in 2009
Monetary policy: High interest rate
 Almost illiquid currency (Iskr)
Keep Iskr. - limits the size of the banking and corporate sector
Unilateral adaptation of foreign currency – no lender of last resort
EU membership and then EMU membership – takes too long time
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Threats to social cohesion
 1.Inequality:
 Rich investors and households :
Better able to hedge in advance and run away
More likely to receive compensation when bank bailouts occur
Better protected when the crisis spreads to the real economy
 Urban poverty increases more than rural poverty (may protect the poor)
 2. Poverty:
 Unemployment (10%) and shorter working hours
 Large fall in real wages (16%)
 Price indexed housing loans
 3. Wealth transfers:
 From the poor to the rich
 From few domestic investors to even fewer domestic investors
 From domestic investors to foreign investors
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Social unrest in Iceland
 IMF program does not tackle the indebtedness of firms and
households.
 No emergency plan
 Social policy measures focuses only on the most needy
 Banks accused of applying discriminatory rules when deciding on loans to
firms
 So far, no consultation with trade unions and interest groups
 Poverty and inequality likely to increase in Iceland:
 Full access to deposits –capital owners compensated by the state
 Limited progressiveness of the tax system
 Price indexed housing loans and high real interest rate
 Voluntary pay decreases
 Low replacement rates of welfare benefits
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Tackle poverty and inequality
 Social costs of financial crisis large and durable (Finland)
 The crisis offer an opportunity to introduce better policies:
 Lower real interest on housing loan and changes to the indexation
 Progressive tax (flat rate tax rate 37,38%)
Lower tax rate among low earners stimulates demand more than
among high earners
Women’s labour supply more sensitive to tax changes than men’s
 Policies focused on reducing poverty essential and more acceptable during
crisis (IMF constrains)
Income support
Workfare - infrastructure and R&D
Knowfare (opportunity cost of schooling falls)
 Centralised wage negotiation to protect those in vulnerable position
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Tackle wealth transfers
 Real estate
 Bubble 1997-2007
250%
 Household debt as % of GDP (2008,Q3)
115%
 Price fall 2008-2010
30%
 Solution: real estate turned into housing cooperatives??
 Stock market (OMX Iceland 15)
 Bubble 2001-2007
500%
 Firm debt as % of GDP (2008,Q3)
316%
 Price fall (last 12 months)
94%
 Solution: Restructuring fund (RSF) – the state (+pension funds)
Depreciate/subordinate debt and injecting capital (share holder/owner)
Depreciate /subordinate debt and allow employees to take over firms
 Relax rules concerning bankruptcy of households and firms
 Investment companies should be forced into bankruptcy
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Growth strategies
Source: Ívar Jónsson (2003)
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Growth strategy for Iceland?
 Export-led growth strategy based on the utilisation of natural
resources and foreign direct investment in aluminium & ferrosilicon
 Falling fish prices
 Falling energy prices
 Too capital intensive strategy
 Likely to involve economic growth without much employment growth
 Require relatively low skill level
 How to manage ownership and utilisation of natural resources
 Import-substitution strategy
 Manufacturing production instead of service provision
 Natural resources used to produce for domestic or foreign markets
 Free trade agreements constrain
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