Iceland may boast the United Nations highest ranking for human development, but the North Atlantic island nation is developing a more-dubious reputation as the country hardest hit by the global credit meltdown.
Its extremely fragile, says Elisabeth Gruié, an emerging-markets currency strategist with BNP Paribas in London. Its one of the most vulnerable countries amidst the credit crunch, and it will remain extremely exposed to any developments given the banking sectors exposure. Icelands three biggest banks Kaupthing Bank, Landsbanki and Glitnir Bank have a higher proportion of debt than almost any other bank in the world, says Gruié. This has sent the krona into a downward spiral it fell to as low as 79.10 to the dollar last month from 62.58 at the end of 2007, before recovering slightly and the banks credit default swap spreads soaring.
Icelands banks, which account for 10 percent of GDP, launched an aggressive international expansion in recent years, leaving the countrys external financing requirements uncomfortably high, says Venla Sipila, senior economist for Europe with research firm Global Insights Country Intelligence group. Kaupthings CDS rate, the cost of insuring the banks debt against default, was 745 basis points early this month, compared with 57 for Barclays Bank and 62.5 for Deutsche Bank, according to data provider CMA DataVision. The prime minister said the banking credit defaults were completely out of line, Sipila says from London. They are wide hugely wide but thats a reflection of the considerable risk. I do feel its justified. Officials from Icelands top three banks could not be reached for comment.
Prime Minister Geir Haarde, in New York in early March for the Icelandic-American Chamber of Commerce annual conference, offered assurances that his countrys $16 billion economy and its lenders can handle the turmoil. Our banks are well positioned, Haarde told Institutional Investor. Their profitability has been very high, their capital ratios are very high, and they have been raising their deposit ratios. Also, they have passed with flying colors all the stress tests that have been put to them by our financial supervisory authority.
Sipila questions those tests. The crisis highlights the governments need to better deal with the underlying imbalances and dependencies that still constrain Icelands financial stability and creditworthiness, she notes.
But Haarde says the government and central bank have the resources at their disposal to fend off a liquidity crisis, protect depositors and avoid disruptions in the payments systems, if necessary. Interest rates in Iceland are about 15 percent, among the highest in the industrialized world. Inflation hit 8.7 percent in March, well above the central banks 2.5 percent target. The banks are retrenching. In late January, Kaupthing canceled its $4.4 billion bid for Dutch investment bank NIBC Holding. And in early April, Standard & Poors cut its outlook for Icelands single-A-plus sovereign credit rating to negative.
The governments efforts to stabilize the economy include opening parts of Icelands funded health care system up to private players. Haarde says he also plans to cut corporate taxes from 18 percent to 15 percent later this year. Icelands net public sector debt is forecast to fall to 6.3 percent of GDP this year from 7.6 percent in 2007. Were going through some turbulence at the moment, says Haarde. My point is that the fundamentals are very good.