Melting of Iceland

Thomson Financial (a week ago): Investors Service in an annual report on Iceland said the economy is heading for a difficult landing that could lead to negative GDP growth for a few quarters. Moody's said as conditions have objectively worsened and risk has heightened, the authorities in Iceland may have to find ways, like in other countries, to support the financial system. However, Moody's said the economy has been extremely flexible in response to shocks, and it does not see a crisis that would disrupt the payments ability of the government. The report takes reference from the large buildup in external debt by the banks over this recent period of overheating. Most of this include financed investments abroad or Icelandic corporates with natural hedges in foreign currency. Moody's believes these foreign currency contingent liabilities are stretching the sovereign authorities' lender of last resort capacity in a way that is not compatible with a 'AAA' standing. This concern prompted the change in outlook on Iceland's 'AAA' government ratings to negative from stable in March. However, Moody's said the recent Central Bank of Iceland measures are helping ease the difficult funding conditions currently prevailing for the banks. Also, a more relaxed fiscal policy will soften the blow of the economy's hard landing, it added.


MyTake: Moody's has been a little accommodating when describing the daunting economic situation Iceland is currently facing. According to the International Herald Tribune, " a huge investment boom and the privatization of the banks eight years ago left the country with a yawning current-account deficit - $2.7 billion, or 16 percent of its total economic output in 2007. By comparison, the much-criticized current-account deficit of the United States is 5.3 percent of total output". The country's economic boom has probably ended and the banks are believed to be facing the prospects of defaulting loans originating from the subprime investments. The Central Bank is expecting negative growth in the few quarters to come due to increasing double digit interest rate (now 15.5%) to fight inflation. The currency (Krona) has collapsed more than 22% since January 1. (note: Fitch and S&P has also done similar down gradings of credit ratings). Only in recent months, market has talked about hedge funds actively shorting Iceland in view of the country's banks defaulting hugh foreign loans. Will Iceland be the first country to be swept away by the credit crisis that originated from the US to the many parts of the world? Would the Government be able to bail out, if these banks and economy collapsed due to insufficient reserves?? I am not sure! In view of the above, would Ice-cream be more expensive in Iceland soon?? You bet!

Iceland is probably best known for the extreme forces of nature. But despite the chilly name of the country, its climate is a lot milder than most people expect. And though being situated on the volcanic active mid-Atlantic Ridge, earthquakes are usually small. In a country which has only about a quarter of a million people, Iceland has supplied three Miss World winners (1986, 1989, and 2005) * Picture above is Miss World 2005.