What’s the difference between Iceland and Ireland?
In late 2008 and early 2009, following the Icelandic banking collapses, a joke did the rounds in Dublin and beyond: “What’s the difference between Iceland and Ireland?” The answer was: “One letter and about six months.” At the time, as Paul Krugman noted in The New York Times, this was gallows humour mixed with a dash of cheery reassurance: no matter how bad the situation in Ireland, at least it couldn’t be compared with the utter disaster in Iceland. The irony is that, two years, on Iceland seems to be doing rather better.
Is Iceland booming again?
No. It would be absurd to claim that everything is rosy in Iceland. For many citizens, the collapse of the krona has all but decimated their purchasing power. Meanwhile, austerity budgets have taken their toll, as in Ireland. And for many households the currency issue has been particularly harsh. As they busily sucked in foreign investment, Iceland’s collapsed banks had specialised in convincing their countrymen to take out mortgages and loans in foreign currencies, even though their earnings were in krona.
So many Icelanders have been crippled by foreign-exchange loans. As the Icelandic journalist Sigrun Davidsdottir points out in a recent blog commentary, this is the issue which has caused most bitterness and claimed most media attention in Iceland. The country remains angry – there were big demonstrations in Reykjavik in October. Its parliament is even trying to prosecute the former prime minister, Geir Haarde, for criminal negligence over his role in the meltdown.
So what’s the good news?
For all that, the country now looks rather better placed to grow its way back to long-term prosperity than Ireland, according to a growing number of analysts. Here’s the International Monetary Fund’s (IMF) notably upbeat update, published a few weeks ago: “Under the recovery programme, Iceland’s recession has been shallower than expected, and no worse than in less hard-hit countries. At the same time, the krona has stabilised at a competitive level, inflation has come down from 18 to under 5%, and CDS spreads [an indicator of how risky financial markets believe Iceland’s sovereign debt to be] have dropped from around 1,000 to about 300 basis points. Current-account deficits have unwound, and international reserves have been built up, while private-sector bankruptcies have led to a marked decline in external debt, to around 300% of GDP.” In other words, paradoxically, Iceland is doing a good job of bankrupting itself back to recovery. Employment, too, is a bright spot. The current jobless rate of around 6% is grim by Icelandic standards, but envied by most of Europe.
Why is Iceland in half decent shape?
Although at the time it seemed cataclysmic, Iceland’s good fortune was that – unlike Ireland – it allowed banks to fail and default. This wasn’t the result of some grand strategy, just necessity. Throughout 2008 Iceland had struggled to raise emergency capital abroad. In the US, for example, the Federal Reserve told Icelandic officials that arranging a loan of a few billion would make their problems worse. It would show the bond markets that Iceland didn’t understand the gravity of its situation. But once forced into a corner, Iceland made the best of a bad job. The banks went bankrupt and were split up: the foreign debt that had capsized the tiny nation of 320,000 people was stacked into bankrupt banks. Domestic debt was taken on by new banks. These then kept a banking system running throughout the crisis. Depositors were protected and bondholders (and their insurance firms) suffered the pain. A potential slump in the krona was stemmed using stringent capital controls.
What next?
As Iceland’s president Olafur Grimsson told Bloomberg this week, “Iceland is faring much better than anyone expected”. It might not even need to draw on the full $4.6bn in IMF-led loans that it arranged to help it rebuild. The nation’s economy is still contracting – by 7% last year and a projected 1.9% this year. But this is a far better performance than other peripheral European nations, such as Ireland, Latvia and Estonia. Iceland has some competitive advantages that were obscured by the financial crisis. These include a young, educated population with few retirees and an over-funded pension system. There’s also a thriving tourism sector, boosted by the devalued krona. Exports, such as aluminium smelting, are booming. It boasts a cutting-edge energy sector based on hydroelectric and geothermal power stations – expertise that is now being exported to China. In short, Iceland may yet have the last laugh.
What can Ireland learn from Iceland?
Iceland has shown that while continually avoiding bankruptcy can do enormous harm (as the likes of Latvia know), bond markets have been very quick to resume lending to Iceland. Part of Iceland’s relative strength is the flexibility of having a floating exchange rate – a route that is closed to Dublin. But arguably the bigger part of Ireland’s pain is down to its decision to accept devastating austerity in return for a credit line. The purpose of that seems to be to let it continue underwriting the private losses of its banks and maintain “confidence” in the country. But bond markets showed what they thought of this strategy this week: interest rates for Irish debt moved even higher. Once its political crisis is resolved, Dublin’s government might want to read the IMF’s warm assessment of Iceland – and look north for inspiration.