What to do when your country’s banking sector and exchange rate look like this?
Iceland is looking to downsize its banking industry altogether.
Yesterday we learned the arctic state may or may not be getting a €4bn loan from the Russians and may also be considering pegging the crown to the euro at 131/euro (however, the crown traded weaker than that for most of yesterday). What has been approved by the government so far is a €500m central bank loan to Kaupthing Bank, regulatory power to take over bank assets and a blanket guarantee of all local deposits. This is Deutsche Bank economist Gillian Edgeworth’s take on the situation:
The above measures help to protect the sovereign’s own balance sheet, allowing it to absorb bank assets and liabilities but not guaranteeing to do so. This has obvious downside for creditors. Aware that it did not have the ability to underwrite the banking sector in full, the government had to decide which banks it chose to offer a lifeline to. Having bought a 75% stake in Glitnir last Monday it has opted to help fund Kaupthing, while leaving Landsbanki to its own devices.
Rescuing the banks is no small task for Iceland however. At the end of July its banking sector liabilities stood at 850 per cent of GDP (73 per cent of which are foreign), according to Deutsche Bank. BIS data has the banks owing $44bn to other BIS banks over the course of 2009, up from $18.5bn over the 12 months beginning in the second quarter of last year, DB says.
Of course the inevitable contraction in Icelandic banking and a weakened currency doesn’t bode well for the government’s own finances. Those deposit guarantees equate to about 88 per cent of GDP (or $17.9bn according to DB) — contingent liabilities of course but they could well add to costs (Not to mention the liabilities from Glitnir which equate to about 269 per cent of GDP).
DB thinks the country could post a deficit next year after a surplus worth 5.5 per cent of GDP in the last. Further downgrades to the country’s sovereign ratings could be on the way too.
So what’s the world’s 18th biggest island to do, other than hope to adopt the euro? Flog its natural assets of course.
Even then however, as DB notes, tough times are ahead.
These latest developments will also likely see the government try to accelerate any potential FDI inflows keen to take advantage of Iceland’s geo- and hydro thermal energy resources. The Finance Ministry estimates these investments at 5-6% of GDP per annum over 2009-11. Such investments offer Iceland a growth strategy over a multi year horizon but will not help avoid recession over the coming quarters.
That said, it’s not looking too pretty in the UK now either. And we have no volcanoes and geysers to sell.
Related links
Iceland pegs it - FT Alphaville
Iced - FT Alphaville
