Wednesday, January 19, 2011

The Icesave Saga May Be Coming to a Close


Even though Iceland is a small country, when the global financial crisis began in 2008, it had a disproportionate share of financial woes. Before crisis struck, Iceland's banking sector was more than ten times the size of its actual economy, and its banks were making risky investments that eventually led to their demise. The collapse of Icelandic banks affected many Europeans with large deposits in Icelandic banks. This was particularly true of British depositors, who had hundreds of millions of pounds of British deposits trapped in the collapsed banks, leading to diplomatic tensions between Iceland and Britain. In late 2008, Iceland received €7 billion in loans: €1.5 billion from the IMF; €2 billion from the Nordic countries, Russia, and Poland; and €3.5 billion from Britain, the Netherlands, and Germany, including £2.3 billion from Britain alone. These countries were willing to give Iceland such large loans in order to ensure that their citizens with money tied up in the Icelandic bank Icesave would have their savings returned when Icesave's parent company, Landsbanki, collapsed in 2008. British investors alone had £800 million deposited in Icelandic banks.

The Icelandic Parliament is currently considering a new repayment plan jointly drafted with the U.K. and the Netherlands. Under this scheme, Iceland would pay 42 billion kronur ($406 million). Britain has agreed to a fixed interest rate of 3.3%, while the Netherlands have agreed to a 3% rate. This deal also limits Iceland's payments relative to its national growth, as payments cannot exceed 5% of Iceland's GDP. It is much more favorable for Icelanders than a previous deal vetoed by Icelandic President Olafur Ragnar Grimsson last year that would have resulted in a payback of 162 billion kronur with a 5.5% interest rate. With an Icelandic population of about 300,000, that deal would have cost approximately $20,000 per person, terms that Grimsson claims were "outrageous."

There is a lot riding on this vote for Iceland as well as Britain, as this matter has put significant strain on diplomatic relations between the two countries. British leaders have threatened that a further delay of the resolution of this issue could result in the U.K. withdrawing its support for Iceland's bid to join the EU. Further, if this repayment plan goes into effect, it may improve Iceland's credit rating. Following the President's veto of the first repayment plan, Fitch Ratings lowered Iceland's sovereign rating to junk status (Moody's and Standard and Poor's maintained investment-grade ratings on Icelandic bonds), making borrowing more expensive for Icelanders. Today, two years after the financial collapse, Iceland appears to be recovering after a 1.2% growth in GDP during the third quarter of 2010. Some analysts claim that Iceland's decision to allow its banks to collapse has promoted the country’s recovery.

Discussion Question: Will this new repayment plan allow Iceland to fully recover from the collapse of its banks? Was Grimsson correct in his decision to veto the original repayment plan?

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