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Sunday, September 12, 2010

Economic Crisis in Iceland

Iceland is a small country in Europe with a total population of around 300,000 people. A country that is smaller population wise to the city in which I was born and brought up (Chennai, India). Iceland was the first country to fall in the long list of countries that succumbed to the global crisis. The country and its economy is so small that a small sum of $20 or $25 billion could have seen it through the economic storm ($25 billion is small considering the trillions of dollars of economic relief that US is giving its economy) but unfortunately it did not have that money. Because of this it suffered a national crisis that has affected its citizens, financial institutions and everyone else. The prime minister of Iceland issued a press release in October 2008 that the country was bankrupt.

We have discussed in detail about the US and the world economic crisis but everyone forgot about this tiny arctic island that was one of the worst hit nations in the global crisis. Let us take a look at what exactly went wrong in the country.

What was Iceland a few years ago?

Iceland is a small arctic island whose main resources prior to their massive misadventure with globalization were thermal springs, fish and cattle. They are a closely knit community where people did not tolerate nonislanders much. To give a clearer example of how small the nation is, the country’s telephone directory lists the people by their first names. Globalization and Privatization were two terms that were not too familiar for this country until a few years ago.

What happened during globalization?


The privatization began in the year 2002 when the nation decided to allow private organizations to grow. The corporate taxes were reduced; incentives were given to people to grow their businesses. New hydro electric plants, aluminium smelting factories etc started sprouting throughout the country. The country decided that it had to grow beyond fishing and grow as a global financial player. With this aim the country privatized its banks. By 2003 there were 3 large private banks in Iceland that were extending easy credit to the islands inhabitants.

In a country with less than 200,000 wage earners, the banks soon ran out of prospective customers to whom they could lend and make money. Hence, they decided to venture outside. They were willing to lend to borrowers from neighbouring countries. To attract more investors from abroad, they were offering interest rates as high as 15% during peak times. This made the Iceland Krona the preferred destination for investors. People would borrow money at their native country at low rates and invest the money in Iceland at such exorbitant rates. Japan was one of the nations from which the country attracted huge sums of money.

By 2005 banks accounted for 95% of the country’s GDP. Borrowed money was the main propellant in this phenomenal growth but still the country ignore the situation and let it continue.

In 2003, Iceland’s government liberalized house-loan standards, in some cases lending purchasers up to 100% of value. Housing prices skyrocketed. Equity refinancing boomed, and people bought more cars, motorcycles and summer homes. Between 2003 and 2004, prices on Iceland’s stock market increased 900%. By 2006, the average Icelander was 300% wealthier than in 2003. As the bubble bulged, Iceland’s banks encouraged customers to buy bank stocks. Because of easy availability of credit, the islanders borrowed money and indulged in luxuries that they would not afford with their income.

By 2006 credit rating agencies around the globe sounded warnings with respect to the credit position of the island. People abroad were wary of the nations credibility and started looking at them watchfully. When the Bank of Japan raised interest rates in 2006, investors sold their positions in Iceland and brought money back to their country. This caused a massive outflow of funds from Iceland but still the country’s financial claimed to be in a sound position and appeased investors and citizens that there was no need to panic.

To repair their damaged credit ratings, some Icelandic financial institutions created online banks, attracting new retail customers, especially from Britain, Germany and the Netherlands.
They offered interest rates of more than 6%, drawing thousands of British and Dutch depositors. Many British institutions – including 116 local governments, plus Oxford and Cambridge Universities – invested in Icelandic banks.

What went wrong?

When the traces of economic troubles were sensed in economic powerhouses like the European union and USA, they tightened credit to countries like Iceland that were growing on borrowed money. They stopped cashflows to the island and asked them to repay. The nations banks were too much exposed to debt from abroad that they were unable to repay their debt obligations. It defaulted, destroying its credit rating and precipitating an economic tailspin. Iceland became linked to the subsequent decline in world financial markets. It suffered first and was deeply wounded, as were other small tax-haven countries, notably Estonia, Latvia and Lithuania.

The Aftermath!!!

In October 2008, the nations prime minister interrupted the TV broadcast and explained the nation of its grave financial adversities. The speech stunned the country. Citizens could not comprehend that their homeland could go bankrupt. One economist later estimated that the nation was €20 to €30 billion in debt. On the personal level, the average Icelander was $403,000 in debt and 25% of homeowners faced mortgage default.

It had tried to move too quickly from poverty to prosperity. As it staggered, aid came from a new source: Russia promised massive loans. Iceland was an ideal fit for its strategic plans to expand its military and commercial ventures in the Arctic.


As the crisis grew, the numbers became staggering: 85% of the banking system failed and more than 50,000 people lost their savings. Eventually more than 7,000 protestors filled the street outside parliament. In January 2009, early elections were announced and the current leaders said that they would not run. The commerce minister fired the head of the financial regulatory authority and then resigned. The Social Democrats and the Left Greens formed a new interim government led by J√≥hanna Sigurdard√≥ttir. She took office in January 2008. She called for joining the European Union, and stressed Iceland’s traditional virtues: modesty, hard work, respect and, in all things, moderation.

Now the country is slowly getting back on its feet just like every other nation that had suffered during the crisis. Because of its small size and population it was hit a bit harder than other countries and would take longer than other nations to recover.

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