Iceland ‘shows the way’ on bailout recovery

Iceland holds some key lessons for nations trying to survive bailouts after the island’s approach to its rescue led to a “surprisingly” strong recovery, the IMF believes.

Iceland’s commitment to its programme, a decision to push losses on to bondholders instead of taxpayers, and the safeguarding of a welfare system that shielded the unemployed from poverty helped propel the nation from collapse toward recovery, according to the organisation.

“Iceland has made significant achievements since the crisis,” Daria Zakharova, IMF mission chief to the island, said. “We have a very positive outlook on growth, especially for this year and next year because it appears to us that the growth is broad-based.”

Iceland refused to protect creditors in its banks, which failed in 2008 after their debts bloated to 10 times the size of the economy.

The island’s subsequent decision to shield itself from a capital outflow by restricting currency movements allowed the government to ward off a speculative attack. That helped the authorities focus on supporting households and businesses.

“The fact that Iceland managed to preserve the social welfare system in the face of a very sizeable fiscal consolidation is one of the major achievements under the programme and of the Icelandic government,” Ms Zakharova said. The programme benefited from “strong implementation, reflecting ownership on the part of the authorities.”

The IMF has programme arrangements with 11 European countries, representing about 65% of its funds, according to its website. Eurozone governments have struggled to comply with the austerity terms prescribed in joint aid packages provided by the IMF and the EU.

Bond markets have reflected a lack of confidence in the recovery programmes, sending debt yields higher and adding to pressure on government finances. Countries have relied on wage cuts and reduced welfare services to reach their bailout goals.

In Iceland, the krona’s 80% plunge against the euro in 2008 helped turn a trade deficit into a surplus by the end of that year. Unemployment, which jumped nine-fold between 2007 and 2010, eased to 4.8% in June from a peak of 9.3% two years ago.

Iceland ended its 33-month programme a year ago. Its €10.5bn economy will expand 2.4% this year, the IMF said in April. That compares with an estimated 0.3% contraction in the eurozone.

Iceland’s growth “is driven by private consumption, investment has picked up strongly and even though, when you look at net exports, those have a negative contribution to growth, it is mainly because imports have been strong, reflecting strong consumption and an increase in income and the healthy expectations of households,” Ms Zakharova said.

“Still, exports have been increasing very strongly. Last year was a banner year for tourism. These are all really positive things.”

Iceland, which started EU membership talks in 2010 with eurozone membership an ultimate goal, is starting to question whether accession is the right way forward. Of the parliament’s 63 members, 39 oppose continuing EU membership talks.

The island still needs to show it can unwind its capital controls successfully, Ms Zakharova said. About €6.5bn in offshore kronur are locked behind the restrictions, which the government has said will be eased gradually by 2015.

“Further monetary tightening is needed, over the next few quarters, in order for Iceland to get to the target.

“But we’ve also seen that the central bank has made strong statements about a hawkish monetary policy stance, indicating that the monetary policy will be tightened over time. So we think that the stance is appropriate at this point.”