Sunday, October 12, 2008

Iceland: a little economy that made a big mess

Iceland’s economy has been hot since 2005, and since 2003, the banking sector has grown to a gargantuan size compared to its tiny economy since 2003. In Iceland’s case, the banking sector outgrew its financial foundation long ago, and now the beanstalk is tumbling down. Key economic statistics are projected to tumble going forward. What is it about this little economy that made big big headlines?

Some facts about Iceland:
- It is roughly the size of Kentucky.
- Population is estimated at 304,367 in 2008.
- Language: Icelandic, English, Nordic languages, German.
- Iceland declared independence from Denmark on June 17, 1944.
- Fishing industry is its primary production advantage, accounting for 70% of export revenues and employing 6% of the labor force.
- Other important industries are aluminum smelting, ferrosilicon production, geothermal power, and tourism.
- Is opposed to EU membership.
- Major export partners: Netherlands 21.3%, Germany 13.3%, UK 13.2%, Ireland 7.7%, US 7.3%, Spain 4.6%, Japan 4.3% (2007).
- The Central Bank of Iceland sets it monetary policy rate, currently 15.5%, in order to target a 2.5% inflation rate.
- Inflation in Iceland averaged 11.14% in 2008 – far from its 2.5% target.

A brief look at Iceland's robust economy

Iceland’s population growth has been strong since 2005, averaging 2.2% during 2005-2008.

Unemployment is low, averaging just 1.08% in 2008.

Strong labor income has contributed to stable and robust economic growth in Iceland.

However, investors saw the crash coming – the Iceland Stock Exchange has lost 66% since July 2007 when it peaked at 8174.28.

The chart lists the Iceland Stock Exchange compared to the Dow Jones Industrial Average on a daily basis through 10/10/08, where the values have been indexed to 1. Both stock markets heated up in 2007, and both have taken a turn for the worse since late 2007. Both markets have lost substantial value since late September; the Dow lost 24%, while Iceland Stock Exchange lost 29%. However, the Dow’s downturn has been much more gradual, losing just 39% since July 2007, compared to Iceland’s 66% loss over the same period.

Why Iceland is suffering relative to other developed economies: DEBT

Such a little economy – with its €14.5 billion total production value – has created a huge mess for itself. According to the Economist Iceland’s two largest banks were privatized in 2003, and since then, have accrued a joint €125 billion in assets, roughly 8.5 times the size of the economy. The debt burden is off the charts: in 2006, the household debt to income ratio was 213% (U.S. debt to income ratio is 169%), and the bank loan to deposit ratio exceeded 300%. The credit crunch hit Iceland particularly hard because banks – which were heavily reliant on outside sources of funds - could/can not roll over debt and are being forced to delever their balance sheets.

The chart lists the ratio of total domestic debt (central government + municipalities + private industry + household minus inter-institutional transactions) as a share of income (nominal GDP) on a quarterly basis spanning the years 2000 to 2008. The Icelandic credit system ballooned to 453% of GDP in the second quarter of 2008, down from its first quarter 2008 peak of 516%. Further, household and industry debt has been growing relative to government debt - which is currently less than 5% of total debt - and together are currently 436% the size of GDP. The central and municipal governments of Iceland run a very tight fiscal budget, while households and private industry have been walking a precarious tightrope of debt management; unfortunately this rope broke with the fallout of global credit markets. Going forward, its debt growth will likely bury Iceland's economy.

Iceland is not alone, but its debt burden is particularly bad relative to other industrial economies.

Source: Economist


With a global credit crunch underway, industry and households in Iceland have been hit particularly hard relative to other industrialized economies. With their total debt burden peaking at 504% of GDP, it was only a matter of time before the financial system toppled over with such a muddy foundation. Now, it is only a matter of time before the hard economic data incorporates the imminent restructuring of the financial system. As households and industry de-lever, unemployment will rise, incomes will fall with consumption and investment, the stock market will continue to decline with expected earnings growth, and the overall economy growth will likely contract.

Rebecca Wilder


  1. Welcome home! The situation in Iceland saddens me. The Icelanders I've met have been interesting, vital people with the touch of Scandanavia. Its too bad the banks were privatized which seems to have led to the present circumstances. There are so few people in the country and where do they turn?

  2.  The initiative taken for the concern is very serious and need an
    attention of every one. This is the concern which exists in the
    society and needs to be eliminated from the society as soon as
     Stock Exchange