A little country with a slew of economic problems

The worst banking crisis relative to the size of its economy: Iceland

The initial stages of the banking and currency crisis:

So far, such protests are the most tangible evidence of the troubles besetting Icelandic society. The landscape bears scars too. From the central bank, the view of snow-dusted Mount Esja across the estuary is blocked by a half-finished grey edifice, sprawled like a dead whale across the harbour-front. This was to have been Iceland’s most spectacular building, crowning 15 years of economic growth: a concert hall facing out to the North Atlantic, covered in glass prisms imported from China meant to resemble glaciers and lava. But since the collapse of the bank that led the funding, construction has almost ground to a halt.

Likewise, blocks of half-built luxury flats stand half-finished along the waterfront. Instead of glass prisms, Icelanders are looking forward to a different Chinese cargo in the dying weeks of the year: fireworks. They set off more per person each new year than any other country in the world. Such is the demand that the Chinese manufacturers are making a special loan to Icelanders to buy them, according to a local newspaper.

The government secures a $US 2.1 billion (roughly 11.7% of GDP) 2-yr loan from the IMF to stabilize the króna, a $10 billion package in total: $827 million available immediately on November 19 (about 4.6% of GDP), and the remainder will be paid in eight quarterly installments. According to the IMF:

• Banking capital controls set in place to limit liability payments; these will be removed as confidence improves.
• As of now, the IMF is allowing fiscal stabilization spending as the unemployment rate rises. The IMF expects the fiscal deficit (spending in excess of revenues) to rise from 0.5% of GDP in 2008 to 8.5% of GDP in 2009.
• The banking crisis is expected to cost Iceland 80% of its GDP; this is roughly 20 times greater than the bill of the Swedish banking crisis.
• GDP expected to drop by 10% in 2009.

The controlling party steps down:

Haarde, who last week said he was suffering from cancer and was to step down as leader of the Independence Party at the party conference in March, said the coalition with the Social Democrats has ended with immediate effect.

A new government leader, Johanna Sigurdardottir, named until the elections on April 25:

Some analysts are already warning that the new government may not be able to make much headway in tackling Iceland's enormous economic problems in the short period until elections in April. But Sigurdardottir's administration will at least no longer be crippled by the widespread public mistrust which brought down her predecessor.

RW: The economic pain is only just getting started. Growth is set to decline precipitously, unemployment will rise sharply, and lending....well, forget about that. And William Buiter warns that the U.K. may face a similar fate:

But even if the UK is not the next European country to face a sovereign debt challenge, there is a non-negligible risk that before too long, the growing exposure of the British sovereign to the banking system (and especially to the foreign currency funding risk faced by the UK banking system), together with the 9 and 10 per cent of GDP general government fiscal deficits expected for the next couple of years, may prompt a loss of confidence by the global financial community in the British banks, currency and sovereign.

We may well witness the UK authorities going cap-in-hand to the IMF, the EU, the ECB and the fiscally super-solvent EU member states (if there are any left), prompted by a triple crisis (banking, sterling and sovereign debt), to request a bail out. I hope and trust that the UK authorities are in regular contact with the IMF, the US administration, Brussels, Frankfurt and the leading EU member countries to prepare for a possible internationally coordinated bail-out operation for the British banking system and sovereign.

Rebecca Wilder