Iceland Gets Help to Recover from Crisis

• Author: Camilla Andersen
• Position: IMF External Relations Department
• Pages: 185-187

Page 185

The financial crisis engulfing the world claimed Iceland-which has a population of just 300,000-as one of its early victims.

In response, Iceland formulated a comprehensive program to tackle the fallout from the crisis, for which it requested IMF support. On October 24, an IMF package totaling $2.1 billion was announced under the Fund's fast-track emergency financing mechanism.

The IMF's Executive Board approved the two-year Stand-By Arrangement for Iceland on November 19, making $827 million immediately available to the country and the remainder in eight equal installments, subject to quarterly reviews.

Iceland's economic program envisages that the IMF loan will fill about 42 percent of the country's 2008-10 financing gap. The remainder will be met by official bilateral creditors.

In the following interview, Poul Thomsen, the IMF's mission chief for Iceland and Deputy Director of the IMF'sPage 186 European Department, talks about the crisis and the country's plans for dealing with the repercussions.

IMF Survey: What went wrong in Iceland?

Thomsen: Iceland allowed a very oversized banking system to develop-a banking system that significantly outstripped the authorities' ability to act as a lender of last resort when the system ran into trouble.

Only a few years ago, Iceland had a banking system that was the normal size.

But after the privatization of the banking sector was completed in 2003, the banks increased their assets from being worth slightly more than 100 percent of GDP to being worth close to 1,000 percent of GDP.

When confidence problems intensified this fall, Iceland was one of the first victims because the market realized that the banking system was far too big relative to the size of the economy. As investors started to pull out, it quickly spilled over into trouble for the Icelandic króna.

Within a week, three banks collapsed, the króna's value dropped by more than 70 percent, and the stock market lost more than 80 percent of its value. For a small economy that is totally dependent on imports, this was a crisis of huge proportions.

IMF Survey: What is the IMF-backed program hoping to achieve?

Thomsen: In the short run, the program is narrowly focused on stabilizing the króna.

Iceland still has a highly leveraged economy.

Most of the debt is either denominated in foreign exchange or indexed to inflation, so when the króna depreciates, debt servicing becomes much more expensive. If we don't stop the decline of the...