Iceland: Quiet Progress on Key Reforms

• Author: Camilla Andersen
• Position: IMF Survey online

A loss of confidence, caused by the financial sector's high leverage and dependence on foreign financing, had led to the collapse of Iceland's three main banks in the span of a single week.

The result was a deep recession that has yet to run its course. Iceland, the first victim of the economic crisis that would soon engulf the world, turned to the IMF for a loan worth $2.1 billion and advice on how to rebuild its shattered economy.

Today, much has changed. Following elections in April 2009, the new government has been working with quiet determination to rebuild the country's crisis-hit economy in consultation with the IMF. Thanks to extensive talks, the government was able to agree a fiscal package with social partners, and good progress has been made on the immensely complicated task of restructuring Iceland's failed banks.

One of the most difficult issues facing the government has been to reach agreement on how to compensate foreign depositors who lost money in Icelandic banks. Problems in reaching agreement with representatives of these depositors complicated the task of securing additional financing for the IMF-supported program and led to a delay in completing the first review of the program. But thanks to recent substantial progress on this and other issues, the IMF's Executive Board is now expected to discuss the first review of the IMF-supported program on October 28, 2009. Once the review has been completed, Iceland's government will be able to access $167.4 million (SDR 105 million) in new financing from the IMF.

In this interview, the IMF's mission chief for Iceland, Mark Flanagan, talks about how far the country has come since the shocking events of last October. Flanagan, who leads a team of nine economists, is in close contact with the authorities. He and his colleagues have held extensive meetings with the government, the central bank, and the financial supervisory authority. To gain a deeper understanding of the challenges facing people in Iceland, they have also met with parliamentarians, CEOs of banks and companies, the employers federation, labor unions, representatives of creditors, and academics.

IMF Survey online: Can you paint a picture of Iceland's economy today?

Flanagan: Well, there's no getting around the fact that 2009 will be the year when Iceland feels the full impact of the crisis. Unemployment now exceeds 7 percent, up from 1 percent in 2007, and preliminary data suggest that the year-on-year decline in GDP will reach 8½ percent. That's a big number, but it's actually less than we originally anticipated. There has been a sharp drop in domestic demand but much of this has fallen on imports. Consumption has also taken less of a hit than we thought it would, thanks to fiscal support and help to consumers with debt rescheduling.

The imbalances that marked Iceland's unsustainable boom-high inflation and an enormous current account deficit-have rapidly unwound.

At the same time, the imbalances that...