The economy is still flat, but a rebound in growth is expected later in 2010.
The IMF’s Executive Board approved September 30 a fourth disbursement of $159 million under Iceland’s $2.2 billion Stand-By Arrangement.
In this interview, Mark Flanagan, IMF mission chief for Iceland for the past two years, reflects on the strength of the recovery and the many challenges that remain, including reaching a final settlement on Icesave (the failed internet bank), consolidating recent fiscal gains, and creating new jobs.
IMF Survey online: Has Iceland finally overcome the crisis?
Flanagan: Iceland experienced one of the deepest financial crises in modern history. In the immediate wake of the crisis, the expectation was for a very deep recession followed by a gradual recovery. In the event, the recession has proved shallower than expected, and Iceland’s growth decline of about -7 percent in 2009 compares favorably against other countries hard hit by the crisis.
Still, there are many headwinds confronting the economy: fiscal adjustment, the private sector debt overhang and, during the second quarter of 2010, the impact of the volcanic eruption. This is why the economy has been struggling to get traction in 2010, but we do expect a durable recovery to begin soon. There are risks, of course, in particular related to the timetable of some major energy-sector investment projects.
While growth has taken some time to revive, there have been other notable macroeconomic successes. The krona has stabilized and over the past year has even appreciated. This is important, because so many companies have heavy exposures to foreign exchange and foreign exchange-linked debt. Inflation has come down from a peak of 19 percent at the time of the crisis to less than 4 percent on an annual basis. This is important, because so many people have mortgages that are indexed to inflation. The very large current account imbalances that characterized Iceland in the pre-crisis boom years have also been completely unwound, and the current account is now in surplus.
Finally, credit default swap (CDS) spreads on Icelandic government debt have come down sharply, from almost 1,000 basis points in the wake of the crisis to around 300 basis points at present, reflecting the macroeconomic stabilization, and also the government’s efforts to consolidate the fiscal position and restore the financial sector.
IMF Survey online: Has Iceland managed to get its debt under control?
Flanagan: The crisis did see an enormous leap in public debt, from under 30 percent of GDP to around 115 percent of GDP. The main contributing factors were the large fiscal deficits that helped cushion the economy from the crisis in the initial phase, and the need to recapitalize the financial system. The government has moved decisively to adjust the fiscal position and contain the initially adverse post-crisis debt dynamics. The 2010 budget contained revenue and expenditure measures amounting to 5½ percent of GDP, and the...