Slow thaw in Iceland's banking system

There are tentative steps that the land of ice and fire is recovering from the collapse of its banking system. The severity of the damage, however, could take a lifetime to repair. Harvey Jones reports If you thought the credit crunch hit Dubai hard, spare a thought for Iceland. The land of ice and fire suffered the world's greatest ever banking meltdown in October 2008, when its banking system collapsed in a week. Before the crash, Iceland's poorly regulated banking system, run by a small band of elite businessmen with close government links, was worth an incredible 12 times the country's GDP. When the line of short-term credit dried up, the entire country went bankrupt.

Yet reporters who fly to Iceland to get a first-hand look at a financial crisis come away baffled. The summer skies are cloudlessly blue, the roads are crammed with Hummers and SUVs, bars and clubs are bursting, and the people are smartly dressed and highly educated. Even the volcano has stopped smoking, for now. If this is a financial crisis, bring it on. The state still functions, but for Iceland's 300,000 inhabitants, the future is highly uncertain, says Sverrir Tomasson, 69, a lecturer in old Norse literature at a college in Reykjavik. "The biggest shock was devaluation. Our currency fell by more than 35 per cent, pushing up the cost of imports. The price of everything shot up overnight, even fish. Many homeowners had taken out mortgages in foreign currencies, and their repayments doubled overnight. Income tax and VAT have also risen sharply."

The Icelandic stock market fell 90 per cent. GDP shrank by 5.5 per cent in just six months. Inflation hit 14 per cent, and interest rates were hiked to 18 per cent. The country erupted. "People were shocked and angry. There were protests and the government was overthrown. Many people lost their jobs, particularly in the construction industry. It has been a very painful time." Like most of the country, Mr Tomasson was watching helplessly from the sidelines, but Asgeir Jonsson had a front row seat. He was chief economist at the country's largest bank, Kaupthing Bank, which went bust along with Glitnir and Landsbanki, and has subsequently written a book on the subject, Why Iceland?.

It was a traumatic time, but Iceland has been lucky in one respect. "Our banking system totally collapsed, which means the government didn't have to spend huge sums of money bailing it out, unlike the US and most of Europe. When it comes to the recovery, you could say we have first mover advantage," says Mr Jonsson. And the collapse in the krona has also boosted the economy. "Our export surplus is now 10 per cent of national output," he adds. "Fish is our main export, and our catch has been boosted by global warming, which has encouraged new species to move up north. It helps that the cost of fish has been rising."

Iceland doesn't just have fish, though, it also has energy, an aluminium industry, and tourism, with foreign visitors attracted by this once-pricey destination's sudden affordability. Mr Jonsson says the economy is slowly returning to health. In June, the Icelandic Monetary Policy Committee cut its key lending rate to 8 per cent, the sixth reduction in a row. Inflation is down to 7.5 per cent. The krona has appreciated more than 8 per cent against the euro. Unemployment recently fell to 7.4 per cent, below the EU average of 10 per cent.

Iceland also has greater access to foreign liquidity, thanks to an IMF bailout. "During the crisis, the country introduced capital controls to stop money leaving the country. We have now lifted those controls for new investments, making the country more attractive to foreign investors," says Mr Jonsson. Foreign investors have been tentatively putting their money into Icelandic government and corporate bonds. "Investors have even been buying bonds in the old banks, which have been selling at a discount, as low as six cents to the dollar. Next, foreign investors will target the stock market. A lot of bankrupt companies will start re-listing, and I expect to see interest in that. But investing in Iceland is still risky."

While the locals remain shaken by the crisis, Mr Jonsson says optimism is returning. "Iceland is now in better shape than many European countries. During the Greek crisis, the spreads on Icelandic credit default swaps didn't change that much. We have no hidden bubbles, so we can concentrate on rebuilding instead. But it will take years to rebuild international confidence in our political and business structures."

The crisis has changed the lives of everybody in Iceland, including Mr Jonsson. "Before, I was the chief economist of an international investment bank. Now I'm the chief economist at Arion Bank, a small domestic bank. We have all gone back to basics. But when everybody is suffering, it isn't so bad." Thordur Hilmarsson, managing director of the Invest in Iceland Agency, which seeks to encourage foreign direct investment, says ironically, Iceland's troubles have put it on the investment map.

"We've had tremendous interest from all sorts of companies over the last year, attracted by the weak krona. Most of these companies are heavily energy dependent and want access to our affordable renewable energy sources." Solar power and information and communication technology companies have set up in Iceland. "We have a good strategic location between the US and Europe, which makes us a favourable location for many Asian companies. Our infrastructure is superb, everybody speaks English, and we are more competitive on costs."

The Icelandic banking saga isn't over yet. In March, local voters rejected a plan to pay £3.4 billion (Dh19.75bn) in compensation to savers in Britain and the Netherlands who put their money into doomed bank Icesave. Iceland has been told that its application to join the EU won't be approved until this issue is resolved. Mr Tomasson will retire when he turns 70. He already knows retirement will be tough. "I face 40 per cent tax on my pension. That is the highest rate among the Nordic countries, and they have famously high taxation rates. The crisis will hurt me and my family for the rest of my lifetime.

"We went from one of Europe's poorest countries to one of the richest. Now we are poor again. We survived previous crises, and we will survive this crisis as well," he says. pf@thenational.ae