Iceland debt and devaluation case paper
1. Could Iceland pay back its debt; how?
2. Moody’s downgraded Iceland, but what did the downgrade do? Was the downgrade justified
3. What was the impact of the collapse of Lehman Brothers on Iceland’s refinance opportunities?
4. Why did Iceland nationalize its banks?
5. What exchange controls did the Central Bank of Iceland impose?
6. What did the IMF do?
7. Why did banks take on so much risk?
8. What about US before subprime crisis? Was the situation comparable?
9.Should Iceland join the EU?
The first reading that can help with the question is attached below.
The second reading that can help with the question is …https://www.bloomberg.com/opinion/articles/2018-09…
(Minimum 1000 word count. Be sure to CITE and REFERENCE 4 sources)Iceland debt and devaluation case paper.
For the exclusive use of v. ernest, 2019. 9-709-011 REV: OCTOBER 22, 2010 ALDO MUSACCHIO Iceland (A) All the fundamentals in our economy are there… in good shape. — Geir H. Haarde, Prime Minister of Iceland, March 13, 20081 Most countries have folk tales of a Faustian character who defies the devil—but the Icelandic Faust, Sæmundur, is the only one to beat the devil. Whether it shows audacity, true genius or pure recklessness can be debated—but beating the devil now seems a small feat compared to fighting rumors and perceptions based on ignorance and investors’ herd mentality. — Sigrún Davíðsdóttir, Icelandic writer and economist, March 31, 20082 In May of 2008, a team of analysts from Moody’s, a ratings agency, considered Iceland. They had to decide whether to maintain Iceland’s Aaa long-term sovereign bond rating (for foreign-currency debt), granted to only the highest grade debt, or downgrade the country’s sovereign bonds to Aa1, or lower (see Exhibits 2a and 2b for ratings). Investor sentiment toward Iceland had changed radically in March, and the Moody’s team was fearful that the situation could spiral out of control. In March 2008 the price of insuring Icelandic bank bonds against default had skyrocketed, and between March and April the Icelandic króna (ISK) exchange rate against the dollar had depreciated 13%. (See Exhibit 4.) In fact, by April 1, Fitch, a ratings agency, had revised its outlook on Iceland from “stable” to “negative,” and on April 17th, S&P, another ratings agency, downgraded the longterm debt of Iceland from A+ to A (with a negative outlook).3 The concerns that emerged in March of 2008 threatened to become another in a series of crises to afflict the Icelandic economy. In 2006, an investor panic had caused Iceland’s banks and other bond issuers to experience a liquidity crunch that led to sharply higher interest rates. The coordinated action of private banks, the Central Bank of Iceland, and the Chamber of Commerce appeased the panic, but in August 2007, the U.S. subprime mortgage crisis erupted unexpectedly, and investors in Icelandic assets became nervous again. The Moody’s team knew that carry traders—investors looking to make a profit by taking advantage of Iceland’s higher interest rates—increased Iceland’s vulnerability to a confidence crisis because they were quick to liquidate their holdings at the first sign of distress.4 Therefore, analysts at Moody’s needed to figure out whether Iceland had enough liquidity to handle a crisis that could involve a run on Icelandic banks’ branches abroad. Moreover, they had to read market sentiment and think carefully about Iceland’s capacity to withstand such a crisis of confidence. (Exhibit 1 shows the factors Moody’s considers to rate sovereigns.) The plunge in the ISK also forced the Icelandic people to confront a decision: would joining the European Union (EU) protect Iceland from capricious swings in investor sentiment? Iceland already enjoyed free access to European markets as a member of the European Economic Area (EEA). As a non-member it retained its autonomy with respect to monetary policy and its ability to protect its ________________________________________________________________________________________________________________ Professor Aldo Musacchio prepared this case with the assistance of Research Associate Jonathan Selter and Gudrun Urfalino Kristinsdottir from the Europe Research Center of Harvard Business School. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2008, 2010 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-5457685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. 709-011 Iceland (A) fishing and energy sectors from foreign ownership. What, if anything, should Iceland do to avoid a future crisis? Iceland debt and devaluation case paper The Icelandic Economy In 874, Norwegian chieftains established the first permanent settlements on the island that would become Iceland. From 1262 until 1944, Iceland was part of the Norwegian, and later Danish, monarchies. In 1940, Allied forces invaded and occupied the island, and on May 20, 1944, the Icelandic people declared independence from Denmark. Iceland joined NATO in 1949 and agreed to host an American military base.5 On June 17, 1944, Iceland formally became an independent republic with an elected parliament, a prime minister and a president. In 2008 the 63 seats of the parliament were divided among five parties as follows: the Independence Party (25), the Left Green Movement (9), the Liberal Party (4), the Progressive Party (7), and the Social Democratic Alliance (18). Iceland developed largely in isolation from the European continent, some 1000 miles away from the United Kingdom. A 2005 European Commission public opinion poll found that Icelanders valued independence highly, with 85% of Icelanders labeling independence as “very important” as compared to the European Union’s average of 53%.6 In November 2007, the U.N. Development Program reported Iceland as the most developed nation in the world.* With a population of just over 300,000, Iceland also ranked as the fifth richest country as measured by GDP per capita (on a purchasing power parity (PPP) basis).7 With few mineral resources, it capitalized on the extensive hydroelectric and geothermal power sources, which filled 70% of the nation’s energy needs.8 The Cod Wars Until the late 1990s, Iceland’s economy had depended largely on fishing. Through the 1970s, Iceland and the United Kingdom faced off over the extension of Iceland’s exclusive economic zone beyond its territorial waters. The conflicts, called the “Cod Wars” by the British press, escalated after the Icelandic Coast Guard cut the nets of British trawlers in what the British claimed was open sea. In order to protect its fishermen, Britain sent warships into the disputed waters in 1972. Ultimately, the British backed down and the Cod Wars ended with a victory for Iceland and with an agreement in 1976. In 2008 Iceland still protected its fishing sector from foreign investment. After the 1980s, Iceland’s dependence on fishing declined.9 By 2001, fishing and marine products accounted for approximately 12% of GDP; by 2006, the share had fallen to 7%.10 This decline was partly explained by the rise of aluminum production and banking as the most dynamic economic sectors. Hydro and Geothermal Power Because of Iceland’s high volcanic activity and high levels of precipitation, hydro and geothermal energy was inexpensive compared to other countries. While most electricity for internal consumption was hydro, investment in geothermal power had increased to facilitate the production * According to the rankings of the Human Development Index, which “provides a composite measure of three dimensions of human development: living a long and healthy life (measured by life expectancy), being educated (measured by adult literacy and enrolment), and having a decent standard of living (measured by purchasing power parity, PPP, income).” For more details on the methodology see the United Nations Human Development Report, available at http://hdr.undp.org/. 2 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. Iceland (A) 709-011 of energy-intensive products such as aluminum. The Reykjanes geothermal power plant began producing energy in 2006 with two turbines producing 100 megawatts. Also in 2006, the Hellisheidi geothermal plant began generating power with two 90-megawatt turbines (with an additional 34megawatts added in 2007). Aluminum Iceland’s cheap electricity made it an attractive location for energy-intensive aluminum smelters (because electricity can account for 20% to 40% of the cost of producing aluminum). Tómas Már Sigurdsson, Managing Director of Alcoa Iceland, noted that “there is a good reason why we’re here. Iceland has the glaciers and geothermal energy,” and added that “we cannot export energy from Iceland, and we [Iceland] need only 5 megawatts… for internal consumption if we don’t include industries. Thus we need to do something with the energy here in Iceland.”11 Most of the aluminum produced in Iceland was exported to Europe, duty-free. In 2007, aluminum made up 20% of Iceland’s exports, very close to fishing’s 30%. According to an IMF mission to Iceland, “[a]luminum-sector investment projects stimulated domestic demand, driving up the level of GDP by more than 20 percent over four years.”12 Iceland’s first aluminum smelter, ISAL, opened in 1969 and was owned by the Swiss company Alusuisse. By 1993, its capacity had tripled to 96,000 tons per year (tpy). In 1997, Alusuisse increased capacity once again, to 160,000 tpy.* The following year, Nordural, a wholly-owned subsidiary of the Canadian firm Columbia Ventures Corporation, launched a 60,000-tpy plant on the western coast. In 2001, the capacity of the Nordural plant reached 90,000 tpy.13 Following Nordural’s sale to the Century Aluminum Company, a $600 million expansion raised its capacity to 180,000 tpy in 2006.14 In 2005 Alcoa, an American aluminum company, broke ground on the $1.25 billion, 346,000-tpy Fjardaral smelter near the town of Reydarfjordur.15 Alcoa, like others, imported most of the capital equipment to build the plant and all of the alumina. The Fjardaral facility opened in 2007 and was expected to reach full capacity in early 2008. Alcoa expected to export at least $1 billion per year in 2008 (or more if prices continued their upward trend).16 In 2008, Alcoa also started to develop a new $1.2 billion plant in Húsavík, northern Iceland.17 Expanding Abroad In the late 1990s Prime Minister David Oddsson led Iceland through a series of reforms later known as the “Icelandic miracle.” His government lowered taxes, cut the budget deficit, deregulated some sectors, and privatized state-owned enterprises. Between 1998 and 1999 state-owned banks were privatized. Domestic investors bought most of the banks because foreigners feared “the fluctuations in the króna exchange rate.”18 Skarphéðinn Berg Steinarsson, CEO of Landic Property and formerly charged with managing the bank privatizations for the Ministry of Finance, explained that “we never expected the privatization of banks to generate such a boom.”19 Newly privatized Icelandic banks expanded rapidly. Lárus Welding, CEO of Glitnir Bank, commented that the expansion of the banking sector took off after 2001. “Icelandic companies were well capitalized, served a small home market, and thus expanded abroad to take advantage of the favorable international environment. The Icelandic banks supported this development, providing financing and solutions to their clients, and expanding internationally at the same time.”20 According to one of the governors of the Central Bank of Iceland, “banks sharply stepped up their activities outside Iceland by acquiring foreign financial companies and establishing branches. These radical changes [were] reflected in the growth of the three largest Icelandic banks’ total assets from 96% of * In 2000, Alcan, the Canadian conglomerate, acquired Alusuisse. Alcan was later acquired by Rio Tinto (in late 2007). 3 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. 709-011 Iceland (A) GDP at the end of 2000 to roughly… [400% of GDP] at the end of 2006 Iceland debt and devaluation case paper.” Kaupthing Bank, Iceland’s largest by assets, acquired Aragon and JP Nordiska (Swedish brokerages), Tyren (a Norwegian asset management company), Norvestia (a Finnish investment company), A. Sundvall (a Norwegian brokerage and research firm), FIH (a Danish bank), Singer & Friedlander (a British integrated financial services company), and the Belgian operations of Robeco Bank. Glitnir Bank also expanded into other Scandinavian countries, buying Kreditbanken, BN bank, and Norse Securities in Norway, and purchasing investment firm Fischer Partners in Sweden and the Asset Management company FIM in Finland. Flexible at Home Iceland followed the economic model of other Nordic nations by having both a market economy and an extensive welfare state, although it maintained tight control over spending and took on relatively little public debt. (See Exhibit 15).21 Life expectancy at birth in Iceland was 81.5 years in 2007, the third highest in the world after Japan and Hong Kong.22 Additionally, at the end of 2007, the fully-funded pension system of Iceland had assets worth almost 130% of GDP. According to most executives, an important characteristic of the Icelandic economy was its flexibility. Despite downturns in 2001 and 2006, unemployment remained low, fluctuating between 1% and 3.5% since 1998. Thordur Fridjonsson, President of Nasdaq OMX, Iceland’s stock exchange, commented “we have a flexible economy used to volatility. We can control unemployment by reducing immigration in downturns or increasing it in upturns. We can also decrease the number of hours worked and we can control our overtime pay.”23 Friðrik Már Baldursson, professor of economics at Reykjavik University, supported this: “We have a flexible economy. Real wages have come down after the exchange rate depreciates; that is, we have inflation and a fall in real wages but we do not have unemployment.” From Baldursson’s point of view Iceland had “fairly lenient labor laws compared to many European countries. Costs of hiring and firing are low.” In addition, low social benefit levels provided incentives to find work. “In fact, people out of work were stigmatized as lazy, the most terrible of sins in Iceland.”24 (See Exhibit 9.) Exchange Rate Regimes and Inflation Iceland’s good fortunes were built on external funding, as foreign capital financed aluminum, hydro and geothermal energy projects, and financial-sector expansion. Iceland’s aluminum-fueled economic expansion came at the cost of sizeable macroeconomic imbalances. According to the report of the 2007 IMF mission to Iceland, “[r]ecord imbalances [i.e., a large current account deficit] built up during the boom,”25 reflecting the “unsustainable pace of domestic demand.”26 Nevertheless, this was not the first time that macroeconomic imbalances had threatened the health of Iceland’s economy. 2001: An Exchange-Rate Odyssey In the 1980s, Iceland’s annual rate of inflation averaged more than 40%. In 1990, the country introduced an anti-inflation plan based on centralized wage bargaining, inflation targeting by the Central Bank, and a fixed exchange rate (pegging the króna to a basket of currencies).27 Inflation fell below 7% in 1991.28 By early 2001, however, aluminum-related capital inflows fueled inflationary pressures. The three governors of the Central Bank faced a tough choice. They could maintain the fixed exchange rate and risk increased inflation, or they could abandon the fixed exchange rate. Iceland faced a classic case of the “unholy trinity” (or “the trilemma”), according to which a nation cannot simultaneously have (1) free capital movement, (2) an independent monetary policy and (3) a fixed exchange rate.29 4 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. Iceland (A) 709-011 An IMF mission recommended that the Central Bank of Iceland abandon its fixed exchange rate and move to a monetary policy of inflation targeting. On March 27, 2001, in the face of mounting pressures, the Central Bank of Iceland heeded the IMF’s advice. The exchange rate depreciated significantly until November. After November of 2001 the exchange rate appreciated rapidly and Icelandic authorities began to fear that with aluminum-sector growth forcing the króna to appreciate, other industries that competed with imports would suffer (See Exhibit 9). Missing the Target In 2001 the IMF mission to Iceland was confident that floating the króna would help control inflation, but it was “less confident about the prospects of achieving…a soft landing.”30 Both predictions, however, were incorrect. The transition to a floating exchange rate had little discernable effect on Icelandic growth, and Fitch noted that “Iceland engineered a remarkable soft landing in 2001-02 following a period of overheating and credit boom.”31 Inflation, however, still overshot the Central Bank of Iceland’s inflation target of 2.5% per year (See Exhibit 9). By June 2005, the OECD noted that, as a result of large capital inflows, “the [Icelandic] economy [was again] overheating.”32 Despite inflation targeting and a floating exchange rate, the board of governors of the Central Bank again faced the problem of “overheating” related to the rapidly expanding aluminum sector, with the largest investment yet to come. Alcoa’s 2005 investment in the Fjardaral smelter represented a capital inflow of over $3,600 per inhabitant. This time, however, the Central Bank had an independent monetary policy at its disposal. The Central Bank of Iceland’s main tool to manipulate interest rates was its collateral loan agreement with credit institutions. The interest rate the central bank charged for 7-day loans to domestic banks based on collateral they provided was referred to as the policy rate. Over the period from May 2004 to April 2008 the policy rate was raised from 5.3% to 15.5%. Nevertheless, the central bank failed to keep inflation under the 2.5% inflation target. Arnór Sighvatsson, Chief Economist of the Central Bank of Iceland, noted that “we’ve had an unusual period. The aluminum and energy sector investments over the last few years were extremely large. At the same time the banking sector was privatized, the restrictions on housing loans by the Housing Finance Fund (HFF) were lifted, and income and consumption taxes were lowered.”33 Sighvatsson and the IMF mission identified Iceland’s Housing Finance Fund (HFF) as one of many obstacles to controlling inflation. In 1999, the HFF had replaced its predecessor, the State Housing Board. The HFF provided housing-related loans to individuals, companies, and local governments. It financed its loans through government-guaranteed inflation-indexed bonds denominated in Icelandic króna. Unsurprisingly, by 2008 the HFF held a 44% share of the Icelandic mortgage market and was an important instrument of the government to get voter support. The central bank’s policy rate had little influence over a large swathe of the Icelandic credit market for three reasons. First, because the HFF funded its mortgage lending via long-term bond issues guaranteed by the government (thus with a Aaa rating), the policy rate did not affect the interest rates on the HFF mortgages.34 Second, since the mortgage rates charged by private banks used the HFF rates as a benchmark, the Central Bank’s monetary policy was also not very effective.35 Finally, as mortgage lending increased so did housing prices and since households were allowed to borrow against the equity of their homes, private consumption also accelerated rapidly during the upswing of housing prices.36 5 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. 709-011 Iceland (A) Carried Away The activities of the HFF were not the sole source of problems for the Central Bank. Iceland’s involvement in the international carry trade undermined monetary policy. “Carry traders” borrowed money in a country with low interest rates and invested it in a currency that offered higher yields. Economic theory dictated that in the long run, the carry trade could not be profitable; gains on interest rate differentials should ultimately be offset by exchange rate depreciation. Despite economists’ predictions, however, the magnitude of the interest rate gap that persisted between Japan and Switzerland and countries such as Latvia, Hungary, or Iceland attracted a robust carry trade. The carry traders’ biggest risk was a sudden depreciation of the currency in which they were investing relative to the currency in which they were borrowing. Thus some carry traders also invested in financial instruments to hedge against currency depreciation.37 International investors were not the only actors to engage in the carry trade. Domestic residents of economies with high interest rates could also borrow abroad to take advantage of the interest arbitrage opportunities. Because Iceland was a developed country with highly efficient financial markets, it became a prime target for “carry traders,” who invested in everything from central government debt to commercial paper to housing bonds issued by the HFF. Icelandic banks themselves had engaged in the carry trade, exploiting the spread between domestic and foreign rates to fund their rapid expansion. The banks, and in particular the three largest banks, used a series of financial transactions and the issuing of so-called Glacier bonds to finance their growing balance sheets.* The Monetary Bulletin of the Central Bank of Iceland argued that low global interest rates meant that the carry trade partly offset the impact of high domestic interest rates.38 Increases in Iceland’s policy rate caused Icelanders to borrow abroad in foreign currencies, replacing expensive domestic credit with cheaper foreign capital. As a result, domestic demand remained resilient despite rising interest rates. Moreover, according to Arnór Sighvattson, since banks in Iceland could not compete with the low rates of the HFF, they lent to households in euros and Swiss francs. 39 The 2006 Near-Crisis and Onwards In early 2006 Iceland debt and devaluation case paper, the chairman of the board of governors of the central bank, David Oddsson, had the unenviable opportunity to prove that he could guide the economy through a shock to the financial system. On February 21, 2006, Fitch revised the outlook on Iceland’s sovereign rating from “stable” to “negative” because there was a “rise in net external indebtedness” that “reached unprecedented proportions and…occurred in the context of clear signs of domestic credit and asset price bubbles.” In Fitch’s view, Iceland would face a crisis as it was forced to correct those imbalances.40 Fitch’s announcement proved to be a self-fulfilling prophecy. A precipitous drop in demand for the króna caused it to depreciate more than 16% between February and March, which further reduced the confidence of international investors. Exchange rate instability continued throughout the first half of the year. Observers worried that Icelandic banks would not be able to refinance their bond issues. (See Exhibit 10, 11a, 11b, 12, 14A and 14B). * Glacier bonds are denominated in Icelandic króna. They are issued by Aaa-rated financial institutions in Switzerland, Austria, Germany, Canada, and other places and sold to retail investors outside of Iceland. These investors buy debt that pays a high return (slightly lower than the interest rate prevailing in Iceland) and are backed by the Aaa rating of the issuing institutions. Since the buyers of these bonds face currency risk because the bonds are denominated in króna, some of them buy swaps to hedge against currency depreciation. Once foreign financial institutions have issued these bonds, they lend the funds to Icelandic banks and companies below the cost of capital in Iceland, but above the interest rate that retail investors in Europe receive for holding Glacier bonds. 6 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. Iceland (A) 709-011 Fortunately, the Icelandic financial system proved its robustness, and the Central Bank shepherded the economy through the brief period of uncertainty. Richard Portes and Friðrik Már Baldursson, wrote that “the ‘mini-crisis’ of 2006 was an informational crisis”41 in which “negative coverage of the banks and Icelandic economy … temporarily erod[ed] international investors’ confidence.”42 After the crisis, Icelandic banks increased their capital ratios, liquidity, and their funding through domestic and foreign deposits. Financial Instability after 2006 After 2006, however, Icelandic banks, citizens, and corporations continued to borrow heavily abroad to take advantage of the spread between domestic and foreign interest rates. On the other side, international carry traders stood ready to lend. With such easy access to international credit, Iceland had become the most highly leveraged economy in the rich world.43 By the end of 2007, total external debt stood at 549% of GDP, and the external debt of Icelandic banks alone presumably totaled more than 400% of GDP. According to the chief economist of Danske Bank, “Iceland [looked] worse on almost all measures than Thailand did before its crisis in 1997, and only moderately healthier than Turkey before its 2001 crisis.”44 Moreover, there was no information on the breakdown of the external debt by type of currency (e.g., a large part of the debt was presumably in Icelandic króna). Yet Almar Gudmundsson, Head of Macro and Credit Strategy of Glitnir Bank, explained “As the Icelandic banks have their headquarters in Iceland, they are considered fully Icelandic for the national accounts, even if a lot of assets and liabilities are for…non-Icelandic businesses. This is why the external accounts are so inflated—the complete balance sheets of the banks are involved. There aren‘t many countries like this in the world…”45 The highly-leveraged financial sector was Moody’s chief source of concern.46 With such vast amounts of foreign capital flowing into the banks, observers began to question the quality of the new assets acquired by Icelandic banks. The IMF noted that “the rapid pace of credit growth suggest[ed] that credit quality could [be] a concern in the event of a sharp domestic downturn.”47 Because of the banks’ extremely leveraged positions, any increase in non-performing loans could cause the banks to default on their debt. Yet Jónas Fr. Jónsson, Director General of the Financial Supervisory Authority of Iceland, pointed out that when looking at credit growth and loan quality, one had to keep in mind that the loan portfolio of the Icelandic banks was highly diversified and asserted that “the banks’ expansion abroad has pre-dominantly been towards wealthy western economies. About 58% of the banks’ income comes from abroad and 55% of loans are made to foreign parties.” Also, “historically there has been a low default rate in the Icelandic mortgage market.”48 In fact, as investors became more risk averse in early 2008 Icelandic banks had a hard time continuing to raise money through new debt. Nevertheless, bankers argued that the financial system was well-placed to withstand the credit crunch. Almar Gudmundsson said that “the leverage of Icelandic banks and the maturity structure of our debt are similar to that of other European banks. Additionally we have enough liquidity to survive 1 to 2 years without new debt issues.”49 (see Exhibit 11a and 11b for the maturity structure of bank debt.) Thordur Palsson, Managing Director of Business Development of Kaupthing Bank, maintained that Kaupthing had “liquidity provisions for more than a year” and “did a private placement of debt of €1.3 billion and we are selling some noncore businesses in [the] UK to increase our liquidity.”50 After 2006, Icelandic banks made concerted efforts to increase deposits as an alternative source of financing. Nevertheless, because Iceland’s population was only 300,000, banks focused on increasing their deposits from overseas. In the January report on Iceland, Joan Feldbaum-Vidra, from Moody’s stated that “the fact that most of the new deposits [were] in countries other than Iceland may mean that they would more likely be withdrawn in the improbable but possible event of a confidence crisis 7 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. 709-011 Iceland (A) affecting the Icelandic banks.”51 Professor Friðrik Már Baldursson remarked that “in 2006 the banks were blamed for relying on wholesale funding [i.e., issuing bonds] and thus increased deposits. Now they are blamed for having too large deposits abroad. At least with bonds you can know the term structure, but with internet banking it is hard to foresee when depositors will withdraw their money.”52 The risk of an electronic bank run was latent for Kaupthing’s operations in England, where in September of 2007 customers of Northern Rock, a British bank, did a run on deposits using the internet. After the 2006 crisis economists worried that, “If the crisis developed into a wider banking sector crisis, it would probably force the government to assume some of the increased debt burden from the banks.”53 According to a Moody’s estimate, in the worst case scenario, a run on deposits outside of Iceland in 2008 would require the Icelandic government to orchestrate a bailout. A run on Icelandic banks could require an intervention of $10 billion in liquidity to pay depositors abroad (in foreign currency). Since the government only had $2.4 billion in foreign exchange reserves and another $1bn from ready credit lines, this was a problem. Given that most of the overseas deposits were other Nordic countries, on May 16th the central banks of Norway, Sweden, and Denmark officially agreed to extend a credit line to the Central Bank of Iceland for up to $2.25 billion to promote financial stability. Moreover, the cost of recapitalizing the banking system and securing credit lines for the initial bailout of Icelandic banks could increase the government’s debt burden by $6 to $7 billion.54 (See Exhibit 7 and 15.) The Debate around EU Accession Icelanders are proud and independent people. We don’t like to be told what to do. But is it possible that now when we are economically challenged we are more willing to run to mama? — Svafa Grönfeldt, President of Reykjavík University55 As the confidence of investors turned against Iceland in early 2008, executives and politicians began a serious discussion of the advantages of joining the European Union. Iceland was a founding member of the European Economic Area (EEA) in 1994. In return for free access to the EU’s internal market, Iceland had had to adopt a significant portion of European law, without any input into how those laws were formed. As a result, however, Iceland would not have to make many future reforms in order to join the EU. Jónas Fr. Jónsson, Director General of the Financial Supervisory Authority of Iceland, explained, “Our legislative framework is very similar to that of other European countries. We are already there.”56 Some Icelandic executives worried that the existence of a separate currency for such a small country forced companies to pay a higher cost of capital. Skarphéðinn Berg Steinarsson, CEO of Landic Properties, stated that it was “hard to explain to foreign banks that the Icelandic króna is not a risk of significance because we operate in many countries, but in times like this bankers don’t like to take any currency risk.”57 Thórður Pálsson, Managing Director of Business Development of Kaupthing Bank, added, “The main problem is not having the ISK [króna] as a currency in a small country, [but] the problem is credibility. The ISK is not like the Swiss franc, an acceptable currency. The ISK has lost value many times and that is why nobody believes in it.”58 According to some executives it would be easy for other Icelandic companies to have accounts in euros. For example, Actavis, a pharmaceutical company, switched its accounting to euros in 2004 and had an easier time getting syndicated loans from European banks. Iceland could eliminate exchange rate risk by unilaterally adopting the euro, much as Montenegro adopted the German mark in 1997 (and later the euro). Unilateral adoption without joining the EU posed two problems. First, according to Almar Guðmundsson, Head of Macro and 8 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. Iceland (A) 709-011 Credit Strategy of Glitnir Bank, by joining the EU Icelandic banks would have access to credit from the European Central Bank (ECB) (e.g., short-term collateralized loans). Second, in February of 2008, Jürgen Stark, from the ECB’s executive board, warned that “the ECB would neither encourage nor facilitate” unilateral euroization in Iceland. Yet the consequences were not clear.59 Becoming a full member of the EU, however, posed political costs. The Icelandic government valued the right to protect some fishing, agriculture, and geothermal energy from foreign competition and investment. The biggest fear for many Icelanders was that EU accession would imply that the government could assign initial fishing quotas, but nothing would prevent Icelandic fishing companies from selling those rights to foreign companies. Given that Icelandic fishing companies supported the Independence Party, the strongest party in parliament since 1944, there was strong political opposition against EU accession. Joining the EU also entailed loss of sovereignty in two other ways. First, the country would lose its de jure monetary policy autonomy if it joined the euro. Second, since it is a relatively developed country, it would have to contribute funds to the EU to make transfers to poorer countries. The former Prime Minister, David Oddsson, from the Independence Party, summed up the opposition to joining the European Union when he said, “EU membership would limit our independence, deprive the nation of the control over its natural resources, increase public expenditures and bureaucracy, and lead to a situation that would be less economically beneficial for the country. As a result, the Independence Party thinks that EU membership would not serve the interests of the Icelandic nation in the present situation.”60 There was no consensus among political parties regarding EU accession though. Prime Minister Geir H. Haarde declared that the Social Democratic Alliance and the Independence Party had different views on the matter of EU membership. According to Haarde, the Social Democratic Alliance wanted to apply for membership but not the Independence Party. Given the agreement between the leadership of both parties as part of the ruling coalition in parliament, Haarde asserted that “the government would not apply for EU membership, as it was not on the coalition’s agenda.” Moreover, it was not clear whether Iceland could meet the criteria required to adopt the euro. (See Exhibit 16 outlining the criteria to join the European Monetary Union.) The Art of Sovereign Debt Ratings With the revival of the international markets for sovereign debt in the 1990s, rating agencies began to play a central role in the international financial architecture. Because of the way financial regulation was structured in the United States and Europe, banks and investment funds depended on the job of rating agencies to determine the riskiness of their portfolios. As financial market integration deepened, the job of rating agencies became more complex. Iceland debt and devaluation case paper “The agencies could not rate the firms without rating their sovereigns first, because of the sovereign ceiling [i.e., firms are usually not more credit worthy than the government of their home country].”61 Occasionally, however, in some countries, companies that earned most of their revenues in foreign currency had ratings above those of the government. In 2008, there were two dominant rating agencies, Moody’s and S&P, both rating most of the securities traded in international markets (Fitch had a small share of the market). These rating agencies developed a rating scale to inform investors of the relative probabilities of default of sovereigns and companies. (Exhibit 2a shows the sovereign rating scales of Moody’s and S&P.) Finally, ratings were not absolute, but only relative measures of default risk. A country with a Aaa rating was less likely to default than a country with a Aa1 rating. Yet, within a range of creditworthiness, comparisons of credit metrics were also important. For instance, an Aaa country 9 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. 709-011 Iceland (A) with a debt to GDP ratio substantially higher than those of other Aaa-rated countries was likely to be downgraded by the rating agencies.62 In describing the special nature of sovereign ratings, a Moody’s official wrote that rating sovereigns requires a combination of quantitative skills with “sensitivity to historical, political, and cultural factors that do not easily lend themselves to quantification.”63 The list of economic fundamentals that were involved in the analysis of a sovereign was long, but was not supposed to be used in isolation from the context (see Exhibit 1). Moreover, one of the most important considerations when rating a sovereign was not only what the government was doing, but also what investors and other rating analysts were thinking. 2008: A Storm Brewing? In March 2008, the króna plunged (See Exhibit 4). Fitch and Moody’s placed Iceland on negative watch arguing that “in the current climate of intense global risk aversion” there were concerns about “Iceland’s heightened vulnerability to market sentiment in the light of its large gross external financing need (mostly due to banks), its wide current account deficit, and rising net external indebtedness.”64 In response, Daniel Svavarsson, an economist at the Central Bank of Iceland, claimed that Iceland’s imbalances were greatly exaggerated. He agreed that Iceland’s gross foreign debt stood at five times GDP and that the country’s net international investment position (i.e., the value of foreign assets held by Icelanders minus the value of liabilities of Iceland to foreigners) stood at negative 125% of GDP. He disagreed, however, that these were useful measures. Iceland recorded FDI at book value while recording other liabilities and assets at market value. If inward and outward FDI were marked to market, Iceland’s net international investment position would fall to only negative 27% of GDP. By the time the English translation of Svavarsson’s arguments came out, S&P had already downgraded the “long-term foreign currency [debt] rating on the Republic of Iceland” from A+ to A (with a negative outlook).65 (See Exhibit 2a). In order to rate Iceland’s sovereign debt, the Moody’s team had to take into account Iceland’s international economic position, the outlook for the country’s major industries, the reactions of participants in the carry trade, the health of the banking system, political factors, and S&P’s decision to downgrade the long-term debt of Iceland. (See Exhibit 1 for the list of factors considered by Moody’s analysts.) On the evening of May 19th the Moody’s team met to make a decision regarding the sovereign rating of Iceland’s long-term sovereign debt. Should they downgrade Iceland’s sovereign rating? 10 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. Iceland (A) Exhibit 1 709-011 Moody’s Criteria for Evaluating a Sovereign’s Outlook Main categories Moody’s considers to rate sovereigns Economic structure and performance Fiscal indicators External payments and debt Monetary vulnerability and liquidity indicators Political and cultural factors Capacity to absorb the shock of banking crisis and bail outs Some of the main metrics used to rate sovereigns GDP, GDP per capita, population, GDPin US$ (PPP), GDP growth, inflation, unemployment, gross investment to GDP, gross domestic savings to GDP, exports, imports, net exports, openness of the economy (exports+ imports of goods and services/GDP) Government revenue to GDP, government expenditures to GDP, fiscal balance to GDP, primary balance to GDP, government debt to GDP, government debt to government revenue Real effective exchange rate, unit labor costs, current account balance to GDP, foreign currency debt, foreign currency debt to GDP, foreign currency debt to current account receipts, net foreign direct investment, net international investment position, official exchange reserves (in US$) Short-term interest rate, domestic credit to GDP, changes in M1 and M2, debt service ratios, external vulnerability indicator (short-term external debt + currently maturing long-term debt / official foreign exchange reserves), and others… “[Q]uantitative metrics do not tell the whole story. Governments rated Aaa are also generally extremely wealthy, with high and relatively even per capita income and low economic volatility.” In fact, “relatively low income dispersion is an important determinant of the political and social cohesion that is the essence of a Aaa-rated country, a characteristic that tends to unite the population in a crisis and drives them to find a solution that serves the greater good of society.” When facing a banking crisis, Moody’s looks at the capacity the sovereign has to absorb the bailout of the banking system without driving the debt metrics of the country out of line with those of other Aaa countries. For instance, when bailing out the banking system, the change in government debt to GDP should not worsen in comparison to peer Aaa-rated countries. Source: Adapted from Moody’s, Moody’s Rating Methodology Handbook, April 2002 and Moody’s, “Anchors in the Storm: Aaa Governments and Bank Bail-Outs,” March 2008. 11 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. 709-011 Exhibit 2a 5-Mar-08 21-Oct-02 20-Jul-97 16-Jun-97 24-Jun-96 10-Apr-96 24-May-89 Exhibit 2b Iceland (A) Ratings for Iceland’s Long-Term Foreign-Currency Sovereign Debt Moody’s Sovereign Rating /outlook Aaa/Negative Aaa Aa3 A1/Possible upgrade A1 A2/ Possible upgrade A2 1-Apr-08 20-Nov-07 22-Dec-06 5-Jun-06 10-Feb-05 16-Dec-03 15-Nov-02 22-Oct-01 21-Mar-01 27-May-98 15-Mar-96 S&P Sovereign Rating /outlook A+ / Negative A+ / Negative A+ / Stable AA- / Negative AA- / Stable A+ / Positive A+ / Stable A+ / Negative A+ / Stable A+ / Positive A+ / Stable Moody’s Ratings for the Long-Term Foreign-Currency Debt of Icelandic Banks Landsbanki Moody’s Date Rating/watch 14-Mar-2008 A2 / Negative Date Mar-2008 28-Feb-2008 30-Jan-2008 10-Apr-2007 3-Apr-2007 24-Feb-2007 7-Mar-2005 14-May-1999 Feb-2008 Jan-2008 Apr-2007 Feb-2007 May-2003 May-2000 Jan-1999 A2 Aa3 / Negative Aa3 Aaa / Negative Aaa A2 A3 Glitnir Moody’s Rating/watch A2 / Negative A2 Aa3 Aa3 Aaa A1 A2 A3 Kaupthing* Moody’s Date Rating/watch Feb-2008 A1 Apr-2007 Feb-2007 Nov-2004 Dec-2003 May-2003 Aa3 Aaa A1 A2 A3 Source: Adapted from Moody’s, “Iceland,” April 2008 and S&P Ratings Direct, available at www.ratingsdirect.com. Bank ratings from the bank web pages, www.glitnirbank.com, www.kaupthing.com, and Bloomberg. Note: For Moody’s, long-term sovereign debt and corporate debt is categorized from highest grade to lowest grade as Aaa, Aa1 ,Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, and C. Sovereign and corporate bonds categorized as Baa3 and above are investment grade. For S&P long-term debt is categorized from highest grade to lowest grade as AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, C, and D. Sovereign and corporate bonds rated as BBB- and above are investment grade. 12 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. Iceland (A) Exhibit 3 709-011 Maps of Europe and Iceland Source: Courtesy of the University of Texas Libraries, The University of Texas at Austin. Note: Iceland is approximately 1,000 miles away from the United Kingdom. Exhibit 4 Exchange Rate (ISK per US$, end of the month), January 2005 to April 2008 Source: Adapted from Global Financial Data. Note: An increase in the exchange rate (ISK per US$) represents a depreciation of the Icelandic króna (ISK). 13 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. 709-011 Exhibit 5 Iceland (A) Iceland’s GDP by Sector (% of total GDP) Agriculture, hunting, forestry and fishing Agriculture, hunting, and forestry Fishing Industry, including energy Mining and quarrying Manufacturing Electricity, gas, and water supply Construction Wholesale and retail trade, hotels, and restaurants Financial, real-estate, and renting Financial intermediation Real estate and renting Other service activities (incl. healthcare) 1970 10.5 4.7 5.8 32.8 0.1 30.2 2.4 14.1 1980 10.6 3.9 6.8 32.9 0.2 29.6 3.2 11.8 1990 10.1 2.8 7.3 28.7 0.1 25.4 3.2 11.7 2000 7.2 1.9 5.3 23.8 0.2 20.7 2.9 10.2 2006 5.2 1.4 3.8 20.6 0.1 17.6 2.9 12.6 22.0 10.0 2.2 7.8 10.7 20.9 11.3 3.2 8.1 12.5 20.2 13.0 3.8 9.1 16.3 23.1 15.4 4.2 11.2 20.3 22.1 20.6 6.3 14.3 18.8 Source: Adapted from the webpage of the National Statistical Institute of Iceland, April 3, 2008, available at http://www.statice.is/. Exhibit 6 Iceland’s Population and Labor Force Distribution Population (millions) 1998 2000 2002 2004 2006 2007 0.28 0.28 0.29 0.29 0.31 0.31 Employment by Sector (as a % of labor force) Agriculture 4.4 4.4 3.8 3.5 3.8 3.4 Fishing and Fish Processing 9.2 8.2 7.5 6.4 5.0 4.2 Manufacturing 11.8 11.2 10.2 10.6 9.5 9.2 Electricity and Water Supply 1.0 0.8 1.0 1.0 0.9 1.0 Construction 7.4 6.7 7.8 7.4 8.7 8.9 Wholesale, Retail Trade, Repairs 13.9 14.0 13.7 12.7 13.9 14.3 Hotels, Restaurants 3.0 4.1 3.5 3.4 3.6 3.5 Transport, Communication 7.3 6.8 6.2 6.9 7.1 6.3 Financial Intermediation 3.2 4.2 3.9 4.4 4.3 4.9 Real Estate and Business Activities 6.4 8.3 8.5 9.3 9.0 9.7 Public Administration 4.7 4.5 5.0 4.8 5.2 5.0 Education 6.5 6.3 8.1 7.8 7.5 7.6 Health Services, Social Work 14.0 13.2 13.8 14.7 15.0 14.7 Other 7.2% 7.3% 7.1% 7.2% 6.7% 7.1% Source: Adapted from the webpage of the National Statistical Institute of Iceland available at http://www.statice.is/. 14 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. Average Real GDP Growth (1998-2007) 4.4 3.5 2.4 3.3 2,0 3.6 2.3 1.5 6.6 1.2 5.3 2.5 3.3 2.5 5.2 3.8 3.2 2.0 2.9 2.9 Government Revenue as a % of GDP 43.2 34.9 47.3 39.6 59.2 51.2 50.2 43.2 36.3 31.7 38.3 47.9 43.0 52.6 14.1 40.0 51.8 36.8 41.0 34.0 Government Expenditure as a % of GDP 44.6 34.0 48.0 39.0 49.8 47.4 52.8 43.3 36.6 35.2 37.2 47.4 40.7 38.4 14.5 38.7 39.7 35.8 44.0 36.8 Government Debt to GDP (%) 29.4 14.3 58.4 64.9 22.2 33.1 64.1 62.6 26.9 184.3 6.0 44.8 23.0 50.6 39.8 34.6 36.2 44.5 44.8 63.2 Government Debt Service to Revenue (%) 5.4 2.3 5.3 2.8 3.2 2.9 5.2 6.2 2.5 9.0 0.5 4.6 n.a. 2.6 0.3 3.8 3.4 4.1 4.9 6.5 Current Account Balance as a % of GDP -15.6 -5.2 5.3 0.8 1.5 5.9 -2.3 5.8 -4.4 4.0 12.7 7.5 -6.6 11.4 22.8 -9.6 6.2 15.0 -3.5 -4.7 Global Competitiveness Index a 5.02 5.17 5.23 5.34 5.55 5.49 5.18 5.51 5.03 5.43 4.88 5.40 4.98 5.20 5.45 4.66 5.54 5.62 5.41 5.67 Government Effectiveness b Index 2.13 1.94 1.62 2.03 2.29 2.08 1.20 1.52 1.53 1.29 1.73 1.86 1.94 2.10 2.20 1.05 2.00 2.13 1.83 1.64 Adapted from Moody’s (www. moodys.com), the Economist Intelligence Unit, Country Data, the International Monetary Fund, International Financial Statistics, the World Economic Forum web page (www.weforum.org), and the World Bank’s Governance Indicators web page (http://info.worldbank.org/governance/wgi2007/). GDP Per Capita, US$ (PPP) 41,824 37,098 38,192 38,459 37,306 35,368 33,273 33,993 43,383 33,610 82,304 38,763 26,613 53,304 41,680 29,900 36,631 39,649 35,050 45,818 Public + Private External Debt as a % of GDP 500.2 86.8 203.9 47.0 153.8 117.7 183.3 147.2 824.6 37.2 n.a. 319.1 n.a. 117.3 n.a. 148.5 n.a. 336.5 416.4 82.4 -15- b The Governmental Effectiveness Index is compiled by the World Bank. It combines responses on the quality of public services and the bureaucracy that provides them, the competence and political independence of civil servants, and the credibility of the government’s commitment to its policies. Since the index is normalized all countries are rated from -2.5 to 2.5, with 2.5 given only to the most effective of governments. a The Global Competitiveness Index (from the World Economic Forum’s Global Competitiveness Report) ranks countries according to publicly available data and using the results of an Executive Opinion Survey (with over 11,000 respondents in 131 countries). The Global Competitiveness Index scores countries along institutional, development, and macroeconomic variables. The index goes from 0 to 7, with 7 representing the highest rating (the United States is the most competitive country according to this index with a score of 5.67). Source: Nominal GDP, US$ bn (PPP) 13 758 318 1,266 203 185 2,051 2,807 186 4,284 38 640 113 250 187 1,351 336 300 2,137 13,841 Selected Economic Indicators of Countries with a Aaa Sovereign Rating from Moody’s (at the end of 2007) Country Iceland Australia Austria Canada Denmark Finland France Germany Ireland Japan Luxembourg Netherlands New Zealand Norway Singapore Spain Sweden Switzerland United Kingdom United States Exhibit 7 709-011 For the exclusive use of v. ernest, 2019. This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. 59.9 22.9 21.8 0.02 33.6 38.3 15.7 58.1 22.2 24.0 0.15 34.7 39.2 19.3 60.6 23.4 22.9 0.37 33.6 40.9 14.3 2000 13,220 8,697 4.32 56.2 23.6 21.5 -0.27 38.8 39.9 20.7 2001 13,737 7,922 3.91 54.9 25.4 18.2 -0.02 37.4 35.9 21.2 2002 13,753 8,906 0.12 57.2 26.1 19.9 -0.17 34.3 37.4 18.7 2003 14,088 10,970 2.43 57.1 25.1 23.5 -0.10 34.1 39.8 16.6 2004 15,179 13,241 7.75 12.78 4.53 7.40 4.71 65.11 5.15 1.65 75.19 63.78 84.83 0.28 2.80 60.83 18.75 Lending Interest Rate (%) Deposit Interest Rate (%) Money Market Interest Rate (%) Long-term Bond Yield (%) Stockmarket Index (2000=100) GDP Deflator (avg % change) Inflation (avg % change CPI) Consumer Price Index (2005=100) Nominal Wage Index (2005=100) Real Wage Index (2005=100) Population (mn) Unemployment (%) Unit Labor Cost Index in US$ (2005=100) Labor Cost (US$/hr) 0.28 1.88 63.99 19.81 3.26 3.23 77.62 68.12 87.76 79.46 13.30 4.84 8.61 4.29 1999 72.34 Source: Adapted from the Economist Intelligence Unit, Country Data. 1998 70.96 Iceland’s Money, Wages, and Demographics Exchange Rate (kr/$), avg Exhibit 9 0.28 1.34 62.61 19.84 3.64 5.14 81.61 72.65 89.03 99.99 16.80 7.11 11.15 5.30 2000 78.62 0.29 1.40 53.73 17.40 8.64 6.41 86.83 79.08 91.08 72.48 17.95 6.94 10.98 5.26 2001 97.42 0.29 2.51 62.02 20.35 5.63 5.20 91.35 84.73 92.76 86.60 15.37 4.70 8.01 5.23 2002 91.66 0.29 3.37 76.33 25.70 0.64 2.06 93.22 89.46 95.96 107.46 11.95 4.83 5.01 4.41 2003 76.71 0.29 3.10 83.30 30.35 2.50 3.16 96.17 93.66 97.39 185.58 12.02 4.88 6.08 3.83 2004 70.19 *Real GDP in Icelandic króna at 2000 chained prices, converted to US dollars using the end of the year exchange rate to the US$ dollar. Source: Adapted from the Economist Intelligence Unit, Country Data. 1999 12,672 8,743 4.09 1998 12,174 8,292 6.32 Iceland’s GDP and its Components Real GDP (in US$ mn, 2005 prices)* Nominal GDP (US$ mn) Real GDP Growth (% pa) Components (as a % of nominal GDP) Private Consumption Government Consumption Gross Fixed Investment Stockbuilding Exports of G&S Imports of G&S Estimated Gross Domestic Savings Exhibit 8 0.30 2.05 100.00 37.80 2.87 3.99 100.00 100.00 100.00 262.63 14.78 7.00 8.96 3.70 2005 62.98 59.5 24.6 28.4 -0.08 31.6 44.0 11.4 2005 16,251 16,251 7.06 0.31 1.29 101.46 37.42 8.99 6.69 106.69 109.54 102.68 356.87 17.93 9.70 12.83 4.38 2006 70.20 58.7 24.4 33.7 1.16 32.0 50.0 11.6 2006 16,942 16,567 4.25 0.31 1.00 123.80 44.93 6.40 5.10 112.10 119.50 106.60 20.90 11.30 15.20 5.30 2007 63.79 58.4 24.6 27.5 0.23 35.3 46.0 12.8 2007 17,498 20,043 3.28 709-011 -16- For the exclusive use of v. ernest, 2019. This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. Iceland (A) Exhibit 10 709-011 Iceland’s Gross External Debt (in US$ billions) 1998 5.8 0.9 4.9 0.0 1999 7.2 1.2 5.8 0.2 2000 8.6 1.4 7.1 0.1 2001 9.1 1.5 7.4 0.2 2002 11.0 2.3 8.5 0.2 2003 16.5 3.7 12.2 0.6 2004 27.2 5.0 21.3 0.9 2005 46.1 7.3 37.3 1.5 2006 72.5 12.2 57.7 2.6 2007 113.4 40.6 69.7 3.1 General Government Debt Short-term debt Long-term debt 2.0 0.2 1.8 1.9 0.3 1.6 2.0 0.4 1.6 2.3 0.4 1.9 2.8 0.4 2.4 3.1 0.2 2.9 3.5 0.2 3.3 2.4 0.0 2.4 3.4 0.0 3.4 3.9 0.0 3.9 Commercial Banks Short-term debt Long-term debt 1.5 0.5 1.1 2.3 0.4 1.9 4.2 0.6 3.6 4.1 0.7 3.4 5.6 1.8 3.9 10.2 3.3 6.9 20.0 4.6 15.4 37.9 7.0 30.8 59.3 11.5 47.9 95.5 39.9 55.3 Other Sectors Short-term debt Long-term debt 2.3 0.2 2.0 2.8 0.5 2.3 2.2 0.4 1.9 2.5 0.4 2.1 2.4 0.1 2.2 2.6 0.2 2.4 2.8 0.2 2.6 4.4 0.3 4.1 7.2 0.7 6.4 11.2 0.7 10.5 Owed to Direct Investors 0.0 0.2 0.1 0.2 0.2 0.6 0.9 1.5 2.6 3.1 70% 59% 82% 66% 99% 82% 115% 93% 124% 95% 150% 111% 205% 161% 284% 230% 438% 348% 566% 348% 192% 159% 229% 186% 300% 244% 294% 240% 267% 206% 357% 275% 460% 371% 685% 572% 908% 750% 789% 529% Total External Debt Short-term debt Long-term debt Owed to direct investors External Debt Ratios External debt as a % of GDP External debt position Of which long-term debt Debt as a % of export revenue External debt position Of which long-term debt Source: Central Bank of Iceland, Statistics… available at http://www.sedlabanki.is/. Some totals may not add up exactly because of rounding errors. Exhibit 11a Amount of Debt Coming Due in Each Year for the Three Largest Icelandic Banks (Glitnir, Landsbanki, and Kaupthing) Exhibit 11b Percent of Debt Coming Due in 2008, 2009 and 2010-and-after for Banks in Iceland, Norway, Denmark, and Sweden (Icelandic Banks Circled) Source: Adapted by the author from data from Glitnir’s research department. 17 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. -6.8% 495 -9.7% 405 2000 -847 -474 1,902 -2,376 -121 -243 147 -390 -10 843 -3 846 -219 -375 155 475 -667 -651 -16 1,142 -44 1,186 591 -70 74 -4.2% 355 2001 -336 -75 2,016 -2,091 12 -264 171 -435 -9 176 4 172 -166 -332 166 601 -64 -67 3 665 43 622 -262 111 48 1.6% 462 2002 145 150 2,240 -2,090 -5 -13 305 -318 14 -65 -1 -64 -250 -342 93 143 -324 -265 -59 467 55 413 43 -19 -61 -4.9% 819 2003 -534 -210 2,386 -2,596 -125 -183 376 -559 -15 439 -5 444 -48 -384 336 3,010 -593 -531 -62 3,604 -46 3,650 -2,518 401 -307 -10.0% 1,074 2004 -1,317 -519 2,896 -3,415 -215 -565 470 -1,035 -17 1,922 -3 1,925 -1,830 -2,587 757 6,725 -1,675 -1,612 -63 8,401 302 8,099 -2,969 -404 -202 -16.2% 1,069 2005 -2,648 -1,482 3,107 -4,590 -516 -622 1,455 -2,078 -27 2,327 -27 2,354 -3,990 -7,114 3,124 12,228 -4,707 -3,279 -1,428 16,935 83 16,851 -5,884 392 -71 -24.6% 2,342 2006 -4,090 -2,239 3,477 -5,716 -691 -1,125 2,495 -3,620 -35 7,084 -26 7,110 -1,669 -5,555 3,886 11,359 -3,021 -1,062 -1,959 14,380 1,166 13,214 -2,580 -1,743 -1,252 -16.2% 2,632 2007 -3,306 -1,385 4,793 -6,179 -691 -1,170 4,358 -5,528 -60 -1,981 -30 -1,951 -11,644 -10,227 -1,417 -6,631 -7,230 -2,565 -4,665 599 211 388 16,324 5,395 -108 The change in foreign reserves and changes in the stock of foreign reserves may not match because of the revaluation of foreign assets from movements in the exchange rate and fluctuations of asset prices. -6.7% 429 1999 -589 -307 2,009 -2,316 -97 -175 129 -304 -10 863 -1 864 -59 -125 65 582 -448 -369 -79 1,030 56 974 341 -189 -86 -18- Source: International Financial Statistics, accessed September 28, 2010. Current GDP in US$ calculated from GDP in krona and average period krona-dollar exchange rate. Foreign reserves include gold at national valuation. Note: Memorandum accounts Current account to GDP Foreign reserves, US$ mn Capital account Financial account Direct investment Abroad In Iceland Portfolio investment Assets Equities Debt securities Liabilities Equities Debt securities Other investments net Errors and omissions Change in foreign reserves Net current transfers Capital and financial account Balance on services Balance on income Receipts Expenditures Balance on goods Goods exports Goods imports 1998 -555 -351 1,927 -2,279 -12 -178 120 -298 -14 678 -5 683 75 -75 150 -235 -303 -253 -51 68 14 54 844 -91 -32 Iceland’s Balance of Payments (US$ millions) Current account Exhibit 12 709-011 For the exclusive use of v. ernest, 2019. This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. Iceland (A) Exhibit 13 709-011 Iceland’s Net International Investment Position (IIP) Panel A. NIIP According to the IMF Methodology, 2004 –2005 Net International investment position (US$ bill.) NIIP as a % of GDP Net external debt position Net external debt position (US$ billions) Net external debt position (as a % of GDP) By sector (as a % of GDP) Central bank Central government Commercial banks Other sectors 2004 -8.8 -62.7 2005 -14.2 -67.4 2006 -21.9 -84.6 2007 -22.1 -125.4 -14.9 93.3 -25.6 113.5 -37.4 152.4 -43.3 246.4 -5.8 18.8 68.9 11.4 -4.9 11.2 93.5 13.7 -10.8 15.7 123.4 24.1 -12.9 19.3 200.7 39.3 Panel B. Iceland’s Foreign Assets and Liabilities (US$ billions) Total assets abroad Components (as a % of total assets abroad) Direct investment abroad Portfolio assets Other investment Reserves Total liabilities abroad Components (as a % of total liabilities abroad) Direct investment in Iceland Portfolio liabilities, of which Equity capital Debt securities Other liabilities, of which Long-term loans Short term-loans Bank deposits 2004 16.3 2005 41.0 2006 71.4 2007 90.2 21.4 32.4 40.6 5.7 25.1 25.4 27.8 44.1 2.7 55.2 21.8 25.9 48.6 3.7 93.3 24.3 25.8 47.4 2.5 112.2 7.2 70.9 2.7 68.2 21.9 12.0 8.3 1.7 8.8 70.9 7.0 63.9 20.3 10.8 8.0 1.5 9.2 66.1 6.0 60.1 24.6 11.4 7.1 6.2 9.4 45.9 4.5 41.4 44.7 14.4 14.3 16.0 Source: Adapted from Central Bank of Iceland, Monetary Bulletin, March 2008. Note: Net International Investment Position (NIIP) is the net of the value of foreign assets held by Icelanders minus the value of liabilities of Iceland to foreigners. Data in this exhibit was estimated by the Central Bank of Iceland following the IMF methodology. Both FDI abroad and in Iceland is included in the calculations at book value. Most other liabilities are valued at market prices. 19 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. 709-011 Exhibit 14A Iceland (A) Consolidated Balance Sheet of Kaupthing Bank, 2006-2007 (in US$ millions) 2007 2006 Assets Cash and balances with central banks Loans to credit institutions Loans to customers Securities and derivatives Other 83,481 1,529 9,186 51,587 13,199 7,979 57,786 1,524 6,916 36,173 9,477 3,696 Liabilities and equity Credit institutions and central banks Deposits Borrowings Subordinated loans Other liabilities and minority interest Shareholders’ Equity 83,481 5,294 21,567 40,839 4,173 6,213 5,395 57,786 1,574 10,696 34,197 3,078 3,631 4,610 Source: Kaupthing Bank, Annual Report, 2007, www.kaupthing.com/ Exhibit 14B Consolidated Balance Sheet of Glitnir Bank, 2006-2007 (in US$ millions) Assets Cash and cash balances with central banks Derivatives Bonds and debt instruments Shares and equity instruments Loans to banks Loans to consumers Investment in associates Investment property Property and equipment Other assets 2007 48,176 870 1,861 4,373 1,655 4,365 30,960 44 87 66 1,947 2006 32,454 291 1,034 3,300 1,551 2,522 22,738 62 47 455 Liabilities +Equity Short positions Derivatives Deposits from central banks Deposits from banks Deposits from customers Debt issued and other borrowed funds Subordinated loans Other liabilities Shareholders’ Equity 47,138 236 1,215 73 792 11,371 27,374 1,594 910 2,665 32,441 69 865 513 606 6,243 19,627 1,553 441 2,081 Source: www.glitnirbank.com. 20 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. Iceland (A) Exhibit 15 709-011 Government Budget Surplus/Deficit as a Percentage of GDP, 1998 -2007 1998 1999 2001 2002 2003 2004 2005 2006 2007 2008* 41.6 44.3 44.4 42.9 43.8 44.5 45.6 47.6 45.1 43.2 42.6 35.6 38.2 38.3 36.5 36.3 37.8 38.8 41.3 38.9 36.9 36.3 Expenditure (incl. interest) 41.1 42.0 42.0 42.8 44.6 46.5 45.3 44.4 43.2 44.6 45.2 Interest expenditure Budget Surplus (+ )/Deficit (- ) 3.4 3.4 3.1 3.5 2.9 2.9 2.6 2.5 2.3 2.1 2.1 0.5 2.3 2.4 0.2 -0.8 -2.0 0.3 3.2 1.9 -1.4 -2.7 Revenue (incl. tax revenue) Tax revenue 2000 Source: Statistics Iceland, Economist Intelligence Unit. *Data for 2008 is a forecast. Exhibit 16 Convergence Criteria to Join the European Monetary Union Requirement Actual target 1. Price stability Inflation must be within ±1.5 percentage points of the average of the three EU countries with the lowest inflation rates (in 2007 this average was approximately 1.2%) 2. Interest rates Long-term interest rates must be within ± 2 percentage points of the average of the three countries with the three lowest inflation rates (in 2007 the average was approximately 4.3%). 3. Government budget deficits Budget deficits must not exceed 3% of GDP 4. Public debt Public debt must not exceed 60% of GDP 5. Currency stability The currency must not have been devalued in the previous two years and should have remained within a normal fluctuation band (originally ±2.25%) in relation to the euro. Source: Adapted from Richard H.K. Vietor, “European Monetary Union,” HBS No. 799-131 (Boston: Harvard Business School Publishing, 1999), p. 6. Note: Countries can join the European Union without adopting the euro as their currency. New member countries are expected to adopt the euro as soon as they meet the convergence criteria listed above. (The U.K., Denmark, and Sweden have opt-outs from this arrangement and are not required to adopt the euro.) 21 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. 709-011 Iceland (A) Endnotes 1 Interview with Gair Haarde, Prime Minister of Iceland, Bloomberg News, March 13, 2008. 2 Sigrún Davíðsdóttir, “In a small community, much can be left unsaid,” Letters, Financial Times, March 31, 2008. 3 Paul Rawkins and David Heslam, “Republic of Iceland,” Iceland credit update, Fitch Ratings, April 22, 2008, p1 and Eileen X Zhang, “Iceland Sovereign Ratings Lowered On External Funding Risks; Outlook Negative,” Standard & Poor’s Ratings, April 17, 2008, p. 1. 4 Moody’s. “Iceland’s Aaa Ratings at a Crossroads.” January 2008, p. 1. 5 Iceland’s history from the official web page www.iceland.is 6 European Commission. “Social Values, Science and Technology.” June 2005, p. XX. 7 United Nations Development Program. “Human Development Report 2007/2008.” November 27, 2007. 8 Statistics Iceland’s web page, http://www.statice.is/. 9 Siv Fridleifsdottir. “Conserving Nature, Creating Wealth – Challenges for Iceland and the Arctic in the 21st Century.” Arctic Environment Times. October 2003, p. XX. 10 Ministry of Fisheries. “Icelandic Fisheries in Figures.” 2006. 11 Interview with Tómas Már Sigurdsson, CEO of Alcoa Iceland, April 17th, 2008. 12 International Monetary Fund. “Iceland: 2007 Article IV Consultation.” IMF Country Report 07/295, p. 3. 13 Hilmarsson, T. “Energy and Aluminum in Iceland.” Symposium. Phoenix, January 12-14, 2003. Paper presented at the Platts Aluminum 14 Data from the Invest in Iceland Agency’s web page, available at http://www.invest.is/. 15 Data from the Invest in Iceland Agency’s web page, available at http://www.invest.is/. 16 Interview with Tómas Már Sigurdsson, CEO of Alcoa Iceland, April 17th, 2008. 17 Data from Alco Iceland’s web page, available at http://www.alcoa.com/iceland/en/alcoa_iceland/ smelter.asp. 18 Interview with Skarphéðinn Berg Steinarsson, CEO of Landic Property and former Head of Division of the th Ministry of Finance in charge of bank privatizations, Reykjavik, April 18 , 2008. 19 Interview with Skarphéðinn Berg Steinarsson, CEO of Landic Property and former Head of Division of the th Ministry of Finance in charge of bank privatizations, Reykjavik, April 18 , 2008. 20 Interview with Lárus Welding, CEO of Glitnir Bank, April 17th, 2008. 21 Organization for Economic Cooperation and Development. Society at a Glance: OECD Social Indicators 2006 Edition. Paris: OECD Publishing, 2007, p. XX. 22 23 Data from the United Nations Human Development Indicators, available at http://hdrstats.undp.org/. Interview with Thórður Friðjónsson, President of Nasdaq OMX, Iceland’s Stock Exchange, April 17th, 2008. 24 Interview with Friðrik Már Baldursson, professor of economics and finance at Reykjavik University, April 18th, 2008. 25 International Monetary Fund. “Iceland: 2007 Article IV Consultation.” IMF Country Report 07/295, p. 4. 26 International Monetary Fund. “Iceland: 2007 Article IV Consultation.” IMF Country Report 07/295, p. 17. 22 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. Iceland (A) 27 709-011 Economist Intelligence Unit. 28 Gudmundsson, M., T.G. Petursson and A. Sighvatsson. “Optimal Exchange Rate Policy: The Case of Iceland.” Central Bank of Iceland Working Paper No. 8. May 2000. 29 International Monetary Fund. Mission.” January 18, 2001. 30 International Monetary Fund. Mission.” January 18, 2001. 31 “Iceland: 2001 Article IV Consultation—Concluding Statement of the “Iceland: 2001 Article IV Consultation—Concluding Statement of the Rating Report on Iceland, Fitch, 5/19/2004. 32 Organization for Economic Cooperation and Development. “Economic Outlook: Economic Developments in Iceland.” June 2005, p. 89. 33 Interview with Arnór Sighvattson, Chief Economist of the Central Bank of Iceland, April 17th, 2008. 34 International Monetary Fund, “Iceland: 2007 Article IV Consultation—Staff Report” IMF Country Report No. 07/295, p. 14. 35 International Monetary Fund. “Iceland: 2007 Article IV Consultation.” IMF Country Report 07/295, p. 32. 36 International Monetary Fund, “Iceland: 2007 Article IV Consultation—Staff Report…” August, 2007, p. 14. 37 The Economist. “Vanishing Vigilantes.” July 15, 2007. 38 Central Bank of Iceland. “Monetary Bulletin.” November 2007, p. 6. 39 Interview with Arnór Sighvattson, Chief Economist of the Central Bank of Iceland, April 17th, 2008. 40 Fitch Ratings. “Iceland: Macro Imbalances Trigger Negative Outlook.” February 22, 2006, p. 1. 41 Richard Portes and Friðrik Már Baldursson, “The Internationalisation of Iceland’s Financial Sector,” Iceland Chamber of Commerce, 2007, p. 5. 42 Ibid., p. 19 43 Danske Bank. “Iceland: Geyser Crisis.” March 21, 2006, p.2. 44 Ibid. 45 Interview with Almar Gudmundsson, Managing Director of Nordic Research of Glitnir Bank, April 16th, 2008. 46 Moody’s. “Iceland’s Aaa Ratings at a Crossroads.” January 2008, p. 1-5. 47 International Monetary Fund. “Iceland: 2007 Article IV Consultation.” IMF Country Report 07/295, p. 6. 48 Interview with Jónas Fr. Jónsson, Director General of the Financial Supervisory Authority of Iceland, April th 17 , 2008. 49 Interview with Almar Gudmundsson, Managing Director of Nordic Research of Glitnir Bank, April 16th, 2008. 50 Interview with Thordur Palsson, Managing Director of Business Development of Kaupthing Bank, April 17th, 2008. 51 Moody’s. “Iceland’s Aaa Ratings at a Crossroads.” January 2008, p. 1. 52 Interview with Friðrik Már Baldursson, professor of economics and finance at Reykjavik University, April 18th, 2008. 23 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019. For the exclusive use of v. ernest, 2019. 709-011 53 Danske Bank, “Iceland: Geyser Crisis.” March 21, 2006, p. 10. 54 Moody’s. “Iceland’s Aaa Ratings at a Crossroads.” January 2008, p. 4. Iceland (A) 55 Interview with Svafa Grönfeldt, President of Reykjavik University and former VP of Actavis, the fifth th largest pharmaceutical company in the world, April 17 , 2008. 56 Interview with Jónas Fr. Jónsson, Director General of the Financial Supervisory Authority of Iceland, April 17th, 2008. 57 Interview with Skarphéðinn Berg Steinarsson, CEO of Landic Property and former Head of Division of the Ministry of Finance in charge of bank privatizations, Reykjavik, April 18th, 2008. 58 Interview with Thórður Pálsson, Managing Director of Business Development of Kaupthing Bank, April 17th, 2008. 59 Speech by Jürgen Stark, Member of the Executive Board of the ECB delivered at the Icelandic Chamber of Commerce, Reykjavik, 13 February 2008 taken from http://www.lawofemu.info/blog/. 60 Quote from Eiríkur Bergmann Einarsson, “Hvers vegna EES en ekki ESB?” (Why the EEA but not the EU?), Tímarit um félagsvísindi, Bifröst University, www.bifrost.is/Files/Skra_0024167.pdf, accessed in April 2008 (in Icelandic). 61 Rawi Abdelal, Capital Rules: The Construction of Global Finance, Cambridge, Mass: Harvard University Press, 2007, p 175. 62 Ibid, p 162-176. 63 Ibid, p 176. 64 Paul Rawkins and David Heslam, “Republic of Iceland,” Iceland credit update, Fitch Ratings, April 22, 2008, p1. 65 Eileen X Zhang, “Iceland Sovereign Ratings Lowered on External Funding Risks; Outlook Negative,” Standard & Poor’s Ratings, April 17, 2008, p. 1. 24 This document is authorized for use only by vanessa ernest in BUSINESS POLICY AND STRATEGY SUMMER 2019 taught by CAROL CONNELL, CUNY – Brooklyn College from May 2019 to Nov 2019.
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