"Iceland will honor its obligations" - II

How highly is Iceland in debt now?

(sigh) This is a very complicated story. The government will take on sizable debts as part of the IMF programme and the settlement of the Icesave deposits and also some domestic debts due to the refinancing of the Icelandic banking sector. Then there are some other liabilities, for example due to the fact that we will have a very sizable budget deficit this year and next year as well. So Iceland’s government debt will rise dramatically, going from being one of the least indebted countries in the world to one of the most indebted ones in Western Europe, at least temporarily.

That said; the gross debt - I’m reluctant to give you a precise estimate because of too many uncertainties involved – will be somewhere around one year’s GDP. That means that the situation here is somewhat worse than the situation in Belgium or Italy before the worldwide financial crisis. But a considerable part of that is temporary.

If we look at the IMF loan for getting assets there is little reason to think that we will use up all of the assets. So when things get calm again, we can repay the loan by returning the assets. There will be costs due to interest rates, but we should be able to significantly reduce the government’s debt when things stabilize and when we don’t need these huge currency reserves that the IMF programme has in its plan.


But how is Iceland supposed to pay all these debts considering the depression, companies going bankrupt, consumption decreasing and interests piling?

It’s certainly going to be tough. I don’t want to say a year or two, because it will most likely take somewhat longer than that, but the immediate future looks pretty grim because of all those factors that you mentioned and with government tax receipts falling at the same time. Demands towards the government are also rising, for example unemployment benefits are increasing.

The financial crisis has devastating effects on financial assets, but we have to keep in mind that it doesn’t destroy real assets. They are all there. We have more or less all the human capital. We certainly hope that we will not face too much of a brain drain abroad, although there will be some. But even then we will still have a very well educated and hard-working, flexible labor force.

We have infrastructure and real assets, including the natural resources. There is nothing that says that - once we have gone through this painful financial reorganization - we can’t pick up speed and use these real assets to generate goods and services, including exports.

And we must also keep in mind that the government is getting a lot of assets as well. For example, it now owns the banks and even if they won’t be sold - which is of course a political question whether you want to privatize the banking system again - these should become healthy companies that provide revenues to the government. So, the government’s net debt should fall below one year’s GDP and end up similar to many Western European countries, maybe 50-60% of the GDP, even if we don’t paint a very rosy picture.

History tells us of course that a lot of countries have gone through financial crises – this one of course is fairly severe by international historical standards - but there is no insurmountable problem.


Do you think that other countries might soon face the danger of bankruptcy like Iceland in the course of the worldwide economic crisis, like Greece, Portugal, Ireland?

I certainly hope not. And what is strikingly different in these countries is the fact that they don’t have a small floating currency like we have and they have the backup of EU Central Bank and maybe even some fiscal backup from their fellow governments within the EU. All of that makes it less likely that these countries will have a financial sector that collapses as spectacularly as the Icelandic one.

On the other hand, our currency, being very weak now, will probably help us faster than other countries that are stuck with the Euro. Because the Euro is so strong now that it doesn’t help exports. So our currency contributed to the downfall and the big problems that we have now with foreign debts. But then again we are probably better situated to recover through exports than countries with a strong currency.


When he resigned, Björgvin Sigurdsson, your predecessor said that he regretted not having pushed Iceland more towards EU-membership. Do you think EU-membership would have prevented or reduced the consequences of the worldwide crisis for Iceland?

It would not have prevented a crisis but it would have made the dynamics different, especially when it comes to debts and the loans and the crushing exchange rates. But I doubt that Iceland as a EU-member with the Euro would have escaped the financial crisis, if nothing else had changed.

Should Iceland join the EU now?

This is a very controversial question. Many people are in favor of many aspects of EU-membership, in particular of adopting the Euro. And most economists claim that having its own floating currency without any ties to another currency, is really not a viable option for Iceland in the long-run. But the main stumbling block on Iceland’s way to EU-membership is domestic opposition to adopting the EU fishery policy.


Are you personally in favor of EU-membership?

I am in favor of finding out what it would entail. We should start negotiating with the full intention of entering but of course not deciding to enter until we know what the framework would look like for Iceland’s entry into the EU. Icelandic negotiators would presumably call for some sort of exemption or special treatment with regard to the fishing industry. After completing the negotiations, it would be possible for the Icelandic people to take an informed decision on whether to join or not. But a deal, where we lose all sovereignty over the fishing rights would never be politically viable in Iceland.

Iceland already enjoys almost all other benefits of EU-membership through the EEA agreement. We already have labor mobility, freedom of investment, free-trade and all the economic aspects of being a EU-member so it really boils down to the fishing rights. EU-membership won’t happen in the immediate future, no matter how we rush it.

But I think that a reasonable plan of entering and – when we have entered – then starting moving towards adopting the Euro would be very helpful to bringing financial stability to Iceland. It would maybe not restore full trust in the Icelandic financial system, but it would contribute significantly to building trust in the financial system both in Iceland and in the international community.

Iceland would have to meet the economic requirements also to join the EU?

It would be one of our challenges, that we brought Icelandic interest and inflation rates down to the Euro-zone average within a few years, which is one of the pre-requisites for adopting the Euro. But having a plan that would bring us on that path would be immensely helpful for getting a calmer economic environment in Iceland.


Last question: David Odsson refused to resign when the current Prime Minister asked the Board of Directors of the Icelandic Central Bank to resign. Will he have to go?

This matter is before the Parliament at the moment. There is a bill for discussion in the Parliament, which will change the legislation regarding the Central Bank. I think it’s most likely that the bill will be passed and then we get not just a new bank government but also new monetary policy board.

http://www.iceland.org/info/news/features/nr/6739