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Iceland

Debt statistics 2016

Overall international debt burden (% of GDP)-3
Government payments on foreign debt (% of revenue)4.5
Government foreign debt (% of GDP)22
Private foreign debt (% of GDP)157
IMF and World Bank debt cancellation ($ billions)0
Country case studiesYes

Country case study

Iceland’s economy had once of the largest foreign debt driven booms in the run-up to the 2007/2008 crisis. But when the crisis hit the government was simply unable to bail out the banks because the debts were too big. Instead, the government protected the domestic banking system and savers, whilst allowing the international banking system to go bust. Debts were effectively written-off. The UK and Netherlands have tried to force Iceland to repay some loans owed by Landesbanki, but the Icelandic people have twice refused in a referendum. The Icelandic people suffered a sharp recession and rise in unemployment. But the economy is now growing again, and unemployment is falling. The crisis prompted a change in government and the writing of a new constitution.

The country with the largest financial boom in the years before 2007 was the Atlantic island of Iceland. Its banking sector went on a borrowing and lending binge, causing external debt to reach 600 per cent of GDP by 2007. In contrast, government debt was just 30 per cent, two-thirds of which was owed in the krona and so likely to be due to Icelandic savers.

When the credit crunch began, the Icelandic banks were no longer able to keep borrowing to role over their debts, and so could not pay their creditors. By October 2008, shortly after Lehman Brothers collapsed, the three largest banks had collapsed.

Unlike in other countries with large foreign debts owed by private banks, such as Ireland, Spain and the UK, the Icelandic government was simply unable to step in and pay the loans instead. Now Prime Minister Jóhanna Sigurðardóttir says “In effect . . . the lion’s share of the banking collapse was borne by foreign creditors. There was no other way, there was no other option, considering that the banks’ assets were ten times Iceland’s GDP.”

Domestic holders of deposits in the banks were protected, with all domestic assets and deposits moved into new banks, with some bailouts from the government. However, the international operations of the banks were put into a regular procedure for bankrupt companies. Effectively, the foreign lenders and speculators into the Icelandic banking system had to write-off large amounts of debt.

One particular set of foreign loans was over £5 billion deposited by savers in the UK and Netherlands in Icesave, an online savings brand operated by Landesbanki, one of the three largest banks. The Icelandic government initially refused to bailout these loans, leading to the UK government seizing Landesbanki UK under anti-terrorism legislation in October 2008.

Through both the EU, and by blocking loan disbursements from the IMF, the Dutch and UK governments put pressure on the Iceland government to take on paying the deposits. They proposed loaning the Icelandic government the money to do so, with repayments to be paid over 14 years. In December 2009 the Icelandic parliament passed a bill in line with this proposal, but a quarter of Iceland’s voters petitioned the President not to sign it. The President refused to sign and a referendum was held, in March 2010, with 93 per cent voting against the UK and Dutch proposal.

A second proposal, this time for repayments of the loans to take place over 30 years, was defeated in April 2011 with 58 per cent voting against. The UK and Netherlands are now taking Iceland to court, through European Free Trade Area procedures. The individual British and Dutch depositors in Icesave have had their money paid out by the UK and Netherlands governments.

The IMF agreed a programme of $2.1 billion of loans in October 2008, and did so accepting the non-bailout of the external banking system. The IMF also unusually allowed capital controls to be brought in to help prevent money rushing out of the country. The Icelandic krona halved in value against the Euro, making exports more competitive, whilst increasing the price for imports. This helped rebalance the Icelandic economy to remove its dependence on foreign lending. A devaluation also increases the relative size of the debt which remains, but the government kept its debt manageable by not taking on large bailouts.

The huge financial crisis had dramatic impacts, with the economy shrinking by 7 per cent in 2009 and 4 per cent in 2010. Unemployment increased from 2 per cent to 8 per cent. Wide-spread protest led to the resignation of the right-wing government in 2009. Subsequent elections led to a coalition government between the Social Democratic Alliance and Left-Green Movement.

One measure of the new government was to create a new constitution. The process involved the random selection of 1,200 people to participate in a constitutional assembly, and the election of 25 people of no declared political orientation to a constitutional council. The new constitution was passed in a referendum in October 2012.

Unlike countries such as Ireland and Spain, Iceland’s economy now appears to be recovering, growing by 3 per cent in 2011 and 2012. Unemployment is falling, so far down to 6 per cent in 2012. And the peak of 8 per cent is well below those in Ireland and Spain of 15 and 25 per cent respectively, so far. The country’s overall net external debt is still high, but projected by the IMF to decline to 65 per cent of GDP by 2017.

Nobel prize wining economist Paul Krugman summarises the Icelandic experience:

Where everyone else bailed out the bankers and made the public pay the price, Iceland let the banks go bust and actually expanded its social safety net. Where everyone else was fixated on trying to placate international investors, Iceland imposed temporary controls on the movement of capital to give itself room to maneuver … Iceland hasn’t avoided major economic damage or a significant drop in living standards. But it has managed to limit both the rise in unemployment and the suffering of the most vulnerable; the social safety net has survived intact, as has the basic decency of its society.”[1]


[1] Krugman, P. (2011). The path not taken. New York Times. 27/10/11.

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