Kreppa No More? Iceland’s Decade of Economic Recovery

This week, the government of Iceland published a white paper [In Icelandic] on the country’s financial system, a move which widely viewed as signalling a long-awaited conclusion to ten years of economic recovery from the country’s devastating banking crisis, commonly known in the country as the kreppa.

Among the recommendations of the report were improved regulation and oversight of the country’s financial sector, steps to rebuild public trust in Icelandic financial institutions, greater efficiency in banking practices in the wake of financial technologies (‘fintech’), and select lowering of taxes. It was also argued in the document that Iceland should have a minimum of three separate banks to ensure healthy competition. As well, transparency and engagement were stressed, along with reducing the number of state financial holdings.

The Icelandic economy became the first major casualty of the global financial crisis, and was arguably referred to as the ‘canary in the coal mine’ which would eventually portend a debt emergency which affected much of Europe over the following years. After the crumbling of banking and financial services giant Lehman Brothers in September 2018, forcing the firm to apply for Chapter 11 bankruptcy protection, debt strains on Iceland’s three largest banks, Glitnir, Kaupthing (Kaupþing) and Landsbanki, resulted in their inability to service their own short-term debts, leading to their collapse and one of the worst economic downturns in modern history.

The bank failures also placed massive downward pressure on the value of the Icelandic króna, and despite an ill-fated attempt to peg the value of the currency to the euro, the króna continued to fall. Discussions began about whether Iceland would need to abandon its previous wariness about joining the European Union in order to make use of the euro instead, as a means of exchange, as well as to provide needed shelter from the developing global debt crises which would eventually affect the United States and other Western economies. This would mean, however, that Iceland would have lost much of its existing trade policy sovereignty, including endangering [paywall] landmark free trade negotiations with China.

In the short term, capital controls were required in order to prevent a further fall in the currency. Other effects of the crash were a spike in unemployment, a rapid drop in imports, an 85% plunge in the stock market, and a political crisis which would bring down the government of Prime Minister Geir Haarde [video, in Icelandic]. After a series of public protests, collectively referred to as the ‘pots and pans’ revolution (‘Búsáhaldabyltingin’) due to the use of kitchenware increasing the noise level during the demonstrations, a new centre-left government under PM Jóhanna Sigurðardóttir was constructed in January 2009 and was given the daunting task of setting the Iceland economy back to rights. Foreign assistance was needed to accomplish this.

After receiving a tepid response from many Western governments to requests for foreign assistance to resolve its debt problems and prevent the krona from falling further, Iceland accepted a loan from the International Monetary Fund (IMF) worth US$2.1 billion. This was the first time that a Western economy required IMF assistance since 1976, when the United Kingdom arranged a US$3.9 billion loan from the organisation. Iceland’s Nordic neighbours, including the Faroe Islands, as well as Poland, also agreed to provide emergency loans to Reykjavík. In exchange for the IMF bailout package, Iceland was prompted to increase interest rates and implement other austerity measures, but unlike in other Western economies hit by the post-2008 financial woes, Iceland opted [pdf] not to fully rescue its three main banks from liquidation.

Despite originally being saddled with a reputation for financial carelessness, the perception that Iceland had allowed its banks to ‘fail’ received grudging global support, especially when replacement banks began to re-emerge during the following years. However, in reality, the situation was that the banks were not permitted to fail per se but rather were extensively regulated and divided into domestic holdings, which were supported by the government to avoid further financial trauma to Icelanders, and international assets which were allowed to become insolvent.

The collapse of Landsbanki’s online banking service, the now-notorious Icesave, not only created further economic trauma in Iceland but also affected numerous British and Dutch clients of the savings scheme. Then-British Prime Minister Gordon Brown was prompted to take the extraordinary step of invoking a 2001 anti-terrorism law to seize UK-based financial assets owned by Landsbanki, worth an estimated £4bn (US$5.1 billion), after the Icelandic government revealed it could not reimburse Icesave’s foreign customers. Britain’s move, which was widely seen in Iceland as excessive, chilled political relations between London and Reykjavík for months afterwards. The final reimbursement payment from Iceland to Britain was ultimately transferred in January 2016.

The worst of the crisis had subsided in 2011 with economic recovery becoming stabilised. Talk about potentially joining the European Union had begun to fade at that time, especially in the wake of the Eurozone debt crisis and concerns about a potential departure from the EU by Greece (‘Grexit’). Iceland’s bid the join the EU was quietly withdrawn in March 2015, although debate remains on whether that subject should be brought to popular vote. Iceland was also able to complete its free trade agreement negotiations with China in 2013, becoming the first European economy to complete such an agreement with Beijing. Iceland lifted its capital controls in May 2017, further indicating that the country’s financial health had been completely restored.

With banking and finance having been largely discredited and facing a long rebuilding process, other economic sectors in the country needed to fill the void. Fishing was the first obvious choice given the longstanding prominence of that industry, and there has been much recent discussion about how global warming might affect local fish stocks as larger numbers of species move northwards with warming Arctic temperatures.

Tourism has also contributed substantially to Iceland’s rapid economic recovery, with numbers reaching 2.2 million [pdf] in 2017, compared with about 673,000 five years earlier, (Iceland’s population is about 339,000). However, the growth of this sector has been seen as a mixed blessing, since there are concerns about whether expanded tourist numbers are placing strains on infrastructure and the local environment as well as questions about whether the boom is sustainable or might turn out to be another form of ‘bubble economy’.

The condition of the Icelandic currency remains a question as well due to its recent volatility, as well as recent rises in inflation, and there are ongoing questions about the long-term trajectory of the country’s welfare state. The question of Iceland’s future relations, economic and political, with the EU also persists, and the country might be facing greater competition for the EU’s attention should the stumbling Brexit process eventually reach an endpoint.

The kreppa continues to be debated both within Iceland and outside, amid questions about whether such a unfortunate chain of events could happen again, especially given the uncertain state of other European economies today. However, what has happened in the past decade is that Iceland has however unwittingly pushed forward a potential alternative model of how to address an abrupt financial downturn.