Iceland’s Dangling Recovery Bait

Years after initiating developed Europe’s resort to IMF and bilateral official rescue Iceland on 3 percent GDP growth from fishing and tourism earnings repaid 2013 obligations early and regained investment-grade status form all three main rating agencies, lifting thinly-traded bonds and stocks. Consumption also improved on household debt restructuring progress which has spurred real estate values, although the big legacy commercial banks from the crash still have 25 percent NPL ratios and court rulings on inflation and foreign exchange-indexed instruments could aggravate the burden. The currency has been steady against the dollar and euro on capital controls which by law will last through the end of next year, with the central bank mounting occasional interventions from its $9 billion in reserves. Inflation has subsided from the 6 percent range on commodity and wage demands and the current account is in modest surplus. External debt could drop to 150 percent of GDP by mid-decade, and liability management could be aided by another planned Eurobond tap in the coming months. Despite a primary surplus, budget balance is elusive with social welfare and local government funding commitments, according to the IMF’s latest Article IV picture. Monetary policy should also be tightened in advance of “gradual” capital account re-opening, it further recommended. Corporate debt equivalent to half of economic output has already been written off and independent supervisors are now monitoring bank health with capital and liquidity positions still a concern, and the state mortgage lender in bad shape. The experience offers “key lessons” for European countries that subsequently entered fiscal adjustment programs, including the importance of protecting vulnerable income groups and imposing burden sharing on private creditors. However numerous risks linger in the Fund’s view with the European Free Trade Association due to decide whether the Icesave non-resident reimbursements violate deposit insurance directives and the imminent prospect of large onshore capital outflows with even incremental liberalization.

At the opposite end of regional arrangements, Ukraine has not met gas pricing and other conditions to unblock multilateral assistance as a Eurobond return was indefinitely postponed and Russia’s VTB bank may not renew a $2 billion loan after June. Foreign reserves are down to $30 billion or 3 months’ imports as the central bank tries to maintain the 8/dollar hyrvnia value on a doubled current account deficit as a portion of GDP. Local government paper yields are at 15 percent and euro-denominated alternatives have been introduced to sustain appetite. Overseas banks that control almost half the system have slashed operations, with a recent S&P report citing “extremely high” credit risk with loans/deposits in excess of 150 percent. Opposition party chief Tymoshenko and allies have been jailed on corruption charges as President Yanukovych tries to skirt international condemnation and default until October parliamentary elections likely prompt more eruptions.