Analysis | Reykjavík is shedding its capital controls, but the economic collapse of 2008 will see Iceland re-emerge onto a considerably different landscape
This week the government of Iceland announced that its capital controls (meaning limits on how much of the Icelandic currency, the króna, could be taken out of the country) would be removed, limits which were put into place at the end of 2008 at the height of the Icelandic banking crisis. This decision, allowing for freer trade in Icelandic currency, would also potentially open the door to greater foreign investment and remove restrictions on Icelandic vacationers and students seeking to go abroad.
Moreover, this move can be seen as a vote of confidence that the country’s economy has recovered to the point where the restrictions can be removed. There will be, however, a major caveat attached to the announcement. In order to avoid the problem of ‘hot money’, large-scale, rapid movement of currency between countries in order to gain short-term profits, and a sudden devaluation of the króna, a one-time 39% tax on creditors seeking to recover lost assets from Iceland’s failed banks would be implemented.
The claims in question cover 1.2 trillion Icelandic krónur ($9 billion), made up of the assets of the bankrupt estates of the collapsed banks, foreign claims of the bankrupt estates and offshore foreign-owned assets in Icelandic currency. It was hoped that the adding of a ‘stability’ tax would not only blunt any attempts to move massive amounts of krona out of Iceland, but also build up revenue which the Icelandic government estimated could be as high as 850 billion krónur.
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These decisions were seen as a necessary step in completing the country’s recovery from the dark days of the banking crisis in 2008, when all three of Iceland’s major banks, Glitnir, Kaupthing and Landsbanki, fell into bankruptcy within weeks of each other after accruing debts totaling over $85 billion, and the value of the króna abruptly crashed. Iceland was among the first economies to feel the effects of the 2008 credit crunch and subsequent global recession, and its decision to allow its ailing financial institutions to fail received much attention in Europe and abroad.
In 2014, the country’s economy grew 2%, with unemployment falling to 4.1%, after spiking to over 9% in the middle of 2010. With the banking sector facing difficult restructuring, fishing and tourism began to represent the vanguard of Iceland’s economic recovery. There are still considerable economic challenges ahead for the country, including a potential housing-price bubble and unhappiness over wages in some sectors (there was a strike by the country’s medical staffs in December last year, and electricians are threatening strike action this month) but there is the general consensus that the worst of the country’s economic problems have passed.
Reykjavík’s financial troubles also had a profound effect on the country’s relations with Europe. During the opening months of the crisis, when the value of the króna fell to almost half its value against the euro, and there was the sense of inevitability that the country would be forced to abandon its currency and join the eurozone, even after the European Union stressed that Iceland would have to become a full member in order to gain the benefit of using the euro.
An initial surge of support for EU membership among the Icelandic public quickly faded however, not helped by disagreements over fishing quotas and strained relations between Iceland and the United Kingdom and the Netherlands over the Icesave debacle. Icesave was an on-line banking scheme overseen by Landsbanki which crashed along with its parent company, leaving many British and Dutch depositors without their savings. The diplomatic fallout was made worse when the government of Gordon Brown used counter-terrorism legislation in October 2008 to freeze Landsbanki’s assets in Britain, a move harshly criticised by the Icelandic government as unnecessarily high-handed.
Iceland’s application for admission to the EU submitted in 2009 was withdrawn in March of this year, to the chagrin of members of the Icelandic public who were pushing for a referendum on the issue. In light of the eurozone’s own economic problems, not the least of which the looming spectre of an exit by Greece, it is unlikely that public support for union membership will grow in the short term despite the still-difficult problem of the króna’s fragility.
Meanwhile, Iceland’s economic diplomacy has expanded beyond Europe, partially as a result of the crisis. As Geir Haarde, the prime minister at the time of the start of the crisis, remarked, save for assistance from the Nordic countries, Europe in general was not viewed as being helpful during the worst of the Icelandic downturn, and therefore “in a situation like that one has to look for new friends”. For example, Iceland’s economic relations with Asia, notably China, have improved since the crisis began. After talks were suspended in 2009 due to economic uncertainty, a free-trade agreement between Beijing and Reykjavík was signed in 2013, the first China signed with a European economy.
As well, a currency swap agreement between the two countries was signed in 2010 and extended in 2013 as a sign of good faith in Iceland’s economic recovery. Via bilateral diplomacy, as well as events such as the annual Arctic Circle conference, Iceland is also seeking to position itself as the ‘gateway to the Arctic’ for Asia and the international community. With the imminent removal of the capital controls and an expansion of economic partners, Reykjavík appears to be ready to move beyond one of the most difficult periods of its current history.
The author is a senior research fellow at the Norwegian Institute of International Affairs (NUPI) in Oslo.
Originally published by The Arctic Journal. Re-published here with the permission of the author.
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