Cablegate: Iceland: It Won't Be the Best Place to Live Anymore

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1. (SBU) Summary: Last year Iceland was rated by the UNDP as the
best place to live in the world, but the October collapse of the
Icelandic banking system has triggered a full scale financial and
currency crisis and delivered a knockout punch for Iceland. Now
experts are just beginning to piece together what will happen in the
economy here and how living standards will be affected. Already we
have seen an immediate, rapid rise in unemployment and inflation.
There is significant trouble with the Icelandic krona and currency
exchange limits have limited foreign trade on this import-dependent
island. As a result, business reps predict 70 percent of Icelandic
businesses will go bankrupt in the near future. The best hope for
the short term is an IMF economic stabilization program awaiting IMF
Executive Board approval. However, before the Board can consider
the package, Iceland must secure $4 billion in other bilateral
loans, and they are only a quarter of the way there. The IMF money
will continue the flow of essential goods to Iceland, but real
economic recovery will take longer. Iceland must address the
creditors of the failed banks to preserve future private sector
financing again and the only long-term solution we've heard for the
currency crisis is joining the EU and adopting the Euro. End

2. (SBU) The collapse of the Icelandic financial sector in October
has triggered an economic crisis, the depths of which are only now
becoming clear. Many Icelanders lost all their investments because
they owned stock in the three banks that collapsed or other
companies that faltered as a result of the banks. Those who had
cash savings in some accounts are unsure if their money is still
there as many accounts remain frozen. There has been a rapid rise
in unemployment in a country that has generally faced labor
shortages. The Directorate of Labor reported in September the total
number of unemployed was about 1.3 percent unemployment, the number
jumped to 3 percent in six weeks and is anticipated to be 7 percent
by January. The Central Bank predicts that at the end of 2009,
unemployment rates will have reached 10 percent.

3. (SBU) As economic conditions worsen, academics and industry
experts alike tell Post they expect a brain drain. Iceland's
semi-skilled foreign work force is expected to be the first to move
away and we have seen anecdotal evidence of that departure already;
the Polish Consulate here estimates that half of the roughly 14,000
Poles who moved here to work in the construction and services
industries have left Iceland in the last three months. As the
condition of the Icelandic labor market deteriorates Icelanders
themselves might start thinking about moving abroad. The Chairman
the Union of Icelandic Electrical workers stated earlier in the week
that hundreds of tradesmen (carpenters, electrical workers,
plumbers, masons) are already preparing to move abroad. The Norden
Association, an organization that promotes Nordic co-operation,
reports a large surge of Icelandic interest in their course that
teaches how to establish oneself when moving to a Nordic country.

4. (SBU) Inflation, always a problem here, is also expected to spike
in the short term despite an overall economic contraction.
Currently, twelve month average inflation is being measured at 15.9
percent, and because Iceland is extremely import dependent,
inflation is directly influenced by the (falling) value of the
Icelandic krona. According to the Central Bank's baseline forecast
inflation will peak at 23 percent in the first quarter of 2009 but
will have fallen to 5 percent by the end of the year. This sharp
decline in inflation is based on the assumption of moderate wage
growth, falling demand for consumer goods, and a stable exchange
rate. If these assumptions do not hold, then inflation might reach a
higher level and remain high for a longer time, something Iceland
hasn't seen since the 1980's.

5. (SBU) Businesses report significant difficulties regarding trade
and the currency. When the U.K. authorities invoked anti-terrorism
and economic crimes legislation against Icelandic banks and froze
Icelandic assets on October 8th, virtually all international
payments to Iceland stopped. Two days later the Icelandic Central
Bank established rations of foreign currencies at a fixed price and
gave priority to importers of food, fuel and pharmaceuticals.
Importers of clothes, electronics and every other good had to get in
line for currency. Post learned of one stationary supply store
which waited for three weeks to get foreign currency to import
office paper. The Confederation of Icelandic Employers told post
that Icelandic businesses are facing serious difficulties that only
seem to worsen with each day; on top of the cross-border payment
problems and restricted access to foreign currencies, Icelandic
companies' standing with their suppliers abroad has suffered
greatly. Virtually all transactions have to be pre-paid. Adding to
the pain, many businesses took out loans in Japanese yen, which has
appreciated 136 percent against the krona and resulted in increases
in payments. The Federation of Trade and Services predicts 70
percent of businesses are expected to declare bankruptcy in the near
future if the currency crisis is not solved.

6. (SBU) For the short term, the IMF assistance is supposed to

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provide foreign currency to support re-floating the krona and
stabilize foreign trade, however the IMF deal is not assured. The
IMF announced on Oct. 24 a $2.1 billion loan provided that
Icelanders raise nearly $4 billion more; thus far they have secured
loans of just over $1 billion from Norway, Poland and the Faroe
Islands. Every day the press speculates who is to blame for no IMF
deal, with the clear favorite the U.K. (reportedly blocking the deal
until a resolution is created for the failed Icelandic banks in the
U.K.) As we understand it, the IMF deal is essential to solving the
immediate currency crisis. The Head of the Research Department at
Kaupthing Bank reiterated to Emboffs that it is of vital importance
to establish a sound currency market in Iceland. He said that once
the krona is floated again, it will devaluate further, but no one
knows by how much; the main fear with lifting restrictions in the
currency market is that of a domestic run, with Icelanders selling
krona to get foreign currencies. This seems to indicate that
currency restrictions will remain in place in some form even if the
IMF loans are approved.

7. (SBU) Addressing longer term conditions will require resolving
the issues with creditors and depositors and the long term strength
of the currency. The British IceSave account holders are still
grabbing the headlines, but behind the scenes there are many
creditors lining up. Post met with a lawyer representing American
bond holders with $3.5 billion invested who plainly stated that if
Iceland does not take a transparent and fair path with creditors,
investors will never come back. This concept is beginning to be
discussed in the media; the most prominent proponent is the head of
the Confederation of Employers, who advocates giving the creditors
ownership of the banks as a way of preserving Iceland's future
access to credit. Most business representatives and economists we
talk to do not see a medium or long term solution with the Icelandic
krona. Everyone seems to feel the joining of the EU and the
adopting of the Euro is not only inevitable, but necessary for long
term economic survival.

8. (SBU) Comment: The situation here is still fluid, but as the
consequences of this crisis continue to play out, we could start to
see the development of a permanently unemployed class, which is
historically unknown here. Iceland has always had reverse brain
drain, where young people are educated abroad, but return to raise
their families. This will likely no longer be the case and young
Icelanders abroad will stay there and those who can move away from
Iceland will. Foreign travel, very common in recent memory, will be
restricted by financial constraints. Once the current stocks of
consumer and luxury goods are depleted, there will not be a
replenishment to the same level as before. In short, Iceland faces
the very real prospect of the rapid undoing of two decades of robust
prosperity and a whiplash-inducing return to scrimping and saving
unknown since the 1980s. This already bitter pill will take on a
new edge if the public holds to its current view that this disaster
is the fault of vindictive foreign parties (e.g, the British).

van Voorst

© Scoop Media

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