Case Study Assignment - Fadli 95592

7/21/2019 Case Study Assignment - Fadli 95592

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Individual Assignment:

Case Study- Iceland: Small Fish in a Global

Pond

Global Economic Theory & Issues

BDMF 7053

Name : Mohd Fadli Bin MahmudMatric No. : 95592Lecturer : Prof. Dr. K. KuperanVisnaathan

Date : Ma 2"#$


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| Global Economic

Theory & Issues

Table of Contents

1.0 Introduction.......................................................................................................... 1

2.0 What was the Global Economic Problem that Iceland was facing?.......................................1

3.0 What caused the problem?........................................................................................ 2

.0 What possible solutions are there for Iceland?................................................................3

!.0 If "ou are the economic and business ad#isor to the Go#ernment of Iceland what suggestion will"ou gi#e to sol#e the economic problems?.........................................................................4

$.0 %onclusion........................................................................................................... 6

MOHD !D"I M!HM#D|$%%$2 |2


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| Global Economic

Theory & Issues

Case Study- Iceland: Small Fish in a Global Pond

1. Int!oduction

In 1&&1' the Icelandic go#ernment began an aggressi#e program of liberali(ation and

pri#ati(ation which ga#e rise to the h"per)e*pansion of three Icelandic ban+s. ,heir highl"

le#eraged growth fuelled massi#e stoc+ mar+et and housing bubbles' all of which combined

to ma+e Iceland-s per capita GP one of the world-s highest b" the mid/2000s. Iceland-s

econom" collapsed in ctober 200 when the three ban+s were forced into ban+ruptc" the

countr" suffered one of the deepest downturns in the world.

". #hat $as the Global %conomic P!oblem that Iceland $as facing&

Iceland-s e*plosi#e growth during the past decade has been accompanied b" macro)economic

imbalances and an accumulation of huge foreign debt' mostl" incurred b" the ban+ing sector

borrowing freel" on the international capital mar+ets. In the wa+e of the global credit crunch'

the Icelandic econom" now faces se#ere challenges.

'ac!o-economic imbalances:

Iceland-s central ban+ has battled inflation through high interest rates. et inflation has

remained at close to double the ban+-s target of 2.!41$ in the past se#eral "ears' partl" due to

eas" access to low)interest foreign)currenc" loans and partl" due to a booming econom" and

a sharp increase in the e5uit" and housing mar+ets. 6igh interest rates ha#e made Iceland a

prime target for the 7carr" trade8 in recent "ears' resulting in a strong 9rona. : strong 9rona

encouraged further spending and foreign)borrowing and a #icious c"cle emerged leading to

an enormous current account deficit ;pea+ing at 2$.2 4 in 200$


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(igh Fo!eign )ebt:

,he e*plosi#e growth of Icelandic firms has been financed b" aggressi#e borrowings b"

Iceland-s three largest ban+s and the total e*ternal debt of the econom" is now more than !

times GP2

' i.e. the econom" is highl" le#eraged. ,he negati#e debt position is partiall"e*plained b" in#estment in new power plant capacit"' the rapid e*pansion of Icelandic firms

abroad' high le#els of outward @I' "oung population' consumer spending and' perhaps'

misleading accounting.

In an" case' it seems clear that the global credit crunch hit Iceland at a #ulnerable time.

Icelandic ban+s' consumers and firms are suddenl" faced with a falling currenc" and

prohibiti#el" high borrowing costs. oubts ha#e been cast on the go#ernment-s abilit" to

support the Icelandic ban+s' simpl" due to the fact that the combined balance sheets of the

three largest ban+s were A4 of GP at the end of 200A3. ,he #ulnerabilities of maintaining

an independent monetar" polic" ha#e also become clear and debate has been #igorous on

how to better defend the currenc" or' alternati#el"' to adopt a stronger currenc". Go#ernment

officials point to a debt)free go#ernment' health" ban+s and a fle*ible econom" as +e"

buffers' but recession seems li+el".

*. #hat caused the +!oblem&

'ac!o-economic imbalances:

,he go#ernment had lowering corporate ta* rates and pri#ati(ing state)owned companies.

Berious change came onl" after 1&&' when Iceland Coined the European Economic :rea

;EE:


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Theory & Issues

mar+et' foreign retail deposits' especiall" in the Dnited 9ingdom and the Fetherlands. :ll

three ban+s also used their subsidiaries in u*emburg to engage in indirect collateri(ed

borrowing from the Euros"stem. >" the end of 200' Iceland was the world-s most hea#il"

indebted countr" measured in terms of gross e*ternal debt to GP.!

,. #hat +ossible solutions a!e the!e fo! Iceland&

Cu!!ency Policy

Iceland-s currenc" remained strong during the countr"-s pre)crisis e*pansionar" period in

spite of its enormous current)account deficit because of the large inflow of foreign funds.

With the collapse of the ban+ing s"stem' that inflow stopped and the +rona went into free fall.

,he decline intensified the countr"-s economic problems. =an" households and businesses

held foreign)currenc" inde*ed debts that e*ploded in domestic cost. :s noted abo#e' the

go#ernment wor+ed to minimi(e the economic harm from this de#elopment b" forcing ban+s

to restructure their loans in domestic currenc".

Iceland-s currenc" polic" also includes the use of strict capital controls which ma+e most

transnational capital mo#ements illegal.$

,hese controls ha#e bloc+ed an estimated billion'roughl" e5ual to !0 percent of Iceland-s GP' from lea#ing the countr". 6ad the go#ernment

not ta+en action' the resulting outflow would no doubt ha#e led to a complete currenc"

meltdown. ,han+s to the controls' the +rona' although lightl" traded' soon strengthened and

then stabili(ed.

(ousing Policy

,he go#ernment too+ strong steps to minimi(e the threat to household finances caused b" thecollapse of the housing bubble and to restore stabilit" to the housing mar+et.

,he go#ernment then introduced se#eral new initiati#es designed to pro#ide more long term

relief. ,hese lowered household debt and mortgage interest pa"ments as well as pro#ided

support for housing alternati#es and renters. @or e*ample' the go#ernment first pursued a

strateg" of encouraging householders to directl" negotiate write)downs with their lenders'

often with the assistance of an ombudsman. Gi#en the slow progress' the go#ernment

introduced a debt)forgi#eness plan that wrote down underwater mortgages to 110 percent of a

household-s assets. ,o ensure that wor+ing people were the main beneficiaries of the plan' the



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Theory & Issues

amount of relief was tied to the #alue of a modest house and famil" si(e. =ore detailed

financial e*aminations were a#ailable for households in especiall" serious financial trouble'

with the possibilit" of greater write)downs.A

Social Policy

,he Icelandic go#ernment faced a serious fiscal challenge as a result of the crisis' with its

budget deficit rising to 13.! percent of GP in 200&. Impressi#el"' it reduced o#erall

spending and the deficit to 2.3 percent of GP in 2011 while simultaneousl" strengthening

+e" social programs. @or e*ample' the go#ernment increased unemplo"ment benefits o#er the

"ears 200A to 2010 and also lengthened the period during which wor+ers could recei#e

unemplo"ment benefits from three to four "ears. In addition it significantl" boosted the

means)tested social assistance allowance and the minimum pension benefit.A

#er the same period' the go#ernment also increased subsidies for mortgage interest

pa"ments b" 10.1 percent' far outstripping the 0.$ percent increase in mortgage costs. ,his

increase raised the a#erage household subsid" for interest costs from appro*imatel" 13

percent to 20 percent of the total interest cost. =oreo#er' the interest rebates were largel"

targeted at wor+ing)class households' which meant 7that about a third of the interest cost of

lower and a#erage income households was paid b" the go#ernment in 2010.8A

. If you a!e the economic and business adviso! to the Gove!nment of Iceland $hat

suggestion $ill you give to solve the economic +!oblems&

ecommendations to Policy 'a/e!s

Add!ess cu!!ent mac!o-economic imbalances:

,his should' 5uite ob#iousl"' be the go#ernment-s first priorit". :nd since this is partl" a Coint

problem of the ban+s and the go#ernment the" should wor+ together to impro#e mar+et

confidence. Bpecific recommendations areH

Pro#ide clarit" on how and under what circumstances the go#ernment will support the

ban+s

@ormall" collaborate with the financial sector to de#elop better accounting methods and

communicate Icelandic conditions abroad



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Impro#e fiscal discipline to help reduce the current account deficit

Btrengthen the currenc" b" either significantl" increasing reser#es or see+ing formal

agreements with other European central ban+s to support it. :lternati#el"' consider

adopting another currenc".

Ado+t cluste! a++!oach to su++o!t the financial secto!:

,he go#ernment pla"ed a +e" role in the rapid rise of the financial sector b" pro#iding a

fa#orable' progressi#e legal framewor+' and access to the European mar+et but more should

be done going forward. Iceland now has a uni5ue opportunit" to build on the recentsuccesses' foster further de#elopment of the cluster and impro#e its long)term

competiti#eness. Bpecific cluster)centric recommendations includeH

e#elop a realistic strategic #ision for the cluster in cooperation with its pla"ersH define

what +ind of financial center Iceland wants to become' how it can attract foreign

financial firms' and how to encourage lin+s and +nowledge flow with other financial

centers' such as ondon and Few or+

Establish formal' go#ernment)endorsed institutions for collaboration that support the

cluster. ,he purpose should be to organi(e the cluster to sol#e Coint problems' impro#e

communication and mar+eting' foster competiti#eness and inno#ation' etc.

Eliminate ob#ious cluster barriersH ;1< pre#ent 6ousing @inance @und from competing

with the ban+s ;perhaps retain social function


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Theory & Issues

incenti#es should also wor+ to attract foreign financial institutions to set up shop in

Iceland.

=aintain a competiti#e general business en#ironment.

0. Conclusion

Icelandic e*perience offers useful lessons for all those wor+ing to build mo#ements capable

of initiating meaningful social transformations. ,he first lesson is that countries do not adopt

neoliberal policies because of a polic" mista+e or the ta+eo#er of go#ernment b" e*tremist

elements. ather it is an e*pression of a generall" shared capitalist desire for bigger profits

coupled with the reali(ation that this re5uires greater mar+et freedom' both regulator" and

geographic.

,he second is that e*pansion generated b" neoliberalism contains the seeds of its own

undoing. %apitalism is a contradictor" and unstable s"stem and the more unchec+ed are

mar+et forces' the faster the economic rise and the more dramatic the economic fall. ,he

Icelandic e*perience' in particular' offers a frightening illustration of how easil" our well)

being can be threatened b" the machinations of financial interests.

,he third is that states can effecti#el" inter#ene in multiple' interconnected mar+ets and

achie#e impressi#e results. =ore to the point' comparing the e*perience of Iceland with that

of other countries ma+es clear that acti#e state inter#ention in restructuring and directing

mar+ets is the +e" to a sociall" desirable response to crisis.

,he fourth is that crisis alone is not sufficient to deter capitalist interests from their support

for liberali(ation and pri#ati(ation. In most countries' the same capitalist interests thatorchestrated the adoption of the neoliberal policies that generated the crisis remain adamant

defenders of the same policies.

,he fifth is that social democratic policies' regardless of how successful the" ma" be in

defending popular interests during a period of crisis' do not automaticall" generate support

for an agenda of social transformation. ne reason is that social democratic parties tend to

present their inter#entions as temporar"' made necessar" b" unusual circumstances. nce

stabilit" is regained' capitalist interests are well positioned to argue that such inter#entions

need to be undone so as not to become fetters on e*pansion.



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,he final lesson is that to ad#ance a meaningful re#olutionar" process' acti#ists must not onl"

build popular support for e*panded public ownership and state capacities to direct economic

acti#it"' but the" must do so as part of a mo#ement that directl" challenges the legitimac" of

capitalist imperati#es and encourages new #isions of social ownership and patterns of

production and distribution.

otes:

1. ,ett' G. 7Indignant Iceland faces a problem of perception.8' ,he @inancial ,imes' =arch

2A' 200.

2. %entral >an+ of Iceland' httpHwww.sedlaban+i.is' accessed :pril 200.

3. >an+ of Iceland ;200an+ of Iceland'

article 13b.

A. Llafsson' Iceland-s @inancial %risis and e#el of i#ing %onse5uences' 1&.

MOHD !D"I M!HM#D|$%%$2 |

Case Study Assignment - Fadli 95592

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