Iceland provides inspiration for Scotland, writes Adrian Murdoch
ICELAND has been the Keira Knightly of the financial markets for the past three years. She has been feted, flattered and waltzed across the floor by a motley crowd of investors and f inanciers alike. The praise has seemingly been endless.
Investors had been seduced by an apparently unstoppable economy. Although the northern European country has a population of only 300,000 – roughly the same as Fife – GDP grew 8.2% in 2004 and 5.5% last year. Compare that to the drab 1% or 2% of most Eurozone economies. Then take a look at the stock market. The ICEX-15 has consistently been one of the best performers in Europe. From March 2003 until this year’s peak, the index rocketed 505% in dollar terms.
But in February, the pedestal upon which Iceland had been placed, began to wobble. The first sign that something might be amiss was when credit-rating agency Fitch Ratings lowered its outlook on the country’s creditworthiness from “stable” to “negative” on February 21. It looked as though the entire house of cards was about to collapse. The ICEX-15 index tanked 18% and the Icelandic krona fell by more than 15% over the month.
The language used by analysts and journalists alike was apocalyptic. Legions of journalists worked “meltdown” into their headlines while one analyst went so far as to hold Iceland up as the butterfly wing that would bring down the world economy. By the end of March, Danske Bank analysts notoriously concluded that: “Iceland looks worse on almost all measures than Thailand did before its crisis in 1997, and only moderately more healthy than Turkey before its 2001 crisis”.
Britain especially began to take notice, primarily because of concern at the number of purchases the – inevitably dubbed – Viking raiders had made over the past few years. Although the names Baugur Group and FL Group are not household names, their goody bag of acquisitions is. To name just a few, main assets include the supermarket chain Iceland, Hamleys toy store, the jewellery stores
Goldsmiths and Mappin & Webb. The most high-profile acquisitions of all have been on the high street. Mosaic Fashion is listed on ICEX and owns Oasis, Karen Millen, Coast and Whistles. No surprise then that there has been a certain nervousness.
What set this all off? As so often, the wobble can be blamed on the f inancial markets, specif ically the perennial baddie, the speculative carry trade. Investors had been borrowing money in countries which boasted low interest rates – Japan especially – and invested it Iceland. The attraction was that its benchmark rates were above 10%, the economy showed no sign of slowing down and both the national currency – the krona – as well as Icelandic shares were appreciating.
Then the report. The biggest concerns were Iceland’s current account deficit (hitting 16%) and the impact of the country’s banking sector – Glitnir, Kaupthing and Landsbanki – on the economy. The large deficit stems from the vast amount of foreign direct investment into the Iceland’s aluminium industry as well as the liberalisation of mortgage lending regulations in recent years. The latter especially has fuelled a large degree of consumer spending and asset price increases. To give just one example, as Halldór Thorbergsson, economist at Iceland’s chamber of commerce, points out, house prices have tripled in last decade and risen 65% in the last two years alone.
Several months on it is clear that these concerns were overstated, the effects of a rumour mill and Chinese whispers that has more in common with the playground than financial markets. Certainly there is no sense of anything other than a boom economy in 101, the downtown centre of Iceland’s capital Reykjavik. Despite the famously eye-watering prices, the bars and cafes are still full of beautiful people, restaurants are packed and the boutiques selling internationally known designer labels are as full as those selling traditional Icelandic jumpers.
Tryffvi Thor Herbertsson, professor of economics at the University of Iceland, admits that he was surprised by some of the analysts’ findings and mutters about “herd behaviour” among research departments. Indignantly he continues: “You can’t seriously find parallels between a high industrial country like us and Thailand”.
Indeed, it is hard to find anyone who takes the deficit seriously. As the newly opened museum dedicated to the first settlers in 871 makes clear, Iceland has always relied on the sea. Centuries of familiarity with the boombust cycle of the fishing industry means that most are used to great swings in GDP and consumption. A small economy is comparatively easy to fix and the last time that the deficit started to loom – in 2001 – it took only 18 months for sanity to be restored.
The reaction to the international brouhaha is typically sanguine and bemused. “Now that the dust has settled, the wording of some of the reports was pretty strong, but that is the nature of the press,” says Jonas Sigurgeirsson with a shrug. As head of investor relations at Kaupthing Bank, he was a man on the front line through much of the crisis. He, like most others, insists on looking forward. Certainly the banks appear to have taken the assessments to heart – something that has found favour with industry observers. Alexandre Birry, associate director of financial institutions at Fitch Ratings, explains that they realised quickly that there was “no point in shouting at analysts”.
But even the more bullish reports on Iceland raised two rather more serious issues about domestic banks: those of their ability to ref inance debt and the complex crossshareholding issues in the market.
The former issue has been flagged as an overriding concern. It has been estimated that 2007 refinancing needs have been in the range of £5-6.4bn. “We have seen credit spreads widening and when it becomes more expensive ref inancing becomes more difficult,” says Lynn Valkenaar, vice president and senior analyst at the ratings agency Moody’s. This may be true, but none of the banks have struggled, partly because they have put a great deal of effort into diversifying their funding markets.
There remains a feeling in Iceland that the second major issue, that of cross-
shareholding, has been overstated. Even though Moody’s Valkenaar believes that major companies making investments and clients of banks taking private equity stakes or listed equity stakes is “a problem in a small economy” the banks themselves point to smaller economies like Scotland, Ireland and Scandinavia where it is not unheard of.
Hreidar Mar Sigurdsson, chief executive of Kaupthing Bank, understands her concerns. “If the markets are uncomfortable then it is a problem, and it is the right thing for us to resolve,” he says. To that end Kaupthing, just like the other banks, has been unwinding its shares in investment companies and investment banks.
This is all good news and should give international investors back whatever trust was eroded by the wobble in February and March, but none of these fixes really approach what is the largest challenge for Iceland – that its banks are no longer really Icelandic. First quarter profits for the banks were £450m up from £183m in the same period last year. With his tongue firmly in his cheek, Kaupthing’s Sigurjon Arnason recently pointed out that his bank’s profits would be enough to buy more than 3,000 SUVs at £37,000 each.
More seriously, as Halldór Kristjánsson, group managing director and chief executive of Landsbanki, shows, finance is now the country’s single largest sector. At 8% of GDP, it is larger than fisheries.
Total assets of the banking system have leapt from 60% (in 1990) to almost 400% of GDP today. It is a significant problem and a case study that could prove useful for Scottish banks. With the majority of profits coming from abroad, the term “Icelandic bank” is increasingly meaningless. “We are proud that we are from Iceland, but last year only 30% of profits came from Iceland,” he says.
The most obvious sign is the way that the banks are rebranding themselves. In March Islandsbanki became Glitnir, a clever name that broadens its appeal without alienating the home market. “It has positive connotations for Icelanders, is both Icelandic and Nordic, is easy to pronounce in all the main languages involved and also contains no unusual letters or accents,” says Bjarni Armannsson, the bank’s chief executive officer. Landsbanki followed suit at the very end of May, harmonising the logos of its main international subsidiaries, the securities companies Kepler Equities in France, Teather & Greenwood in the UK and Merrion Capital in Ireland which were all purchased last year. Kaupthing has made no moves in this direction yet, but has rebranded itself on its website as a northern European investment and corporate bank.
Few now seriously believe in an Icelandic meltdown. Even the medium-term is looking pretty rosy. While there is no doubt that growth rates for the banks of more than 100% and GDP growth for the economy above 5% cannot continue indefinitely, even doommongers who cite the slow down in investment in the aluminium sector after 2007 might have to eat their words. Thordur Hilmarsson, managing director of the Invest in Iceland agency, points to the emphasis that there has been on attracting investment from software, biotech and knowledge-based industries which have benefited from £430m in investment since 2003.
Most believe that GDP growth in 2007 will decline a little. It is likely to slip to 2% from 5% this year, but that will be the bottom of the recession. “There will be a soft landing,” says Herbertsson.
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Points north: Reykjavik is the hub of Iceland’s booming economy which has been through rocky times recently but is now back on course