Ice­land pro­vides in­spi­ra­tion for Scot­land, writes Adrian Mur­doch

The Herald Business - - Country Profile -

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.

Vik­ing raiders: Ice­landic com­pa­nies have bought up many fa­mous Bri­tish high street names

Points north: Reyk­javik is the hub of Ice­land’s boom­ing econ­omy which has been through rocky times re­cently but is now back on course

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