Icelandic Recovery Slow, but Release of Capital Controls May Provide Boost

After the Global Recession in 2008, Iceland suffered enormous losses in its financial sector. Loose regulations and lack of oversight led to a situation in which three failed banks had more than 10 times the Icelandic economic output in assets at the time of their collapse. To prevent a complete tailspin, the government froze foreign investments in the country and reneged on guarantees to pay back savers from the UK and the Netherlands.

After the Global Recession in 2008, Iceland suffered enormous losses in its financial sector. Loose regulations and lack of oversight led to a situation in which three failed banks had more than 10 times the Icelandic economic output in assets at the time of their collapse. To prevent a complete tailspin, the government froze foreign investments in the country and reneged on guarantees to pay back savers from the UK and the Netherlands.

These decisions, in turn, led to years of legal wrangling between Iceland and its European neighbors, as well as an almost total loss of confidence by investors both at home and abroad. Like dominoes falling, this chain of events toppled other elements of the Icelandic economy, toppling others, and so on, and ultimately stymieing efforts to boost the economy. This made Iceland one of the most deeply affected European countries following the Global Recession, as well as one that took the longest to recover.

Fortunately, it appears the Icelandic government has spotted relief on the horizon. It has announced plans to unfreeze foreign investments. However, to prevent a run on the banks, Iceland will impose a 39 percent tax rate for any funds withdrawn by foreign creditors.

Iceland’s finance minister, Bjarni Benediktsson said, in an interview with the Guardian, “Today is a milestone, a very happy milestone…I expect we will see a complete change of the [financial] landscape in 6-12 months.”

Iceland has been attempting to rebuild not just, its banking system, but also its reputation with the rest of the world. After the debacle regarding foreign investments and refusals to pay on guarantees, Iceland began repaying the guarantees, anyway, despite a favorable international court ruling advising that it did not need to do so. According to Iceland, it has returned about 85 percent of the total it had guaranteed, and anticipates paying the remainder by the end of the year.

Moreover, the government recently voted to lift tight capital controls imposed more than six years ago on the advice of the International Monetary Fund as a condition to receiving bailout funds. The measures had been intended to expire after only six months, but the chance of plunging the nation back into a financial crisis due to loose lending principles so quickly after teetering on the brink of total collapse stayed the nation’s hand. While the vote to lift the measures should encourage more foreign investment, it also creates some concerns about a return to the old ways of lending and the possibility of rapid inflation.

The capital controls also created the freeze on foreign investment funds. Lifting the controls will allow those investors to retrieve their assets, but analysts are concerned this could lead to a rush, which Icelandic banks could not handle. On the other hand, the 39 percent tax should mitigate some concerns about a run, and could generate as much as 850 billion Icelandic Krona, according to one government report.