Shunning creditors, Iceland goes it alone as economy rebounds

REYKJAVIK/STOCKHOLM Mon Feb 17, 2014 6:33am EST

REYKJAVIK/STOCKHOLM Feb 17 (Reuters) - Iceland's government feels it can shun international investors while enjoying economic growth - witness its dismissive response to a $5 billion lawsuit over Icesave debts and a tough stance on paying bond creditors.

The centre-right administration, elected last year, has turned its back on talks to join the European Union, largely opting to go it alone in rebuilding an economy shattered by a banking collapse.

That had forced the nation of 320,000 to take an international bailout and slash public spending, but now the economy is growing at the fastest pace since before the crisis and better than many EU countries - expanding by 3 percent in 2013.

Meanwhile, the tough stance over creditors remains popular with voters despite capital controls that hamper foreign investment.

"There are no good reasons for Iceland becoming financially isolated, and we have seen things developing in the right direction," Icelandic Prime Minister Sigmundur Gunnlaugsson told Reuters.

Foreign visitors have flocked to the island. Tourist revenues for the year to the end of September were 267 billion Icelandic crowns ($2.3 billion) up from 73 billion in the whole of 2008. Earnings from fishing and aluminium are up 60 percent and 25 percent respectively in the 2008-2012 period.

"Iceland has recovered faster than most others," Eirikur Bergmann, professor of politics at Iceland's Bifrost University, said. "Of course, capital controls skew the economy, so in the long run it needs to be sorted, but there doesn't seem to be any immediate need to rush into doing that."

Indeed, economists say the protective shell around the economy also makes things difficult for local businesses while the island's financial markets are being distorted.

But for now, there is little public appetite for the compromises needed for reintegration into the financial mainstream.

Earlier this week Iceland's Depositors' and Investors' Guarantee Fund said Britain and the Netherlands had filed a $4.87 billion claim with a Reykjavik court over money they paid out to cover domestic savers losses in Icesave accounts when Landsbanki collapsed in late 2008.

Iceland's prime minister dismissed the suit, saying that the two countries would not get much for their efforts as there was no state guarantee for the debt.

His lack of concern reflects a sense of wounded pride following the banking collapse and the Icesave spat when the British used anti-terrorist laws to seize Icelandic assets.

Support for joining the EU has slumped and there has even been talk of adopting Canada's currency, not the euro.

"I actually thought the Icesave dispute had ended and this suddenly popped up," 41 year-old Gudrun Gunnarsdottir said. "It's another case of the big countries trying to use their strength against a smaller nation."

NOT TOO BIG TO FAIL

Iceland's main banks had assets worth around 10 times the value of the country's economy when they collapsed in late 2008. Iceland bailed out domestic savers, but not those overseas with money in Icelandic banks, leading to a bitter dispute with the Dutch and the British.

Much of the money has been paid back from the assets of the collapsed banks, but the new claim is a nasty reminder that foreign creditors still feel they have been short-changed.

Equally intractable is a standoff between holders of bonds issued by failed banks and the government over an estimated $3.4 billion worth of assets.

The estates of the banks and the creditors cannot finalise a deal without an okay from the government. It will not agree to a solution unless it can remove capital controls, put in place in 2008 and still in place five years later.

"To date, there has not been meaningful engagement by the Icelandic authorities on these issues," Matt Hinds, partner at Talbot Hughes McKillop, financial adviser to the Informal Creditor Committee of Glitnir, said in an emailed comment.

"What the creditors now need is engagement from the government."

But the government appears happy to play a waiting game.

Icelandic PM Gunnlaugsson has built his political capital from his opposition to Icesave deals that would have seen Iceland pay heavy interest costs to Britain - proposals rejected by voters.

A similarly tough stance over payments to bank creditors - many of which are hedge funds that bought the assets after the island's lenders collapsed - is popular with many Icelanders.

But there are risks going it alone.

Capital controls are a drag on growth and foreign direct investment, at about 130 billion crowns in 2012, is around one third of the level it was prior to the crisis.

Jon Bentsson, economist at Islandsbanki, says there are concerns over asset bubbles as money that would otherwise be invested abroad is pumped into domestic markets.

He said that so far, there had only been mild distortions of the equity, bond and real estate asset prices.

"But every year that passes ... the amount (of money) increases and that puts corresponding pressure on Icelandic markets," he said.

Businesses are also suffering. In a poll by Capacent of CEO's of 158 start-up companies in Iceland, around 38 percent said they could move their company abroad in the next couple of years. The key reason was to access foreign investment.

Removing the controls, however, is proving tough and even if they are ended, a free-floating currency puts Iceland's tiny economy at risk when global markets hit turbulence again.

"In the long run, the outlook for GDP growth has improved markedly from the middle of last year - but within the capital controls, it is like a bubble," Regina Bjarnadottir, head of research at Arion Bank. "If you want sustainable long-term growth, you need to lift the controls."

A couple walks along the rough surf during sunset at Oahu's North Shore, December 26, 2013. REUTERS/Kevin Lamarque

Find your dream retirement town

Florida? Hawaii? Reuters has teamed up with Zillow to give you the power to customize a list of your best places to retire.  Video | Full Article