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Tags: Iceland | EU | economy | forex

Iceland's Euro Dreams Vanish Along With EU Membership

Tuesday, 18 March 2014 12:01 AM EDT

Iceland's currency, the krona, was declared "dead" five years ago but it survived and with European Union membership ruled out for the foreseeable future it is likely to limp on.

"The krona is dead. We need a new currency. The only serious option is the euro," an Icelandic official told the British newspaper The Guardian in January 2009.

Five years later, Iceland's economy is still recovering from a crisis caused by its financial sector imploding when global financial markets seized up, and euro dreams are still a long way off.

"I don't think it will happen any time soon," said economist Asgeir Jonsson at Reykjavik University.

Two euroskeptic parties took power in the island nation of 320,000 people in 2013, forming a center-right coalition that has since decided to drop the bid for EU membership.

The Icelandic krona was badly damaged by the financial crisis which swept the country in autumn 2008, causing it to lose almost a half its value — as well as its status as an internationally tradeable currency.

And that damage has had long-lasting effects.

The government brought in tough currency exchange restrictions to prevent a hemorrhage of cash out of the country, as recommended by the International Monetary Fund.

Although the IMF is long gone, the capital controls are still there, with no plans to remove them.

Iceland has little choice, according to local bank Arion, as foreign investors hold krona worth the equivalent of 70 percent of GDP, which they would most likely take out of the country at the first opportunity.

If that were to happen the krona's value would plummet, but the economy is paying a high price for propping up its tiny currency.



The Iceland Chamber of Commerce estimates that capital controls cost an estimated 80 billion krona ($695 million, 500 million euros) in lost exports in 2013 — 4.4 percent of the country's GDP.

"Companies spend a lot of time thinking about the currency," said Jonsson.

The chief economist at the national chamber of commerce, Bjoern Brynjulfur Bjoernsson, said the currency issue was hampering growth.

"An Icelandic company competing internationally can't invest in projects abroad or take over foreign companies. If it is in a consolidating industry, it will often get left behind," he told AFP.

Any firm that raises funds abroad must lodge them with the central bank, which gives permission to use them or not according to the company's business plan.

"In fact we have a central bank that is overseeing the international growth strategy for all Icelandic businesses. That is not a healthy situation," said Bjoernsson.

The country found itself in crisis for the opposite reason — without effective oversight Iceland's banks had taken out massive cheap loans abroad, scooping up assets worth several times the island's annual output.

When international markets seized up, Iceland's banks collapsed, and the country was forced to take a loan from the International Monetary Fund — the first by a western European country in more than two decades.



For the average Icelander, the lack of international confidence in the nation's currency has meant more costly imports.

Since 2008 the country has been hit by a whopping 7.2 percent average inflation rate, with salaries falling behind, increasing only 6.2 percent per year.

And households have been doubly hit, with 80 percent of them struggling with heavy debt from inflation-linked mortgages.

During the boom years Icelanders traveled abroad in droves — 469,000 trips in 2007 — but today exchange rates make foreign spending appear incredibly extravagant and few have much affection for the national currency.

Even the country's most fervent EU opponents — the Federation of Icelandic Fishing Vessel Owners — are unhappy, although they believe the krona is overvalued.

"There is no other nation in the world with fewer than a million people which has its independent monetary zone," said Jonsson.

"The currency market is not liquid and the krona is very volatile. It only takes four or five hedge funds to move the exchange rate."

A currency with a mere $14.6 billion (10.5 billion euros) money supply will remain a drop in the ocean of global finance but Iceland would appear to be stuck with the krona for some time to come.

Even if the country were to take a rapid pro-EU turn, adopting the euro may still be a pipedream.

"It is clear that the krona will be Iceland's currency for at least the next five or ten years," said Bjoernsson.

"But if even if Iceland wanted to adopt the euro earlier than that, it wouldn't be easy as we don't fulfill the criteria, with a public debt at 90 percent of GDP."

© AFP 2023

Iceland's currency, the krona, was declared "dead" five years ago but it survived and with European Union membership ruled out for the foreseeable future it is likely to limp on.
Tuesday, 18 March 2014 12:01 AM
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