VZCZCXYZ0010
PP RUEHWEB

DE RUEHRK #0055/01 0981746
ZNR UUUUU ZZH
P 071746Z APR 08
FM AMEMBASSY REYKJAVIK
TO RUEHC/SECSTATE WASHDC PRIORITY 3610
INFO RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHSM/AMEMBASSY STOCKHOLM 0172

UNCLAS REYKJAVIK 000055 
 
SIPDIS 
 
USDOC FOR LEAH MARKOWITZ 
TREASURY FOR LAWRENCE NORTON 
STOCKHOLM FOR KEITH CURTIS 
 
SENSITIVE 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN IC
SUBJECT:  IS ICELANDIC GOVERNMENT DOING ENOUGH TO HALT ECONOMY'S 
SUDDEN DOWNFALL? 
 
¶1. (SBU) Summary: Iceland's economy has recently gone wobbly, with 
the currency depreciating to a near record low and consumers facing 
sudden price hikes of near ten percent.  In response to inflationary 
pressures, the Central Bank raised its prime rate 1.25 percent on 
March 25 to a new record high of 15 percent.  International media 
commentary on Iceland's financial sector may be fueling much of the 
anxiety.  To calm jitters, government officials argue publicly that 
the economy has faced the worst and is now on the upturn.  The 
Central Bank also accused foreign speculators of trying to bring 
down the financial system, and called on Iceland's Securities and 
Exchange Commission equivalent to pursue lawsuits.  It is still 
unclear if the government will be successful at positively 
influencing the situation.  So far, the results are uneven at best: 
two foreign ratings companies recently changed their outlook on 
Iceland's sovereign credit rating to negative, with one directly 
citing the lack of information on Iceland's strategy to address 
economic policy issues.  End Summary. 
 
¶2. (SBU) Iceland's economy has been in turmoil in recent months. 
The Icelandic stock market has lost 32 percent of its value over the 
last year, which has affected access to credit through leveraged 
loans.  The Icelandic krona, which some experts say was overvalued 
to begin with, depreciated 20 percent to reach a near historic low 
index, even against the US dollar.  Although Icelandic fish 
exporters rejoiced (fishing remains the largest sector of the 
economy), most consumer goods are imported and the media was quick 
to highlight instantaneous 10 percent price hikes.  Director of 
University of Iceland's Economic Institute Gunnar Haraldsson told us 
that despite little exposure to the global subprime mortgage market, 
Iceland's financial sector is suffering from worldwide tightening of 
credit, and the resulting slowdown is coinciding with a forecasted 
slowdown related to the scheduled completion of capital intensive 
energy and aluminum smelter projects. 
 
¶3. (U) On March 25, in response to inflationary pressures and the 
depreciating krona, Iceland's Central Bank Board met in an emergency 
meeting and raised the interest rate 1.25 percent to a new record 
high of 15 percent.  The krona and the stock market responded 
immediately, reversing slightly some of the losses.  At the same 
time, government officials began a public campaign to bolster 
confidence in the economy.  In a speech at the annual meeting of the 
Central Bank on March 28, Prime Minister Geir Haarde emphasized that 
Iceland's government has almost no debt, and the Treasury and 
Central Bank could provide assistance should the need arise.  During 
Haarde's address to the Parliament on March 31, he stated the bottom 
of the devaluation of the krona had been reached.  Haarde allowed 
that the devaluation had been faster than anyone had expected but 
was sure it would not last.  He has also given a series of upbeat 
interviews with the Financial Times to counter generally negative 
international coverage. 
 
¶4. (U) Meanwhile, the search for scapegoats is well underway.  On 
March 30, the Central Bank asked the Financial Supervisory Authority 
(Iceland's equivalent to the Securities and Exchange Commission) to 
investigate foreign investors who "attacked" the krona for 
speculative gains.  The media reported the next day that British 
investor Hugh Hendry of Eclectica Asset Management had gloated in 
2006 that he would become famous for bringing down the krona.  The 
Prime Minister told the media on April 1 that Iceland was 
considering all options available to influence the financial 
situation.  He emphasized that foreign investors were to blame and 
that Iceland would consider "setting a bear trap" to punish them. 
 
¶5. (U) The idea that foreigners are responsible for the economic 
mess is a welcome distraction for Icelandic consumers, many of whom 
have, in addition to paying higher prices for food and consumer 
goods (most of which are imported), acquired foreign currency car 
loans and mortgages.  These loans, typically in Swiss Francs or 
Japanese Yen, are low in interest but carry the risk of currency 
fluctuations.  With the sudden krona depreciation, consumers are 
seeing their monthly payments rise immediately.  Truck drivers began 
daily traffic-snarling protests all over Iceland on March 27 against 
spiking diesel prices. 
 
¶6. (U) Notwithstanding the government's spin attempts, international 
attention remains on the situation.  In the New York Times on March 
31, Paul Krugman blogged about the krona speculation and likened it 
to the situation with Hong Kong in 1997-1998.  During the April 2 
Congressional testimony,  Federal Reserve Chairman Ben Bernanke was 
asked about Iceland and speculative hedge funds.  The markets appear 
to be equally concerned:  on April 1, both Fitch and Standard and 
Poor's changed their outlook on sovereign credit rating to negative, 
with the latter directly citing a lack of information on Iceland's 
strategy to address economic policy issues. 
 
 
¶7. (SBU) Comment: Only time will tell if the government will be 
successful at positively influencing the situation.  Experts at the 
University of Iceland and the Ministry of Finance tell us that much 
depends on the global availability of credit.  Haarde's government 
has its work cut out.  It may take more than a few pep talks to 
repair investor confidence. 
 
Van Voorst