Iceland Gets $11 Billion Bailout, but Will be Saddled with Debt for Years to Come

By Jason Simpkins
Associate Editor
Money Morning

Iceland today (Thursday) secured nearly $11 billion in loans from the International Monetary Fund (IMF) and other nations. The bailout will help the island nation stabilize its currency and recapitalize its banks, but it will also saddle its tiny population with a huge debt burden.

The IMF will lend Iceland $2.1 billion, and Finland, Sweden, Norway and Denmark will loan $2.5 billion to help the country re-float its currency and shore up its banking sector. 

The Icelandic krona, or crown, has lost about 70% of its value since the nation’s financial crisis first began. The government put restrictions on currency trade as it wrestled with the crisis, however one of the stipulations of the IMF loan is that Reykjavik once again float its currency. Once it does, it’s likely that there will be a “massive currency outflow,” Iceland’s central bank said.

The krona, which traded at 176 against the euro at a Nov.19 auction, could trade weaker than 250 per euro after the float, Lars Christensen, chief analyst at Danske Bank A/S, told Bloomberg.

“They’ll have to accept that there’ll be a pretty significant pressure on the currency when they reintroduce a free float,” Christensen said.

The IMF said that $827 million of its loan would be made available immediately and the rest in eight installments of about $155 million, subjected to quarterly reviews.

Iceland will also get about $6.3 billion from the United Kingdom, the Netherlands, and Germany to cover foreign deposits at Icesave – a unit of the failed bank Landsbanki Islands.

“Iceland is in the midst of a banking crisis of extraordinary proportions,” John Lipsky, deputy managing director of the IMF, said in a statement. The country “is facing a severe recession, given the high debt level in the economy and significant dependence of the private sector on foreign currency and inflation-indexed debt.”

The debt burden resulting from IMF, European, and Nordic loans totals nearly $11 billion, greater than the nation’s gross domestic product (GDP). The Icelandic economy is worth roughly $7.5 billion, based on 2007 GDP at current krona exchange rates, Bloomberg reported.

Divided amongst a population of 320,000, each citizen would have to come up with $34,375 to pay off the debt. But that’s only if Icelanders stick around.

Up to a third of Iceland’s population is considering leaving the island, the Financial Times reported. That kind of exodus would result in even less tax revenue and economic development and deepen a recession that is already expected to be severe.

The IMF expects Iceland's GDP to contract 9.6% next year, while Danske Bank’s Christensen estimates the economy will contract by a full 10%.

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