Iceland Economy: from fishing to banking to tourism…will it sustain?

Nice piece by Leonid Bershidsky:

Iceland, compared with Ireland and Greece, is an economist’s dream. It’s tiny and open, so it responds to stimuli spectacularly and almost without delay. It turned overnight from a fishing-dependent economy to a highly financialized one — a transition brilliantly described in Michael Lewis’s book “Boomerang”; it went just as quickly to a tourism-driven economy after the banking crash. The quick turnaround is an advantage, but also a potential drawback.

The lifting of capital controls is driving the krona back up. It achieved its post-crisis high earlier this month and is close to that level now. It’s one of the world’s five best-performing currencies so far this year.

Without the capital controls, Iceland, with a benchmark interest rate of 5.75 percent, again becomes attractive to carry traders — something that nearly killed its economy last decade. Now, they can provide cheap resources for the construction boom, which depends on tourism, which, in turn, depends on a relatively cheap krona. But the influx of these resources will strengthen Iceland’s currency, and if the government and the central bank are not careful, the country may soon find itself in trouble again. The Organization for Economic Cooperation and Development pointed to that danger in November, writing in a brief economic assessment that “liberalization of the capital account raises uncertainty about capital flows, while at the same time the relatively high interest rates could cause large capital inflows and strong appreciation of the krona, hurting the economy.”

It’s likely that Iceland wasn’t really saved by the convenience of having its own currency or by the resolve it showed in cleaning up banks and jailing bankers. A unique combination of attractiveness to international tourists and a nine-year disconnection from global financial markets were the major drivers behind its recovery.

The volcanoes, glaciers and hot springs are still there, but Iceland is dangerously open to the global capital flows again — something it may not be able to afford.

Hope to visit this place sometime..


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