02:34 GMT +324 September 2017
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    Iceland turns to Russia for bailout

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    MOSCOW. (RIA Novosti economic commentator Yelena Zagorodnyaya) - Russia has agreed to bail out Iceland by granting this small island state a huge stabilization loan at an unbelievably low interest rate. Is it an act of wanton generosity, or a far-sighted geopolitical step? And in general, four billion euros, is it a lot or a little?

    The fate of Iceland has until recently not concerned Russia one bit. Now only a lazy person is not discussing the incredible sum the "island of stability" is going to inject into the economy of a sinking island of geysers.

    Europe has meanwhile been discussing Iceland for a long time. Hedge-fund country, an example of liberal economic regulation and a model of a rapidly developing economy, Iceland was the first in the world to feel the impact of a full-bodied economic crisis. This happened at the end of 2007. Since this year began, Iceland's currency - the krona - has lost one-third of its value against the euro. Iceland's leading banks - Kaupthing, Glitnir and Landsbanki - have been marauded by international financial sharks. At the end of September, the country's authorities bought out (read, nationalized) Glitnir bank, and on October 7 Landsbanki, while on the same day Kaupthing bank received a 500 million euro loan from Iceland's National Bank. By the autumn of 2008 it had become clear Iceland might become the world's first country to suffer a default.

    Why is the bubble of Iceland's economy bursting so loudly? It ballooned too rapidly, the IMF believes. In 2003-2007, the country's GDP had risen by 25%, with this robust growth fed mainly by outside borrowing. To attract foreign investments, the authorities strengthened the currency and ratcheted up interest rates (by the beginning of 2008, they were the highest in Europe - 15.5% per annum). The result was a monstrous misbalance: a modest GDP, on the one hand, and immense financial assets and tremendous liabilities, on the other. According to 2007 figures, Iceland's GDP was $16 billion, while its financial assets stood at 1,000% of GDP and an external debt of 550% of GDP.

    With Iceland teetering on the brink of default, Russia's stabilization loan of four billion euros is a lifebelt, and a very sizeable one (on the evening of October 7, Finance Minister Alexei Kudrin acknowledged Russia's readiness to pay, although previously he had denied such claims by Iceland's National Bank). Judge for yourself: when, in May 2008, Iceland was drowning, the central banks of three Scandinavian countries - Sweden, Denmark and Norway - set up a special $2.3 billion rescue fund for Iceland. Now Russia alone is ready to fork over two and a half times as much for the same purpose. In other words, four billion euros by Iceland's standards is substantial.

    In Russian eyes, it is a vast sum, too. And one pledged at a very fair rate. To judge from a release issued by Iceland's National Bank, Russia promised it at LIBOR+(0.3-0.5)%. This compares with LIBOR+1% at which the Russian Central Bank wants to offer loans to Russia's Vnesheconombank. At a time when Russian authorities hold crisis emergency meetings almost daily, this looks strange, to say the least. The man in the street would say this is no time for liberal loans when one's own existence is at stake. This man's response would not be quite right, in my opinion.

    There are several reasons why Russia should agree to issue the loan to Iceland.

    The first and overwhelming one is geo-economic.

    Leaders in many countries are gradually beginning to understand that a world caught in the maelstrom of a financial crisis could be saved only by cooperative efforts. This was a theme running through a three-day world policy conference in Evian; it will certainly be taken up at an annual meeting of the International Monetary Fund and World Bank.

    WB chief Robert Zoellick only recently proposed that the G8 also include BRIC countries (Brazil, Russia, India and China), Mexico, Saudi Arabia and South Africa. World leaders more and more often speak of the need to shelve personal ambitions, put away political squabbles and do something.

    To come to the aid of Iceland at such a time has been for Russia a decision prompted by stark necessity. Russia has a rich war chest of windfall oil money. By the end of September, its Central Bank had $566 billion in international reserves, and $32-plus billion in the National Welfare Fund and the Reserve Fund. Of course, Russia could sit it out on its "island of stability" and fight the crisis within its four walls. But in this case Russia risks suddenly discovering that the global financial storm whipped up even further by Iceland's hurricane has wiped out all its stockpiled reserves.

    Most of Iceland's lenders are European banks. Should Iceland declare a default, the whole of Europe would go into a spin, and would drag Russia after it, which now has a chance to scrape its way out of the crisis the cheap way. It emerges that by saving Iceland, Russia is saving itself first.

    Other considerations are less global and more pragmatic.

    Crises come and go, but allies (sometimes) remain. Iceland, a rapidly developing economy and a happy hunting ground for businessmen from many European countries, is certain to remember this gesture and take more kindly to Russian investments in the future. So far, Russia-Iceland trade has been $100 million per year. And it was only shortly before the crisis that Russian business (represented by Roman Abramovich and Oleg Deripaska) began exploring the country's investment possibilities. Now the price for entering Iceland's economy could prove very low.

    Besides, it makes a good staging post for flights to Latin America.

    The opinions expressed in this article are the author's and do not necessarily represent those of RIA Novosti.

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