Last week, Iceland’s central bank raised interest rates to a record 15.5 percent to curb inflation and shore up the currency. The krona has lost 22 percent of its value against the euro since Jan. 1. On Thursday, Standard & Poor’s cut its credit rating on Iceland, citing the vulnerability of the banks.
Here’s why, in part:
A huge investment boom and the privatization of the banks eight years ago left the country with a yawning current-account deficit - $2.7 billion, or 16 percent of its total economic output in 2007.
By comparison, the much-criticized current-account deficit of the United States is 5.3 percent of total output.
Iceland’s banks have grown out of all proportion to its little economy. The total assets of the banks are nearly 10 times the size of the country’s gross domestic product. The three largest banks — Glitnir, Kaupthing, and Landsbanki — have expanded into Scandinavia and Britain, have bought European banks, and have even opened branches in China and Canada.
One analyst said Iceland is in a situation similar to that of South Korea before the Asian monetary crisis of the late 1990s.
One difference. South Korea has more than 20 times the population of Iceland and a much more robust manufacturing center.
Sounds like it’s time to batten down the hatches in Iceland.
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