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### Viewing cable 08REYKJAVIK267, ICELAND: IT WON'T BE THE BEST PLACE TO LIVE ANYMORE

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
08REYKJAVIK267 | 2008-11-14 07:07 | 2011-01-13 05:05 | UNCLASSIFIED//FOR OFFICIAL USE ONLY | Embassy Reykjavik

`

    VZCZCXRO0820
    PP RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
    RUEHLZ RUEHNP RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
    DE RUEHRK #0267/01 3190748
    ZNR UUUUU ZZH
    P 140748Z NOV 08
    FM AMEMBASSY REYKJAVIK
    TO RUEHC/SECSTATE WASHDC PRIORITY 3887
    INFO RUCPDOC/USDOC WASHDC PRIORITY
    RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
    RUEHZL/EUROPEAN POLITICAL COLLECTIVE

` `

    UNCLAS SECTION 01 OF 02 REYKJAVIK 000267

    SENSITIVE

    SIPDIS

    E.O. 12958: N/A
    TAGS: ECON EFIN PGOV IC
    SUBJECT:  ICELAND: IT WON'T BE THE BEST PLACE TO LIVE ANYMORE

    ¶1. (SBU) Summary:  Last year Iceland was rated by the UNDP as the
    best place to live in the world, but the October collapse of the
    Icelandic banking system has triggered a full scale financial and
    currency crisis and delivered a knockout punch for Iceland.  Now
    experts are just beginning to piece together what will happen in the
    economy here and how living standards will be affected.  Already we
    have seen an immediate, rapid rise in unemployment and inflation.
    There is significant trouble with the Icelandic krona and currency
    exchange limits have limited foreign trade on this import-dependent
    island.  As a result, business reps predict 70 percent of Icelandic
    businesses will go bankrupt in the near future.  The best hope for
    the short term is an IMF economic stabilization program awaiting IMF
    Executive Board approval.  However, before the Board can consider
    the package, Iceland must secure $4 billion in other bilateral
    loans, and they are only a quarter of the way there.  The IMF money
    will continue the flow of essential goods to Iceland, but real
    economic recovery will take longer.  Iceland must address the
    creditors of the failed banks to preserve future private sector
    financing again and the only long-term solution we've heard for the
    currency crisis is joining the EU and adopting the Euro.  End
    Summary.

    ¶2. (SBU) The collapse of the Icelandic financial sector in October
    has triggered an economic crisis, the depths of which are only now
    becoming clear.  Many Icelanders lost all their investments because
    they owned stock in the three banks that collapsed or other
    companies that faltered as a result of the banks.  Those who had
    cash savings in some accounts are unsure if their money is still
    there as many accounts remain frozen.  There has been a rapid rise
    in unemployment in a country that has generally faced labor
    shortages.  The Directorate of Labor reported in September the total
    number of unemployed was about 1.3 percent unemployment, the number
    jumped to 3 percent in six weeks and is anticipated to be 7 percent
    by January.  The Central Bank predicts that at the end of 2009,
    unemployment rates will have reached 10 percent.

    ¶3.  (SBU) As economic conditions worsen, academics and industry
    experts alike tell Post they expect a brain drain.  Iceland's
    semi-skilled foreign work force is expected to be the first to move
    away and we have seen anecdotal evidence of that departure already;
    the Polish Consulate here estimates that half of the roughly 14,000
    Poles who moved here to work in the construction and services
    industries have left Iceland in the last three months.  As the
    condition of the Icelandic labor market deteriorates Icelanders
    themselves might start thinking about moving abroad.  The Chairman
    the Union of Icelandic Electrical workers stated earlier in the week
    that hundreds of tradesmen (carpenters, electrical workers,
    plumbers, masons) are already preparing to move abroad. The Norden
    Association, an organization that promotes Nordic co-operation,
    reports a large surge of Icelandic interest in their course that
    teaches how to establish oneself when moving to a Nordic country.

    ¶4. (SBU) Inflation, always a problem here, is also expected to spike
    in the short term despite an overall economic contraction.
    Currently, twelve month average inflation is being measured at 15.9
    percent, and because Iceland is extremely import dependent,
    inflation is directly influenced by the (falling) value of the
    Icelandic krona.  According to the Central Bank's baseline forecast
    inflation will peak at 23 percent in the first quarter of 2009 but
    will have fallen to 5 percent by the end of the year. This sharp
    decline in inflation is based on the assumption of moderate wage
    growth, falling demand for consumer goods, and a stable exchange
    rate. If these assumptions do not hold, then inflation might reach a
    higher level and remain high for a longer time, something Iceland
    hasn't seen since the 1980's.

    ¶5.  (SBU) Businesses report significant difficulties regarding trade
    and the currency.  When the U.K. authorities invoked anti-terrorism
    and economic crimes legislation against Icelandic banks and froze
    Icelandic assets on October 8th, virtually all international
    payments to Iceland stopped.  Two days later the Icelandic Central
    Bank established rations of foreign currencies at a fixed price and
    gave priority to importers of food, fuel and pharmaceuticals.
    Importers of clothes, electronics and every other good had to get in
    line for currency.  Post learned of one stationary supply store
    which waited for three weeks to get foreign currency to import
    office paper.  The Confederation of Icelandic Employers told post
    that Icelandic businesses are facing serious difficulties that only
    seem to worsen with each day; on top of the cross-border payment
    problems and restricted access to foreign currencies, Icelandic
    companies' standing with their suppliers abroad has suffered
    greatly.  Virtually all transactions have to be pre-paid.  Adding to
    the pain, many businesses took out loans in Japanese yen, which has
    appreciated 136 percent against the krona and resulted in increases
    in payments.  The Federation of Trade and Services predicts 70
    percent of businesses are expected to declare bankruptcy in the near
    future if the currency crisis is not solved.

    ¶6. (SBU) For the short term, the IMF assistance is supposed to

    REYKJAVIK 00000267  002 OF 002

    provide foreign currency to support re-floating the krona and
    stabilize foreign trade, however the IMF deal is not assured.  The
    IMF announced on Oct. 24 a $2.1 billion loan provided that
    Icelanders raise nearly $4 billion more; thus far they have secured
    loans of just over $1 billion from Norway, Poland and the Faroe
    Islands.  Every day the press speculates who is to blame for no IMF
    deal, with the clear favorite the U.K. (reportedly blocking the deal
    until a resolution is created for the failed Icelandic banks in the
    U.K.)  As we understand it, the IMF deal is essential to solving the
    immediate currency crisis.  The Head of the Research Department at
    Kaupthing Bank reiterated to Emboffs that it is of vital importance
    to establish a sound currency market in Iceland.  He said that once
    the krona is floated again, it will devaluate further, but no one
    knows by how much; the main fear with lifting restrictions in the
    currency market is that of a domestic run, with Icelanders selling
    krona to get foreign currencies.  This seems to indicate that
    currency restrictions will remain in place in some form even if the
    IMF loans are approved.

    ¶7. (SBU) Addressing longer term conditions will require resolving
    the issues with creditors and depositors and the long term strength
    of the currency.  The British IceSave account holders are still
    grabbing the headlines, but behind the scenes there are many
    creditors lining up.  Post met with a lawyer representing American
    bond holders with $3.5 billion invested who plainly stated that if
    Iceland does not take a transparent and fair path with creditors,
    investors will never come back.  This concept is beginning to be
    discussed in the media; the most prominent proponent is the head of
    the Confederation of Employers, who advocates giving the creditors
    ownership of the banks as a way of preserving Iceland's future
    access to credit.  Most business representatives and economists we
    talk to do not see a medium or long term solution with the Icelandic
    krona.  Everyone seems to feel the joining of the EU and the
    adopting of the Euro is not only inevitable, but necessary for long
    term economic survival.

    ¶8. (SBU) Comment: The situation here is still fluid, but as the
    consequences of this crisis continue to play out, we could start to
    see the development of a permanently unemployed class, which is
    historically unknown here.  Iceland has always had reverse brain
    drain, where young people are educated abroad, but return to raise
    their families.  This will likely no longer be the case and young
    Icelanders abroad will stay there and those who can move away from
    Iceland will.  Foreign travel, very common in recent memory, will be
    restricted by financial constraints.  Once the current stocks of
    consumer and luxury goods are depleted, there will not be a
    replenishment to the same level as before.  In short, Iceland faces
    the very real prospect of the rapid undoing of two decades of robust
    prosperity and a whiplash-inducing return to scrimping and saving
    unknown since the 1980s.  This already bitter pill will take on a
    new edge if the public holds to its current view that this disaster
    is the fault of vindictive foreign parties (e.g, the British).

    van Voorst

`