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### Viewing cable 09REYKJAVIK15, ICELAND ECONOMIC SITUATION EXPECTED TO DETERIORATE FURTHER

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
09REYKJAVIK15 | 2009-01-23 16:04 | 2011-01-13 05:05 | CONFIDENTIAL | Embassy Reykjavik

`

    VZCZCXRO3840
    PP RUEHFL RUEHKW RUEHLA RUEHNP RUEHROV RUEHSR
    DE RUEHRK #0015/01 0231648
    ZNY CCCCC ZZH
    P 231648Z JAN 09
    FM AMEMBASSY REYKJAVIK
    TO RUEHC/SECSTATE WASHDC PRIORITY 3956
    INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
    RUEHZL/EUROPEAN POLITICAL COLLECTIVE

` `

    C O N F I D E N T I A L SECTION 01 OF 02 REYKJAVIK 000015

    SIPDIS

    E.O. 12958: DECL: 1/22/2019
    TAGS: EFIN ECON PGOV IC
    SUBJECT: ICELAND ECONOMIC SITUATION EXPECTED TO DETERIORATE FURTHER
    BEFORE IMPROVING

    Classified By: Amb. Carol van Voorst for reasons 1.4 (b) and (d).

    REFS: A) Reykjavik 13 B) Evans - Reykjavik Morning Update emails
    1/23/09

    1.(C) Summary: The Ministry of Finance's report on Iceland's economic
    health this week forecast a dismal eighteen months before recovery.
    This assessment was echoed by the new Chairman of the Government
    Coordinating Committee, Mats Josefsson, who is charged with creating
    a framework for restructuring the banking sector.  Restructuring has
    been slow, but seems to be headed in the right direction, and
    Josefsson is confident that the IMF will be satisfied with their
    mid-February review.  However, problems persist, such as the lack of
    an overall "Economic Czar" for Iceland to deal with other issues like
    the currency depreciation.  Recent public unrest and uncertainty on
    the political scene are also complicating.  Also unresolved are the
    issues with the old banks' creditors and the negotiations to settle
    the unsecured IceSave deposit accounts.  Overall, the situation is
    tough and stressful and is testing the fortitude of the Icelandic
    people as well as their government.  We expect that matters will
    deteriorate further before recovering.  End Summary.

    ¶2. (U) "The Icelandic economy is heading for a deep recession in 2009
    that is forecast to reach a trough in the first half of 2010,"
    concludes the Ministry of Finance produced national economic forecast
    released this week.  The summary goes on to say that Real GDP
    declined by a small margin in 2008, but is predicted to decline by
    9.6 percent in 2009.  Unemployment, previously at 1.7 percent in
    2008, is predicted to average 7.8 percent in 2009 and 8.6 percent in
    ¶2010. Inflation, calculated at 12.4 percent in 2008, is expected to
    increase to 13.1 percent in 2009 and then decline to average 2.7
    percent in 2010. The report recognizes that there "is considerably
    more uncertainty than before about most elements of the forecast" as
    the model relied on historically measured relationships, some of
    which have likely changed since the collapse of the banking system.

    ¶3. (C) Mats Josefsson, newly appointed Chairman of the Coordination
    Committee, and Gudmundur Arnason, newly assigned Director of Special
    Projects at the Prime Minister's Office, echoed these predictions to
    Econoff on January 23.  Josefsson's mandate is to create a framework
    for restructuring the banking sector, and Arnason "makes sure the
    recommendations of the Committee are implemented by the ministers."
    Josefsson remarked that the government had let the banks handle
    everything over the last ten years and there was not the
    infrastructure in place to deal with the crisis.  This led to
    inaction, and in hindsight, more could have been done more quickly in
    October.  However, Josefsson said that the attitude is changing in
    the government and "there is a realization that things have to
    happen."  He also said that he has advised the Icelanders that it is
    better to do things on their own before being told by the IMF to do
    things "the IMF way."  Josefsson said that changes take time, but the
    direction is good and he was optimistic that the IMF will be
    satisfied with the first review.

    ¶4. (C) Regarding the banking sector, Josefsson said the new banks
    still need to be capitalized and must start lending, as a functioning
    banking system is necessary for the economy to recover.  He said the
    business plans of the banks are OK, but the new banks need "to be
    cleaned up."  He further clarified that since the creation of the new
    banks, some of the healthy assets moved from the old banks to the new
    banks have deteriorated.  Most of these are related to corporate
    loans and this debt needs to be restructured.  (Note: Businesses are
    heavily in debt with foreign currency loans and with the krona's
    devaluation, and many are unable to service their debt.  End Note.)

    ¶5. (C) Josefsson said that since the old banks are in moratorium
    (court administration), creditors must address issues with the
    Resolution Committees, and not lobby the Prime Minister's office.  He
    said that the Resolution Committees need to be affirmed by the court
    to prevent committee members, or the Government who appointed them,
    from being sued.   Financial advisors are in place at the banks, but
    the Government of Iceland, which is also a creditor, needs to have
    its own voice before these Committees.  Once that official, whom
    Josefsson called a "spokesperson," is in place, then all the parties
    can get together to talk.  Josefsson said there has been discussion
    about the bond or instrument that the new banks would provide as
    value for the assets removed from the old banks.  He saw these bond
    negotiations taking two to three months, because some want to wait
    until the new banks start increasing in value to pass some of this
    value to the old banks, but the government did not want to pass back
    all of the value.  He said the old banks' value still needs to be
    assessed and there has been some delay because it is very expensive
    to hire the necessary experts, who Josefsson felt were "taking
    advantage" of the situation for financial gain.

    ¶6. (C) When the U.S. Department of Treasury Deputy Assistant
    Secretary visited Reykjavik December 8 - 9, 2008, there was a visible
    lack of an "Economic Czar." It took two full days of meetings to
    obtain a coherent picture of the economic situation.  In December,
    the Advisor at the Prime Minister's Office Bjorn Runar Gudmundsson,
    described his office as playing a coordinating role, but conceded

    REYKJAVIK 00000015  002 OF 002

    there was a lot of misunderstanding and difficulty in getting
    "everyone to talk the same language."  Gudmundsson had noted that the
    initial crisis was not managed well, coordination had been difficult,
    and that tensions in the political arena had been stirred up.
    Gudmundsson had mentioned three priorities - the currency, the fiscal
    policy, and the banks.  Now in January 2009, it appears Josefsson has
    the banking sector reform laid out, but Josefsson was clear that his
    mandate does not extend to exchange rate issues.  Also complicating
    matters is the current uptick in public unrest (Ref A) and the
    announcement the Prime Minister will retire from politics in March
    because he has cancer of the esophagus (Ref B).  Josefsson said
    political stability is important as there has to be a government in
    place to implement these necessary changes.

    ¶7. (C) Further unresolved are the negotiations with the U.K., the
    Netherlands and Germany on the unsecured IceSave deposit accounts.
    At the Ministry for Foreign Affairs, Martin Eyjolfsson, the lead
    negotiator, said that the parties have agreement on the principle of
    paying the EU minimum deposit guarantee.  However, to make the
    payments, Iceland will have to borrow from the other states in the
    short term, and disagreements persist on the interest rate, length of
    loan, grace period, and other terms.  In mid-December, Eyjolfsson
    described the British and Dutch representatives as presenting a
    united front in the meetings, but having separate views on interest
    rates.  The British wanted a 6.7 percent loan, which Eyjolfsson said
    could block Iceland from meeting the Maastricht requirements and bar
    Iceland from the Euro.  Eyjolfsson said for every one percent in
    interest on the loan, there will need to be a corresponding 1.5
    percent decrease in the state budget.  Eyjolfsson told Econoff
    January 22 that negotiations were still ongoing and the next meeting
    with the British, Dutch and Germans together, was set for the first
    week of February.

    ¶8. (C) Comment: Overall, the aftermath of the October 2008 banking
    sector meltdown continues to test Icelandic fortitude, inside and
    outside government.  All indications are that the economic situation
    will deteriorate further before recovering.  Icelanders have a
    tradition of being flexible and hardworking.  If they can adapt and
    endure the next six to 18 months, then they will have made it through
    the worst.  However, the recent political turmoil and grave illnesses
    of the leaders of both Coalition parties only adds to the
    difficulties of recovery.  End Comment.

    VAN VOORST

`