What's Right and What's Hype?

They might not admit it at first, but anyone working in the market will tell you that 90 percent of a companys value is based on public perception. Psychology, in other words. Having worked at a stock brokerage myself, Ive seen companies with a great product, strong staff and healthy revenues suddenly tank due to rumours of financial difficulties, whether they proved true or not. The reverse is also true companies consisting of little else besides a PR staff with snazzy-looking literature can earn tremendous revenue. In the end, though, its always that crucial ten percent the real value of a company that determines where things will level off. In addition, even the most successful companies go through continuous upswings, downturns and levellings-offs. This same principle can be applied to the economic strength of a nation, and Iceland is no exception.

Iceland wasnt always the fairly well-off country it is today. Before the arrival of British and American forces during and after the Second World War, Iceland was mostly agricultural. The development of the infrastructure by foreign armed forces helped propel Iceland into a more industrialized society. While many industries were state-owned, the early 1990s saw a tremendous privatization drive, with the government selling many of its assets to private businessmen. Many of these formerly state-owned companies, such as Landsbanki, are today among the top earners in the country.

Not that all of Icelands success stories are the result of sold-off state assets. One of the strongest and arguably the most visible corporations in Iceland, Baugur Group, started as a single grocery store, Bónus, in 1989. Today, Baugur Group owns 27 companies in Iceland and abroad. In fact, recent overseas investment and acquisition is without a doubt the biggest reason why the international business community has been following Iceland so closely, with the U.K. and Scandinavia being the primary targets, and Baugur Group being the primary investor. People began to sit up and take notice of Icelands business world they had no choice.

Of course, not everyone took Icelands investment manoeuvres well. That a nation of just over 300,000 people could be home to a number of dollar millionaires who made their money within an amazingly short period of time seemed a hard pill to swallow. A now-infamous 2005 article that appeared in the Guardian entitled Next-generation Viking invasion implied that Björgólfur Þór Björgólfsson and his father, Björgólfur Guðmundsson, and Magnús Þorsteinsson profited from the St. Petersburg mafia when they opened the Bravo brewery in 1993. Financial and political squabbles within the country shortly after the Guardian article was published in particular, the government taking Baugur to court for alleged economic crimes, of which theyve since been acquitted, and evidence suggesting Prime Minister Halldór Ásgrímsson engaged in market manipulation published in the daily newspaper Fréttablaðið made already growing suspicions in the international business community increase that much more. A backlash or rather, that aforementioned downturn was inevitable.

The Fitch rating vs. the Mishkin report

Last February, market analysts Fitch Ratings revised their currency rating for Iceland from Stable to Negative. The report said that Icelands economy had long showed signs of overheating, citing rising inflation, fast credit growth, and escalating foreign debt, among other things. Senior director in Fitchs sovereign team in London Paul Rawkins said in the report, In the absence of a more balanced policy response, Fitch believes that the risks of a hard landing have increased, raising concerns about how well the broader financial system would cope. The report also said that Icelands net external debt is higher than virtually any other Fitch rated sovereign, and makes comparisons to the Asia crisis some years back, saying in part, countries with seemingly sound public finances ignore the private sector imbalances at their peril.

This seemed to start a domino effect throughout the spring, with Bloomberg, Moodys and the Financial Times reiterating what Fitch had said. The word in the financial pages of the international press was, Icelands currency is overvalued, their foreign debt is rapidly rising, inflation continues an upswing. During this time, the Icelandic stock market was hit with a five percent drop on a single day, and the value of the Icelandic crown went from about 70 ISK per USD to 81 ISK per USD within the span of a few days. Did the bad press hit Icelands economy, or did Icelands economy deserve bad press? The truth is: both.

The Central Bank set an interest rate of about 10.5 percent in February (its at 12.25 percent today) while in the rest of Europe its about three percent. This pushes the exchange rate up, which makes imports cheaper but also makes exports more expensive (in case you were puzzled as to why the same product from overseas is cheaper than one made in Iceland, now you know). While Iceland prohibits the importation of dairy, poultry, and some other forms of meat, it still has not raised import tariffs that could help make home-grown goods more affordable than imports. In addition, much of Icelands agricultural goods are subsidized. This one-two combination makes for an import-based economy, and widens the trade gap. About half the deficit is due to overconsumption of imports because imports are cheaper than domestic goods.

Things now seem to be levelling off. The Icelandic Business Council responded by calling on a respected international specialist to assess the Icelandic financial system. The report made by Frederic Mishkin and Tryggvi Þór Herbertsson seems to have reached the ears of those following news of the Icelandic economy. In short, the report results showed that the foundations of the economy are good and that there is little danger of a financial recession. This is good news but no one is forgetting that Iceland needs to tread carefully. Mishkin and Herbertsson point out that a few changes should be made to ensure the good stance of the economic and financial systems. Firstly, they believe that the department of financial control should return to the Central Bank. Secondly they believe that banks should increase their information flow and transparency. Thirdly, they believe that the housing fund should be taken out of the consumer price index once that equilibrium is restored. And fourthly, they call for moderation in state budgets. The Mishkin report and the Economist conference held this spring were important to the discussion of the Icelandic economy. Such discussion is valuable in informing the outside world of the reality behind the great Icelandic business adventure of recent years.

Compiled by Paul Nikolov and Anna Margrét Björnsson.