Everything seems to be in a limbo in the country right now. Parliament is too new to develop its own personality, and acquiring one could be difficult until many new members find the right balance between living up to their resource nationalist identity and living it down after donning a new garb. The Government is still to find its feet or to decide on the exact ground where it will place those feet. Businessmen wielding political power need to tread a straight and narrow path of public probity, and the people wonder if the new set can. General policy and specific issues wither in an impasse or, maybe it would be better to say, loiter in a maze. Foreign investors, from neighbours of both the immediate and the third sort, keep their fingers crossed and purse strings tightly closed. Mining, seen only recently as an unstoppable engine of growth, is hobbling, with promise overshadowing performance.
This is no time to write about Mongolia. Instead, let us go to a small and far away land, whose success in coming out of a crisis that also caused national shame has largely gone unnoticed, but which I find both exhilarating and uplifting. And much in the story will be familiar to Mongolians.
I talk of Iceland. I was there some four decades ago but even today’s visitors must come back with the same impression of an icy country, relieved by enormous geysers spouting steam. But it also has bauxite, and in 2003, it began large aluminium projects that generated demand, leading the labour market to tighten, and the balance of payments to worsen. So the central bank raised interest rates, and its three banks followed. The interest rates were locally high; but since krona (crown), the local currency, was appreciating, the cost of interest in foreign exchange was low. The banks began to borrow abroad at low rates, and lent the money locally at high rates. People were prospering, and they borrowed to feel even richer. Foreign investors sold krona-denominated debt in their own countries, and used the money to buy the foreign currency loans raised by Icelandic banks at high interest rates. Both made money.
Property prices shot up,making them even more attractive, and this raised prices even more. Icelandic banks’ assets were roughly equal to the country’s GDP in 2004; by 2007, they had risen to nine times GDP. The finance ministry ran respectable fiscal surpluses, and the Central Bank kept raising rates. The country’s growth rate in 2001-06 was the highest amongst OECD countries and, by 2006, it was the fifth richest country, after Norway, the USA, Ireland and Switzerland. Unemployment was under 3 per cent, and its Gini coefficient was amongst the lowest.
Then, in early 2008, the banks started finding it difficult to borrow abroad: their credit default swap spreads increased to 10 per cent and, worse still, the sovereign bonds of the government also depreciated. As banks’ borrowings abroad shrank, the krona began to depreciate; between October 2007 and June 2008, it fell more than 50 per cent against the euro and the dollar.
The government did all the right things by the book. The CBI raised its policy rate, relaxed rules about eligible securities, and reduced the maximum difference between permissible foreign exchange assets and liabilities of banks. It made swap arrangements with other Scandinavian central banks to be able to borrow 1.5 billion euros, and the government gave it permission to borrow another 500 million euros. But in 2008, a global financial crisis descended, and all the three banks of Iceland collapsed within a week.
In October 2008, the government asked the IMF for a standby loan. The IMF found that the external debt exceeded six times GDP. Reserves covered less than 10 per cent of short-term debt. The payments deficit was close to 20 per cent of the GDP, and inflation was 10 per cent, which may sound normal in Mongolia but was unheard of in Europe. The top three banks’ assets exceeded nine times GDP. Corporate borrowings were almost three times GDP, two-thirds of it in foreign exchange, and household borrowings were more than the GDP. Two-thirds of loans became non-performing. A quarter of the households could not service their debts without reducing their standard of living. Almost half of businesses defaulted on their loans.
The IMF gave $827 million immediately and another $1.3 billion in eight quarterly instalments subject to reviews. Now, almost four years later, Iceland is still heavily indebted. Official debt is almost equal to the GDP, so is household debt, and corporate debt is roughly twice GDP; thus, total indebtedness is almost four times GDP, of which more than half is external. But its trade balance turned positive soon after the crisis, and has remained so. Two of the three banks were restructured and handed back to private owners. The number of banks has shrunk from 23 to 14, and bank assets from nine times GDP to twice.
Unemployment continues at a level of 6-7 per cent. The proportion of population receiving income transfers has gone up from about a quarter to a third; the poverty ratio after income transfers remained below 10 per cent, and the Gini coefficient remained low.
Foreign exchange reserves began to rise from 2009 onwards; by 2011, Iceland had paid off IMF loans and Nordic countries. The real effective exchange rate has depreciated by about 40 per cent since 2006. The current account turned positive in 2009, and was 10 per cent of the GDP in 2010 and 2011 — a remarkable turnaround. More important, an international competitiveness index calculated by the IMF had been falling steadily from 100 in the early 1990s to about 70 in 2006; it is now back to 100. House prices came down by about a third in the crisis, and have remained at that level. The share of consumption in the GDP, which used to be about 60 per cent, came down almost 10 percentage points, and continues to be low. The investment ratio, which had soared to 30-35 per cent, is down by about 20 points, and continues to be low.
Bank debt was restructured; as a result, the nonperforming assets ratio came down from 40 per cent at the end of 2010 to 23 per cent at the end of 2011. That is still high; either the nonperforming borrowers will have to start performing, or their debts will have to be written off. Old banks were closed down; new banks are making handsome profits.
There is continuing litigation about how interest payable on external loans is to be calculated. There was also some political turmoil; the party in power changed. But altogether, the management of the crisis has been extremely smooth. Iceland continues to be heavily indebted, and will take years to come out of it. It operates capital controls, which will continue to be in place meanwhile. But the country came out of the crisis without a sovereign default. This is partly due to good friends abroad, but also to a democratic government which continued to function and manage the crisis. It is a model of the kind of government a country should have if it is to be prepared for a modern crisis. Only resoluteness guarantees success.
The moral is too obvious to be mentioned.
Everything seems to be in a limbo in the country right now. Parliament is too new to develop its own personality, and acquiring one could be difficult until many new members find the right balance between living up to their resource nationalist identity and living it down after donning a new garb. The Government is still to find its feet or to decide on the exact ground where it will place those feet. Businessmen wielding political power need to tread a straight and narrow path of public probity, and the people wonder if the new set can. General policy and specific issues wither in an impasse or, maybe it would be better to say, loiter in a maze. Foreign investors, from neighbours of both the immediate and the third sort, keep their fingers crossed and purse strings tightly closed. Mining, seen only recently as an unstoppable engine of growth, is hobbling, with promise overshadowing performance.