Iceland proposal to write off debt triggers S&P outlook downgrade

Government pledge to cut up to 20% off mortgages results in slew of warnings

Reykjavik, Iceland. Growth has slowed and the fiscal outlook has deteriorated, although Iceland’s position is brighter than four years ago and the economy is on a broadly sustainable path, according to Jon Bjarki Bentsson of Islandsbanki.

Reykjavik, Iceland. Growth has slowed and the fiscal outlook has deteriorated, although Iceland’s position is brighter than four years ago and the economy is on a broadly sustainable path, according to Jon Bjarki Bentsson of Islandsbanki.

Sat, Jul 27, 2013, 01:04


Rating agency Standard & Poor’s yesterday added its voice to a chorus of warnings against a pledge by Iceland’s new government to write off as much as 20 per cent of all its citizens’ mortgage debt, announcing that it had revised downwards its outlook for the country from stable to negative.

The revision reflected a one-in-three chance that the agency could lower Iceland’s credit rating within the next two years, S&P said. The country’s triple B minus rating is considered the lowest investment grade, just one notch above junk. The proposed debt writedown could cost 10 per cent of 2013 economic output, and “possibly much more”, the agency said.


Campaign promise
The promise of debt relief was the main campaign pledge of the Progressive party and the Independence party, who went on to form a coalition after the election. They focused on inflation-linked loans, payments on which soared following the country’s deep financial crisis owing to a 36 per cent depreciation of the currency.

Sigmundur David Gunnlaugsson, prime minister and head of the centrist Progressive party, said before the April election he would pay for the mortgage write-off through funds raised from imposing a haircut on foreign creditors of Iceland’s failed banks.

Concerns have since been raised about the proposal, but S&P’s warning is the first sign it could materially affect government financing in the short and medium term. The International Monetary Fund said in June there was “little fiscal space for additional household debt relief”, while the OECD said any debt relief should be targeted at distressed households.

Mr Gunnlaugsson last month dismissed these concerns and said it would have surprised him if these institutions were open to such “radical” measures. Parliament has agreed a 10-point working plan on the proposals, which the government says will deliver “the biggest improvements for the benefit of indebted households anywhere in the world after the economic crisis began in 2007”.

Growth has slowed and the fiscal outlook has deteriorated, although Iceland’s position is brighter than four years ago and the economy is on a broadly sustainable path, according to Jon Bjarki Bentsson, senior research economist at Islandsbanki. However, he said: “It is of concern that it is now more than half a year since [the mortgage writedown] idea was presented by the Progressive party in its campaign, yet there is still no detail on the size, scope or technicalities, so it is understandable that a rating agency would see this as not very reassuring . . . There will be a lot of pressure later this year from households to receive these writedowns.”

Vilhjálmur Bjarnason, an Independence party MP and member of parliament’s economic and commercial affairs committee, and a persistent critic of the plan, said: “It is some kind of voodoo economics, somebody must pay for it.” The measure would “put more pressure on the currency and escalate inflation”, he added.


Alternative vision
Moody’s and Fitch, the two other main rating agencies, have maintained a stable outlook for Iceland. Moody’s annual report just two weeks ago focused on its “improving economy and public finances”.

A spokesperson for the Icelandic government was not available for comment. – (Copyright The Financial Times Limited 2013)