Iceland Economy Contracts on Imports, Government Spending

Iceland’s economy contracted in the fourth quarter as the government spent less and imports grew, offsetting gains in investment and exports.

Gross domestic product shrank 1.5 percent from the third quarter after expanding a revised 2.2 percent in the previous period, the Reykjavik-based statistics office said in a statement on its website today. Output was unchanged from a year earlier, the office said. The economy contracted 3.5 percent last year, it said.

The $12 billion economy hit bottom in the middle of last year after the fallout from its 2008 banking meltdown stymied investment and demand. Still, the government’s decision two years ago to let lenders fail and force losses onto investors instead of taxpayers may allow Iceland to recover faster than some debt-stricken euro members such as Ireland as exports pick up and households start to spend, according to Nobel Prize- winning economist Paul Krugman.

“The contraction is greater than most people anticipated,” said Hogni Haraldsson, an economist with IFS Consulting in Reykjavik, by phone.

Government spending fell 0.5 percent, while fixed investment grew 14.9 percent and exports rose 3 percent. Still, a 10 percent increase in imports kept the overall contribution from trade negative, the office said. On an annual basis, fixed investment slumped 8.1 percent, it said.

“The contraction in investments and private consumption is staggering,” Haraldsson said. “I don’t think investments and private consumption can get any lower.”

Unemployment

The north Atlantic island’s jobless rate rose to 8.5 percent in January, as the number of unemployed people reached 14,688, according to Iceland’s Directorate of Labor. The office estimates more people registered as unemployed in February, sending the rate as high as 8.9 percent.

Iceland needs to pass a depositor claims accord with the U.K. and Netherlands before it can consider removing capital controls imposed following its banking collapse, the government has said. Icelanders vote on the so-called Icesave bill, named after the high-yielding internet accounts offered by Landsbanki Islands hf before its failure, on April 9. Most polls show a majority of voters will back the accord.

More than 350,000 British and Dutch depositors risked losing their savings when Landsbanki failed with the rest of Iceland’s over-leveraged banking system more than two years ago.

Key Factor

“One of the key factors to resurrecting the economy is the approval of Icesave,” said Economy Minister Arni Pall Arnason in a March 3 interview. “Without that, we’re facing a continued weak growth, high unemployment and a weak real value of the krona. That all translates into weak purchasing power. This is a very conservative assessment.”

Prime Minister Johanna Sigurdardottir struck an accord with the British and Dutch governments in December on settling the claims. That bill was passed by a two-thirds majority in parliament last month before being blocked by President Olafur R. Grimsson. A Feb. 25 Frettabladid poll put voter support of the bill at 61.3 percent.

The collapse of Landsbanki, Kaupthing Bank hf and Glitnir Bank hf precipitated an 80 percent decline in the krona against the euro offshore. The currency has been protected by capital controls since the end of 2008. Arnason warned last week that some form of capital controls may have to stay in place until the island is on track for euro adoption.

The economy will expand 2.8 percent this year, 3.2 percent in 2012 and 3.4 percent in 2013, the central bank estimates.

To contact the reporter on this story: Omar R. Valdimarsson in Reykjavik valdimarsson@bloomberg.net

To contact the editor responsible for this story: Tasneem Brogger at tbrogger@bloomberg.net

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