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Iceland Party Ousted During Bank Crisis Starts Coalition Talks

Photographer: Odd Andersen/AFP via Getty Images

While outgoing Icelandic Prime Minister Johanna Sigurdardottir has won praise from the International Monetary Fund and debt rating companies for her handling of the crisis, voters are still burdened by excessive mortgage debt. Close

While outgoing Icelandic Prime Minister Johanna Sigurdardottir has won praise from the... Read More

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Photographer: Odd Andersen/AFP via Getty Images

While outgoing Icelandic Prime Minister Johanna Sigurdardottir has won praise from the International Monetary Fund and debt rating companies for her handling of the crisis, voters are still burdened by excessive mortgage debt.

The party ousted from government in 2009 after presiding over Iceland’s financial meltdown emerged as the biggest winner in the weekend’s parliamentary elections as talks start to form a ruling coalition.

The Independence Party, whose former leader and Prime Minister Geir H. Haarde was tried in court last year for economic mismanagement, won 26.7 percent of votes in the April 27 parliamentary elections. The Progressive Party -- a coalition partner of the Independents before Iceland’s banking collapse -- won 24.4 percent. The Social Democrats of Prime Minister Johanna Sigurdardottirsaw backing plunge by 16.9 percentage points to 12.9 percent. Together with their coalition partner, the Left Green Party, they garnered just 23.8 percent support.

Though Sigurdardottir’s government had won praise from the International Monetary Fund for its crisis management policies, which included capital controls and burden sharing for creditors, voters responded to opposition pledges to raise their standard of living. Unemployment (ICUNEMRT), though well below a crisis peak of 9.3 percent, is still more than five times 2007 levels. The winning parties said they will now start talks to form a government as soon as possible.

“Now things will develop quickly,”Bjarni Benediktsson, chairman of the Independence Party, told state broadcaster RUV. “I think it’s right to attempt to form a two-party government” with the Progressive Party, he said.

Household Debt

Benediktsson’s pledges to voters include tax cuts and debt writedowns. He has sought to distance himself from the bank- friendly policies his party backed in the 2000s, while continuing to target a smaller role for government. Benediktsson, who wants Iceland to abandon European Union accession talks, argues his program will create a stronger middle class.

Most of Iceland’s consumers are struggling to repay home loans linked to the consumer price index. Their obligations have swelled as inflation hovers close to 4 percent.

The outgoing government could have done more to ease households’ burdens, according to Valdimar Armann, an economist with Reykjavik-based asset manager GAMMA.

“In many ways the last four years have been a period of lost opportunities,” Armann said by phone. “Despite some good efforts, the economy has been lagging and will continue to do so unless the new government facilitates investments.”

That’s prompted some voters to ignore the two main political blocs and vote for a new group, A Bright Future. The party, which targets EU Membership, won 8.2 percent. Another group, The Pirates, won 5.1 percent, just passing the 5 percent minimum needed to get into parliament.

Bank Deregulation

Iceland’s $14.4 billion economy collapsed in 2008 after the country’s three-largest banks failed under a mountain of debt. The lenders had grown to about 10 times the size of the economy after a period of financial deregulation spearheaded by the former coalition of Independents and Progressives.

Sigurdardottir has had to balance efforts to protect households without alienating foreign investors after the island returned to capital markets. After exiting a 33-month IMF program in 2011, Iceland successfully completed two dollar-bond auctions, even as capital controls remain in place.

Sigurdardottir said she was “deeply saddened” by the larger-than-expected loss. “We knew that we wouldn’t gain popularity in our mission to save Iceland from bankruptcy,” she told RUV.

The government has grappled with hurdles surrounding its efforts to lift capital controls in place since 2008. The restrictions are blocking as much as $8 billion in offshore kronur holdings from being offloaded. The turmoil in 2008 sent the krona plunging as much as 80 percent against the euro in the offshore market. Even the official onshore rate dropped close to 50 percent.

Krona Losses

Inflation spurred by krona losses has crippled households. With more than 80 percent of private debt linked to consumer prices, Icelanders are vulnerable to currency swings as they try to repay domestic banks about 1.43 trillion kronur in loans indexed to inflation.

The Progressives have pledged to reduce consumer mortgage debt by using the proceeds from writedowns on 450 billion kronur of domestic-currency assets held by the creditors in the banks that failed in 2008.

The Progressives will put their “influence to good use for households,” said Sigmundur David Gunnlaugsson, the party’s chairman, in a televised speech. “We don’t make proposals unless they can be carried out and when we put forward proposals we are going see them through.”

May Backfire

The proposed writedowns have spurred criticism abroad. The plan to force losses on creditors may backfire on Iceland’s resurrection, according to Lars Christensen, Danske Bank A/S (DANSKE) chief emerging markets economist and one of the first to predict the island’s 2008 collapse.

While there’s a need to ease household debt, “paying for that by seizing the assets of foreign investors such as the creditors of the failed banks isn’t the way,” Christensen said in an interview this month. “If their assets are seized, the international investor community won’t soon forget that.”

Iceland has passed numerous milestones on its path to recovery. In January, it won a court battle against the U.K. and the Netherlands, freeing it from as much as $2.6 billion in damages for not honoring depositor claims stemming from failed Landsbanki Islands hf.

The island, which is ranked just above junk at the three main ratings companies, is unlikely to be upgraded as long as currency restrictions remain in place, according to Moody's Investors Service, Standard & Poor’s and Fitch Ratings.

“The capital controls are one of the malignancies of the economy,” said Benediktsson in a televised interview. “I think it’s possible to remove the capital controls fast in a secure manner” and removing them “is one of the priorities” of the next government, he said.

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

To contact the editor responsible for this story: Jonas Bergman at jbergman@bloomberg.net

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