Iceland's Recovery Will Be Tough to Sustain

The end of Iceland's nine years of capital controls on Tuesday is an occasion to celebrate for Icelandic businesses -- and for those economists who, like Nobel Prize winner Paul Krugman, touted Iceland's post-crisis recovery as an example of how it should be done. Yet even after almost a decade, Iceland may still need a relatively closed financial market for that recovery to stick.

Iceland is the favorite country of those who say currency devaluation and capital controls are essential tools for countries battling debt crises. After the island nation's banks, whose assets had reached 14 times its gross domestic product, went bust in 2008, Iceland's government separated the banks' foreign clients -- who had invested in Iceland in search of relatively high yields -- from domestic depositors; it froze payments to the foreigners and transferred the domestic clients' assets to nationalized successor banks. That allowed the country -- with assistance from the International Monetary Fund -- to rebuild its financial and fiscal systems. Icelandic banks have head-spinning capital ratios (30.2 percent for Landsbankinn, the heir of Landsbanki, one of the lenders that crashed in 2008) because supervision has tightened substantially and perhaps because Iceland is the only nation that jailed big bankers after the financial crisis. The government closed last year with a bumper fiscal surplus.