Iceland has been hit by a severe financial crisis. The nature, origin and timing of the crisis has raised closely linked economic and political challenges which might have a greater impact on international relations than would otherwise be expected given the dimension of the country. This article outlines the main features of the crisis and stresses the role and the geopolitical implications of Russia’s unconventional decision (perhaps opportunity) to fund a NATO country.

“We have not received the kind of support that we were requesting from our friends. So in a situation like that one has to look for new friends.”

Geir Haarde

INTRODUCTION

Iceland has been hit by a very severe financial crisis caused by the difficulties experienced by its three major international banks: Landsbanki, Glitnir and Kaupthing. In the wake of the unraveling global financial crisis, which started with the burst of the real estate bubble and of the so called “subprime crisis” in the US, these banks found themselves particularly vulnerable to liquidity shortages due to their excessive exposure to short-term foreign currency denominated liabilities.

The dimensions of the three banks and their exposure to international creditors have raised both economic and political issues. Further, following the announcements by Icelandic political and economic authorities that the state would not guarantee the repayment of the deposits held by foreigners, in particular 300,000 British savers, countries whose citizens have been affected, namely, England, Netherlands, and Germany, have threatened to start legal action against Iceland. The political tension was further accentuated by the actions undertaken especially by the British government which, in an attempt to reduce the exposure of its citizens to the default of the three banks, froze the assets of Landsbanki in the UK and the assets belonging to the Central Bank and the Government of Iceland related to Landsbanki, by means of an anti-terrorist act.

The political friction generated by the financial crisis is now affecting Iceland’s economic solution. The country is finding it hard to gather the funds necessary to satisfy its need for liquidity. The IMF offered to lend up to $2.1bn conditional to the attainment of an additional €3bn from other countries. This has proven a difficult task, especially since many countries are facing grim economic outlooks in the forthcoming quarters and because they too have to face the effects of the credit crunch by bailing-out banks, injecting liquidity, cutting taxes and/or busting public spending to avoid entering into a recession. However, Icelandic authorities do not believe that enough is being done. In a diplomatic meeting, Ólafur Ragnar Grímsson, the President of Iceland, was very clear on this point and confirmed the impression that Russia would help Iceland[1][2].

The first part of the paper briefly describes how the banking crisis developed. The second part looks at the economic and political effects of the crisis.

[1] The Financial Times on October 7, 2008 reported that: “Iceland earlier revealed that Russia had agreed to provide the country with a €4bn ($5.4 bn) loan as the crisis-hit country set about shoring up its foreign exchange reserves, although Russia’s deputy finance minister, Dmitry Pankin, later said no agreement had been reached”.

[2] Politiken.dk, a Danish news press, reported on the 12^th of November 2008 that, according to a memo by the Norwegian embassy, in a diplomatic meeting held the previous week Ólafur Ragnar Grímsson had shocked diplomats by issuing: “heavy criticism against several of the countries represented, including Sweden and Denmark. And the President delivered directly insulting assertions against the British“.