Russia’s pragmatism in bailing out Iceland

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Russia has agreed to bail out Iceland by granting this island state a huge stabilisation loan at an unbelievably low interest rate. Is it an act of wanton generosity, or a far-sighted geopolitical step? And in general, four billion euros, is it a lot or a little?

The fate of Iceland has until recently not concerned Russia one bit. Now only a lazy person is not discussing the incredible sum the “island of stability” is going to inject into the economy of a sinking island of geysers.

Europe has, meanwhile, been discussing Iceland for a long time. Hedge-fund country, an example of liberal economic regulation and a model of a rapidly developing economy, Iceland was the first in the world to feel the impact of a full-bodied, economic crisis.

This happened at the end of 2007. Since this year began, Iceland’s currency—the krona—has lost one-third of its value against the euro. Iceland’s leading banks—Kaupthing, Glitnir and Landsbanki—have been marauded by international financial sharks. At the end of September, the country’s authorities bought out (read, nationalised) Glitnir bank, and on October 7, Landsbanki, while on the same day Kaupthing bank received a 500 million euro loan from Iceland’s National Bank. By the autumn of 2008 it had become clear Iceland might become the world’s first country to suffer a default.

Why is the bubble of Iceland’s economy bursting so loudly? It ballooned too rapidly, the IMF believes. In 2003-07, the country’s GDP had risen by 25%, with this robust growth fed mainly by outside borrowing. To attract foreign investments, the authorities strengthened the currency and ratcheted up interest rates (by the beginning of 2008, they were the highest in Europe—15.5% per annum). The result was a monstrous misbalance: a modest GDP, on the one hand, and immense financial assets and tremendous liabilities, on the other. According to 2007 figures, Iceland’s GDP was $16 billion, while its financial assets stood at 1,000% of GDP and an external debt of 550% of GDP.