In a statement released yesterday the ratings agency Fitch declared it had “revised the Outlooks on the Republic of Iceland’s foreign and local currency Issuer Default Ratings (“IDRs”) to Negative from Stable.”
The change in rating, was “triggered by a material deterioration in Iceland’s macro-prudential risk indicators, accompanied by an unsustainable current account deficit and soaring net external indebtedness,” said Paul Rawkins, Senior Director in Fitch’s Sovereign team in London.
“All the signs of economic overheating – rising inflation, rapid credit growth, buoyant asset prices, a steep current account deficit and escalating external indebtedness – have been evident for a while,” said Fitch, but “the rate at which some of these indicators has deteriorated has exceeded the agency’s expectations. Thus, credit growth of over 30% per annum continues unabated, the current account deficit expanded to 15% of GDP in 2005 and net external debt has climbed to well over 400% of current external receipts.”
Fitch said it was “critical of the current policy framework, arguing that monetary policy has been left to take the strain, while fiscal policy has been a silent partner.”
Fitch also observed “that a wave of structural reforms since the 1990s, including the adoption of a floating exchange rate in 2001 and better financial supervision, have made Iceland’s economy more resilient to shocks. Moreover, the public finances continue to go from strength to strength – general government debt is forecast to fall to 25% of GDP in 2006 – underpinning the sovereign ratings.”
But, according to Fitch “the rest of the economy is significantly indebted now: credit to the private sector – much of it price or exchange rate linked – stood at an estimated 218% of GDP at end-2005, having doubled in three years. Yet Icelandic banks and corporates continue to pursue ambitious expansion plans abroad, accumulating external debt at an unprecedented rate in the process.”
Fitch further observed “Iceland’s net external debt is higher than virtually any other Fitch rated sovereign, while its external liquidity ratio – liquid external assets as a share of liquid external liabilities – is among the weakest, particularly if banks’ foreign assets are excluded.”
At the same time Fitch acknowledged “that Icelandic banks’ foreign assets have expanded considerably, but cautions that the banks remain heavily dependent on foreign funding and could ill afford to be shut out of international capital markets for any length of time.”
According to Fitch “other highly rated countries like Australia and New Zealand display similar, albeit less extreme external financial constraints to Iceland.” But “the structure and hedging characteristics of these countries external indebtedness is much better documented than in Iceland. Moreover, whereas Australia and New Zealand’s economies have been successfully stress tested over a long period of time, Iceland has yet to establish a similar track record in more indebted circumstances.”
Fitch concluded, “Such uncertainty accounts in large measure for the agency’s decision to revise the outlook on Iceland’s sovereign rating to Negative from Stable.”
