Iceland’s Credit Default Swap (CDS) level has plummeted this week and now stands at 285 points, compared to 600 at the beginning of the year. Economists say the improvement is partly down to IMF statements of confidence that the country is recovering well. Read the full story

Iceland has dropped out of the top ten countries most likely to default, according to CMA Credit Market Analysis. CMA’s list is compiled daily and distributed to financial markets. Read the full story

As news broke that Greek Credit Default Swaps (the cost of insuring international debt against default) have risen sharply, the international press quickly found out that it had risen above Iceland’s CDS level and turned it into a global “wow” story. Read the full story

The three main Icelandic banks, Glitnir, Kaupthing and Landsbanki, have all put out statements saying their exposures to the collapse of Lehman Brothers Bank is insignificant, Reuters reports.

The collapse of the fourth-largest US investment bank, Lehman Brothers, which has filed for bankruptcy protection, continues to send Read the full story

According to IcelandReview.com, the Icelandic state treasury has been granted a ISK 30 billion (EUR 246 million, USD 355 million) loan in foreign currency to sure up the country’s foreign currency reserves and stabilise the economy.

Now standing at ISK 500 billion (EUR 4.1 billion, USD 5.9 billion), Iceland’s foreign currency reserves have increased fivefold in two years.

Read the full story

CDS spreads on Icelandic banks improved significantly last week, according to research from Nordic bank Glitnir.

Kaupthing’s CDS level fell by 350 basis points (bp) last week to 630bp. The CDS on Glitnir is down by 305bp and is now 680bp and the CDS for Landsbanki is now 410bp after having decreased by 240 bp.

The price of CDSs (credit default swaps) is seen as a sign of a bank’s credibility in global markets. The lower the CDS level the better, as the CDS reflects investors’ faith in financial companies to keep their commitments.

Glitnir Bank has given a number of reasons for the tightening of the spreads, including increased market activity and positive earnings statements from the banks.

Additionally, positive news came on Thursday that the three major Icelandic banks had comfortably passed the stress test set by the Icelandic Financial Supervisory Authority.

Concerns over the Icelandic economy have receded following the publication of financial results of the three main banks in Iceland, reports the Financial Times.

Icelandic banks Glitnir, Kaupthing and Landsbanki released their second quarter results on Friday which showed better results than many analysts had forecast. Capital strength, core lending and fee and commission income remained strong for all three banks during the quarter, despite credit losses and weaknesses in global markets.

There were concerns that the rapid international expansion of Icelandic banks, financed principally by overseas borrowing, could prove detrimental in light of the increased cost of borrowing during the credit crisis.

These fears helped create a surge in CDS (credit default swap) spreads to around 1,000 basis points, indicating that the market considered a banking collapse in Iceland to be likely.

However, the second quarter results show that a collapse is increasingly unlikely. Instead, they demonstrate that Icelandic banks have responded by deleveraging, diversifying their operations geographically, reducing their reliance on wholesale funding in favour of deposits, and expanding fee and commission based income.

Glitnir’s net profit was up 29.3% from the first quarter to ISK 7.6 bn whilst its net interest income rose 84 per cent to ISK17.8bn compared with the same period last year.

Landsbanki’s net interest income rose 37 per cent. “There is nothing in our results to justify CDS spreads of 1,000 basis points,” said Sigurjon Arnason, joint chief executive.

Even though loan losses are increasing, Icelandic banks’ capital adequacy ratios remain solid by international regulatory standards. The banks have met funding requirements for next year and reduced their wholesale borrowing, and are also increasingly relying on deposits as a source of funding.

In an article published on Friday in the Financial Times, Professor Fridrik Mar Baldursson and Professor Richard Portes defended the Icelandic economy against a highly critical article which appeared in the same publication two days previously.

In the article the pair argue that Iceland’s current economic slowdown is actually welcome news, given the fact that the country’s annual growth rate was an average of 5.2 percent between 2003 and 2007, and that unemployment is still running at just one percent.

A correction is necessary to relieve pressure on the economy; but with Q1 2008 showing growth of 1.1 percent over Q1 2007, the slowdown is very real, “but hardly a catastrophe,” the professors state.

They go on to say that Iceland’s over-valued currency has weakened to a point considerably lower than it perhaps should be – a point of view echoing the Prime Minister’s comments earlier this month. But the professors believe it to be a normal fluctuation that will right itself.

In the meantime, the current account deficit will probably fall below 10 percent of GDP this year – welcome news for treasury and Central Bank alike.

Many Icelanders on the street feel like they are having a hard time, but nonetheless they remain the fourth wealthiest nation per capita, according to the OECD (Organisation for Economic Co-ordination and Development). In short, they will survive, the professors say.

With the completion of aluminium smelters in Iceland, exports grew by 22 percent in 2007 and future financial returns should be “excellent”, as aluminium and energy prices are at all-time highs.

On the subject of foreign debt: “External debt figures that omit returns on portfolio investments and count direct investments at book value greatly exaggerate Iceland’s negative net international investment position,” professors Baldursson and Portes write. “On IMF definitions, that was 120 percent of GDP at end-2007. The Central Bank of Iceland, no fan of spendthrift ways, reckons that a reasonable estimate of the market value of direct investments brings it down to a negative 27 percent of GDP, which is not exceptional.”

The previous FT article had criticised Iceland for the precarious position of its household debt (over 200 percent of disposable income); but apparently failed to take into account that assets, including fully funded pension funds, are over 750 percent of disposable income. The professors therefore argue that Icelanders’ debt is actually considerably less than the Americans or British, for example.

The professors close by defending the Icelandic banks, saying that the allegedly lax regulation imposed on them and their gung-ho attitude towards foreign debt are just rumour. As Iceland is a member of the EEA (European Economic Area), the country’s banks are subject to the same rules and regulations as any EU bank, and Iceland’s Financial Services Authority is “very professional”.

The fact that Iceland’s banks had “almost no exposure to the toxic securities that almost all other banks did buy,” should be a better-distributed fact, the professors believe. Nordic bank Glitnir has included this fact in a number of Icelandic market research reports distributed this year.

In a satirical article published last week on Condé Nast Portfolio.com, finance blogger Felix Salmon discusses the Icelandic economy and comes to some strong conclusions.

In the article, Salmon criticises a recent Financial Times piece which was critical of Iceland and the current state of its economy: “Robert Wade, in the FT, pulls no punches: ‘the size of the accumulated macroeconomic imbalances beggars belief,’ he says, but then just comes up with a list of percentages of GDP. In Iceland, anything looks big as a percentage of gross domestic product, because there’s very little produced domestically.”

Salmon believes that Icelandic businesses probably did borrow too much abroad to finance their international expansion – but also wonders if there was any other way.

The article concludes that Iceland’s biggest problem is having the smallest free-floating currency in the world, “which is easily buffeted by international capital flows going in and out of the carry trade”.

The carry trade is where investors buy money in low-interest currencies like the yen or the Swiss franc and invest it in high interest currencies like the Icelandic krona and Brazilian real.

In a previous article, Salmon wrote, “when the carry trade is unwound – and it always unwinds with a snap, never gradually – then Iceland is forced to implement extremely unpleasant pro-cyclical monetary policies to avert financial disaster.”

If Iceland had been a member of the euro, Salmon theorises, then it would have escaped its current woes altogether.

A February 2008 opinion poll showed that over 55 percent of Icelanders wish the country to begin negotiating for EU membership. The possibility of adopting the euro without joining the EU has been discussed, but largely dismissed over recent months.

Icelandic Prime Minister, Geir H. Haarde, said in a speech in London on Tuesday that the current weakness of the Icelandic krona is exaggerated. The PM believes that although some depreciation had long been expected, the currency’s current status is “lower than its equilibrium level should be”.

Speaking at a conference of international investors, Haarde emphasised that the fundamentals of the Icelandic economy remain strong and stressed his belief that the country will emerge unscathed from the global economic downturn.

The currency has faced downward pressure as the recent flow of direct foreign investment in large-scale industrial developments begins to dry up with the completion of construction projects.

The krona has been further dragged down by fears that the Central Bank would be unable to bail out Iceland’s huge banking sector in the event of a crisis. The Icelandic banks have expanded rapidly over the last decade or so and have significant foreign debts. Their combined assets are nine times the national GDP.

The government’s actions to help the currency and the property market at the end of last week are expected to help, and any foreign currency loans the government takes out will make a positive difference very quickly, according to research from Glitnir Bank.

Haarde said he believes Iceland’s trade deficit and the Central Bank base interest rate will begin falling before the end of the year – a development that would significantly aid the krona in its recovery. A new Glitnir research report echoes the PM’s sentiments on the decreasing trade deficit and interest rates.