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.

The 5-year CDS level for Kaupthing now stands at 710 basis points (bp), which is 340bp less than at the beginning of April when the spread peaked at 1,050bp. The spread on comparable CDSs for Glitnir has fallen by 280bp from its peak and is now 720bp. The spread on Landsbanki has fallen by 400bp from the end of March when Landsbanki’s 5-year CDS level peaked at 800bp.

The Icelandic Prime Minister and a number of Icelandic banks, financial institutions and international analysts have attributed the recent surge in the CDS of Icelandic banks on market manipulation by foreign investors and hedge funds. This so-called ‘attack’ is now being investigated by the Financial Supervisory Authority in Iceland.

Hedge funds and investors had bought CDSs on Icelandic banks with the view of profiting from the financial instability in the country. According to Glitnir Bank and economics professor Dr. Richard Portes, this is however not likely to prove the case. They say that many people who have bought CDSs for this purpose can be expected to close their positions in due time.

As a result of this, CDS spreads on Icelandic banks are forecast to move closer to levels corresponding to their real default risk. The recent CDS turnaround indicates that this development has already started and a further correction can be expected in coming months, says Glitnir.

Meanwhile risk aversion in global markets has abated in recent days with CDS levels on large European corporate falling considerably this week.

Dr Richard Portes, professor in economics at the London Business School and President of the Centre for Economic Policy Research, was allegedly contacted by the hedge fund which urged the professor to consider his reputation when reporting on Iceland and Icelandic banks.

Dr Portes is the author of a number of influential reports on the financial situation in Iceland and has recently portrayed the Nordic country and its banks in a more positive light than many other foreign analysts and media outlets.

The hedge fund in question is one of the four foreign hedge funds that Sigurdur Einarsson, Chairman of Kaupthing Bank, has accused of instigating an attack on the Icelandic financial market and Icelandic banks.

“I quickly realised what was happening and decided to listen carefully and take notes,” Dr Portes said. He then contacted the FSAs in both the UK and Iceland to report the incident.

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