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New Europe Weekly

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Iceland's Geyser crisis − any lesson for CEE?

Fri, Oct 10 2008, 12:25 GMT
by Danske Research Team

Danske Bank A/S

This week Iceland has been thrown into its worst financial and economic crisis ever with the collapse of its financial markets. The "Geyser Crisis", is a result of the combination of a massive increase in Iceland's foreign debt, a very leveraged expansion of the Icelandic banking sector abroad, and the global credit crunch. It is estimated that the balance sheets of Icelandic banks were in total around 10 times larger than GDP in Iceland before the collapse.

The macro implications of the Geyser crisis will be serious, with the likelihood of a very large drop in the country's GDP. This provides a warning for CEE given the very significant expansion of leveraging there, which has created an unhealthy and unsustainable housing boom. Furthermore, like in Iceland, most CEE countries have large current account deficits.

We believe it is natural to draw a comparison between the two regions, as there are obvious similarities between Iceland and CEE in terms of macro economic indicators and the development in asset prices. Therefore one might expect the Icelandic crisis to spread to CEE. That said, there are also significant differences, most important in their respective banking systems.

Principally, the CEE banking system is to a large extent foreign owned while the Icelandic banking system is domestic owned. We therefore don't envisage a crisis in CEE on the scale that Iceland is suffering. That said, we continue to believe that the most leveraged CEE countries - the Baltic States, Romania, Bulgaria, Kazakhstan and Ukraine - are facing serious economic challenges in today's "de-leveraging world".

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Published on  Fri, Oct 10 2008, 12:29 GMT