Essay About Moody’S Downgrade Iceland And Moody’S Analyst

Iceland Harvard Case Study
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If you were a Moody’s analyst in May of 2008, would you recommend that Moody’s downgrade Iceland’s Aaa soverign-debt rating? Why? Why not? The economy of Iceland, being one of the most stable and highly-developed economies, had enjoyed immense investment potential. It has attracted huge foreign investments due to its credibility over the years. It has been rated “Aaa” in the past due to its low government debt, economic flexibility, high per capita income and government financial strength and access to liquidity.However, and given its smaller population size and higher global openness, it’s economy is more volatile than other “Aaa” countries. In addition, the financial sector of Iceland, being highly leveraged sector, the households as well as the private institutions had the tendency to borrow heavily from the foreign markets utilizing the advantage of the spread between domestic and foreign interest rates and this trend existed even at the end of the year 2007, just before the occurrence of the global economic crisis. The total external debt of the country was 549% of the GDP of the country of which the banks had an outstanding debt of 400% of GDP. Moreover, Iceland is more vulnerable to confidence crises than its Aaa peers and had large amount of contingent foreign currency liabilities coming mainly from its Icelandic banks that have rapidly expanded internationally through borrowing foreign money.In this context with the advent of the global economic crisis in the year 2008, collectively with the high debt statistics of the country, would lead to negative speculations about the credibility of the country regarding the debt prospects. The speculation regarding the expansion of the crisis, further into a more serious banking sector crisis, if showed credibility, would lead to a possible bank default risk that could affect government’s balance sheet. Therefore, being an analyst in the Moody’s, these speculations would lead to the recommendations of down grading of the sovereign debt rating of the country, post May 2008. The investors also, with the advent of the crisis, were also becoming skeptic and it was becoming difficult for the country to finance any other expenditures by taking further debt thereby asserting more on the need for downgrading the long-term debt rating. 2. What is most worrisome in Iceland’s balance of payments? What is most encouraging? Why were investors concerned about Iceland’s net international investment position in May of 2008?The most worrisome aspect of the Balance of Payments (BOP) of the economy is the sudden fall in the financial account in 2007. The financial account balance which continually increased to reach $7,110M in 2006, decreased hugely to ($-1,951M) in 2007. This can be due to the huge outflows of direct and portfolio investments abroad and the reduction of the foreign direct investment inside Iceland in addition to the large inflows of loans and carry traders’ deposits as indicated by the “net other investments”. This is also accompanied with the high increase in expenditures indicating increase in loan interests and reinvesting earnings paid to entities abroad. This means entities and people of Iceland have taken huge foreign loans to invest abroad and this is worrisome as with the crises approaching, it will become difficult for them to repay their loans or roll them over and might reach default.The most encouraging would be only the consistent increase trend in exports as it increased from $1,927M in 1998 to as high as $4,793M in 2007 which would support improving the current account deficit and help in quicker economy recovery post the crises.With the economic crisis approaching, the investors became highly worried about the net international investment position (NIIP) because of the considerable high foreign assets and even higher liabilities compared to other countries making the NIIP negative. The higher the percentage of foreign assets to a country’s wealth, the bigger the impact will be from the global economic crises as assets may depreciate in value, in addition, the more the shorter-term liabilities are, the more risk on the financial stability of the economy since refinancing would be more difficult and lenders would be more aggressive in demanding their loan payments. As the external debt stood at 566% of GDP and 789% of exports (Exhibit 10) of which 218% of GDP and 260% of exports are short-term debt, this would have severe short-term impacts on the NIIP and the overall economy.Should Iceland seek to join the European Union? Are there other actions the Icelandic government and business community could pursue in order to avoid a crisis of confidence?There are opinions, both for and against joining of the EU and I’m supporting against. On one hand, some economists agree that being a small country, maintaining separate currency becomes costly on part of the country as well as the companies operating in it and Iceland doesn’t need to make many reforms to join EU as its legislative framework is very similar to other EU countries. By joining the EU Iceland can also improve investors’ confidence and eliminate risk of exchange rates through adopting the Euro as its currency. However, there are risks regarding the dispersion of fishing, agriculture and geothermal energy rights from the domestic control to the foreign companies; as these sectors affect around 25% of GDP and around 19% of labor force. Joining EU would also lead to loss of sovereignty on part of the country and being a developed country it will also have to contribute funds for EU poorer members. Another point is that Iceland didn’t fully comply to the criteria of joining EU (e.g. inflation at 5.1%>2.7% and currency devaluation) Because of the severe global and Icelandic debt crises, I think the crises of confidence cannot be avoided in 2008. The following actions would help to minimize the effect on Iceland economy collapse:The government might arrange to get good amount of liquid foreign assets through credit lines (e.g. IMF) or by assembling collaterals utilizing its resources in HFF, pension funds and its potential revenues from energy and geothermal resources.Another option would be moving their banks outside the country; but this could be also difficult as all countries were also dealing with the global crises.In order to stabilize the economy and restore investors’ confidence, government need to work on fiscal consolidation, incorporate open policies on investment, partner with private stakeholders and provide investment incentives. Further, the government should implement an effective monetary policy to curb inflationary pressures, stabilize interest and exchange rates which supports creating friendly investor environment. In addition, they need to regulate the financial institutions framework to cushion it against future financial shocks.