Entrades
Five countries that crashed and burned in the credit crunch face a hard road to recovery
At best, the legacy of the economic crisis means tough times. At worst, it could spark political turmoil
- The Observer, Sunday 3 January 2010
- Article history
The decade ahead promises to chart a struggle as epic as any of the nation's famous literary sagas. The legacy of the worst economic crisis in its history has ravaged the broader economy, triggering bankruptcies and sending unemployment, virtually zero before the crisis, surging to 10%. Burglaries have doubled, but police are being made redundant as cuts to public-sector budgets cause fissures in the country's social fabric. At year end the national debt was expected to have reached £6bn, a hole as big as the economy that will take an entire generation to repay.
Things became so bad last year that local media were asked by the Public Health Institute to write more positive stories. But even the most determined Pollyanna is tested by the facts. This year's bill for repayments to the UK and Dutch governments, after they compensated savers who lost money in Icesave internet accounts, is more than the annual education budget.
The country was plunged into turmoil in October 2008 when its main banks, Kaupthing, Landsbanki and Glitnir, collapsed in frozen credit markets. The banking crisis also laid low the Icelandic currency, forcing the government to ask the International Monetary Fund and its European neighbours for billions of dollars of aid.
The shocks continue, with the economy suffering its sharpest ever contraction, shrinking 7.2% in the third quarter. However, after hitting record highs, interest rates have eased back to 10%. The government has completed the expensive process of recapitalising Iceland's banks, but it still has a long way to go to convince investors to return. Analysts at Moody's recently cut the country's credit rating again.
Its forgotten fishing fleet, as well as geothermal energy, are once again important facets of the economy. But with limited job prospects and financial austerity, the small nation will have to fight to keep its 300,000 inhabitants this year. Half of 18 to 25-year-olds are said to be considering emigrating, while professionals are being lured overseas by higher salaries.
The island's salvation may lie in hitching its fiercely independent wagon to Europe. It will be a bitter pill for the resolutely independent Nordic nation to swallow – it had previously resisted joining the EU over concerns about losing control of its rich fisheries. But accession talks could start by March.
PANIC FACTOR: 3/5
Greece, the European Union's most indebted country, enters 2010 at the top of most investors' watch lists, but for all the wrong reasons. Downgraded by all three of the main credit rating agencies last month, financial markets have already punished the Greek government by demanding higher payment for financing its ballooning budget deficit.
Markets hate uncertainty and were very unimpressed when the new government, elected in October, admitted that the country's economic statistics were unreliable and that this year's budget deficit would be more like 12.7% of national income than the 6.7% forecast by the previous government.
Markets fretted that Greece could be in danger of defaulting on its sovereign debt, which has now reached 125% of national income, a figure that will rise sharply given the size of the government's annual deficit. Its problems also made investors nervous that if Greece imploded, countries such as Italy, Ireland and Spain could be next in line, with even a major economy such as Britain's, which has a similar budget deficit to Greece, potentially at risk.
But, unlike Ireland, which imposed an austerity budget last month, the government of George Papandreou gave a vague pledge to reduce the budget deficit to below 3% of gross domestic product by 2013. But markets were worried by a lack of detail and optimistic assumptions about future tax revenues, and took little comfort, despite a road show of European capitals by finance minister George Papaconstantinou.
Indeed, speculation is rife that Greece might have to seek a bailout from the International Monetary Fund. Last week the IMF's European head, Marek Belka, said it stood ready to help. But he urged the European Union to set up a formal mechanism to help cases such as Greece, since many EU countries are locked together in the eurozone, so have a common interest in the fiscal and economic stability of the bloc as a whole. This Greek tragedy thus has implications for the rest of Europe.
PANIC FACTOR: 5/5
IRELAND
Ireland was long one of Europe's poorest countries, with high unemployment, a dearth of foreign investment and a skills shortage. But in the past two decades it has become a wealthy, modern industrial state, dubbed the "Celtic Tiger", with low taxes luring multinationals, fuelling a huge expansion in employment.
But the tiger's roar turned to a whimper as the economy was hammered, with Ireland overdependent on housing and financial services. Irish banks funded an unsustainable property boom that saw glitzy apartment blocks thrown up for miles around Dublin, and thousands of investors snap up buy-to-let places. When the bubble burst, the government was forced to guarantee the deposits of the five biggest institutions in an attempt to prevent a Northern Rock-style bank run. With questions over the banks' very survival, the government has since had to shore up their assets by agreeing to take over the worst of the sector's property loans.
Tax receipts from property and financial institutions dried up and unemployment soared, along with the public-sector borrowing requirement. A few weeks ago, finance minister Brian Lenihan announced sweeping cuts to stabilise the shattered public finances as he presented the harshest budget in decades. He unveiled public-sector pay cuts and reductions in unemployment and child benefits in a bid to achieve savings that would restrain the deficit to a projected 11.6% of GDP next year.
But the move was opposed by trade unions, which had been pushing for an alternative plan that envisaged 300,000 public-sector workers taking 12 days' unpaid leave in 2010, as well as agreeing to reforms in working practices.
Despite signs of industrial unrest, there are indications that the worst is over: Dublin said recently that GDP expanded by 0.3% in the three months to September, though it had shrunk by 7% over the previous year. Kevin Gardiner, the economist who coined the phrase "Celtic Tiger", predicts that the economy will do no worse than bump along the bottom in 2010, with growth turning positive by the end of the year.
But Ireland will take years to recover from a crash that has dented national pride and could yet result in a winter of discontent as Lenihan's brutal budget takes effect.
PANIC FACTOR: 3/5
The tallest building in the world, the Burj Dubai, will officially open tomorrow, but instead of underscoring the ambition of the emirate, it will now be viewed as a towering symbol of its folly.
Construction of the $4.1bn project began in 2004, during a boom that saw increasingly ambitious projects designed to create a millionaires' playground. But the view from the summit is of a skyline marked by half-finished buildings and immobile cranes.
Property prices had already fallen by 50% last year, before the emirate pitched into crisis in November, when one of its largest conglomerates, Dubai World, admitted it did not have the cash to repay looming debts. The company is still in negotiations with its banks, including HSBC, Lloyds, RBS and Standard Chartered, which together are owed around $5bn, in the hope of achieving a standstill agreement on further repayments until it can restructure $22bn of its debt.
The immediate crisis was contained when Abu Dhabi threw Dubai a $10bn lifeline for an imminent bond repayment, and to allow the company to pay running costs while discussions continue. But analysts believe recovery will be slow and that the emirate, now in thrall to its more conservative neighbour, will never quite be the same.
In a report last week, Beltone Financial said Dubai had been too heavily reliant on real estate and warned its markets would underperform for the foreseeable future. European and US banks are also likely to be more wary of investing after the government said last month that it was not liable for the debts of Dubai World, despite the company being state owned.
"The damage to Dubai's reputation in financial markets has been profound," the report said. "It is going to become difficult for Dubai to raise new capital from global markets, despite it now working with creditors to fulfil its long-term obligations with transparency."
PANIC FACTOR: 4/5
SPAIN
Spain's woes may have been overshadowed by alarm about the fortunes of Greece, but the chaos caused by its crumbling property boom is far from over. Consumers overstretched themselves as house prices more than doubled in a decade, but that left many buyers heavily indebted and facing negative equity as prices began to slide. Building activity spiralled up in response to the frenzy of speculative demand, with construction accounting for more than a 10th of the economy during the boom years.
These two factors mean plunging property prices have blown a huge hole in families' finances – and in economic growth, as the building frenzy came to an abrupt halt. At the same time, Spanish exporters have suffered from the collapse in world trade, and the relative strength of the euro can hardly help the battle to build a more stable economy, less reliant on property.
Spain's banks escaped much of the pain experienced by rivals in the rest of Europe and the US because its regulators kept them on a much tighter rein, forcing them to accumulate more capital in good times to see them through lean years. But that didn't stop them lending enough to fuel the boom.
As consumers repair their finances, builders nurse their losses and thousands of migrants who flocked to Spain to take up jobs in construction and tourism return home, the good times will not return quickly. The Economist Intelligence Unit reckons Spain will experience another economic contraction in 2010, putting it, with Greece and Ireland, among the world's 15 slowest-growing countries this year.
Madrid has promised to wrest its deficit back below the eurozone's official 3% of GDP ceiling by 2013, but that will require a grim period of austerity, just as the economy is struggling to emerge from recession. Many analysts believe there could be worse problems to come: in December, ratings agency Standard and Poor's expressed doubts about Spain's ability to get its finances back under control by revising its outlook on the kingdom's AA+ rating to "negative".
PANIC FACTOR: 3/5
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