Iceland’s recovery threatened by impending challenges

Iceland’s moderate recovery is likely to steer growth away from domestic investment projects and towards opening up exports, according to the International Monetary Fund (IMF).

Having reviewed the recovery process Iceland has undergone since its financial crisis, the IMF has released a positive concluding analysis that is careful to warn of further challenges that lie ahead.

“Iceland has achieved much since the crisis and its economy is growing again. Nonetheless, considerable challenges remain,” it warns.

“Tackling these will require steady policy implementation, increased coordination, and stronger policy frameworks.”

Iceland famously elected to let its three national banks – with combined assets worth more than 1,000% of GDP – fail, following the financial crisis, rather than undergo the painful process of nationalisation.

Growth returned to Iceland in 2011 after two years of recession, while inflation rose in tandem, which the IMF highlights as a continued cause for concern.

GDP is expected to continue, at 2.5% for 2012, led by investment and consumption. A medium-term outlook, however, suggests these drivers will start to be edged out by a developing exports industry, boosted by the completed investment projects.

As well as delays to the current investment projects, the biggest threats to any recovery stem from possible contagion spreading from the eurozone.

“The most significant risk arises from the possibility of a marked deterioration of conditions in Europe, with implications for Iceland through trade, market access, foreign direct investment, and commodity prices,” according to the IMF.

As inflation continues to rise, the recommendation comes for monetary policy to be tightened with higher interest rates.