Attack on the Crown, version 2.0
Written by A Forex View From Afar on Tuesday, October 07, 2008A little more then one year had passed since the credit crunch began, and the crisis is ready to proclaim its first victim among emerging economies: Iceland
Earlier this year, in April, the Icelandic Krona (which means crown) was under siege from a speculative attack, and as we reported at the time, it was likely to lead to a second round effect, which now spawns. Last time around sources said that the defunct Bear Stern was behind the speculative move, while today it seems the Icelandic economy is just a victim of the credit crunch, helped of course by some macro-funds and banks.
Iceland was forced to take a $5 billion loan from Russia today, after the country’s second biggest bank collapsed and another required a $500 million loan from the Central Bank. The country’s current account deficit (the difference between imports and exports) reached 34% of the GDP, becoming unsustainable for the real economy. As a consequence of the economic background the country’s debt rating has been cut to BBB, the lowest investment grade. If the debt rating is cut lower than this the country is in danger of defaulting, since most hedge funds and banks are not allowed to hold assets with a lower grade than ‘investment’.
The Icelandic Krona fell 40% in just one trading day, from 172.00 krona per euro to today’s 234 krona. The krona’s weakness came as the central bank took the decision to peg the currency to a trade-weighted index. "The emerging countries look very vulnerable, especially the ones with a high current account deficit. The Icelandic case raises some interesting questions, since the banks had still failed even tough the central bank and the government had provided liquidity, suggesting that it is a solvency problem" said Semar Bezau, European currency strategist at TheLFB-Forex.com. The small Icelandic economy looks to be the first victim of the credit crisis. The question is whether there are other economies that will follow.
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