Icelanders Tighten Belts, End Spending Spree as Recession Looms

By Tasneem Brogger

Sept. 12 (Bloomberg) -- Gunnar Hjalmarsson, a 43-year-old journalist from Iceland's capital Reykjavik, can't bear to look at his mortgage statements any more.

He borrowed 14.3 million kronur ($173,334) to buy a house in an inflation-linked loan four years ago and now owes 18 million kronur after consumer prices soared. ``It's like having the Mafia cut off a finger,'' he says. ``Maybe it'll be an arm when they adjust my interest rate next year.''

Hjalmarsson is typical of many consumers on the Atlantic island, where the third-highest interest rates in Europe and soaring inflation are forcing Icelanders to slash spending. That's pushed the economy close to recession after a four-year boom.

The economy will contract 2 percent next year compared with 1.1 percent growth this year, the central bank forecast on July 3. Gross domestic product shrank 1.4 percent in the first quarter before rebounding 4.9 percent in the second as a jump in aluminum production offset falling household expenditure.

``GDP will contract over the next two years despite the unexpected vigor in the economy this year,'' the central bank said yesterday. ``A contraction is an inevitable element in the economy's adjustment towards a sustainable equilibrium.''

New-car registrations tumbled an annual 60 percent in July, the biggest drop of any European nation, and consumer confidence is at a record low. Credit card turnover contracted an annual 15 percent in July, after dropping for the first time in six years in June, according to lender Kaupthing Bank hf.

`Absolute Opposite'

Consumers started their spending spree after the government cut taxes and banks were granted access to the mortgage lending market, underpinning gains in property values. Gross domestic product expanded 4.9 percent last year, 4.4 percent in 2006 and 7.5 percent in 2005. The good years may have now gone.

``Sales of new cars have basically stopped,'' said G. Birnir Asgeirsson, owner of Bill.is, the country's biggest independent car retailer. ``Two years ago it was the absolute opposite. We sold lots, lots of off-roaders, jeeps and luxury cars.''

A 28 percent slump in the krona against the euro this year led the central bank to push its key rate to 15.5 percent from about 6.5 percent when Hjalmarsson bought his house. That's the highest in Europe after Turkey's 16.75 percent and Serbia's 15.75 percent. Inflation was 14.5 percent in August, the fastest in 18 years.

A further slump in the krona may lead Iceland to draw on a $1.5 billion euro ($2.1 billion) emergency loan facility agreed with other Nordic central bank to shore up its economy.

`Manic-Depressive'

The current account deficit, a measure of how much more a country spends than it earns, reached a record 28 percent of gross domestic product in the fourth quarter.

``We had good times a few years ago, everybody was confident, like Vikings going on a conquest,'' Hjalmarsson said. ``Now we're a manic-depressive patient.''

Still, there are signs that the ``equilibrium'' forecast by the central bank may be on its way. A surge in aluminum exports following the construction of plants by companies including Alcoa Inc., which are tapping Iceland's cheap hydro and geothermal energy, will narrow the trade gap.

Exports leaped an annual 25 percent in the second quarter while imports fell 12 percent on lower investment and consumer spending. The combination of soaring commodity exports and plummeting domestic demand may help stabilize the krona and control inflation.

No Stimulus Plans

The government, led by Prime Minister Geir Haarde, is unlikely to step in to avert a recession as it remains keen to end the currency slump.

``We will let things take their course,'' Finance Minister Arni Mathiesen said. ``We're not planning a stimulus package to keep up consumer spending.''

That stance is welcomed by some economists, who say consumer spending was out of control and a ``rebalancing'' is needed.

``In the long term it's a good thing that the economy's contracting,'' said Sunil Kapadia, an economist at UBS Ltd. in London. ``A rebalancing of the economy will move it away from its credit-fueled successes and back to more sustainable growth.''

Icelanders, whose per capita gross domestic product is the fifth-highest in the world, according to the United Nations 2007/2008 Human Development Index, are no strangers to volatility.

On an island where houses are designed to cope with the 10,000 earthquakes and tremors the nation experiences every year, adaptation to changing fortunes is second nature.

``We're a fat society and we're now getting trimmed,'' said Hjalmarsson. ``The whole country has just flipped. It's just a different state of mind.''

To contact the reporters on this story: Tasneem Brogger in Copenhagen at tbrogger@bloomberg.net;