What's Right and What's Hype?

They might not admit it at first, but anyone working in the market will tell you that 90% of a company's value is based on public perception. Psychology, in other words. Having worked at a stock brokerage myself, I've seen companies with a great product, strong staff and healthy revenues suddenly tank due to rumours of financial difficulties, whether they proved true or not. The reverse is also true - companies consisting of little else besides a PR staff with snazzy-looking literature can earn tremendous revenue. In the end, though, it's always that crucial 10% - the real value of a company - that determines where things will level off. In addition, even the most successful companies go through continuous upswings, downturns, and levellings-offs. This same principle can be applied to the economic strength of a nation, and Iceland is no exception.

Iceland wasn't always the fairly well-off country it is today. Before the arrival of British and American forces during and after the Second World War, Iceland was mostly agricultural. The development of the infrastructure by foreign armed forces helped propel Iceland into a more industrialised society. While many industries were state-owned, the early 1990s saw a tremendous privatisation drive, with the government selling many of its assets to private businessmen. Many of these formerly state-owned companies, such as Landsbanki, are today among the top earners in the country.

Not that all of Iceland's success stories are the result of sold-off state assets. One of the strongest and arguably the most visible corporations in Iceland, Baugur Group, started as a single grocery store, Bónus, in 1989. Today, Baugur Group owns 27 companies in Iceland and abroad. In fact, recent overseas investment and acquissition is without a doubt the biggest reason why the international business community has been following Iceland so closely, with the UK and Scandinavia being the primary targets, and Baugur Group being the primary investor. People began to sit up and take notice of Iceland's business world - they had no choice.

Of course, not everyone took the Iceland's investment maneuvers well. That a nation of less than 300,000 people could be home to a number of dollar millionaires who made their money within an amazingly short period of time seemed a hard pill to swallow. A now-infamous article that appeared in the Guardian in 2005 entitled, "Next-generation Viking invasion" made implications that Bjorgólfur Þór Bjorgólfsson and his father, Bjorgólfur Guðmundsson, and Magnus Þórsteinsson profitted from the St Petersburg mafia when they opened the Bravo brewery in 1993. Financial and political squabbles within the country shortly after the Guardian article was published - in particular, the government taking Baugur to court for alleged economic crimes, of which they've since been acquitted, and evidence suggesting Prime Minister Halldór Ásgrímsson engaged in market manipulation published in the daily newspaper Fréttablaðið - made already growing suspicions in the international business community increase that much more. A backlash - or rather, that aforementioned downturn - was inevitable.

Bad press hits the Icelandic economy

Last February, market analysts Fitch Ratings revised their currency rating for Iceland from Stable to Negative. The report said that Iceland"s economy had long showed signs of overheating, citing rising inflation, fast credit growth, and escalating foreign debt, among other things. Senior Director in Fitch"s Sovereign Team in London Paul Rawkins said in the report, "In the absence of a more balanced policy response, Fitch believes that the risks of a hard landing have increased, raising concerns about how well the broader financial system would cope." The report also said that Iceland"s net external debt "is higher than virtually any other Fitch rated sovereign," and makes comparisons to the Asia crisis some years back, saying in part, "countries with seemingly sound public finances ignore the private sector imbalances at their peril."

This seemed to start a domino effect throughout the spring, with Bloomberg, Moody's and the Financial Times reiterating what Fitch had said. The word in the financial pages of the international press was, Iceland's currency is over-valued, their foreign debt is rapidly rising, inflation continues an upswing. During this time, the Icelandic stock market was hit with a 5% drop on a single day, and the value of the Icelandic crown went from about 70 ISK per USD to 81 ISK per USD within the span of a few days.

Did the bad press hit Iceland's economy, or did Iceland's economy deserve bad press? The truth is: both. The Central Bank has set an interest rate of about 10.5% in February (it's at 12.25% roday) while in the rest of Europe it's about 3%. This pushes the exchange rate up, which makes imports cheaper but also makes exports more expensive (in case you were puzzled as to why the same product from overseas is cheaper than one made in Iceland, now you know). While Iceland prohibits the importing of dairy, poultry, and some other fo rms of meat, it still has not raised import tariffs that could help make homegrown goods more affordable than imports. In addition, much of Iceland's agricultural goods are subsidized. This one-two combination makes for an import based economy, and widens the trade gap. About half the deficit is due to overconsumption of imports because imports are cheaper than domestic goods.

While market analysts such as Fitch Ratings have advised that the government step get involved, the Icelandic government position has been decidedly stand-offish. Privatisation has done Iceland good, so some are naturally skittish about government "mucking things up" in economy again. Halldór Ásgrímsson told a group of investors, businessmen and members of government from Iceland and abroad who met a conference in Hotel Nordica earlier this month that rather than raise the lowest wages in Iceland, he intended on cutting taxes, as he believes raising wages would exacerbate inflation. However, as Rawkins of Fitch Ratings pointed out, "If the economy's overheating, tax cuts aren't the way to go. While I can appreciate the government's privatization policy, they look a bit too relaxed about it. You can't always stand back and do nothing."

Things now seem to be levelling off. Icelandic banks have initiated an aggressive information campaign to stem off the bad press. Ásgrímsson himself believes that the recent tumbles in the Icelandic market were the result of, "a widespread lack of knowledge abroad of the Icelandic economy," adding, "We are confident that when the dust settles, Iceland will still be one of the richest, most fastest growing economies in the world." Hopefully, Ásgrímsson's right. But remember: while the market might be 90% psychology, it's that crucial 10% - the real value of an entity - upon which everything inevitably rests.

By Paul Fontaine- Nikolov