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Global Credit Research - 27 Jul 2012
London, 27 July 2012 -- In its annual credit report on Iceland, Moody's Investors
Service says that Iceland's Baa3 government bond rating is based
on the country's moderate economic and high institutional strength
as well as low government financial strength and high susceptibility to
event risk. The downside risks facing Iceland's sovereign
creditworthiness are reflected in the currently negative outlook on the
The rating agency's report is an annual update to the markets and does
not constitute a rating action. Moody's determines a country's
sovereign rating by assessing it on the basis of four key factors --
economic strength, institutional strength, government financial
strength and susceptibility to event risk -- as well as
the interplay between them.
Iceland's moderate economic strength score balances the high levels
of wealth with the small size and undiversified structure of the economy.
The post-crisis recovery is now under way and Iceland's short-term
growth outlook is favourable. A further escalation of the euro
area crisis is a risk as the EU is Iceland's main trading partner.
Moody's assesses Iceland's institutional strength as high,
given the important progress that the authorities have made in bringing
the economy, the financial system and the public finances back onto
a sustainable path. The government is in the process of implementing
wide-ranging changes to the institutional set-up so as to
avoid a repetition of the crisis.
Government financial strength is considered to be low, mainly on
account of the still elevated debt burden. At the same time,
the government has managed to reduce the budget deficit significantly
since the peak in 2008. Fiscal consolidation continues this year
and will likely result in the first decline in the public debt ratio since
the crisis erupted. While an important and positive first step,
the Icelandic authorities will need to strengthen the country's
fiscal position further and run consistent and substantial primary surpluses
in the coming years in order to materially reduce the still very high
debt ratio. The Icesave dispute is less of a risk to public finances
than previously thought, but remains to be solved.
Susceptibility to event risk is assessed as high, mainly reflecting
the risks entailed in the process of capital control liberalization.
The size of potential capital outflows is substantial and the risk of
policy mistakes in the context of loosening the controls remains the key
event risk for Iceland. At the same time, Moody's acknowledges
that the authorities are well aware of the risks of a too rapid liberalization.
Also, by repaying early some of its own obligations the government
has reduced some of the potential pressure on the ISK exchange rate in
the years 2013-2014, which are most likely the years with
significant steps in liberalizing the capital control regime.
The negative outlook on Iceland's Baa3 rating reflects the above
risks. The outlook could be returned to stable provided the government
remains on track to achieve its fiscal target for the year and there are
no further legal developments that have a negative impact on the government's
fiscal and debt position. The ratings could be upgraded if the
economic recovery is sustained, significant fiscal consolidation
continues and the exchange rate remains broadly stable during the process
of gradual capital control relaxation. Conversely, the rating
could be downgraded if the current commitment to fiscal consolidation
showed signs of declining or the remaining legal risks related to a resolution
of the Icesave issue resulted in a significantly higher liability for
the government than is currently expected.
Moody's annual credit report on Iceland is now available on www.moodys.com.
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MD - Sovereign Risk
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Moody's publishes annual sovereign credit analysis on Iceland
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