Nowhere was hit as hard by the credit crisis as Iceland, but as the country rebuilds its economy and banking sector, it is determined to learn from this harshest of lessons.

Almost a year has passed since all three of Iceland's large commercial banks collapsed within the space of little more than a week, forcing the country's economy into severe financial turmoil. After months of intense crisis management, rescue endeavours are giving way to restructuring efforts, while everyone remains conscious of persistent risks to the economy and the financial system.

These efforts are guided by a political focus on equality and social justice, avoiding neoliberal excesses and rebuilding the Nordic welfare model, which has been undermined in recent years. For the purpose of reconstruction and stabilisation, we have sought extensive assistance from and co-operation with the international community, not least through credit provided by other Nordic countries, Poland and the International Monetary Fund (IMF) to strengthen our currency reserves.

Rebuilding the economy

The government's policy for overcoming the current crisis - formulated in close co-operation with the IMF - is focused on stabilising the exchange rate, solidifying government finances and restructuring the banking sector. After months of unfortunate delays in implementing the programme, we now expect it to proceed according to plan and we remain, as before, fully committed to the process.

The government places great emphasis on restoring confidence in the Icelandic economy. Co-operation with the IMF is instrumental in this respect and this is backed up more generally by following international best practice as the standard for all measures taken. This includes strengthening the central bank's independence and effective leadership by appointing a new professionally qualified governor and a monetary policy committee comprised of highly respected domestic and international experts. The leadership of the Icelandic Financial Supervisory Authority has also been changed and measures taken to increase co-operation between micro- and macroprudential supervision. Rules on large exposures, concentration of risk and cross-holdings will be tightened and we are studying the possibility of establishing a national credit registry.

Although the three new domestic banks carved out by the authorities as the system collapsed will hopefully be largely owned by their foreign creditors, the government intends - at least initially - to hold a substantial stake in at least one bank. Other Nordic governments took similar steps following their financial crises nearly two decades ago.

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Kaupthing Bank: one of three Icelandic banks that needed government intervention last year

Learning from the past

Furthermore, we are leaving no stone unturned in investigating how our small nation found itself in such a dire situation, because social reconciliation is no less important than economic rehabilitation. An independent special committee appointed by the Icelandic parliament, Althingi, is investigating all relevant events leading up to and following the crisis, and four special prosecutors are investigating possible criminal offences. My government is determined to take all necessary measures to prevent the reoccurrence of such a calamity and to do so we need to fully understand what happened.

However, Iceland is not the only country that can learn from these lessons. One of the conclusions we have drawn, and hope that partners in the European Economic Area will understand, is that the EU regulatory framework on cross-border banking surveillance, deposit insurance and home-host responsibilities needs to be revised.

The concurrent failure of all three large banks - with assets of 120% of Iceland's gross domestic product (GDP) and representing more than 90% of the country's banking system obligations to insured depositors of privately owned Icelandic banks in the UK and the Netherlands, and the sharp deterioration of the economy will place great strains on the state budget and push Iceland's external debt to very high levels. While shouldering our responsibilities abroad, we also have a responsibility to future generations in Iceland and intend to bring this year's deficit of 13% of GDP to balance by 2012, no small achievement for any government. We have already published a medium-term fiscal policy that outlines our priorities. We have taken the first steps on this difficult journey.

Such large consolidation measures are only possible through widespread consultation with and acceptance by the social partners. To this end, my government has concluded a 'stability pact' with labour and employers' federations. The pact describes our common vision and defines how the burdens should be shared through increased taxes and reduced spending. We intend to defend vital public services and shield those most vulnerable in society. Close consultation and co-operation is essential to ensure national cohesion in the face of such a challenge.

Partnering with the EU

Iceland's application for EU membership is an integral part of achieving economic recovery and increased economic stability. It would eventually offer greater currency and price level stability, with clear goals and guidelines. I also believe that Iceland can make a contribution to the EU, as a country with a long history of democracy, gender equality and sustainable resource management. Iceland could also become Europe's window to the Arctic - a region of rapidly growing importance.

We have previously stated that we hope for a relatively short accession process, not because Iceland expects special accelerated treatment, but because we have been members of the European Single Market since 1994 and have already incorporated most of the relevant legislation. Iceland is also a party to the Schengen Agreement. We do recognise, however, that our own house needs to be in order before we can expect to reap the benefits of EU membership.

Ultimately, the government's goal is to rebuild Iceland's economy on shared values of social cohesion and social responsibility, which is at the core of our Nordic welfare model. This refocus on a more egalitarian society is perhaps our best defence against the recurrent crises of unbridled capitalism. It is in this sphere that Iceland has major strengths to build on; for example, good and comprehensive educational and health care systems. Iceland also has an abundance of green energy, a highly skilled labour force, major opportunities in the field of tourism and a strong fisheries and food processing industry.

The population is small, but is also young and innovative, making it easier to overcome the present crisis. We aim to build a more balanced and sustainable basis for the Icelandic economy and maintain our full participation in international activities. While the next two years will be very difficult for Iceland, we are on the right track towards recovery and the longer-term outlook is bright.

Jóhanna Sigurdardóttir is the prime minister of Iceland


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