Thursday, September 09, 2010 Publisher: Íslandsbanki Research - greining@islandsbanki.is - Resp.Editor: Ingólfur Bender

CDS spread holds stable
The CDS spread on the Republic of Iceland's euro-denominated obligations has remained rather stable in the recent past. According to data from Bloomberg, it stood at 315 points (3.15%) at the close of business yesterday, close to the levels of recent months. An examination of developments since the beginning of the year reveals that the sovereign CDS spread has dropped considerably, which cannot be said for the Western European average. Actually, the reverse has been happening in Europe: the average sovereign spread for Western European countries has been inching upwards.

Ireland's sovereign CDS spread has risen sharply
The rise in the average CDS spread in Western Europe is attributable in part to Ireland. At the beginning of August, Ireland's spread was 209 points, but by yesterday's close, it had risen to 371, second-highest among the Western European countries for which CDS spreads are traded. This steep rise in Ireland's sovereign spread is not entirely unexpected, however, as the national government has been criticised heavily for its involvement in the banking system. As is well known, the Irish government took on colossal debt in order to rescue its banking system, and Ireland's sovereign credit rating has deteriorated somewhat as a result. Most recently, Standard & Poor's (S&P) lowered its long-term ratings for Ireland to AA-. Fitch gives the Irish sovereign the same rating, while Moody's assigns a rating one notch higher. Before the financial crisis struck, Ireland had sovereign ratings of AAA/Aaa, the highest offered by the three major agencies.

Out of sync with credit ratings
Although Ireland's CDS spread is much higher than Iceland's, its credit rating is far more positive. For long-term foreign currency obligations, Iceland receives Moody's lowest rating of BB+, one notch lower than its country ceiling, which is BBB-/Baa3 from Fitch and Moody's. Iceland's sovereign credit ratings are therefore 6-7 notches below those of Ireland, and it is clear that these two criteria for measuring risk are utterly at odds with respect to the internal credit risk inherent in the two countries. Moreover, all of the rating agencies assign a negative outlook for Iceland's ratings, while the outlook for Ireland is negative according to S&P and stable according to the other two.


Iceland's competitiveness plummets

Iceland has taken a nosedive on the World Economic Forum's competitiveness scale in the past few years. According to the Forum's most recent Global Competitiveness Report, 30 countries are more competitive than Iceland, whereas only four countries outperformed Iceland five years ago. Iceland is now in 31st place on the list, down from 26th place last year and 20th place in 2008. In 2005, however, Iceland was in 5th place according to the Global Competitiveness Report, which is compiled annually. As it was last year, Switzerland is the most competitive country in the world. The top 10 countries are also the same as last year, although their order has shifted a bit. Three Nordic countries are in the top 10 - Sweden in 2nd place, Finland in 7th, and Denmark in 10th -  and Norway is close behind, in 14th place. The African nation Chad is considered the least competitive of the 139 countries evaluated.

The World Economic Forum examines 12 different factors, or pillars, in its evaluation of competitiveness: institutions, infrastructure, macroeconomic environment, health and primary education, higher education and training, goods market efficiency, labour market efficiency, financial market development, technological readiness, market size, business sophistication, and innovation. These 12 pillars are classified into three basic categories: basic requirements, efficiency enhancers, and innovation and sophistication factors. In the basic requirements category, Iceland is in 41st place. As regards efficiency enhancers, it is in 31st place, and in innovation and sophistication factors, it is in 20th place. The factors reducing Iceland's competitiveness are its low scores in areas such as macroeconomic environment (138th place) and financial market development (122nd place). As before, however, Iceland receives stellar ratings for its educational and healthcare systems, placing 4th overall. 


Pessimism subsiding

In Europe, as in Iceland, consumers appear more or less convinced that the worst is behind them in economic affairs, and sentiment is turning distinctly more positive than before. In Europe, optimism levels have risen for three consecutive months, with the outlook towards the current economic situation climbing to levels not seen for two years. In Iceland, the Gallup Consumer Sentiment Index has risen steadily for the past five months to its current 69.9 points, its highest value since before the crisis struck. Given that the index has averaged about 40 points since the banks collapsed, Icelanders are clearly more upbeat than in the recent past. This should not come as a surprise, though, as many indicators suggest that the bottom of the recession is either just behind us or on the horizon: the labour market appears to be rallying, inflation is on the wane, the króna has appreciated, interest rates are down, and real wages have risen.

American consumers uncertain
American consumers, on the other hand, appear undecided about the current economic situation, and they are notably cautious in their response to news that the worst is over. As a result, consumer sentiment in the US has held relatively stable in the recent term and will take some time to return to previous levels. Optimism among Americans sustained a setback this summer, due to a string of negative news reports, including news about the US housing market. American consumers appear to have recovered some of their good cheer, however, as the Consumer Sentiment Index rose by 2.5 points in August to its current level of 52.9. In February 2009, the index hit a 28-year low of 25.3 points. So far this year, it has averaged about 54 points, a drastic departure from the 2007 average of 103.


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