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Analysis
What Greece could learn from Iceland

What Greece could learn from Iceland

Concentrate creditors’ minds: hold a referendum

by Meghnad Desai, Chairman, Advisory Board

Wed 2 Nov 2011

Greek referendum call presaged by Prof. Desai’s July 2011 proposal
Financial markets and European politicians have been stunned by the decision of Greek prime minister Greek Papandreou to call a referendum on last week’s Brussels debt deal. Readers of the OMFIF Bulletin may remember that Prof. Meghnad Desai, Chairman of the OMFIF Advisory Board, proposed such a move on p.3 of the July 2011 issue. See extract below and the full article.

As the euro drama slides into melodrama and then possibly into farce, Greece should learn from the example of Iceland, which went bankrupt two years ago. Like Ireland, Iceland ran into problems with its private banks which built up excessive liabilities by offering an above-market interest rate on deposits and then crashed when Lehman Brothers went down. The debt - which were the deposits taken by the banks operating abroad - was left with the Icelandic Treasury. But in a referendum the Icelanders voted to renege on the debt and forced the creditor countries - mainly the UK and the Netherlands - to renegotiate.

Not being in the euro, Iceland could let its currency depreciate – a painful exercise, but one that lets individual citizens make their own adjustments to inflation. Now two years on, Iceland is on track for annual growth above 2% this year and next after a cumulative 10% fall in output in 2009 and 2010. Iceland has returned to the international capital markets and can borrow at 5% - a rate the Greeks can only dream of.

There is a lesson for the euro area here. Not every creditor deserves a break. They should have known it was risky to lend to Greece. Let them bear the cost. I believe Greece should hold a referendum on whether its citizens are willing to pay back the debt. That should concentrate minds - both in Greece and among the creditor countries – and might make a contribution to resolving the issue.

A referendum would certainly be better than the other options that are feared – a revolution or even a military coup. But Greece is used to such shocks – and has a long history of reneging on its international obligations. The Papandreou government is fast running out of options. It’s hoping for respite from privatising many of Greece’s assets. But this is a tricky political decision for an ostensibly Socialist Party. Even if the government decides to sell, it may not get its hands on the money for a while. And a fire-sale will be counter-productive.

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