Wednesday 23 November 2011

The effect of currency devaluations on external debt : the case of Iceland

I want to take a look at one particular consequence of currency devaluations. The effect they have on external debt. 

The case of Iceland is quite revealing in this respect.

Since external debt is mostly denominated in foreign currency (in most cases that is, not always), when expressed in local currency terms, it balloons after currency devaluations.

At first I intended to include data about the defaulted banks’ external debt which comprises the lion’s share of total Icelandic external debt. Since the issue is a bit controversial I decided to just include General Government’s external debt, which is not defaulted upon. Here’s the chart.


source: Central Bank of Iceland, Statistics Iceland, own calculations

I think that the chart’s enough to showcase the effect of the Krona’s devaluation on external debt...

P.S. I should mention that the Krona depreciated all through 2008.

2 comments:

  1. Hi Nick!

    I am just wondering, does the depreciation of the krona explain the whole increase of the government external debt? I don't know too much about the Icelandic crisis, but is it possible that contingent liabilities, bailout of private companies also contributed to the increase of external debt? So, in this case the government's external debt contains that of the defaulted banks.
    But I agree with you, that a country with high external debt faces big problems in the case of serious currency depreciation.

    Robi

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  2. Hey Robi,

    Thank you for reading the post and for taking the time to comment.The failed banks external debt per se is not included in the chart. That figure stands at about 90% of GDP if I haven't got it all wrong. As far as I know these are still contingent liabilities (it is still not decided what will become of them) so they are not included in the figure used in the chart. But you're right a small portion of the banks debt/liabilities, were dirrectly or indirectly transferred on the public debt figure. I assume (don't know for sure) that this was not done instantaneously, but gradually, maybe these liabilities were netted against recovered assets and so on. I wish I could tell you what percent of the increase can be attributed solely to that effect but I'm afraid I can't...Thanks for adding a new angle to the discussion!

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