Iceland is 'bankrupting itself to recovery'
Iceland is betting its decision two years ago to force bondholders to pay for the banking system's collapse may help it rebound faster than Ireland.
Iceland's taxpayers face a smaller debt burden than their Irish counterparts, where the Government's guarantee of the financial system in 2008 backfired this year when the banks came close to insolvency.
Iceland's budget deficit will be 6.3pc of gross domestic product this year and will vanish by 2012, compared with the 32pc shortfall in Ireland, the European Commission estimates.
While analysts expect Iceland's recession to extend into next year, the nation's exporters are benefiting from a 28pc drop in the krona against the dollar since September 2008.
The decline may help the nation of 320,000 people rebalance its economy faster than Ireland, whose euro membership rules out a currency devaluation.
With Iceland's OMX share index up 17pc this year -- the third-biggest gain in Europe after Denmark and Sweden -- Nobel Prize-winning economist Paul Krugman says Iceland may be an example of "bankrupting yourself to recovery".
"The difference is that in Iceland we allowed the banks to fail," Iceland president Olafur R Grimsson said.
"These were private banks and we didn't pump money into them; the state did not shoulder the responsibility of the failed private banks."
The island's bank debt remains with the failed lenders, whose creditors have yet to recoup $85bn (€64bn). Deciding who should bear the cost of banking failures was becoming a "burning" question in Europe, Mr Grimsson said.
"Senior bondholders in some countries must accept that they may have to take haircuts or participate in restructurings," said Michael Derks, the London-based chief strategist at FXPro Financial Services.
"It just doesn't add up otherwise."