Decision Point In EU Relations Nearing?

BMI View: Iceland is coming close to a decision point in its EU accession process. If the government wishes to hold a referendum on continuing talks it will have to do so quickly, as elections in April 2013 will likely see the opposition Independence Party topping the polls. Moreover, tensions with the EU over Iceland's mackerel catch could well sour relations further, unless the government can find an early resolution to this problem.

Ever since Iceland first applied to join the EU in 2009, it has been our view that the window for a successful accession process would be limited by the country's eventual recovery from recession, the duration of the current parliament and the speed with which difficult negotiating briefs such as agriculture and fisheries could be finalised. With Iceland having posted positive real GDP growth in 2011, parliamentary elections being due by April 2013 and the growing risk of a 'Mackerel War' with the EU, we think that Prime Minister Johanna Sigurdardottir's hopes of securing a yes vote in an early accession referendum are ebbing.

The effects of faster growth: A key attraction of applying to join the EU in 2009 was the desire to look to the EU as a stabilising economic and political force after the collapse of the country's banking system. With economic growth having returned, the krona beginning to appreciate in real effective exchange rate terms and capital controls being slowly lifted, the incentives to make tough political choices to secure EU membership are waning. Furthermore, the comparison between the relative success of the Icelandic economy - which we forecast to grow by an average 2.7% per annum through to 2021 - and the sclerotic eurozone economy teetering on the brink of its own existential crisis is becoming starker. Indeed, according to our forecasts by 2021 the Icelandic economy will have grown by a cumulative 31% in real terms against just 15% in the single currency area.

Upcoming parliamentary elections: Parliamentary elections are due by April 2013, and the centre-right euro-sceptic Independence Party is still outpolling the government by a significant margin. The September opinion poll put the Independence Party on 36% against 21% for senior coalition partner the Social Democratic Alliance and 13% for its junior Left-Green Movement junior partners. Even though the polls have narrowed in recent months, the Independence Party looks set to make very strong gains in the spring. With the government not making sufficient progress in EU talks to call a snap referendum on the final membership terms ahead of the polls, intra-government talks on the best way ahead have become fractious. Some members of the Left-Green Movement are notably less keen on accession and have moved to distance themselves from the SDA's pro-EU stance ahead of the polls. An additional wild-card could be provided by the re-election in June of President Olafur Ragnar Grimsson for a fifth term of office. In his fourth term, Grimsson departed from the largely ceremonial character of his office to use the presidential veto in controversial circumstances over the Icesave bill, and he has indicated that he may take a more activist political stance going forward. Given his euro-sceptic views, this could be to the detriment of the European aspirations of the SDA.

Little progress on mackerel dispute: Agriculture and fisheries were always going to be one of the trickiest negotiating areas for Iceland in its EU bid. Adhering to both the Common Fisheries Policy and Common Agricultural Policies would require significant changes in industries which are big employers, especially in rural areas, and occupy a unique place in Iceland's national heritage. However, a dispute over quotas for the mackerel catch threaten to bring Iceland and the Faroe Islands on one side, and the EU on the other into a major clash. In 2010, Iceland unilaterally raised its quota for mackerel from 2,000 tonnes per year to 130,000 tonnes per year, citing changing patterns in fish shoal migrations, which took them across maritime boundaries. The EU has accused Iceland and the Faroe Islands of ignoring pre-existing agreements and threatening sustainability of fish stocks by refusing to back down or compromise. Indeed, a recent study by the European Commission has suggested that this year's total catch could be 36% above sustainable levels. This has prompted the Commission and European Parliament to authorise sanctions against countries which overfish their waters. While no formal action has yet been taken against Iceland, and restrictions are unlikely to be imminently imposed given that talks are ongoing, the move does underline the growing seriousness of the dispute, especially within the context of Iceland's existing membership of the European Economic Area which guarantees free movement of people, goods and capital. Moreover, if implemented in a wide-ranging manner, sanctions such as restrictions on fisheries imports or on Icelandic-flagged vessels using EU ports could put certain firms under significant financial or operational stress. Moreover, we would imagine that the impositions of sanctions could have significant political repercussions in Iceland, and further undermine the government's argument that EU membership would help the country's economy.

Implications For Iceland

With the latest political developments in Iceland pointing towards a decreasing likelihood of early EU membership, greater clarity is emerging on the country's long-term political trajectory. Our core scenario is that Iceland will remain a member of the European Economic Area (EEA), and that the country's relationship with the EU will reset to that which existed before membership talks began in 2009. Indeed, the implications of having opened 18 chapter of the Unions' negotiating acquis and closing 10 of them before halting talks, are likely to be limited. Iceland's Scandinavian neighbour Norway trod a similar path in 1972 and 1994, rejecting membership in a referendum on both occasions. Norway today has a close relationship with the EU within the EEA, and suffers no ill effects from its two abortive attempts to join the Union.

This article is tagged to:
Sector: Country Risk
Geography: Iceland

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