Faced with the complete collapse of its financial system, the Icelandic government has accepted a US$6 billion "bailout package", which would include more than $1 billion input from the International Monetary Fund.
The IMF is infamous for its global "shock therapy" approach to economic problems, where loans are granted on the provision that the receiving governments implement harsh austerity, privatisation and deregulation measures. Such measures have had disastrous effects on many countries.
Iceland has been especially hard hit by the global economic crisis, driven to the brink of bankruptcy.
Having nationalised Iceland's three major banks, Prime Minister Geir Haarde stated: "There [was] a very real danger ... that the Icelandic economy, in the worst case, could be sucked with the banks into the whirlpool and the result could be national bankruptcy.
"The state now owes more than $60 billion, more than 80% of which was held by the banking sector, which is more than six times its annual gross domestic product."
Iceland's crisis was greatly worsened by the neoliberal drive led by the right-wing Independence Party (IP), which has dominated Icelandic politics since independence in 1944.
The regime of former IP prime minister from 1991-2004, David Ottison, implemented "a radical (but now familiar) program of privatization, tax cuts, reductions in spending and deficits, inflation targeting, central bank independence, free trade and exchange rate flexibility", according to an October 21 Alternet.org article by Toby Sanger.
"Corporate taxes were cut from 50 percent down to 18 percent. Privatization and deregulation were driven directly through the prime minister's office, and the major banks were privatized."
The potential problems behind such moves were identified by former World Bank chief economist Joseph Stiglitz, who commented in his working paper prepared for the Icelandic government in 2001 on the "problems posed by global financial instability".
He stated: "Tax and regulatory policies (including financial sector regulation and disclosure regulation) can and should be used both to reduce the likelihood of a crisis and to help manage the economy through the crisis."
The government chose not to listen to Stiglitz's advice as its financial and banking sector aggressively expanded overseas, while offering higher interest rates. This resulted in billions of dollars flowing into the Iceland's finance sector, particularly from Britain.
This fuelled economic growth, which has averaged 4% since 1994, and helped created Icelandic billionaires, such as West Ham Football Club owner Bjorgolfur Guomundsson.
However, with the banks overseas expansion, they raked up debts 10 times the size of Iceland's GDP. With a meltdown in the financial system, Iceland's government, unlike other larger nations, could not guarantee the debts of the banks, leading the main three to collapse.
The impact has been severe — the Icelandic economy is expected to contract by 10% in 2009, while 2008 growth is expected to be zero.
Immediate job losses are set to be 7000 in a country of only 350,000 people, while the unemployment rate could rise to as high as 8% in 2009 from around 3% currently.
According to an October 15 Bloomberg report, Danske Bank chief analyst Lars Christensen predicted that inflation could rise to 75%, while Iceland's currency, the krona, has declined in value by 35% this year.
The government has placed restrictions on foreign currency exchanges, which means Iceland now can only import products such as food, medicine and oil.
The crisis was made worse, however, by Britain's intervention. Britain used "anti-terrorism laws" on October 8 to freeze all assets of the Icelandic bank Landsbanki, as well as assets belonging to the Central Bank of Iceland.
Britain claimed it carried out the move "because the Treasury believed that action to the detriment of the UK's economy (or part of it) had been or was likely to be taken by certain persons who are the government of or resident of a country or territory outside the UK".
The British government also placed the British operations of Iceland's largest bank, Kaupthing, into administration.
The head of the Left Green parliamentary bloc, Ogmandur Johnson, told the US radio show Behind The News that this action was responsible for the bank's collapse. Britain has "forgotten nothing from its colonial days", he stated, and was treating Iceland in an "incomprehensible manner".
Haarde, meanwhile, described Britain's the move as an "unfriendly act".
The October 20 British Financial Times reported on the IMF loan to Iceland, stating: "The IMF sought assurances on the restructuring of the banking sector and has demanded a review of Iceland's banking legislation to ensure it conforms with international best practice."
"Crucially, the IMF is not insisting on the privatisation of Iceland's huge Housing Financing Fund, a state-backed mortgage lender", the article reported. "The IMF will ask the government to compile a credible plan for fiscal tightening in response to government debt levels."
This means that, in effect, all decisions about Iceland's economy will be subject to IMF approval. Such an approach has been a universal disaster wherever it has been implemented.