(Bloomberg) -- The rally in Icelandic markets is stalling as one of Europe’s fastest growing economies faces the possibility of a regime change next week.
With latest surveys suggesting the center-right coalition stands little chance of surviving the Oct. 29 election, opposition parties have started exploring possible alliances designed to bring about far-reaching change, from a new constitution to higher levies on fishing rights. Local investors say a potential left-wing government that includes the maverick Pirate Party, which is leading in some polls, will mean higher taxes to fund a spending spree.
"When you look at the election pledges of the left-leaning parties, you can see that they are planning to raise taxes and more Treasury spending," Sveinn Thorarinsson, equity analyst with Landsbankinn hf, said in a telephone interview. "It’s no secret that those plans aren’t exactly music to the ears of business owners and investors."
Despite strong fundamentals -- Iceland’s economy surged 4.1 percent in the first six months of the year -- bond yields and credit default swaps have edged up over the past two months. The GAMMA government bond index has dipped 1 percent from its early September high and the country’s main stock index has slid almost 9 percent from a high in April.
"Investors are a little stressed out about the possibility of a left-leaning government," Johann Gisli Johannesson, a fund manager at Reykjavik-based asset manager Gamma Capital Management hf, said in a telephone interview.
Although it turned a 14.3 billion kronur ($125 million) deficit into a projected 408 billion kronur surplus while in office, the incumbent government -- backed by the Progressive Party and the Independence Party -- is struggling in the polls. One survey published a week before polling stations open put support for the ruling alliance at a combined 30.2 percent, down from 51.1 percent in the 2013 election.
A regime change could be a rude awakening for investors who have been pouring back into Iceland as the government dismantled many of the capital controls that were implemented after the nation’s banking system collapsed, in 2008. Even as the government put in place rules to limit the so-called carry trade and the central bank cut interest rates, the krona is up 11 percent this year and hit an eight-year low against the euro this week.
Next week’s snap election was called after former premier Sigmundur David Gunnlaugsson was forced to resign following revelations in the Panama Papers that he and his wife held investments in offshore accounts.
According to Johannesson, the biggest impact of an alternative ruling coalition possibly extended to the Pirate Party could be on the fishing industry, the country’s third-largest.
There are signs that may be already happening. Iceland’s largest fishing company, HB Grandi hf, has seen its stocks tumble almost 15 percent since Iceland’s government announced early elections seven months ago.
Despite positive forecasts, the country’s benchmark OMX all-share index has fallen almost 13 percent on an annual basis over the last six months. Analysts, however, note that the wavering fortunes of Icelandair have played a major role in the OMX drop.
Although fears about a left-leaning government may be an "oversimplification," Thorarinsson predicts that market "jitters will continue until election day."
"At the moment, most investors seem to be waiting for this campaign to finish," Thorarinsson said.