Today, the Icelandic Supreme Court annulled the Reykjavík District Court acquittal in the Aurum case. This means that the District Court has to start all over again on the case. Those charged are Jón Ásgeir Jóhannesson and Lárus Welding who became Glitnir’s CEO when Jóhannesson and a group of investors bought over 30% in the bank in spring 2007. Two other Glitnir employees are also charged.
At the centre of the case is a loan from Glitnir to a shelf company, FS38 to buy a share in the retailer Goldsmith, owned by Aurum Holding, from Fons, owned by Pálmi Haraldsson, a business associate of Jóhannesson. Haraldsson was i.a. a co-investor in Glitnir with Jóhannesson, where the duo were close up and intimate with the management. So much so that Welding at some point, in an email to Jóhannesson, complained that he was being treated like a branch manager and not the CEO.
The particulars of this whole loan arrangement was that after various evaluations of Goldsmith, Glitnir lent ISK6bn to FS38; it so happened that of the 6bn ISK1bn landed on Haraldsson’s account with Glitnir and an equal amount landed on Jóhannesson’s personal account.
The FS38 loan saga was already familiar from the SIC report, published in April 2010, one of many SIC’s loan sagas related to the major shareholders of the three banks. The four were charged by the Office of the Special Prosecutor. When the case came up in the District Court it was presided over by two District Court Judges the third one being a Court-appointed external expert, Sverrir Ólafsson.
In June last year the Court acquitted all four charged in the Aurum case. Soon after, it transpired that Ólafsson was the brother of Ólafur Ólafsson, at the time already sentenced by the District Court in the so-called al Thani case. Ólafur is now serving a sentence of 4 1/2 years after the Supreme Court sentenced him last January (thereby adding a year to Ólafsson’s sentence in the District Court). Foreigners always think that in Iceland everyone knows everybody, which definitely was not the case with the Ólafsson brothers – special prosecutor Ólafur Þ. Hauksson denied he had known about the relationship (and yes, Ólafsson is a very common name in Iceland and the two brothers are not at all similar) nor had the Icelandic media picked this up.
Following the revelation, Sverrir Ólafsson said in an interview with Rúv that it was inconceivable Hauksson and the OSP had not been aware of whose brother he was. According to Sverrir the fuss was only to undermine the judgement. In this interview Ólafsson used harsh words about Hauksson, seen by many as somewhat unsuited for a judge, even a lay one.
Following the District Court ruling in the Aurum case the state prosecutor (a different authority from the OSP) demanded that the judgement should be annulled because of doubt of the impartiality of one of the judges. Today, this is exactly what the Supreme Court did, which means that now the case must start anew, probably adding at least another year and probably more to the story of this case.
In addition to this the Glitnir Winding up Board has sued Jóhannesson and others for damages caused by the FS38 loan. In connection to that case, and at the demand of Glitnir, Jóhannesson’s assets were subjected to an international freezing order by a London Court in May 2010 (see here, here and here). The Glitnir case is resting until a final judgement in the criminal case; as far as is known the freezing order is still standing. However, Jóhannesson is again an active investor, i.a. in the UK but investing on behalf of his wife.
Recently, there have been articles in Icelandic on the website Vísir and in the newspaper (distributed for free) Fréttablaðið owned by 365 Media, under the ownership of Ingibjörg Pálmadóttir, wife of Jóhannesson. These articles have been insinuating lies on behalf of the Special Prosecutor regarding Ólafsson, i.e. stating that Hauksson and others at the OSP did indeed know whose brother Sverrir Ólafsson was. Earlier, the paper had also sought to sow doubt of the al Thani judgement; the sentence in one of its articles, saying that when the Courts fail the media must take over, was much noted. No doubt, Jóhannesson and his allies will fight their case ferociously, not only in the Courts but also in the media in the Jóhannesson’s sphere of influence.
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Bjarni Benediktsson minister of finance did not answer directly when asked by Rúv if he knew beforehand that prime minister Sigmundur Davíð Gunnlaugsson. He only said that he and the prime minister were working closely together towards lifting the capital controls. He said work was ongoing to prepare Bill, expected before summer, but was not firm on a date.
He reiterated that the estates were a threat to stability and stability tax – not a concept heard until mentioned by the prime minister on Friday – was intended to do just that: preserve stability when it came to lifting capital controls. He did not want to answer exactly who would pay this tax or how but the tax would help authorities to control the process of lifting the controls. He also repeated what the prime minister said, that the estates had not put forward any useful plan for lifting controls.
The winding-up boards of the estates will no doubt beg to differ: they have put forth plans, which have not been answered.
At an open committee meeting on Monday governor of the Central Bank of Iceland Már Guðmundsson was asked about the tax. He said it could be compared to “pollution tax” – the estates were like a source of pollution within the economy and the tax was to mitigate the effect of this pollution. What exactly this Delphic utterance meant in practice he would not say.
For more on this issue see the two most recent blogs here below.
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Going on the fourth day since prime minister Sigmundur Davíð Gunnlaugsson announced stability tax, minister of finance Bjarni Benediktsson has not yet said a word on the announcement. Arriving from two weeks holiday in Florida Monday morning he did not attend the first meeting of Alþingi after the Easter break, nor did Gunnlaugsson. The two ministers are said to have spent the afternoon in meetings with Már Guðmundsson governor of the Central Bank, CBI.
My hunch is that Gunnlaugsson did not discuss his statement with Benediktsson before making the speech. The preparations of the capital controls plan-to-be have been carried out in utmost secrecy, drafts not sent in emails etc. and it certainly was not anticipated that one of the insiders, the prime minister, would then go out and announce it at a time that suited him and his party politics. Hardly a statesman-like behavior to use a party conference to make a prime-ministerial announcement of this kind. But with the prime minister getting some numbers wrong it seems he did not have the best advisers at his side in preparing for the speech.
It is also clear that the Bill Gunnlaugsson announced had not been presented earlier because the government leaders had not been able to come to an agreement on the final version. By saying that a stability tax bringing billions to the state will be presented before the end of this Alþingi Gunnlaugsson has put pressure on Benediktsson. It seems like a retaliation for the pressure Benediktsson tried to put on Gunnlaugsson last year when Benediktsson kept announcing that a liberalisation plan would be presented last year – only a much harder pressure because Gunnlaugsson did not just announce the plan but also what it actually should contain.
Vilhjálmur Bjarnason MP for Independence party said in Morgunblaðið yesterday that a tax on estates was far from international practice, would be contested in court, leading to years of court wrangling during which time the controls could not be lifted. Hörður Ægisson journalist at DV said in an interview with the webzine Eyjan that using the lifting of capital controls to make money for the state ran counter to earlier statements. Anything except dealing with foreign-owned ISK was unacceptable, according to Ægisson.
Gunnlaugsson then went a step further over the weekend when he said, in an interview to Morgunblaðið, that the billions from the stability tax would not be used but set aside, on which he and Benediktsson were in total agreement – another poisoned arrow.
So what is all this about? First of all, the stability tax is nothing like the previously discussed exit tax. An exit tax taxes capital movements. The stability tax is indeed a form of asset tax, i.e. will be levied on assets according to certain criteria. One theory is that it will be levied on assets in order to prepare for or at the time of composition of the banks’ estate. And it is to be a double digit tax.
That the advisory committee has been split on how to proceed on the tax, i.a. how to use the billions, echoes in Gunnlaugsson’s words. Of course, parking the billions goes counter to what Gunnlaugsson has been announcing. For Gunnlaugsson to claim that the two agreed on this seems like an attempt to making peace with Benediktsson after his major faux-pas in his speech.
Benediktsson was unavailable for comments yesterday. Gunnlaugsson did not want to be interviewed on Rúv. What happens now is anybody’s guess – some say this is the end of the government but as I have pointed out earlier Benediktsson is in a difficult situation. Should he swallow this or try to act? In theory, he could turn to the opposition and see if he can find some common ground there to form a new government. That would though crave a heroic force and spirit, non of which Benediktsson has shown so far. In addition, the opposition parties have been fairly lame, difficult to gauge there the energy needed for some political fireworks.
According to a Sunday Times article by Philip Aldrick there are some meetings going on between government representatives and creditors. I have not been able to ascertain that this is indeed the case but I believe that yes, there have been some meetings, even as late as last week. The winding-up boards do not seem to be involved and only a few large creditors. It may well be that there are some parties involved trying to map some common ground where negotiations could start from. So far, the government’s official line has been not to negotiate although that seems the most sensible approach for a speedy and efficient end to the misery of capital controls. Remains to be seen.
And it also remains to be seen what comes out of Gunnlaugsson’s statement and how the government will proceed. Benediktsson has been badly treated by Gunnlaugsson who, though most likely not seeing any fault with his behaviour, has not only breached the trust of his coalition party but also ventured into Benediktsson’s territory, quite apart from the substance, i.e. that the Bill had not been presented yet because there was, as yet, no final agreement on the coming plan.
Why Gunnlaugsson chose to make his announcement? Well, this was panic politics in practice: he was standing in front of a party he led to almost 25% of votes, but now standing at ca. 10% in the polls.
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Gunnlaugsson speech is now available online, in Icelandic. I.a. he claims the numbers at stake for creditors in Iceland are high in international context as can be seen from Hollywood films, where $10m are a high number. An interesting insight into an apparently quite parochial mind who likes Hollywood films.
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In an “overview speech” at his party’s annual conference prime minister Sigmundur Davíð Gunnlaugsson announced today an outline of an abolition plan, short on content – only stability tax mentioned – but long on scaremongering of creditors and their wealth amassed in Iceland, with strikingly wrong numbers. From earlier statements by Bjarni Benediktsson minister of finance, whose remit the capital controls are, it is difficult to imagine he condones Gunnlaugsson’s views. Apart from whether this is a good plan or not it is worrying that the prime minister has lately been quite “statement-happy,” expressing views, which neither Benediktsson nor others have heard of until reported on in the media.
Before the Parliament’s summer recess the government will present a Bill to lift capital controls. This is what prime minister Sigmundur Davíð Gunnlaugsson leader of the Progressive party announced at the party’s annual conference Friday.
The only concrete measure Gunnlaugsson announced is “stability tax” that according to the prime minister will bring billions of Icelandic króna to the state coffers. As earlier, Gunnlaugsson emphasised the financial gain and the need to remove the new bank’s ownership from creditors. Worryingly, Gunnlaugsson presented wrong numbers and statements, which do not quite seem to make sense or at least rest on some fairly particular interpretation of reality.
From earlier statements by minister of finance Bjarni Benediktsson on capital controls it is difficult to see how Gunnlaugsson’s statements fit Benediktsson’s prerequisites of an orderly process based on classic measures, as outlined in Benediktsson’s last status report on the controls (see my take on it here). In addition, Gunnlaugsson has now taken the initiative from Benediktsson. The question is if he did at all discuss his speech with Benediktsson beforehand – allegedly, the two do not spend much time and effort communicating.
This in addition to some recent statements from Gunnlaugsson, which have not been discussed with Benediktsson or in the government. Also, there is the report by his fellow party member Frosti Sigurjónsson on monetary systems, another solo initiative by the prime minister.
With Gunnlaugsson’s latest statement there have been some speculation if Benediktsson and his party feel to stay in this coalition much longer. However, it might prove tricky for the party to leave without making it look as if they are somehow caving into creditors whereas Gunnlaugsson is gallantly fighting them.
Icelanders are slowly learning that whenever the prime minister speaks they glimpse the world according to his “Weltanschuung” – and it does not always seem to rhyme with reality.
Wrong numbers, remarkable calculations
In his speech Gunnlaugsson said, according to Icelandic media (I have so far not found a link to the speech), that most of the creditors were hedge funds that having bought the claims in a fire sale had profited quite enormously. The claims in the collapsed banks are so high, he said, that it is difficult to imagine it – as much as ISK2500bn (which being ca 1 ½ Icelandic GDP is not that hard to imagine). “Were this sum invested it would be possible to hold Olympic games, just for the interests, every four years, for eternity.”
This is wrong. The claims themselves are around ISK7000bn, the assets of the three estates are at ISK2250bn. As to the interests of this sum possibly being a sort eternity machine to finance the Olympics this hardly adds up. If we postulate that half of the assets are in cash at 1% interest rates and other assets carry 5% interest rates the annual interest rates would amount to ISK67.5bn or ISK270bn, just under $2bn, over four years. Would that be enough to finance the Olympics? The cost of the London games amounted to $14.6bn, ISK2000bn, the cost of Sochi $51bn, ISK7000bn.
This is worryingly wrong and far beyond reality. The fact that the prime minister does not know the correct numbers is bad but almost worse that he does not have advisers to enlighten him and find the correct numbers for him. Whoever tried to impress him with the Olympics parallel if clearly not fit to be an adviser on financial matters.
Tellingly, all these numbers and the Olympics calculations were diligently reported on Morgunblaðið’s front page today.
The spying conniving creditors
With all these assets (albeit a wrong number) Gunnlaugsson concluded that creditors would be prepared to go to some length to protect their assets. Who wouldn’t? he asked, considering the sums.
“It is known that most if not all larger legal firms in Iceland have worked on behalf of these parties or their representatives. It would be hard to find a PR firm, operating in Iceland that has not worked for these same parties in addition to a large number of advisers in various fields. This activity is almost frightening and it is impossible to tell how far they reach but according to recent news creditors have bought services to protect their interests in this country for ISK18bn in recent years.”
Again, there is no reference to where this number comes from but it seems farfetched, to say the very least. Further, Gunnlaugsson stated:
“We know that representatives of creditors have gathered personal information on politicians, journalists and others who have expressed views on these issues or are likely to do so. And in some cases people have been psychoanalysed in order to better understand how best to deal with them. Secret reports are written regularly in this country for creditors, which inform on how things are going in Iceland, on the politics, public debate, the financial system and so on. In one of the first reports it was stated that the greatest threats to the hedge funds reaching their goals, the main obstacle for them to do as they pleased, was called the Progressive party.”
Exactly what creditors have done to collect information in Iceland I don’t know but what the prime minister describes here is normal proceedings for doing business in a country (though the psychoanalysis might be rare though by far not unknown): they want to follow what is going on, how it affects their interests and so on. The alarmist tone is somewhat misplaced – creditors would not be pursuing their interests well if they did not keep a close eye on Iceland. It does not matter if it is Argentina, Greece of Iceland: firms want to understand the environment they operate in.
“One has to give it to these guys (creditors): they get the main facts right,” said Gunnlaugsson. – Getting the facts right is something less accurate people might try to learn from creditors.
The government’s turnaround in lifting capital controls
According to Gunnlaugsson it was a narrow escape that there were not major mistakes made in 2012 with regard to creditors. He especially thanked “our Sigurður Hannesson,” the MP banker who heads one of the party’s committees, is also on the capital controls’ advisory committee and known to be a close friend of Gunnlaugsson. – Gunnlaugsson did not clarify what heroic deeds were won in 2012; could be the decision to send the Icesave case to the EFTA Court or change in the currency controls legislation, which placed the foreign assets under the controls.
Gunnlaugsson stated that after the present government came to power there had been a real turnaround with regard to the capital controls and all earlier plans had been revised. – This work may ongoing but the only official plan in place is the plan presented by the Central Bank of Iceland, CBI, in 2011.
According to Gunnlaugsson, creditors worked diligently for having Iceland joining the European Union, EU, which would have forced Iceland to follow the bailout path of the euro-crisis countries. This would have forced Iceland to “pay all creditors in full and the whole overhang, not only at full price but at the overprice inherent in the creditors’ paper profit being financed by the Icelandic public through loans. This would have left Icelanders with the debt and no mercy shown. For this government this was always out of the question.”
I am somewhat at loss to understand the remarks about overprice etc. so I leave it to the reader to find the logic here. I am also unaware that creditors have been trying to drag Iceland into EU but they prime minister may well know more on this than mere mortals.
When the road towards the EU had been closed, stated Gunnlaugsson, the government told the representatives of the winding-up boards and the hedge funds that it could not wait any longer. Action will be taken in the following weeks and they will bring the state hundreds of billions of króna, he said.
Again, it is difficult to marry this statement with facts. Just recently, the government sent a letter to the EU, apparently intending to break off negotiations. However, the EU says nothing has changed. According to Icelandic officials briefing foreign diplomats in Iceland the letter does not materially change anything. And so on. Linking the recent moves on the EU and the government driving a harder bargain is not obvious, to say the very least.
The need to act
Gunnlaugsson claims the creditors are not putting forth any realistic solution, which now forces the government to act on lifting capital controls. The plan is to do it before the Parliament’s summer recess. – No mention here of winding-up boards sending composition drafts to the CBI without getting answers.
As often pointed out on Icelog it is clear that government advisers have for over a year been trying to come up with a plan that could suit the two coalition leaders. Tax is one of the points of disagreement: the prime minister wants to make money on the estates; Benediktsson wants to lift the capital controls according to practice in other countries.
It might be difficult to join Benediktsson’s many statements on orderly lifting to the Progressive’s money making scheme. Politically, the Independence party does not feel it owes much to the other coalition party after Benediktsson masterminded the “correction,” Gunnlaugsson’s great election promise of debt relief.
By the time the deadline for handing in new parliamentary Bills expired end of March the coalition parties had not found a common ground on important issues regarding a plan to lift capital controls. A government can always make use of exemption to get Bills into parliament but now the thorny topics are being discussed – reaching an agreement has so far eluded the government.
With his speech Gunnlaugsson might intend to bring pressure on Benediktsson – as did Benediktsson try to do, albeit unsuccessfully, last year with repeated statements on a plan by the end of the year.
The only measure announced: stability tax
According to Gunnlaugsson, with no realistic plans from creditors there is no other way for the government is now forced to launch a plan to lift credit controls before the Parliament ends. The plan is a special stability tax that will bring hundreds of billions to the state, stated Gunnlaugsson. Exactly how it will be applied is unclear but it seems to replace ideas of an exit tax.
This tax, together with other action will enable the government to lift controls without endangering financial stability. “It is unacceptable,” said Gunnlaugsson, “that the Icelandic economy is held hostage by unchanged conditions and to have ownership of the financial systems as it is now (i.e. that the two new banks, Íslandsbanki and Arion Bank are owned by creditors).” – This fits with Gunnlaugsson’s earlier ambitions of both getting money out of creditors and ownership of the two new banks.
The left government would have made “terrible mistakes” of all this, contrary to the Progressive party, which has been remarkable prescient time and again, said Gunnlaugsson:
“It is indeed remarkable how often we (i.e. Progressive party) experience that when we point out opportunities, warn against threats or urge that something is more closely explored or in a new light it is at first met with derision. Then it is fought but in the end viewed as common sense that should have been obvious to all. The main thing is that we Icelanders do not forget that for us everything is possible.”
“Pinch of butter” policies
During his years in office the prime minister has time and again made unfounded allegations and presented views he has not discussed with the government. In a recent article in Morgunblaðið MP Vilhjálmur Bjarnason pointed out how unfortunate it was when ministers thought aloud. One characteristic of the prime minister’s statements that sometimes he is not heard or seen for weeks for then suddenly to burst on the scene with views on everything.
Gunnlaugsson has accused the CBI of being engaged in politics. And he has accused ministries officials of leaking information, almost on a daily basis, he said. Neither allegations have been clarified or substantiated. He also worried about import of foreign food to Iceland because it could carry with it something that was changing the character of whole nations; he did not name it but seemed to be talking about toxoplasma, which luckily has not had this drastic effect in foreign lands.
Then there are all the “plans” Gunnlaugsson has announced without carrying them out or having sought any anchoring in the government. Just after coming into office he was going to appoint a capital controls “abolition manager.”
Most recently, Gunnlaugsson has announced plans to extend the Parliament house by a building sketched by Iceland’s most famous architect, Guðjón Samúelsson (1887-1950) – a house that only exists in a sketch from 1918, the year Denmark acknowledged Iceland’s sovereignty. Gunnlaugsson made this statement of Facebook April 1; when reported in the media it was widely thought to be April fools’ news.
Around that time, Gunnlaugsson also said he thought it was a good idea to build a new hospital – a long-running plan and matter of great debate in Iceland – by the Rúv building, thereby introducing a wholly new direction for the hospital. No previous discussion with minister of health or Landspítali management.
The Icelandic media has now found a name for these unexpected ideas of Gunnlaugsson: “smjörklípa” or “pinch of butter,” meaning that something is thrown into the debate to divert attention. Around the time Gunnlaugsson aired his most recent views one of his party member ministers had been unable to introduce a new housing policy, planned in four new bills. It will come at a great cost, is uncosted, and apparently the Independence party is wholly against it.
Another “pinch of butter”: new monetary system in Iceland?
Plans to revolutionise the Icelandic monetary system has made news abroad recently but less so in Iceland. The news spring from a new report, written at the behest of the prime minister (as I have already explained in detail in comment to FT Alphaville). In short, this report seems more of a favour to a Progressive party member than a basis for a new and revolutionary monetary system in Iceland.
It is indicative of the lackadaisical attitude to form and firm procedures that this report was written at the behest of the prime minister and not the minister of finance, who indeed has never expressed any interest for this topic and has not commented on the report.
All those who have been hyper-ventilating in excitement at this bold Icelandic experiment now starting should find some other source of excitement: this experiment has no political backing in Iceland. The Progressive party, whose following has collapsed from 25% in the 2013 election to ca. 10% in the polls, has little political credibility and force to further this cause.
Political risk: the major risk in Iceland
I have earlier pointed out that the greatest risk in Iceland is the political risk. It is intriguing that Gunnlaugsson chose to break the secrecy of the capital controls plan at a party conference, where he has to confront a total collapse in voters’ support is intriguing. His rhetoric of fights and battles against the conniving creditors and the party’s and his own earlier prescience is an important element in this respect.
With the two party leaders at loggerheads on major topics like the capital controls it is unavoidable that it will come to a confrontation at some point if the government is to take action. The outcome is far from clear.
There is great unhappiness among many of Benediktsson’s MPs, whom he incidentally has not trusted recently with cabinet seats. The general feeling is that it is the Independence party, which so far has been carrying out the policies of the coalition partner.
Whatever Benediktsson chooses to do he will need great political skill to steer the party through the coming months. Inaction might not help since creditors may well lose patience and explore their own possibilities, i.a. legal possibilities. If Benediktsson chooses to break away from the Progressive party he will need a clever scheme if he is not to give the coalition party and Gunnlaugsson the role that Morgunblaðið’s cartoonist has given Gunnlaugsson after his speech on Friday:
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Update: minister of finance Bjarni Benediktsson has not yet made himself available to the Icelandic media on his view regarding stability tax. Some members of the opposition have expressed surprise that there is now talk of stability tax instead of the earlier much discussed exit tax. Guðmundur Steingrímsson leader of Bright Future pointed out both the legal risk and risk to the economy were this plan to be pursued.
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In its Financial Stability reports and other reports the Central Bank of Iceland, CBI, has increasingly been stressing that conditions in Iceland and internationally for lifting controls are optimal. The same is reiterated in the latest status report by the minister of finance on progress in lifting the capital controls. However, if the status report is read closely it digresses intriguingly from what the CBI has been stressing. That poses the question whether the government is really on its way towards easing controls or only obfuscating the matter. This brings the focus to a statement increasingly heard in terms of Iceland and risk: “The main risk in Iceland is political risk”
“Premises for abolishing capital controls could hardly be better than those now in Iceland…,” minister of finance Bjarni Benediktsson said yesterday at the CBI annual meeting. “Consequently, my hopes are that major decisions will be made now in the first half of this year, pointing the way forward. The year of 2015 will be a year of action and solutions in this matter (capital controls).”
In his speech at the CBI annual meeting governor Már Guðmundsson also stressed an imminent action, stressing the unavoidable damages invariably caused by capital controls in the long run.
However, an action must be based on political synergy within the government. As I have often stressed the statements of minister of finance Bjarni Benediktsson and prime minister Sigmundur Davíð Gunnlaugsson on capital controls consistently point in different directions. Benediktsson has stressed the importance of a solution that minimises legal risk, takes as short time as possible and of course does not undermine financial stability. In addition to safeguarding financial stability, Gunnlaugsson has been focused on what Iceland could get out of the estates, recently by arguing for fairness.
In the latest status report by the minister of finance on progress in lifting the capital controls, presented on 18 March, the problem Iceland faces is defined as a balance of payments, BoP, problem. Quite rightly not a word about Icelandic debt burden; debt is not the Icelandic problem. However – and quite interestingly – the report defines this problem differently from the CBI definition. This difference has, to my mind, wide ranging consequences when it comes to understanding what the government really is doing – or not doing – to solve the capital controls.
The Icelandic business community has for a while been complaining loudly about the controls. Once upon a time every word this community uttered was law for the Independence party – but not any longer as seen so clearly from the debate on the European Union, EU and the (failed!) action to break off negotiations. This schism between the business community and the Independence party goes hand in hand with the fact that the party seems to have, possibly irretrievably, lost voters: earlier polling 35-40% it now hovers around 25%, its new normal.
I might well be reading too much into the situation but based on observations of the political realities in Iceland, i.a. the lack of political determination within the government not only regarding capital controls but in general, I very much wonder what the next two years will bring for Iceland in general and capital controls in particular.
A closer reading of the capital controls report
I have already gone through the status report here on Icelog, writing about politics in times of crashing popularity, the government’s popularity that is. There are some statements in the report, which I think give an inaccurate and misleading picture of the BoP problem. As I concluded earlier, the report seems to magnify the problems to be solved re capital controls and minimise what the government can to stabilise the situation, mostly the importance of securing trust.
If the government sincerely wants to minimise the risk of lifting the controls a plan that inspires trust is of vital importance. If that is not done – or worse, if action taken inspire fear and not trust – the outcome will inevitably be disastrous… for Iceland.
But there is one aspect of the report, which I had not paid close enough attention to until I reread it: the definition of the BoP problem. According to the report, the problem consists of three parts: “the offshore ISK problem, difficulties arising from distributions by financial undertakings in winding-up proceedings and potential capital outflows from other parties, including residents.” – Compared to customary definitions this is a somewhat non-standard definition, apparently a home-made one.
In the CBI Financial Stability report I 2014 governor Már Guðmundsson defines the Icelandic balance of payments problem: “…the problem falls broadly into three categories. First of all, the debt service burden on foreign debt is heavy, both this year and in the four years following, and exceeds the foreseeable current account surplus. Second, domestic entities other than the sovereign and the Central Bank still have only limited access to foreign credit markets on affordable terms. Third, the settlement of the failed banks’ estates could add substantially to the stock of volatile króna assets held by non-residents locked in by the capital controls. These króna assets could rise as high as nearly half of GDP if the failed banks’ ISK assets are collected in full and paid to creditors. Iceland has no excess foreign exchange revenues with which to unwind such positions, however.“
As can be easily seen from the above, there is only one source of the BoP problem in common, as defined in the status report and the CBI report: the CBI groups together ISK assets in the estates and the old offshore ISK overhang, the status report keeps it in two separate categories. The status report ignores the debt service burden but has “capital outflows from other parties, including residents.”
How to avoid solving a problem: define so it cannot be solved
Earlier, I had pointed out that the status report seemed somewhat too pessimistic in terms of outflows – trust will matter a great deal when it comes to lifting capital controls. If there is no trust in the plan on lifting or easing controls it will be a catastrophe, as indeed Guðmundsson reiterated in his speech at the CBI annual meeting.
Included in the status report’s definition of offshore ISK is also this:
Investment by non-residents in ISK-denominated domestic securities has increased greatly in recent years in tandem with their participation in the Investment Programme of the Central Bank. Total investment through the Investment Programme from the time it commenced at the beginning of 2012 now amounts to ISK 206 billion, of which ISK 97 billion is invested in bonds and ISK 82 billion in equities. Of this amount, non-resident investors own ISK 134 billion. At the beginning of 2017 the encumbrances on the first investments under the Investment Programme expire; however, these investments did not include an exit ticket. Non-residents have furthermore invested in Treasury securities through the Central Bank’s foreign currency auctions; their outstanding holdings in two inflation-indexed bond series currently amount to around ISK 9 billion. In addition to this, non- residents hold various other domestic assets which can be regarded as liquid or volatile. The conceivable outflow in connection with these assets, however, is subject to high uncertainty.
Adding these investments widens the offshore ISK definition considerably – and consequently the size of the problem. Claiming that all foreign investments in Iceland are volatile is rather stretching it – hardly any country could pay out in one go all foreign investment.
If this is the definition of the offshore ISK problem that the ministry of finance is trying to find a solution to it is not likely that a solution will be found any time soon, a version of the drunken Scot problem. Yes, defining a problem in such a way that it cannot be solved is one way of avoiding to tackle it.
Interestingly, in his speech at the bank’s annual meeting governor Guðmundsson indeed repeated the status report definition, saying the most common BoP definition was looking at funds, which might flow out as soon as controls were lifted. These funds are, he said, in the estates, the offshore ISK and then, contrary to the bank’s earlier definition, potential outflows owned by domestic entities. Problems related to the estates are well documented, he said; secondly, offshore ISK was partly non-volatile though that had to be ascertained and dealt with first, akk perfectly doable, according to Guðmundsson.
“The greatest uncertainty is connected to possible outflows connected to domestic entities… Here the most important aspect is trust in Iceland and its financial system at that time, difficult to estimate right now. This will at the same time also impact on possible inflow from foreign entities,” Guðmundsson said.
The governor did not mention it but here it would be important to keep in mind that for the time being interest rates abroad are low, asset prices high – not necessarily an enticing environment for Icelandic entities.
Differently defined problems – but one-size solution
As pointed out earlier the status report concludes with two classic ways of solving BoP problems like the one Iceland now faces: “(i) imposing a haircut on domestic assets when they are converted to foreign currency, or (ii) ensuring that volatile assets are transferred to long- term assets, i.e. extending the term of liabilities. The terms and conditions of such converted assets and liabilities must ensure that they cannot be accelerated or revert to their former status. If this is done, short-term owners of such instruments can be expected to accept a discount (haircut) upon their sale while longer-term investors will profit on them in the longer term.”
These solutions are tailored to the classic BoP problem the CBI has described it earlier: a haircut on ISK assets converted to foreign currency – and binding the volatile assets, as the CBI has already started doing (taken half a step, with the missing half said to be imminent).
However, these two ways do nothing to solve the very elusive problem of “capital outflows from other parties, including residents.” The foreign-owned ISK and the old overhang are a tangible size, which as Guðmundsson said the CBI has worked on and where the methods above are a classic tool to diminish the overhang.
The capital outflows are a potentially large chunk, where haircut and extension does not help. The government is hardly keen on draining pension funds of money, “hair-cutting” debt payment etc. In other words, this problem of outflows has no clear and classic solution. Yes, the oft mentioned exit tax could be used on domestic outflows but at a cost to domestic entities and without targeting the real problem, the foreign-owned ISK.
Who wrote the status report?
The short answer is: I don’t know. As far as I know, CBI staff has mostly written earlier status reports. But on close reading it is difficult to believe that this latest status report is written there. It simply does not fit with what the bank has published earlier. But funnily enough, the conclusion with the two paths as a solution does not fit the problem as spelled out in the status report.
My hunch is that the Ministry of Finance probably got a draft from the CBI but someone else, most likely someone from the advisory committee on capital controls (though hardly Glenn Kim) then finished it, concluding with classic solutions to a BoP but not as defined in the report.
A nerdy quibble over definitions and so what?
It may very well be that I am over-extrapolating on spurious evidence. However, if the forces at large around the status report are leading the process towards lifting the capital controls I cannot see that this process will ever get near to easing or lifting the controls simply because of the lack of clarity. If the status report signifies the thinking of the advisory group it does not bode well for the process.
In addition, the process so far – changes among the advisers, conflicting statements by the government leaders, imprecise messages from the prime minister, broken promises on timing, the difficulty in acting on the Landsbanki bonds agreement, the rather remarkable side process regarding the CBI itself, re-hiring the governor and now planned CBI organisational changes – does not bode well either.
Undoubtedly, lot of ground has been covered within the CBI and in the advisory committee. The work within the CBI is clearly geared towards solving the BoP problem. And undoubtedly the minister of finance and the governor are both keen to work towards easing and lifting the controls. The question is if they will be allowed to work towards solving the BoP problem according to the classic CBI definition or if the goal is the much more elusive problem of finding funds to stem domestic and foreign outflows.
Political unpopularity and panic politics
What are the main risks in a country where the economy is going reasonably well? In terms of Iceland it is clearly the political risk.
Talk about the absent prime minister is constant in Iceland. Quite remarkably he did not show up at the CBI annual meeting – no one can remember that a prime minister has ever ignored the meeting. This week an opposition MP, Helgi Hjörvar (social democrat), pointed out that in the last six months the prime minister has answered only one written question in Parliament. Time and again the prime minister is absent and invisible, keeping the rumour mill running. Erratic behaviour and rather odd remarks is another aspect of the prime minister’s character much discussed privately but rarely on the media.
Alleged break down in communication between the two government leaders is a widely heard explanation of the government’s lack of action in various matters. Although the two have, of course, strenuously denied this it does not quell the rumours; this lack of communication is now taken for a fact among political observers in Iceland.
Looking at the erratic course of the government, shortsightedness, the lack of professionalism (because the civil service is side-lined in important issues) it is clear that the greatest risk in Iceland is political risk.
The government’s astounding unpopularity only seems to add to that risk. Will the prime minister, desperate to prove himself, make use of unconventional measures following his belief that foreign creditors are unjustly and unfairly making huge gains out of ordinary Icelanders? Will he work on wrenching the ownership of Íslandsbanki and Arion Bank, widely thought to be of great interest to him, from the estates? In all of this he apparently has unwavering backing from the darkest corners of the Independence party, visible in the writings of Morgunblaðið, which repeatedly opposes Benediktsson overtly or covertly.
By constantly promising action last year Benediktsson was no doubt trying to put pressure on his coalition partner but his tactic failed. Instead he made creditors feel he was unable to fulfil his intension. But as one observer pointed out Benediktsson has at least withstood all pressure of acting according to the prime minister’s sentiments. Many feel that compared to earlier Benediktsson is strengthened, both from this process and other things. I still feel unable to draw that conclusion, would like to see more tangible evidence.
The question for the coming months is if this government will have the courage to lift capital controls – and, if not in the short run then if indeed this government will ever have the courage. And if it does act regarding the capital controls will it be according Benediktsson’s outlines or will he be pushed to follow panic politics of a political leader who has lost popularity in record time. – It is not difficult to analyse the situation but, as always, forecasting action is infinitely trickier.
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The Minister of Finance Bjarni Benediktsson has just released his twice-a-year report on progress in removing capital controls. The tone is as if prime minister Sigmundur Davíð Gunnlaugsson did not exist. Another event, distantly related to the capital controls, is a draft Bill by two academics on the future organisation of the Central Bank of Iceland, CBI. The draft is hardly bringing out the champagne bottles since the academics propose that governor Már Guðmundsson, whom the government has been trying to remove ever since it came to power, should remain in office but with diminished power and two deputies. The backdrop to these events if the drastic fall in the government’s popularity, this time hitting the Independence party, buoying the Pirates.
Last year, the government held the CBI in uncertainty for half a year while trying – and then failing – to substitute Már Guðmundsson as the bank’s governor. At the end of that ungraceful saga (see earlier Icelog) he was reappointed but given to understand that the bank’s organisation model would be revised, even before the end of 2014, which might mean his days in office were numbered.
So far nothing has happened until recently that the two academic asked to revise the CBI Act, handed in their proposal. It is safe to conclude that it will not create much happiness, neither in the Ministry of Finance nor in the Prime Minister’s office.
This last week also saw the minister of finance present his spring report on the capital controls. Apart from general remarks on how to lift the controls in an environment suffering from balance of payment problems it is more worrying that the report seems to include some misleading or even factually wrong statements. I am not aware of this happening before, which leads me to believe that there was less input in the report from the CBI, compared to earlier, and more input from those working on lifting the controls. Again, not a good sign.
If the government is going to make a move in either of these two cases, it has to make up its mind soon because the deadline for new Parliamentary proposals, new law or amendments is the end of this week as Alþingi goes on summer recess at the end of May. There is however a legal provision for presenting Bills later requiring an agreement with the opposition. The latest opinion polls also raise the question if the government’s diminishing popularity will push the government to come up with some measures to win voters over. Another test is the fact that strikes and labour market unrest is foreseeable, most agreements will run out now in spring; particularly dark forebodings in these matters.
A sluggish reaction to CBI proposals
The two academics, Friðrik Már Baldursson professor at the University of Reykjavík and Þráinn Eggertsson from the University of Iceland, sent in their proposals on 6 March. Not until 20 March, following news based on the leaked proposals, did the Ministry of Finance publish the proposals. The academics have as yet only filled part of their remit, there is more to come but these proposals cover the most sensitive part, i.e. how to change the organisational structure of the bank. Benediktsson now has to make up his mind as to what changes he intends to make.
The proposals underline that the power given to the governor of the CBI far exceeds power wielded by central bank governors in the neighbouring countries. The two academics propose a board of three governors similar to the structure at the Bank of England where there is one governor and two deputy governors, each heading a special field within the bank.
In addition, the academics propose that Guðmundsson remains in office. If, follwong the ungraceful process last year, the government was planning to remove the present governor from office on the basis of these proposals they certainly do not provide the government with the ammunition for such action.
In Iceland, it is widely thought that the two party leaders want to revert back to the bad old days of continuous political pressure on the CBI with politically appointed governors. The sentiment in the air is that in addition to a governor with the proper professional qualification the government would like to see two more governor by his side, one anointed by the Independence party, the other by the Progressive party.
If the two government leaders find some solution here remains to be seen, also if Guðmundsson will be part of the solution or not. If things move as they mostly have done under this government, i.e. slowly, indecisively and inconclusively, not much will happen re the CBI any time soon. In addition, blatant political interference is much harder in the present day and age than some decades ago. The International Monetary Fund, IMF, has used every report on Iceland since the crisis to emphasis the importance of an independent central Bank.
Capital controls: two possible solutions
The new report by Benediktsson on the capital controls concludes that there are indeed only two possible options in dealing with balance of payment problems akin to those Iceland is now faced with: either by “(i) imposing a haircut on domestic assets when they are converted to foreign currency, or (ii) ensuring that volatile assets are transferred to long- term assets, i.e. extending the term of liabilities. The terms and conditions of such converted assets and liabilities must ensure that they cannot be accelerated or revert to their former status. If this is done, short-term owners of such instruments can be expected to accept a discount (haircut) upon their sale while longer-term investors will profit on them in the longer term.”
This is quite correctly a description of classis solutions in countries with similar problems Iceland is dealing with. But this description seems completely unrelated to the political situation in Iceland where politicians, with the exception of Benediktsson, have lately been falling over themselves in outdoing each other in exit tax on the estates in their entirety, ISK assets as well as foreign assets.
The prime minister has earlier talked about the inevitability of the state accruing funds from the estates and “vulture funds” gaining distastefully on Iceland. Lately he has presented it as a principle of fairness that the estate leave funds to the state for the harm the banks caused Iceland.
There is nothing of this tone in the report.
There are however statements in the report, which are either inaccurate or misleading.
The report states: “The estates’ largest ISK assets are holdings in the new banks, in addition to which they own considerable amounts of cash. Distributions by these domestic undertakings to resident creditors will not affect the balance of payments, but distributions to foreign creditors will impact the balance of payments when the distributed assets exit Iceland.” – The fact is that if domestic creditors repatriate their foreign currency distribution this has a positive impact on the balance of payment whereas the impact is negative if foreign creditors move their ISK assets abroad. This will hardly be categoric: not all FX owned by domestic creditors will be left abroad and not all foreign-owned ISK will leave.
Re “possible outflows by domestic parties” the report points out that it is difficult to assess what these outflows could amount to. It quotes the latest IMF report, which guesses that this could be as much as 25% of GDP or ca. ISK500bn; however, IMF underlines that this development very much depends on stability and trust in Iceland, as well as the currency rate. – What this analysis in the new report lacks is to underline how Icelandic action or non-action influences these eventualities.
The same counts for the effect of trust on foreign investment in Iceland. Foreign investment will not leave a trustworthy environment. No country is in the position to pay out all foreign investment at any given time. To set that as a benchmark makes little sense.
The report points out that Iceland faces balance of payment problem, consisting of three part: “the offshore ISK problem, difficulties arising from distributions by financial undertakings in winding-up proceedings and potential capital outflows from other parties, including residents.”
However, this last part, potential outflows from other parties, including residents, differs from the balance of payment problem, as defined by the CBI. In the Financial Stability Report 1 last year the problem is said to consist of three parts: “First of all, the debt service burden on foreign debt… Second, domestic entities other than the sovereign and the Central Bank still have only limited access to foreign credit markets on affordable terms. Third, the settlement of the failed banks’ estates could add substantially to the stock of volatile króna assets held by non-residents locked in by the capital controls.”
For some reason, the new report magnifies the problem and minimises the effect of what the authorities can do to stabilise the situation by inspiring trust.
Political outlook: panic politics or power to the Pirates!
New poll caused a political earthquake last week: it showed the Pirate Party with a following of 29.1%, equivalent to 19 MPs. The party now has three MPs, got 5% in the last election. The Progressive party got 11.6%, the social democrats make a slight gain from previous poll, with 16.3% and Bright Future and Left Green with 9% each. The biggest loser is the Independence Party, falling from 28% in last poll to 23.4%. – This does not seem a freak outcome, the upswing for the Pirates, over 20%, was seen in an earlier poll from a different polling company.
To Rúv, prime minister Gunnlaugsson said that this outcome certainly was surprising but a sudden gain by one party had been happening frequently in the past years and decades. “This is perhaps first and foremost a message that people are now impatient to see the results of what the politicians are working on. However, these results are now starting to be visible however they are measured.”
This result is singularly bad for the two coalition parties. Part of the explanation is no doubt its action to break off accession negotiations with the EU, which cause great and general anger in Iceland where there is not majority for membership but strong majority for bringing the negotiations to an end. Also, the Pirates have been measured and professional in debates, ignoring special-interest groups. The rest of opposition has been fairly lame.
In addition to crashing popularity, the government now has gone through half its mandate period. It is clear that the debt relief, orchestrated by the Progressive party but brought to fruition by Minister of Finance Benediktsson has not helped. Nor has changing direction on the EU negotiations helped. The question is if this crash in popularity will cause the government to turn to panic politics, if it will possibly attempt some drastic measures to gain popularity.
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As reported earlier on Icelog, the French investigative judge Renaud van Ruymbeke is conducting an investigation of Landsbanki Luxembourg activities in France regarding the bank’s equity release loans. With the investigation ongoing it was assumed that the bank’s liquidator Yvette Hamilius would suspend recovering assets by sending bailiffs to the bank’s customers in France.
This however has not been the case as the Luxembourg Paperjam reports (yet again by Véronique Pujoul who has followed this case diligently) and Icelog has heard. Lawyers for the clients are now asking if this could be seen as both harassment from the administrator and also constitute a contempt of the French Courts with an ongoing investigation where charges have been brought.
Icelog has earlier reported extensively on this saddest part of the Icelandic banking collapse saga. What is truly shocking is the utter and complete disregard Luxembourg authorities have shown the clients who have at length described their dealings with the bank and administrator, i.a. conflicting messages from the administrator on outstanding debt. Part of the scheme were investments, which the clients have questioned as they got more understanding of them as well as being kept in the dark about the administrator’s handling of the investments.
Instead, the Luxembourg state prosecutor has, without any investigation, placed himself firmly on the side of the administrator by claiming that the clients were only trying to evade paying back their loans. This behavior by a public prosecutor in a European country is utterly inconceivable.
Although investigations into the banks are ongoing in Iceland, with serious charges and severe prison sentences, Luxembourg has done nothing to investigate the Icelandic operations in Luxembourg, i.a. that of Landsbanki. Yet, the Icelandic investigations show that in many of the worst cases, such as in the so-called the al Thani case, the schemes were partly planned and carried out in the Icelandic banks in Luxembourg. In many cases, the alleged and proven criminal wrongdoings by the Icelandic banks could not have been done without their Luxembourg operations. Yet, Luxembourg ignores the banking problems in its own front yard.
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“… the Icelandic Government wishes to clarify further its intentions. The Government of Iceland has no intentions to resume accession talks. Furthermore, any commitments made by the previous Government in the accession talks are superseded by the present policy.”
This is part of a letter, which the minister for foreign affairs Gunnar Bragi Sveinsson handed over today as he met with Edgars Rinkevics, who currently holds the Presidency of the European Union. According to the letter the Government of Iceland decided at its meeting last Tuesday that Iceland is no longer is a candidate country to EU membership and asks the EU to act accordingly. However, Sveinsson emphasized the importance of relations and cooperation between Iceland and the EU and Iceland’s commitment to the EEA Agreement.
Tonight, there will be protests by Alþing, the Parliament, to be continued over the weekend. Opposition MPs claim that even with its strong majority the Government did not dare to pass this through Alþing. One MP, Birgitta Jónsdóttir from the Pirate Party, says this will be the beginning of the end for the Government. Regardless of what opinion people hold on the EU the fact that the Government took this decision without conferring with Alþing shows that this Government is ready to bypass the parliamentary process.
Árni Páll Árnason, leader of the social democrats, pro-EU party, says this decision, taken without any consultation and behind closed doors shows the Government’s insecurity and fear of the people. By choosing this method the Government is trying to bypass democratic rules. In spite of the letter Alþingi’s mandate to negotiate accession still stands. “This only shows that the Government does not have a grip on its task.”
The Government tried last winter to end the EU negotiations but incurred great protests, which put an end to its effort. Opinion polls show that although there is not majority for Icelandic EU membership clear majority of Icelanders want the negotiations to be brought to an end, followed by a membership referendum.
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Friday 6 March Central Bank of Iceland changed rules for offshore króna investment in order to prepare for lifting capital controls. Restricting the investment possibilities might seem only to increase the króna pressure, not lessen it but this step is a first step or half a step: further measure for binding these funds or attracting them with good offers will follow. This is a step in the right direction – but only if other measures follow. And so far, there is nothing to indicate that there is any rapprochement in diverging views on how to solve the ISK problems of the estates of the old banks. The problem is that the government seems to be looking for a solution that does not exist – and this is very time-consuming as the Scot looking for a penny where he had not lost it found out
Foreign-owned króna, or offshore króna, was the original problem, which on November 28 2008 called for capital controls. At the time, this overhang amounted to 44% of GDP but has since dwindled down to 15%. The rules regarding investment of offshore ISK have now been changed.
The new amendments to the CBI exemption lists and to the Rules on Foreign Exchange and the Foreign Exchange Act mean that there are now only two option for the offshore ISK to invest in: Treasury bills and one Treasury Bond, RIKB 15 0408. As before, interests earned can still be taken out of the country.
Restrictions might seem counter-productive – but this move is the first one: other investment offers will follow. To Reuters CBI governor Már Guðmundsson said the aim is to reduce the overhang and to induce investors to stay in Iceland when further steps towards liberalisation will be taken. “… it would be very imprudent if we were just to assume that these 15 percent were stable… We will shortly be offering investors alternatives … and these alternatives are such that they will greatly reduce the likelihood of instability when controls are lifted.” Guðmundsson said that further measured will be announced in a “few weeks or very few months.” Minister of finance Bjarni Benediktsson said to Rúv that the work is aimed to finish within the first half of this year.
There have lately been changes in the government’s advisers: now Eiríkur Svavarsson has left. The rumour is that Glenn Kim has not been seen much in Iceland lately. And as before: no official announcement of any changes, neither of Svavarsson leaving or the new member, Ásgeir Helgi Reykfjörð Gylfason, who recently joined the government’s group of advisers.
The focus of these measures is only offshore ISK. Still unsolved are the foreign-owned ISK assets in the estate of the failed bank, admittedly the politically most difficult nut to crack. It seems that instead of using tried and tested measures from other countries with capital controls the government is trying to find a solution that does not exist. Meanwhile, Iceland is trapped in capital controls.
CBI’s new measures – in detail
Those holding RIKB 16 etc are not being forced to give up their holding – but for reinvestment there is nothing on offer except about-to-expire maturity and Treasury bills. The crude choice for the offshore ISK owners is either to use deposits accounts to keep their funds or accept the new double offer of Treasury bills or RIKB 15 0408, which is maturing 8 April. Amongst those who follow things in Iceland the feeling is that the imminent maturity was a significant reason for acting now considering the fact that maturity of a big issuance is in sight.
At the end of January foreign-owned RIKB 15 amounted to ISK18.7bn (might have changed in February since RIKB 15 could be swapped for RIKB 17; now no longer possible). The RIKB 16, maturing 13 October 2016 is a much larger issuance where foreigners owned ISK57.9bn.
The effect of the changes is that offshore ISK holders cannot swap to longer maturity. Longer maturity gives less impetus to leave, creating possible hold-outs and unforeseen behaviour, from the point of view of the CBI. Consequently, whatever the possible offer will be the hold-out problem is less, or so the thought goes. When this future offer comes, whatever it will be, the offshore ISK holders are more likely to participate.
The critical issuance might be the RIKB 19, where the foreign holding is ISK42.9bn – those holding longer maturity are unlikely to make a move since hopefully/most likely the controls will have been lifted by then. Those with shorter maturity might give it a thought to swap into what is now on offer. Those with RIKB 19 are in the tricky situation of having to gauge the likely scenario.
After the RIKB 15 0408 matures now in April offshore ISK holders can only reinvest in Treasury bills. Interestingly, some years ago foreigners were the largest holders of T-bills but there is at present no foreign-owned holding there. This is bound to change. Treasury bills now amount to ISK22.1bn but is expected to rise to ISK30bn at the end of the year. Next Treasury bills’ issuance in on 18 March.
In an interview on Rúv minister of finance Bjarni Benediktsson said that the government was now well on its way to solve the offshore ISK problem and this could be seen as the first steps towards lifting the controls. “These are preparatory actions, which in a short while could result in the offshore ISK problem being behind us.”
Further, Benediktsson said that the investment options was being restricted but nothing was taken away from anyone. The idea is, according to Benediktsson, to eradicate uncertainty and prepare the ground for further action.
Next step: what and when?
There is of course no official answer to the questions above. However, since the guiding idea is to bind funds to hinder instability the offer clearly has to be long maturity bonds – there have long been rumours that the euro bonds might be offered. Remains to be seen.
Apart from what will be offered the question is when. Governor Guðmundsson vaguely talks about few weeks or few months. To Rúv minister of finance Bjarni Benediktsson said the new investment offers were being worked on. “We hope to conclude this part of the matter in the coming months. I would mention the first half of the year in this context. That is what all our work aims at but it would not be responsible to fix exact dates.”
Considering how tortuous the path towards lifting the controls has been so far, in spite of the optimism expressed by Benediktsson and prime minister Sigmundur Davíð Gunnlaugsson when they came to power, it is not advisable to hold one’s breath. However, if the government wants to maintain credibility and trust in these issues, home and abroad, it has to act resolutely and not too sluggishly.
In terms of securing the offshore ISK funds, hindering instability, the measures now are only half a step: these are the restrictions – the offer to go with it, the other half step, is still missing. Until that step has been taken the usefulness of this measure cannot be judged.
Steps so far
Interestingly, Benediktsson talked about the new measures as the “first steps” towards lifting the capital controls. It can be debated which measures have been towards lifting controls but there have definitely been other measures, which merit to be called “steps towards lifting the controls.”
The first plan to lift controls was published in the summer of 2009 in co-operation with the International Monetary Fund as Iceland was then in an IMF programme. The CBI published a new plan in March 2011. The CBI auctions, an important step intended to reduce the offshore IKS, ended now in February.
Another major step was the bonds agreement between Landsbankinn and the LBI, the estate of the old Landsbanki May 5 2014. Although the agreement had been long time in the making Benediktsson, who needed to grant the exemption from capital controls in order to complete the agreement, took until December 4 2014 to grant the exemptions needed. I have earlier pointed out that it seems to have been more the irritation of the UK government, notably (fearsome) Andrea Leadsom, which pushed Benediktsson to take that step rather than any political energy and initiative on the Icelandic side.
The political outlook
There have been certain discernible trends lately in the political debate on the capital controls. Prime minister Gunnlaugsson has lately neither talked about the exact sums, the ISK billions, he claims the state should gain from the estates nor has he talked about vulture funds, as he did earlier. His new reasoning is “fairness:” Iceland suffered from the collapse of the banks, i.e. the banks caused sufferings and now it would be only fair that the banks paid back to the state for the hardship caused.
Apart from this rather narrow retelling of the collapse saga – after all the SIC report gave a somewhat more nuanced picture of a wider failure of public institutions, politicians and banks – Gunnlaugsson has referred to practices abroad, that foreign banks have paid fines to make up for their misdeeds towards society. (In general, the prime minister has become well known in Iceland for his at time rather inaccurate grasp of facts and reality).
Gunnlaugsson has also recently said in an article in Fréttablaðið that the new banks are too big, they got too much assets on too favourable terms, again arguments for the state getting a cut of the estates (an echo of an earlier debate where an old industrialist, Víglundur Þorsteinsson has been making similar claims, see here). On the same day Gunnlaugsson’s article was published, four members of In Defence, the organisation formed to fight the Icesave agreement, wrote an article in Kjarninn.
The four asked if the state is really going to enable foreign investors to run off with the equivalent of a whole year GDP, partly the profit from resurrecting the economy, paid for with the great sacrifice of Icelanders and sky-high loans. Their suggestion is an exit tax of 60%, not the 40% they claim Benediktsson has mentioned (which he has not; on the contrary he has been unwilling to confirm exit tax and much less any percentage). Gunnlaugsson was at the time very close to In Defense, which has neither been seen nor heard for years until now. It is hardly a coincidence that the two articles appeared the same day.
Benediktsson has mentioned the cost to society of the banking collapse but he has never argued for great sums to be gained from the resolution of the estates. In a speech last October he made some general comments on the controls, the topic of an earlier Icelog: Benediktsson want to avoid risk of legal wrangling with creditors and prefers simple and straightforward solutions.
Eiríkur Svavarsson, who now has left the group of the government advisers, was a vocal part of the In Defence group and is said to be close to the prime minister. Svavarsson has not been replaced. There has been no official announcements of this change, nor has there been a formal announcement of the new member, Ásgeir Helgi Reykfjörð Gylfason.
The prime minister has recently expressed his opinion that not too much should be said about the lifting of the controls since that might feed valuable intelligence to creditors. Whether the names of advisers are part of this intelligence, which should be hidden from creditors, is not clear. It does however look strangely lackadaisical that there is so little stringency as to what is announced and what is not.
Lately, members of Parliament have complained about the secrecy regarding lifting the controls, claiming they are kept uninformed. The Ministry of Finance has now published the text of the contract all advisers have to sign, see the text here (in English) with relevant laws on insiders. Interestingly, there is now gardening leave stipulated at the end of the assignment.
Glenn Kim is still in charge of the group, at least in name; some observers close to the process claim he is increasingly distant and not much seen in Iceland lately.
Looking for a solution that cannot be found
In earlier Icelogs I have often referred to an alleged split between the two government leaders as to how to tackle the estates. The two have time and again denied these rumours but the rumours are still alive and kicking. There are also speculations in the Icelandic media that the underlying strive of the government is to be in the position of deciding to whom the banks are sold.
Both government leaders have talked about the need for a holistic solution. Exit tax on all cross border transactions has i.a. been mentioned. The problem here is that this tax would hit all cross border capital, also debt payment of Icelandic entities – and it will not reduce the core problem: the foreign-owned ISK assets in the estates. I have the feeling that this idea has been abandoned: it might in theory bring the much-desired funds to the state (which is actually doing rather well, thank you, and not much wanting, compared to many other European countries) but it is for many reasons unworkable.
As I pointed out to Reuters it seems that these conflicting views prevent the government from acting on capital controls. But it might me more than only conflicting views. After watching one group of advisers after the other working on capital controls I cannot avoid the feeling that the government is looking for a solution that does not exist. A solution that i.a. would bring funds to the state, make it possible for the government to decide who owns the banks and yet be simple and risk-free. Like the drunken Scot looking for his penny under the street lamp because the light is there, though he lost it elsewhere, the government has been using, or squandering time, on a solution nowhere to be found.
This is doubly regrettable because the problems Iceland faces are neither unique nor particularly hard to solve. That is if, instead of looking for a home-grown Icelandic solution, advisers would look for realistic solutions where the gain would be not billions to the state but the trophy of lifting the controls. Instead, while the search for the non-existing solution, Icelandic businesses are slowly being starved of oxygen as always happens in countries with long-time capital controls.
As far as I understand the two government leaders have not reached an understanding as to how to proceed. Their statements on the capital controls and the banks normally point in different directions. The closer to dealing with the estates the more difficult to iron out these divergences and the harder the political cohesion of the government will be tested. As the drunken Scot found out looking for a solution where it demonstrable is nowhere to found is never a promising approach.
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Both in Cyprus and Iceland foreign funds flowed into the islands, in the end forcing the government to make use of extreme measures when the tide turned. These measures are normally called ‘capital controls’ which in these two cases hides the fact that the measures used are fundamentally different in all but name. In Iceland, the controls contain the effect of lacking foreign currency, effectively a balance of payment problem – in Cyprus, the controls were a way of defending banks against bank run, i.e. preventing depositors to move funds freely.
It is a sobering thought that two European countries now have capital controls: Iceland and Cyprus; sobering for those who think that in modern times capital controls are only ever used by emerging markets and other immature economies. Cyprus has been a member of the European Union, EU, since 2004 and part of the Eurozone since 2008; since 1994 Iceland has been member of the European Economic Area, EEA, i.e. the inner market of the EU. – The two EEA countries were forced to use measures not much considered in Europe since the Bretton Woods agreement.
Although the concept “capital controls” is generally used for the restrictions in both countries the International Monetary Fund, IMF, is rightly more specific. It talks about “capital controls” in Iceland and “payment restrictions,” i.e. both domestic and external, in Cyprus.
Both countries enjoyed EEA’s four freedoms, i.e. freedom of goods, persons, services and capital. –Article 63 of the Treaty on the Functioning of the European Union prohibits “all restrictions” on the movement of capital between Member States and between Member States and third countries.
Both countries attracted foreign funds but different kind of flows. While the going was good the two islands seemed to be thriving on inflows of foreign funds; in Iceland as a straight shot into the economy, in Cyprus by building a financial industry around the inflows. Yet, in the end the islands’ financial collapse showed that neither country had the infrastructure to oversee and regulate a rapidly expanding financial sector.
It can be argued that in spite of the geography both countries were immature emerging markets suffering from the illusion that they were mature economies just because they were part of the EEA. As a consequence, both countries now have capital controls and clipped wings, i.e. with only three of the EEA’s four fundamental freedoms.
The “international finance centre”-tag and foreign funds
Large inflows of foreign funds are a classic threat to financial stability. At the slightest sign of troubles the tide turns and these funds flow out, as experienced by many Asian countries in the 1980s and the 1990s. Capital controls are the classic tool to resume control over the situation. None of this was supposed to happen in Europe – and yet it did.
Although not on the OECD list of tax havens Cyprus has attracted international funds seeking secrecy by inviting companies with no Cypriot operations to register. After the collapse of the Soviet Union money from Russia and Eastern Europe flowed to the island as well as from the Arab world. Even Icelandic tycoons some of whom grew rich in Russia made use of the offshore universe in Cyprus.
The attraction of Cyprus was political stability, infrastructure, a legal system inherited from its time as a British colony and the fact that English is widely spoken in Cyprus. By the time of the collapse in March 2013 the Cypriot banking sector had expanded to be the equivalent of seven times the island’s GDP. This status did also clearly limit the crisis measures: president Nicos Anastasiades was apparently adamant to shelter the reputation of Cyprus as an international finance centre arguably resulting in a worse deal and greater suffering for the islanders themselves (see my article on the Cyprus collapse and bailout here).
Iceland also tested the offshore regime. Under the influence of a growing and partly privatised financial sector the Icelandic Parliament passed legislation in 1999 allowing for foreign companies with no Icelandic operations to be registered in Iceland. Although it could be argued that Iceland enjoyed much the same conditions as Cyprus, i.e. political stability etc. (minus an English legal system), few companies made use of the new legislation and it was abolished some years later.
But Iceland did attract other foreign funds. Around 2000 a few Icelandic companies started their shopping spree abroad. The owners were also large, in some cases the largest, shareholders of the three main banks – Kaupthing, Landsbanki and Glitnir. The banks’ executives saw great opportunities for the banks to grow in conjunction with the expanding empires of their main shareholders and largest clients. By 2003 the financial sector was entirely privatised, another important step towards the expansion of the financial sector.
In addition, the Icelandic banks had offered high interest accounts abroad from autumn 2006, first in the UK, later in the Netherlands and other European countries, even as late as May 2008. Clearly, Icelandic deposits were not enough to feed the growing banks. They found funding on international markets brimming with money. In 2005 the three banks sought foreign financing to the amount of €14bn, slightly above the Icelandic GDP at the time. In seven years up to the collapse the banks grew 20-fold. In the boom times from 2004 the assets of the three banks expanded from 100% of GDP to 923% at the end of 2007.
The Icelandic crunch: lack of foreign reserve
At the collapse of the Icelandic banks in October 2008 Icelandic króna, ISK, owned by foreigners, mostly through so-called “glacier bonds” and other ISK high interest-rates products amounted to 44% of GDP. These products, popular with investors seeking to make money on high Icelandic interest rates, had been flowing into the country, very much like “hot money” flowing to Asian countries during 1980s and 1990s.
Already in early 2005 foreign analysts spotted funding as the weakness of the Icelandic banks. In. February 2006 Fitch pointed out how dependent on foreign funding the Icelandic banks were. In order to diversify its funding one bank, Landsbanki, turned to British depositors in October 2006 with its later so infamous Icesave accounts. The two other banks followed suit. In addition, the banks were supporting carry trade for international investors making use of high interest rates in Iceland.
Steady stream of bad news from Iceland during much of 2008 caused the króna to depreciate drastically. After the collapse foreigners with funds in Iceland sought to withdraw them. On November 28 2008 the Central Bank of Iceland, CBI, with the blessing of the IMF, put capital controls in place (an overview of events here). IMF’s favourable stance to capital controls was a novelty at the time; not until autumn 2010 did the Fund officially admit that controls could at times solve acute problems as indeed in Iceland.
It was clear that the CBI’s foreign reserves were not large enough to meet the demand for converting ISK into foreign currency. What no one had wanted to face before the collapse was that the CBI could not possibly be a lender of last resort in foreign currency.
The controls were from the beginning on capital, i.e. capital could neither move freely out of the country nor into the country. The controls were not on goods and services, hence companies could buy what they needed and people travel but investment flows were interrupted (further re the controls see here).
The migrating króna problem
The core problem calling for controls was and still is ISK owned by foreigners, i.e. offshore ISK, but the nature of the problem has changed over the years: the original carry trade overhang has dwindled down to 16% of GDP, through CBI auctions where funds seeking to leave were matched with funds seeking to enter. Now, the major problem is foreign-owned ISK assets in the estates of the three banks, i.e. owned by foreign creditors who, without controls, would seek to convert their ISK into foreign currency.*
As outlined in CBI’s latest Financial Stability report, published last September there is a difference between the onshore and the offshore ISK rate: 17% in autumn 2014, about half of what it was a year earlier. These and other factors indicate that the non-resident ISK owners, i.e. those who owned funds in the original overhangs, are most likely patient investors; after all, interest rates in Iceland are higher than in the Eurozone. Although these investors cannot move their funds abroad the interests can be taken out of the country.
The classic problem with capital controls as in Iceland is that the controls – put in place to gain time to solve the problems, which made them necessary – can also with time shelter inaction. With the controls in place the urgency to lift them disappears. Over time, controls invariably create problems as the CBI pointed out in its latest Financial Stability report: The most obvious (cost) is the direct expense involved in enforcing and complying with them. But more onerous are the indirect costs, which can be difficult to measure. The controls affect the decisions made by firms and individuals, including investment decisions. Over time, the controls distort economic activities that adapt to them, ultimately reducing GDP growth.
The main ISK problem is now nesting in the estates of the three collapsed banks where the problem, as spelled out in the CBI’s last Financial Stability report , is that “…settling the estates will have a negative impact on Iceland’s international investment position in the amount of just under 800 b.kr., or about 41% of GDP. This is equivalent to the difference in the value of domestic assets that will revert to foreign creditors, on the one hand, and foreign assets that will revert to domestic creditors, on the other. The impact on the balance of payments is somewhat less, at 510 b.kr., or 26% of GDP.
The balance of payment, BoP, problem could be solved in various ways, i.a. through swaps between Icelandic creditors who are set to get foreign currency assets from the estates, sales of ISK assets for foreign currency and write-down on some of the ISK assets. In addition there are tried and tested remedies such as time-structured exit tax where those who are most keen to leave pay an exit tax, which is then scaled back as the problem shrinks.
The political stalemate
In March 2011, under the Left government in office from early 2009 until spring 2013, the CBI published Capital account liberalisation strategy, still the official strategy. The strategy is first to tackle the offshore króna problem outside the estates, which has been done successfully (judging by the diminishing difference between the on- and offshore ISK rate) through the CBI auctions. That part of the strategy has now come to an end with the last auction held on 10 February.
The next important step towards lifting the controls is finding a solution to the foreign-owned ISK in the bank estates. Their creditors are mostly foreign financial institutions, either the original bondholders or investors who have bought claims on the secondary market.
As indicated above there are solutions – after all, Iceland is not the first country to make use of capital controls while struggling with BoP impasse. However, as long as the political unwillingness, or fear, to engage with creditors prevails nothing much will happen.
When the present Icelandic coalition government of Progressive party (centre; old agrarian party) and the Independence party (C) came to power in spring 2013 it promised rapid abolition of the capital controls. So far, the process has been a protracted one with changing advisers, unclear goals and general procrastination. There has at times been an echo of the belligerent Argentinian tone, blaming foreign creditors for the inertia in solving the underlying problems; importantly, the Progressive party has promised huge public gains from the resolution of the estates, which it seems to struggle to fulfil.
In its concluding statement in December 2014 following the Article IV Consultation IMF points out that the path chosen in lifting the controls “will shape Iceland for years to come. The strategy for lifting the controls should: (i) emphasize stability; (ii) remain comprehensive and conditions-based; (iii) be based on credible analysis; and (iv) give emphasis to a cooperative approach, combined with incentives to participate, to help mitigate risks.” The “cooperative approach” refers to some sort of negotiations with creditors, which the government has so far completely ruled out.
It is important to keep in mind that the estates of the banks, by now the major obstacle in lifting the controls, are estates of failed private companies. The banks were not nationalised and the state has no formal control over the estates. However, as long as the ISK problems of the estates are unsolved the winding-up procedure cannot be finished and consequently there can be no payouts to creditors.
The winding-up procedure will either end with bankruptcy proceedings, which majority of creditors are against, or with composition agreement, which the majority seems to favour. Crucially, the minister of finance has to agree to exemptions needed for composition, which means that the government is indirectly if not directly responsible for the fate of the estates.
The political tension regarding the controls is between those who claim that solving problems necessary to lift the controls is the main objective and those who claim that no, this is not enough: the state needs and should get a cut of the estates.
Finance minister Bjarni Benediktsson has strongly indicated that his objective is to lift the controls whereas prime minister Sigmundur Davíð Gunnlaugsson has allegedly been of the latter view. He has recently been supporting his views by stressing the great harm the banks caused Iceland reasoning that pay-back from the banks would be only fair. This simplified saga of the banking collapse is in conflict with the 2010 report of the Special Investigative Committee, SIC, which spelled out the cause of the collapse as regulatory failure, failure of the CBI and political failure in addition to how the banks were funded and managed.
The government has Icelandic and foreign advisers working on these issues. But as long as the government does not make up its mind on what direction to take nothing moves. Meanwhile Iceland is effectively cut from markets, which makes the financing cost high, in addition to other detrimental effects of the capital controls.
The Cypriot crunch: bank run
The run up to the Cypriot banking collapse in March 2013 was a sorry saga of mismanaged banks, mismanaged country and the stubborn denial of the situation ever since Cyprus lost market access in May 2011. But contrary to Iceland, there has been no investigative report into the collapse, which means that in Cyprus hardly any lessons can be drawn yet from the calamities.
Data from the European Central Bank, ECB, shows that deposits were seeping out: in June 2012 they stood at €81.2bn. In January 2013 they were €72.1bn, down by 2%, in February at €70bn, 2.1% month on month and in March €64.3bn. According to the Anastasiades report (written at the behest of president Anastasiades, leaked to NYTimes and published in November 2014) €3.3bn were taken out of Cypriot banks March 8–15, the week up to the bail-in.
This was an altogether different situation from circumstances in Iceland ensuing from the collapsing banks. Cyprus, part of the Eurozone, was not struggling to convert euros to other currency but it was struggling to convince those holding funds in the Cypriot banks not to withdraw them and move them abroad.
As Iceland, Cyprus was trying to maintain a banking system far larger than the domestic economy could possibly support under adverse circumstances. By the end of 2011 there were 41 banks in Cyprus: only six were Cypriot; 16 were from EU countries and tellingly 19 were non-EU banks. It was clear to regulators that the size was a risk but they maintained that both regulation and supervision was conservative enough to counteract the risk, as bravely stated in a report by the Ministry of Finance on the financial sector in Cyprus. – Ironically, Cyprus had to seek help from the troika just a few months after these assertive words were written.
The controls were put in place with the full acceptance of the troika, i.e. the IMF, the EU Commission and the ECB. “The Enforcement of Restrictive Measures on Transactions in case of Emergency Law of 2013” as the capital controls measures were called by the Cyprus Central Bank, CBC, restricted i.a. daily cash withdrawal to €300 daily, no matter if directly or with a card, or its equivalent in foreign currency, per person in each credit institution. Cheques could not be cashed.
Trade transactions were restricted to €5,000 per day; payments above this sum, up to €200,000 were subject to the approval of a Committee established within the CBC to deal with issues related to the controls. For payments above €200,000 the Committee would take into account the liquidity buffer situation of the credit institution. Salaries could be paid out based on supporting documents. Those travelling abroad could only take the equivalent of €1,000 with them.
The roadmap for abolishing them came in August 2013, again with the full blessing of the troika. There was no time frame, only that the measures would be “in place for as long as it is strictly necessary.” They would be removed gradually and with prudence, always with a view on financial stability. First the restrictive measures on transaction within Cyprus would be abolished and only subsequently could the restrictions on cross-border transactions be lifted.
The controls have since gradually been eased and by May 2014 all domestic restrictions were indeed fully eliminated. On 5 December 2014 i.a. the limit for travel abroad was sat at €6,000, from previous €3,000 and business activity not subject to approval was sat at €2m. With the last change, on 13 February, those travelling abroad can now take €10,000 with them. Transfers of funds abroad were increased from the December limit of €10,000 to €50,000. The island’s pension funds are still subject to capital controls.
As in Iceland, abolishing, for unspecified time, one of the EEA’s freedoms was to be in place only for a short time. Until late 2014 it seemed as if the Cypriot capital controls might be entirely abolished by the end of that year. That did not happen. The last bit remaining is the politically tough one.
The task for Cyprus: overcoming the political hurdles
With the domestic restrictions abolished the IMF Staff report in October 2014 for the Article IV Consultation pointed out that the “external-payment restrictions” in Cyprus have to be relaxed in a gradual and transparent way. “…owing to the short deposit-maturity structure, significant foreign deposits (close to 40 percent of the total), large reliance of BoC (Bank of Cyprus) on ELA (Emergency Liquidity Assistance), and the lack of other market funding, external restrictions remain in place. While restrictions do not apply to fresh foreign inflows into Cyprus, they limit outflows, hampering trade credit and affecting overall confidence.” If the external restrictions remain in place they can damage investors’ confidence and consequently foreign direct investment, FDI.
As in Iceland, the main Cypriot problems stem from political tensions, which “could have adverse implications for confidence and the recovery,” according to the IMF. The key obstacle in Cyprus is lack of progress in addressing non-performing loans, NPL, staggeringly high in Cyprus at 37.9% of total gross loans in 2014. Debt-restructuring framework, including i.a. a foreclosure legislation and insolvency regime is still a lingering political problem. Further, banks need to restructure and build capital buffers, critical to lift the remaining restrictions.
Visiting Cyprus in early December I was told that the work on the NPLs was about to be finished and a new insolvency framework would be in place by the end of the year. It is still not in place, a sign that the politial tensions have not eased. In spite of all that has been done Cypriots have lost trust in their banking system: almost two years after the collapse it is estimated that the islanders keep up to 6% of GDP at home, under their proverbial mattresses or wherever people stash cash.
The political test for Cyprus and Iceland
Both islands face a political challenge lifting capital controls.
In 2012 the CBI published a report on Prudential Rules Following Capital Controls, thus outlining what is needed once the capital controls have been lifted. This is greatly facilitated by the fact outstanding work of the SIC. Consequently, life and prudence after the controls are lifted has been staked out.
Iceland is however struggling to throw off shackles of nepotism, even more so under the present government than for quite a while: personal connections seem to matter more not less than before. Lifting the controls will test the times, if they are new times with accountability, transparency and fairness or the old times of nepotism, opacity and special favours.
Cyprus stands harrowingly high on the Eurobarometer corruption index and it suffers from lack of stringent analysis of what happened, making it difficult to draw any lessons, i.e. on how regulation needs to be improved, failures at the CBC etc. Cyprus authorities have some way to go in order to win trust with the islanders. The fact that no public inquiry has been held into the collapse, no investigation, no report written adds fuel to the already low trust. I have earlier written that Cyprus with high unemployment and contracting economy bitterly needs hope.
Both Cyprus and Iceland will have to show that they understand what happened and how it can be prevented from happening again. The exit from capital controls for both these islands will depend on political decisions, which will shape their next decades.
*I have blogged extensively on Icelog on the capital controls in Iceland. Here is the latest one, on the politics. Here is one from end of last year, on i.a. the various possible solutions. I have at times blogged on Icelog on Cyprus or compared Iceland and Cyprus. Here is a collection of blogs on Cyprus, i.a. two on the topic of Cyprus, Iceland and capital controls. – This post is being cross posted on A Fistful of Euros.
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