Sigrún Davíðsdóttir's Icelog

Capital restrictions until 2015?

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Four more years – that’s the perspective on capital restrictions in Iceland. Today, the Icelandic Central Bank published its long awaited report on capital restrictions in Iceland. In tune with the general tendency for a positive spin on things the title is ‘Capital account liberalisation strategy.’ The Icelandic title is less sophisticated and more down-to-earth; literally translated it’s ‘A plan to abolish currency restrictions.’ An upcoming bill in Althingi will allow the CBI to extend the capital restrictions for four years.

For those of us who breathlessly follow the Icelandic economy this report has been long awaited. It was due on March 11 but was delayed because, according to Governor of the CBI Mar Gudmundsson, it was cooked up by many cooks who all wanter to add their touch. The new report discusses previous strategy, the various conditions needed for lifting capital controls and sets out a plan for easing the country out of the restrictions into the real world.

The first two steps regard the offshore krona, now estimated to be ISK400-500bn, a quarter of the estimated 2011 GDP of Iceland. In phase I, CBI will offer currency to those who hold offshore krona, through an auction process. In phase II, CBI, then the happy owner of  possibly 400-500bn of OS krona, will auction the OS krona to owners of foreign currency who are interested in longterm investment in Icelandic state bonds or in Icelandic companies. In addition, owners of OS krona will be offered to bring their OS krona to Iceland for the same kind of investment though under some restrictions: the OS krona amount can only amount to half the investment and the investment be kept in Iceland for a certain amount of time. – The use of OS krona in new investment in Iceland has been an issue lately. It’s been forbidden but there have been rumours that some investors have been trying to smuggle their cheap OS krona into investments in Iceland.

In phase III, those who hold OS krona but have neither participated in the auctions nor used it for investment in Iceland will be offered to exit by changing their holdings into longterm state bond in foreign currency or by paying an exit fee.

Obviously, the ultimate goal is to strengthen and stabilise the economy but how the measures will pan out is still unclear. The underlying problem with the OS krona is the divergence between the onshore and the offshore rate. It’s i.a. unclear how free the auctions will be, i.e. if the CBI will try to control the exchange rate in some way.

In the short term, the outcome of the Icesave referendum April 9 will have an impact on how speedily the strategy can be executed. If the Icesave agreement is rejected the execution of phase I and II will no doubt be delayed as a ‘no’ might cause great uncertainty in terms of Iceland’s legal status regarding the Icesave debt and other issues arising from the collapse of the banks in October 2008.

The biggest owners of foreign capital in Iceland are the pension funds. At a press conference today, Gudmundsson emphasised that the pension funds’ foreign capital will not be affected by the first easing. Their capital will be fenced in at home, leading some to believe that the funds, willingly or not, will bear some of the burden that the capital restrictions create.

Alexander Macgregor Bruce-Brand, an expert in the field with experience from South Africa and elsewhere, has worked on the new strategy. It remains to be seen how the strategy will be viewed by those part of the Icelandic business community worst hit by the restrictions. Though four more years of restrictions seems a long period of an anormal situation, the plan sets out a clear vision of how things will be done. So at least there is clarity – and clarity might cement some much needed trust in the CBI and Icelandic authorities. And that’s ultimately a positive thing.

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Written by Sigrún Davídsdóttir

March 25th, 2011 at 6:52 pm

Posted in Iceland

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