Sigrún Davíðsdóttir's Icelog

A good way to inspire trust is to make sensible plans and stick to them. In November last year the Icelandic Central Bank outlined a plan to work towards the abolition of the capital control. According to the CBI’s press release, “the Central Bank of Iceland will hold foreign exchange auctions in which it will purchase foreign currency in exchange for Icelandic krónur to be used for domestic investment, provided that the investment remains in Iceland for a long-term commitment period… The Central Bank’s aim with the transactions is to facilitate the removal of the capital controls without causing major exchange rate or monetary instability or jeopardising financial stability.”

This plan, built on a liberalisation strategy announced March 25 2011, was clear-cut, straight and simple, aiming at financial stability. The theory was that this would gradually make the offshore rate and the onshore rate converge, in the sense that the offshore rate would approach the onshore rate.

The CBI badly needs foreign currency and an auction last summer was a failure. The only buyers were Icelandic pension funds – not terribly prudent of them to be selling off foreign assets – but they were clearly under pressure to step in.

But now it turns out that the CBI only has a plan until it conjures up another one. In a daily note (in Icelandic) on Feb. 3 the financial analysts at Islandsbanki pointed out that after a failed auction last summer and a most remarkable deal at the end of last year with an unknown foreign seller the bank was still short of €130m.

In this unexpected and inexplicable deal, the CBI bought Icelandic sovereign bonds for ISK18bn, €111m – and paid for it in foreign currency. As is scarily obvious, this deal, not a trivial one in terms of size, goes completely against the bank’s plan from last year.

At an auction on Feb 15 the bank intends to buy €100m from pension funds and from foreigners wanting to invest in Iceland, by making use of the so called 50/50 way: foreigners (not Icelanders) can use offshore ISK as half of any investment made in Iceland; the rest has to be in foreign currency.

So far, the 50/50 way hasn’t aroused much interest and the pension funds might be squeezed again. It could even be argued that the funds’ foreign assets will be used to finance the deal with this mysterious seller. A seller who was deemed to be of such importance that he got paid in foreign currency that that bank is sorely lacking.

At a press conference recently, CBI governor was asked about this deal. He claimed it was an entirely regular affair, it had been a good offer but the bank would not give any information on the mysterious buyer; such information was never public. – According to rumours, CBI staff had no inkling of the deal until it was done. It seems that in accordance with a tried and tested Icelandic management style, the CBI governor didn’t much confer with staff regarding this move.

The question is how anything can be a good offer if you are selling what you really need more of, not less? And when part of the cost is diminished trust? Whose offer was so good that the governor gladly accepted to ignore the bank’s policy?

After this event it is only fair to say that the CBI has a plan to abolish the capital controls but it doesn’t stick to it. Its course towards abolishing the controls isn’t straight but crooked. So much for the vital need of a central bank to be seen as trustworthy.

*If anyone has information on this mysterious deal and who was lucky enough to sell ISK assets to the CBI against currency I would love to know.

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