Compared to the skepticism of many Icelandic economists (except those who worked on the debt relief or were somehow connected to it), it was surprising to see how positive Fitch Ratings review of the Icelandic debt relief plan is: Fitch deemed the program “appears” to be “fiscally neutral” but added that “another round of write-downs may dent investor perceptions of Iceland’s business environment, and the prospect of foreign bank creditors in the failed banks bearing most of the cost may make it more difficult to remove capital controls.” The program amounts to ISK150bn, 8.5% of GDP (see earlier report on Icelog).
As Fitch points out the government aims to “fully finance the plan, via as-yet-unspecified budget adjustments, and tax increases – primarily an increase in the levy on Icelandic banks’ balance sheets from 0.145% of total outstanding debt to 0.366%. This bank tax is levied on Iceland’s new banks as well as on its failed banks, Kaupthing Bank, Glitnir Bank, and Landsbanki Islands, through their winding up committees.”
The often-stated aim of the government was not to finance the plan itself but that is indeed what it turns out to be: government funded. The funding is to come from increasing levy on the balance sheets of banks, as pointed out earlier on Icelog, from 0.145% to 0.366% – not only on operating banks but on the failed banks as well.
The Winding-up Boards of both Glitnir and Kaupthing have both stated that they doubt the legality of posing a levy on estates as expressed in a written statement by Kaupthing. The levy will most likely be challenged. Maybe it is unlikely that the Supreme Court will dare to go against the government but the levy is by no means in the Treasury coffers yet.
Economists have also pointed out that the estimated effect on inflation in the government’s calculation is 3.7% over 4%, not a trivial number but others see this as an unlikely low number. To “correct” inflation some years ago by possibly increasing inflation in the coming years and thereby wiping out the effect seems unwise, to say the least.
The unavoidable negative effect on the Housing Finance Fund – this almost decade old unsolved disaster – makes the debt relief all the more worrying. This government, as the previous government, keeps throwing money at the fund – this year ca ISK5bn (€31.8m) – only to keep the fund going, without resolving the underlying problems.
Fitch points out that a levy could dent recovery of the estates (which is why it will most likely be challenged in court) “and may further dent international investor sentiment towards Iceland. This could have a negative impact on investment, growth, and external finances, and may make it even more challenging to unwind capital controls in an orderly fashion.”
This is of great concern for Iceland since foreign investment and expertise is greatly needed. And everything that makes it more difficult to unwind the capital controls poses a major problem for the Icelandic economy. In addition, as the Argentinians know all too well, demagogy and populism thrive in capital controls.
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