Sigrún Davíðsdóttir's Icelog

If minister of finance Bjarni Benediktsson sticks to his well-publicised intension of moving towards lifting the capital controls before the end of the year a plan must be imminent; some of the foreign advisers have been visiting. One strategy being examined is exit tax on both ISK and FX. Such an exit tax will not solve the offshore króna problem and might prolong the capital controls under a different name. A new judgement by the Icelandic Supreme Court may well have effected the certainty of those pleading for the “ISK-isation” of the failed banks’ estates. Central to the coming plan is whether the government is content with lifting the controls – or if it wants to gain funds for the state coffers as well. As before, the politics count more than the economics.

As soon as they were in office both prime minister Sigmundur Davíð Gunnlaugsson and minister of finance Bjarni Benediktsson said they would work towards quickly lifting the capital controls. In office since early summer 2013 the two leaders do not have much concrete to show for their oft-repeated words.

To those close to the process the reason for the sluggish pace is clear: the two ministers have diametrically opposing ideas. Gunnlaugsson has not been saying much recently on the controls but has earlier championed the idea of enriching the state with money from the foreign creditors he invariably calls “vulture funds.” Benediktsson’s speech in October indicated a willingness to avoid legal uncertainties.

An exit tax is a classic solution to capital controls as Malaysia demonstrated in the 1990s. It is also part of the three-step liberalisation strategy set out in 2011 and in its original form intended for offshore ISK. Now however the feeling is that the Icelandic government is planning an exit tax on all funds leaving the island, ISK or FX. And the percentage? Anything less than 30-35% is hardly credible given that the difference between the ISK on- and offshore rate is now 17%; as much as 50% has also been mentioned. Whether this strategy would be based on a transparent plan is not clear.

The rumour in the Icelandic echo chamber is that a plan, some plan, might be presented by the end of November and the exit tax will be a part of that plan. What else it might contain is not yet clear.

Exit tax – in theory not a new idea

As mentioned in the most recent IMF report on Iceland the 2011 capital controls liberalisation strategy included FX auctions, as the CBI has been doing and then further two steps, Eurobond swap and exit tax, not yet implemented.

This exit tax is in line with measures taken in other countries with capital controls: in order to temper outflows, which the controls were put in place to contain, there is a tax. The transparent way is to announce at the outset both the percentage and a schedule for lowering it. If things go well the easing can be accelerated as turned out to be the case in Malaysia: the plan was implemented in less time than foreseen at the beginning. Those holding the problematic currency can then choose if they want a tax haircut or if they wait; other capital movements are not affected.

However, the rumour is that the Icelandic government is planning an entirely different version of the classic exit tax, i.e. a tax on all movement of capital out of the country, whether offshore ISK or FX. This prolongs the controls in all but name. In theory everyone is equally (badly) off, which solves the problem the government is actually very worried about: equality between creditors and others.

In particular the government does not want to be seen as aiding greedy foreign creditors to exit while Icelandic individuals and entities are still locked inside controls. Unfortunately this is partly a misconceived argument – Iceland as a whole stands to gain quite immensely by lifting the controls. This should be the focus of the government, not the possible gain of the creditors. Whether the lifting happens some months later is of a much lesser importance than Iceland getting out of controls. The Icelandic gain of lifting the controls is escaping the controls.

Interestingly, this timing problem could indeed be solved in a fairly simple way: if a composition agreement for Glitnir and Kaupthing is reached it will take at least 4-6 months to work out the details. With an agreement in place this time could be used to open up exit avenues for Icelanders.

Acting so as not to act

An exit tax on all flows seems to be a (not so?) clever way of avoiding a decision on the, for the government, thorny issue of composition or bankruptcy proceedings for the estates of Glitnir and Kaupthing (and for Landsbanki further into the future). The message to the creditors is then that they can decide whatever they want – composition or bankruptcy, no problem, make your own choice. Beyond the estates there is the exit tax.

An exit tax on all outflows does not necessarily solve the offshore ISK problem – the underlying cause for the capital controls – and it does not solve the problem of that particular part of the foreign-owned ISK in Glitnir and Kaupthing: Íslandsbanki and Arion.

The recent judgment by the Supreme Court in the case of Kaupthing v Aresbank SA (in Icelandic; here an unofficial English translation) did not come as a surprise for those who had interpreted Icelandic state and creditors v Landsbanki Supreme Court judgement from September 2013 along the lines now clarified. For those working for the “ISK-isation” of the estates this judgment is no happy tidings. Not only can the estates pay out in FX if they or creditors so wish: the estates can go out into the market and buy FX in order to pay out; quite a feisty judgment as judgements come.

Will the government act at all?

The government is no doubt working on a plan but will it actually have the courage to act? Interestingly, some hardened political observers in Iceland do believe that in spite of all the rhetoric the government will actually not be able to make the necessary decisions. They think the government will simply limp through its four years continuously finding some reasons for in-action on the controls.

Rationally, I have to say I find it difficult to believe this could be the case not least with Benediktsson’s oft repeated intention to act before the end of the year. On the other hand this government has shown some spectacular abilities for inaction or leaving things open (appointing a new CBI governor; a debt relief yes but very different from the original intentions; Landsbanki bonds agreement etc.). With this in mind it is easy to believe that the difficult issues regarding the controls will prove to difficult to solve.

Most strikingly, the government – or, to be more precise, the minister of finance and the prime minister – has not been able to act so far on the Landsbanki bonds agreement and the ISK226bn, €1.45bn, remaining for Landsbanki to pay LBI. If agreed on it will most likely be with some further restrictions for general creditors than in present agreement (though they will not get paid until the estate either goes into bankruptcy proceedings or there is a composition agreement; i.e. the agreement sets on precedence since priority creditors have been paid out in Glitnir and Kaupthing). The next deadline (the fifth) is Monday 17 November.

Regarding Landsbanki the delicate act is how to treat the main priority claimant, the UK deposit guarantee scheme. Economic Secretary to the Treasury Andrea Leadsom allegedly did not mince her words when talking to Benediktsson on his visit to London in autumn. He thought he was coming for a collegial meeting over drinks but instead got an almighty dressing down from the fearsome Leadsom. There are even rumours that the Secretary was waiving a legal writ already penned. All of this is rumours rumours and nothing more.

Political tremors

I have earlier pointed out that so far the prime minister has had an upper hand since he apparently stopped Benediktsson from agreeing to the Landsbanki bonds agreement. Now that Gunnlaugsson’s grand promise on debt relief is being carried out, to no great happiness of many Independence Party MPs, Benediktsson needs to strengthen his grip on lifting the controls his way if he wants to maintain his political credibility. The question whispered is “When will Benediktsson man up?”

Coalition certainly is built on compromises but since the controls are part of Benediktsson’s portfolio anything that smacks of the Progressives steering the controls policy will make Benediktsson look weak, very weak indeed. If he is forced on a path fundamentally different from the one he has outlined it will seriously harm his political credibility.

Interestingly, the political focus is firmly kept on the losses the creditors suffer from the waiting game as if none of this mattered for the interests of Icelanders themselves. The legal risks are hardly ever mentioned nor the fact that threatened Landsbankinn is indeed the state’s largest single asset, amounting to 12% of the state’s assets. Benediktsson talks about starting to sell shares in Landsbankinn next year and yet never mentions the connection between the bonds agreement and the possibility of a sale. This rather skewed picture is rarely challenged also because very few people, also politicians, have any firm understanding of the underlying facts.

A political wrestle is also taking place over the 2015 Budget. Benediktsson wants to increase VAT on food from 7% to 12%, a principal change towards simplification from Benediktsson’s point of view and therefore of fundamental importance for his strategy. Progressive Party MPs are against. The intriguing question is if the prime minister will side with his finance minister or his party. Again, any change here reflecting badly on Benediktsson’s political strength will undermine him. (Those who think ex-prime minister Davíð Oddsson still is a political force to reckon with will notice that Oddsson, in Morgunblaðið, has come out against the VAT increase yet again siding with the Progressive party and not with the leader of his own party.) Benediktsson can take some comfort in the fact that the Progressives have plunged in opinion polls whereas his own party is strengthened.

Cyprus implemented capital controls last year. Aimed at hindering outflows from banks the Cyprus controls are intrinsically different from the Icelandic ones. As in Iceland the controls were meant to be in place only for a few months. Cyprus is now far into lifting the controls, has indeed already eased them quite a bit contrary to Iceland where they have gradually been tightened. Cyprus might possibly have lifted them altogether by the end of the year.

Six years into controls Iceland seems far from lifting them – though this year the Christmas crackers might contain unexpected surprises. It remains to be seen who will then have a crackin’ good time.

*I have often gone through the underlying economic problems of the controls; also well explained in the CBI Stability Reports over the years. The last one, published in autumn, clearly underlines the cost and damaging of the controls. – The government’s basic information, in English, on the debt relief is here. (Correction: in the first published text it said the government had been in power since early 2014; that should of course be early 2013 as it now says.)

Follow me on Twitter for running updates.