Sigrún Davíðsdóttir's Icelog

The depressing thing is that resolving the capital controls in Iceland might not be that tricky: there are some really sound ideas on lifting the capital controls and there is no lack of literature/IMF papers on similar situations in other countries. The problem is a political one: politicians have on one hand promised too much, on the other fear the responsibility of fateful decisions. Dallying around has already caused a costly delay for Iceland. But two significant steps have been taken recently: the Landsbankinn bonds agreement is finally in place and the Central Bank has announced its final foreign currency auction on February 10.

Finally, creditors – or rather the Winding-up Boards of the three failed banks and some of their advisers – got to meet the government’s so-called advisory group. An IMF-group, in Iceland now, was not at the meeting according to sources but had meetings with i.a. representatives of the creditors following the meeting yesterday. This is a meeting that will sprout many meetings but nothing more concrete for the time being.

The meeting was called for by the foreign advisers to hear the view of Winding-up Boards and creditors. With no plan presented it seems a bit of an exercise in trying to be seen doing something but as Lee Buchheit said to Rúv last night the foreign advisers thought it was time to hear from the Winding-up Boards before presenting their proposals. – And when could a plan be expected? Early next year, according to Buchheit. In the light of the past that seems an optimistic bid.

With the Landsbankinn bonds agreement in place Benediktsson has shown long-awaited determination though the press release curiously has six statements about what is not being done. Further, it is of great interest to see that the CBI auctions are now being brought to an end with a final auction on February 10. It is reasonable to think it will then take a couple of months to finalise plans, which means that in early spring some plan for dealing with the estates and easing capital controls might reasonably be expected; perhaps in the Icelandic tradition of giving summer presents on the first day of summer, celebrated annually on the third day of April.

However, an exercise in cleverness that does not resolve quickly and effectively the ISK assets, the core of the capital controls, will not be a happy solution for Iceland: most Icelandic business leaders agree that Iceland needs a speedy lifting of the capital controls, of course always with an eye on financial stability.

No conclusion – it wasn’t that kind of a meeting

Ever since Glitnir and Kaupthing presented their draft for a composition agreement to the CBI in 2012 creditors have been waiting to meet someone with authority to negotiate a deal. With foreign advisers at hand they had hoped the government would feel confident enough but so far it has not happen. Although nothing was decided today it was at least a day where it was acknowledged that the WuBs and creditors are a party to lifting the controls.

“No, it wasn’t that kind of a meeting,” Jóhannes Rúnar Jóhannesson from Kaupthing’s Winding-up Board said to Rúv when asked if an official plan of lifting capital controls had been presented. Steinunn Guðbjartsdóttir, Glitnir, said the meeting had been a positive step in the right direction. “I think we have to be optimistic. At least this has started and judging from what Icelandic authorities indicate they seem to be optimistic and steadfast in putting an end to this and start working towards lifting the capital controls,” Guðbjartsdóttir said.

Kaupthing’s main message, according to Jóhannesson, was that composition would be the best way forward for Kaupthing’s creditors but also for the Icelandic state, given that such an agreement would be final and abolish both uncertainty and risk. Being based on an agreement composition would be binding for all creditors. Jóhannesson also said that Kaupthing’s message to Icelandic authorities was that the WuB could offer to conclude Kaupthing’s resolution without challenging financial stability in Iceland. – This last thing is very much what the WuBs have been offering: a balance-of-payment, BoP, neutral resolution.

The possible measures

This was a meeting for the WuBs to make their voices heard and they had all worked hard to prepare for it. The WuBs were asked to explain how their proposals would support the aim of the government to secure financial stability. As mentioned above: the WuBs have all been working towards a balance-of-payment neutral resolution, which they aim at concluding through composition.

An exit tax is still being discussed.* The debate in Iceland has been un-nuanced: there is a huge difference if an exit tax is levied on the offshore ISK assets – as was part of the 2011 CBI plan for lifting the controls; same as i.a. Malaysia did with good results at the end of the 1990s, a classic solution in this situation – or on all funds (of course above a certain amount) leaving the country. Would this cover transactions/payouts between the WuBs’ foreign accounts to the creditors’ foreign accounts? No doubt, those who are constructing this plan would be of that opinion because it is first and foremost foreign funds prime minister Sigmundur Davíð Gunnlaugsson and those who agree with him are keen on securing.

Árni Páll Árnason leader of the social democrats who met with the advisers on Monday as part of the Alþingi Economic and trade committee on Monday pointed out after that meeting that the prime minister’s plan to catch funds from lifting the controls had always rung hollow. As far as he could see the aim of the plan-in-the-making was nothing like the prime minister had not only promised but claimed it was unavoidable that the state would accrue money out of the process of lifting the controls.

The goal here is a tax that would be non-discriminatory, not a trivial thing and yet create money flows to the Icelandic treasury. From the point of view of creditors such a tax is akin to an expropriation (especially if not based in national necessity as was the Emergency Act in 2008) and will no doubt be challenged.

The tax levied on the estates this year to fund the latest write-downs, the “Correction,” will as well be challenged. Then there is also another tax, ,,asset-handling tax” (“fjársýsluskattur”), hardly ever mentioned in the debate in Iceland but also greatly upsetting from the point of view of creditors. This tax is, according to them, levied on funds that arise only in the accounts, due to the effect on the asset status when i.a. claims that have been filed twice are corrected and other such measures, i.e. with no tangible funds.

Converting ISK assets into bond with long maturity – 30 years have been mentioned – is one classic solution to prevent funds from leaving the country. Creditors could then sell these bonds or keep them, meaning that for them ISK assets were tradeable. This seems to be part of the plan now in the making.

Solutions tailored to the ISK problem

The problem is that these are all general measures. It would be quicker and more to the point to simply negotiate with Glitnir and Kaupthing regarding their ISK assets, which after all is the core of the problem. The old ISK overhang, now ISK 307bn or just under 16% of GDP.

As the CBI pointed out in its latest Financial Stability report: A solution must be found for the estates’ ISK assets. This is the problem keeping the controls in place – and this is the problem that should be solved.

According to the CBI “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 … The impact on the balance of payments is somewhat less, at 510 b.kr., or 26% of GDP, because a portion of the estates’ foreign-denominated domestic assets are backed directly or indirectly by foreign assets. Residents with foreign-denominated debts to the estates own substantial foreign assets that could be sold upon settlement. Furthermore, the estates’ foreign-denominated sight deposits are backed by foreign liquid assets, according to the Central Bank’s liquidity rules. The impact of the estates’ settlement on the balance of payments is virtually the same as their ISK assets. All of the above amounts will decline by 110 b.kr., or 6% of GDP, with the payment of bank taxes. (Emphasis is mine.)

In addition “Glitnir and LBI have now converted about 70% of the estates’ original asset portfolios to liquid funds, and Kaupthing has converted roughly 60%.”

The sentence in bold outlines how this part of the foreign-denominated debt could be resolved. The book value of the estates’ holdings in Arion Bank and Íslandsbanki accounts for ca. 77% of their domestic ISK-fixed assets. Roughly the whole of Kaupthing’s ISK problem is its holding in Arion. Glitnir has ca. ISK100bn in addition to its holding in Íslandsbanki. There are persistent rumours that Glitnir is close to finding foreign buyers to Íslandsbanki. Another way would simply be to list one or both banks abroad as well as in Iceland – the Norwegian stock exchange has been mentioned as an option.

Agreeing with the CBI the ISK problem needs to be solved. The easiest way to tackle it is by simply negotiating with creditors of the two estates. Swaps with the CBI’s ESÍ and other technical solutions could be used. But as long as the government is captured by its thoughts of making money out of the estates simple solutions are in the danger of being pushed aside for more complex and riskier plans.

Another reason for staying away from negotiations is the government’s fear of getting exposed to legal risk arising from an involvement. But that risk is, to my mind, already there as any exemption granted by the CBI needs the blessing of the minister of finance.

The economic environment: from inflation to deflation

In November Statistics Iceland forecast growth of 2.7% this year. Three weeks later it published new data showing a growth of 0.5% over the first nine months of the year with recession of 0.2% during the third quarter. All of this is way off the 3% widely forecasted at the beginning of the year. Inflation is now at 1%, historically low. As expected, the CBI lowered its rates today: the seven-day collateral lending was lowered from 5.75% to 5.25% (its press release throws some light on the economic situation of weaker growth than previously forecasted).

After living (rather too happily, it seems) with inflation (or the “ghost of inflation” as it is often called in Iceland, perhaps indicating that it is not taken very seriously: a ghost sounds less ominous, more ethereal, than the real thing) Iceland now seems headed for deflation though still too incredible to contemplate. Interestingly, this does not seem to register much. Strangely, compared to other countries, DEFLATION has not been printed in big letters or caused furious and worried debate. Oil price has fallen by 40% over a short time and such swings in commodity can very well aid deflation. People might have been waiting to see what the “Correction,” the debt write-down, would bring – these are the explanations economists have been coming up with.

A deflationary environment is of course a wholly different thing than a growing economy and would pose some real challenges in lifting the capital controls. After all, the conditions for lifting have been most favourable, both in Iceland and abroad.

Iceland’s economy, being a small one, often shows great big swings for little reasons. However, the deflationary tendency is a novelty. It remains to be seen if this is a trend or just a bleep.

An IMF-group was in Iceland yesterday to follow things though not present at the meeting. Both the IMF and the EU are monitoring the situation and a solution without their blessing is unthinkable.

What can unhappy creditors do?

The short answer is: plenty. Still too early to speculate, and hopefully there will not be much reason to, but the hedge funds and other claimants would not have been doing their job if they did not have plan A-Z at hand. Law suits abroad is a common route, plenty of scope there for speculation.

Or something as simple as to short Icelandic sovereign bonds.

Again, remains to be seen. A topic for another day but all of this is clearly been worked on by those whose job it is to steward claims in the estates of the three banks.

The government’s foreign advisers live and breath this environment and there will be nothing there they have not encountered before in other parts of the world. The advisers will be aware of the reputational risks for Iceland (and for themselves).

It is – of course – all about politics but not only in Iceland

There are now three things that indicate the growing political strength of Bjarni Benediktsson. The Landsbankinn bonds agreement went through, as did the ISK400bn payment to the priority creditors. This is allegedly what Benediktsson wanted to do all along, unsuccessfully until recently.

This might indicate an upper hand over the prime minister who was allegedly vehemently opposed to the deal though there was no plan in sight as to how to then save Landsbankinn from default in the foreseeable future.

But it was not only Benediktsson’s growing strength that helped finalise the agreement. According to various sources the Icelandic government sensed great pressure from abroad, first and foremost from the British government, eager to recuperate its Icesave expense but also from the European Union. “Quite severe pressure,” one source said. US officials were putting a lot of pressure on the government earlier this year but do not seem to have shown much interest lately.

If this foreign pressure has been a decisive factor the Landsbankinn move might be more due to the pressure than Benediktsson’s strength. The sticks and carrots were not needed for the LBI, the old bank, but for the government, which allegedly got more sticks than carrots from abroad to accept the agreement.

But there is also another movement: the CBI is resuming its currency auctions, which have been stalled for the last many months. There have been various explanation as to why but whatever the reason was the auctions have now been revived – definitely an important step. Being the final auction it will complete this stage of the plan from 2011.

After the whole sorry affair of getting rid of Hanna Birna Kristjánsdóttir minister of interior Benediktsson appointed a new one, Ólöf Nordal. She is not an MP and was a most unexpected choice. gave Benediktsson the possibility to show the capacity to finding an unexpected solution. It however did take him over a week, though Kristjánsdóttir’s resignation certainly did not surprise. It has generally been taken as a sign of Benediktsson’s strength but others think that in the long run this affair will weaken Benediktsson because it shows he has no faith in his Parliamentary group. He might discover at his peril that few bear grudges like belittled MPs.

Rather tomorrow than today

“Morgen Morgen nur nicht heute, sagen alle faule Leute, (tomorrow and not today, say lazy people)” is a German saying. In the case of Iceland it is not so much about being lazy as being fearful in front of the task of taking decisions that will set the course for Iceland in the coming years; and a political disharmony within the government.

There is an on-going action towards lifting the capital controls. Important steps have been taken but they have been taken rather on the back-foot than with a forward surge and energy. The difficult issues are still unsolved: to lift the controls with the lifting itself as the reward – or lifting by trying to get hold of foreign assets of the estates; two different routes demanding different approaches.

With the long preparation, dealing with the ISK assets is the most direct and shortest route towards lifting the controls. The creditors have a full understanding of the situation, also the political situation. Though they will evidently fight fiercely for every króna in the estates there is no doubt also a sense of reality among them what is likely to be within reach, also because a BoP neutral solution is needed as far as possible. If the Icelandic government could muster the courage, aided by their foreign advisers, to take an aim at the core problem it is perfectly achievable to lift the capital controls in the foreseeable future. Again, this is a problem of politics, not economics – and that does not make it any easier to tackle.

*To clarify: in the 2011 capital control plan the exit tax, called “exit levy,” was presented as last-step in the plan to lift the controls: “Finally, the remaining owners of offshore krónur will be offered the chance to sell their ISK deposits for foreign exchange, subject to an exit levy, or to swap króna‐denominated Treasury bonds for eurobonds issued by the Treasury. It is difficult to state when this phase will be concluded; this will be determined by the interplay of internal and external factors.” – As has been emphasized above and earlier on Icelog: what is now being discussed is a very different beast: exit tax on all funds (above a certain amount, no doubt a matter of severe discussion among the advisers) leaving the island, creditors, pension funds and all and sundry. The offshore ISK exit tax targets the core problem, the omnibus exit tax does not: offshore ISK owners, within the estates and those from the old overhang (now ca. 16% of GDP) could well wait, which means that there is nothing to ensure the offshore ISK problem will be solved. – For this reason I find it difficult to imagine that the IMF and the EU would accept the omnibus version of the exit tax though nothing is ever certain in this world.

Update: among the questions WuBs were asked about was why they preferred composition to bankruptcy proceedings – and also their opinion on inserting some sort of a sunset clause into the process (retroactive law?)

Further: I was asked what I thought the exit tax would be. It seems impossible to answer this question in a rational way. First: the estates aim at a BoP neutral solution – as Lord Eatwell suggested in his advice to Glitnir. Kaupthing is talking about the same. Second: what is the tax being used for? To raise money for the state? Then it is impossible to calculate the tax unless knowing how much the government is seeking to raise. Or, tax to solve the problem of the ISK? As far as I can see an omnibus exit tax does not solve the ISK problem, see above. – That said, the number must consistently mentioned is 45% but again, will it be a transparent tax/levy, i.e. with a clear aim/timeframe, as successfully used in Malaysia; or a non-transparent one with no clear aim/timeframe.

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