Sigrún Davíðsdóttir's Icelog

Icelanders have been drip-fed with promises of an almost-there plan to lift capital controls, so far nothing but the question is if this plan is now about to be introduced. A plan will most likely need to be supported by a new Bill, on much-mentioned tax, either exit tax or recently mentioned stability tax, which means it should first be presented to the government, which would mean either any Tue. or Fri., the two days the government holds its regular meetings.

However, this government does not always follow the normal route, remains to be seen if a plan will emerge at all, how it will be presented and, most of all, what it will contain.

There is indeed still a plan in place, from 2011, as I have pointed out before but what is needed is i.a. how to deal with ISK assets in the estates of the failed banks. A tax on the estates will not solve the underlying issue of the foreign-owned ISK, which are holding the controls in place. But it will fulfill promises made by prime minister Sigmundur Davíð Gunnlaugsson, at least if it will not end in legal wrangling in various jurisdictions and hinder the easing of the controls.

As I have often outlined earlier, it seems that Gunnlaugsson and minister of finance Bjarni Benediktsson have not been looking into the same direction for a solution: Gunnlaugsson has underlined the moral necessity of the banks paying for the harm caused and that there would, unavoidably, be a windfall for the state; Benediktsson has stressed the need for an orderly process that should take as little time as possible and not incur a legal risk.

Given that the prime minister’s party now hovers at 8% in the opinion polls, after harvesting 25% in the elections two years ago the question is whether he will be prone to panic politics, i.e. instigating a conflict with creditors he would try to orchestrate as a victory. After all, he has very little to lose – the party can hardly sink further. It is always a dangerous situation when politicians have little to lose and much to gain. Close to him is ex-PM and ex-governor of the CBI Davíð Oddsson, who is adamant that his legacy especially of his time at the CBI is without a blemish. Oddsson has often shown that he prefers a hard line against creditors, no matter what.

As I have said time and again (after all, most things have been said regarding the capital controls, now it is just waiting to see what there is to come…) Benediktsson’s leadership will be seriously tested by the big Plan to-come. Although leading the same party Oddsson led, the Independence Party, Benediktsson seems further from Oddsson on these issues than the PM. If Gunnlaugsson’s – and Oddsson’s – view prevails it means that Benediktsson is literally powerless in this government. After all, capital controls are his remit, not the PM’s and he would lose all credibility as a leader in his sphere.

The topic of capital controls is muddled in the debate. Very few seem to remember that the problem, which holds them in place is foreign-owned ISK, the old over-hang (now much reduced and already being worked on by the CBI; further steps awaited) and the ISK in the estates of the old banks. Any action that does not solve this problem is no solution at all. Taxing the estates clearly does not solve the problem – after all, this is not a problem of debt but of currency shortage, not enough to convert the foreign-owned ISK. Iceland does not lack funds but funds – the estates are failed private companies, unconnected to the state – and the easiest way would be a haircut of some sort.

The effect for Iceland of a plan will not only be on the economy but very much a political effect. If Benediktsson loses this battle his party – or at least the more sensible part of it – must ask itself if the Independence party is only in government to promote policies of the coalition party. Certainly a role, which would have been unthinkable in earlier times, for example at the time Oddsson was the party leader and PM.

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Will they or won’t they? That is the question regarding how, if and when the Icelandic government will take the long-announced decisive action on easing the capital controls.

The news keeps seeping out in Iceland is that the Icelandic government is just about to present a plan for lifting capital controls. That would then, most likely and uncontroversially, entail the second part of the CBI action from earlier, when investment opportunities for offshore ISK were reined in. Seems, as I mentioned in a blog on earlier CBI action, that this would then be bonds, most likely in FX, with long maturity.

The main interest for foreign creditors will be what measures are chosen regarding the estates of the failed banks, most notably what form of levy or tax will be chosen. Stability tax is the latest jargon to circulate whereas minister of finance Bjarni Benediktsson mentioned an ISK haircut in his March report on capital controls progress.

As often mentioned on Icelog there is “sky and ocean between” (this is an “Icelandicism”) cutting foreign-owned ISK assets or targeting the entire assets – the former is a classic way under similar circumstances, the latter would be an all-Icelandic solution.

What the government is really struggling with here is how to tax only foreigners without touching Icelandic entities. If such discrimination were simple it would have been done long ago but it clearly is not: a whiff of discrimination would unleash the litigation hounds. This is the main issue and also the main reason for it taking so looong to come up with a solution: the government has, I am told although this is staunchly denied, been looking for a solution that does not exist. And that is famously very time-consuming – a grand “sprecatura” as the Italians would say.

As before, the Icelandic economy is slowly being starved of oxygen – and as before, qui vivra verra.

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The latest is… that there is nothing much to report on how the Icelandic government is progressing on lifting the capital controls. For the best part of last year Bjarni Benediktsson minister of finance said there would be a holistic plan by the end of the year; none was seen. Now prime minister Sigmundur Davíð Gunnlaugsson has said action will be taken before the end of this parliament, i.e. by the end of May. However, in addition to capital controls the government is dealing with strikes and contentious issues like fishing quotas.

Bankruptcy route, exit tax and stability tax – these have been the ideas flickering in the Icelandic media and among those following the arduous course of lifting capital controls in Iceland. And as spelled out earlier, both the Central Bank of Iceland, CBI, the International Monetary Fund, IMF and minister of finance Bjarni Benediktsson have been advocating for an orderly consensual solution, which should include the assets for foreign creditors.

After so many unfulfilled announcements by the government leaders it seems difficult to believe that this government is ever going to take any decisive steps towards lifting capital controls. Indeed some long time observers of Icelandic politics have repeatedly told me that this government will take no such steps. But lifting now seems the plan, according to recent announcement by prime minister Sigmundur Davíð Gunnlaugsson, who has otherwise been quiet on the controls for some while, after big words earlier on the money that could be made.

The circle to square: levying foreigners but not discriminating

According to Icelandic media a Bill of law has been drafted and is just waiting to be presented to parliament. Such a draft has existed for a long time, I believe, but has not been presented because the two government leaders do not agree on fundamental issues. Though firmly denied by the two leaders I hear from all directions that this disagreement has been there from the beginning. Whether they are now any closer to a common solution remains to be seen.

Part of the impossibility of deciding on a plan is the strife to slam a levy on creditors without hitting Icelandic pension funds, other Icelandic entities and last but not least the UK Treasury, which holds claims stemming from Icesave. Whatever the measure it has to, or should, fulfill some legal parameters such as not discriminating between domestic and foreign entities. This has proven to be the real hindrance, as far as I understand.

At the behest of Glitnir Winding up Board, two Icelandic academics recently published a report outlining possible solutions. It has been clear for a long time that there are sensible solutions to be found. Unfortunately, the sensible solutions to not include a massive transfer of money to the state, which seems to be what some are seeking. I have earlier pointed out that looking for a solution, which does not exist, might take a long time. The feeling is that a lot of time has been wasted on exactly that though Benediktsson staunchly denied this following the new report.

Political storm and strange behaviour

One reason some observers remain doubtful on any action regarding capital controls is that the government is struggling with many thorny issues. Like wood fires in dry weather strikes are springing up all over Iceland and in different sectors. And as so often with this government there seems remarkable bewilderment as to how to proceed. Yet, the strikes were of course announced months ago – already in autumn it was clear what was coming.

In addition there are several politically seriously divisive topics up in Alþingi, the Icelandic Parliament. Just today, proposals for new power plants was introduced, with some unexpected additions, which caused a hefty debate and angry words from the opposition. Recently presented changes to fishery management and quotas, mackerel quotas in particular, led the opposition to accuse the government of handing out Icelandic resources to the few against the general interest of all Icelanders. The government is introducing a new housing Bill, presented by a Progressive minister, but only part of it has been presented so far, allegedly because Benediktsson opposes his coalition partner’s plan on how to finance it.

The prime minister’s behaviour keeps drawing attention. It was noted that he did not show up at the CBI’s annual meeting earlier this year. And he made the disappearing act during a recent Alþingi question time: he showed up at the beginning only to leave unannounced before it ended, much to the anger of opposition MPs who feel they rarely get to debate with him in person.

The rising cost to Iceland of inaction

In a nut shell this is the political situation in Iceland: topics that touch a raw political nerve, such as power plants and fishing quotas, strikes, a prime minister whose erratic behaviour is much noted and an alleged disagreement between the two government leaders on the capital controls and other key issues. Under these circumstances it remains to be seen if this long awaited plan on lifting capital controls, i.e. how to deal with the estates of the failed banks, will indeed see the light of day any time soon.

While all of this is going on creditors can just quietly sell their claims. In general, as the price of claims goes down the litigation appetite goes up; so far this market is still thin and no great changes visible. As oft repeated here on Icelog the sad thing is that yes, there are indeed viable solutions to lifting the capital controls. While politicians postpone viable solutions Iceland is living with the unavoidably rising cost of capital controls: there is a cost to doing nothing.

*For earlier Icelogs on capital controls see here. I don’t think there is any angle of this issue I haven’t covered earlier so for those who are looking for particular issues do use the “search” option.

*UPDATE – forgot to mention: for the latests data on economy and the estates of the failed banks relevant for capital controls see the CBI’s latest Financial Stability report, published  in April, especially the governor’s introduction and chapter VII.

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Friday 6 March Central Bank of Iceland changed rules for offshore króna investment in order to prepare for lifting capital controls. Restricting the investment possibilities might seem only to increase the króna pressure, not lessen it but this step is a first step or half a step: further measure for binding these funds or attracting them with good offers will follow. This is a step in the right direction – but only if other measures follow. And so far, there is nothing to indicate that there is any rapprochement in diverging views on how to solve the ISK problems of the estates of the old banks. The problem is that the government seems to be looking for a solution that does not exist – and this is very time-consuming as the Scot looking for a penny where he had not lost it found out

Foreign-owned króna, or offshore króna, was the original problem, which on November 28 2008 called for capital controls. At the time, this overhang amounted to 44% of GDP but has since dwindled down to 15%. The rules regarding investment of offshore ISK have now been changed.

The new amendments to the CBI exemption lists and to the Rules on Foreign Exchange and the Foreign Exchange Act mean that there are now only two option for the offshore ISK to invest in: Treasury bills and one Treasury Bond, RIKB 15 0408. As before, interests earned can still be taken out of the country.

Restrictions might seem counter-productive – but this move is the first one: other investment offers will follow. To Reuters CBI governor Már Guðmundsson said the aim is to reduce the overhang and to induce investors to stay in Iceland when further steps towards liberalisation will be taken. “… it would be very imprudent if we were just to assume that these 15 percent were stable… We will shortly be offering investors alternatives … and these alternatives are such that they will greatly reduce the likelihood of instability when controls are lifted.” Guðmundsson said that further measured will be announced in a “few weeks or very few months.” Minister of finance Bjarni Benediktsson said to Rúv that the work is aimed to finish within the first half of this year.

There have lately been changes in the government’s advisers: now Eiríkur Svavarsson has left. The rumour is that Glenn Kim has not been seen much in Iceland lately. And as before: no official announcement of any changes, neither of Svavarsson leaving or the new member, Ásgeir Helgi Reykfjörð Gylfason, who recently joined the government’s group of advisers.

The focus of these measures is only offshore ISK. Still unsolved are the foreign-owned ISK assets in the estate of the failed bank, admittedly the politically most difficult nut to crack. It seems that instead of using tried and tested measures from other countries with capital controls the government is trying to find a solution that does not exist. Meanwhile, Iceland is trapped in capital controls.

CBI’s new measures – in detail

Those holding RIKB 16 etc are not being forced to give up their holding – but for reinvestment there is nothing on offer except about-to-expire maturity and Treasury bills. The crude choice for the offshore ISK owners is either to use deposits accounts to keep their funds or accept the new double offer of Treasury bills or RIKB 15 0408, which is maturing 8 April. Amongst those who follow things in Iceland the feeling is that the imminent maturity was a significant reason for acting now considering the fact that maturity of a big issuance is in sight.

At the end of January foreign-owned RIKB 15 amounted to ISK18.7bn (might have changed in February since RIKB 15 could be swapped for RIKB 17; now no longer possible). The RIKB 16, maturing 13 October 2016 is a much larger issuance where foreigners owned ISK57.9bn.

The effect of the changes is that offshore ISK holders cannot swap to longer maturity. Longer maturity gives less impetus to leave, creating possible hold-outs and unforeseen behaviour, from the point of view of the CBI. Consequently, whatever the possible offer will be the hold-out problem is less, or so the thought goes. When this future offer comes, whatever it will be, the offshore ISK holders are more likely to participate.

The critical issuance might be the RIKB 19, where the foreign holding is ISK42.9bn – those holding longer maturity are unlikely to make a move since hopefully/most likely the controls will have been lifted by then. Those with shorter maturity might give it a thought to swap into what is now on offer. Those with RIKB 19 are in the tricky situation of having to gauge the likely scenario.

After the RIKB 15 0408 matures now in April offshore ISK holders can only reinvest in Treasury bills. Interestingly, some years ago foreigners were the largest holders of T-bills but there is at present no foreign-owned holding there. This is bound to change. Treasury bills now amount to ISK22.1bn but is expected to rise to ISK30bn at the end of the year. Next Treasury bills’ issuance in on 18 March.

In an interview on Rúv minister of finance Bjarni Benediktsson said that the government was now well on its way to solve the offshore ISK problem and this could be seen as the first steps towards lifting the controls. “These are preparatory actions, which in a short while could result in the offshore ISK problem being behind us.”

Further, Benediktsson said that the investment options was being restricted but nothing was taken away from anyone. The idea is, according to Benediktsson, to eradicate uncertainty and prepare the ground for further action.

Next step: what and when?

There is of course no official answer to the questions above. However, since the guiding idea is to bind funds to hinder instability the offer clearly has to be long maturity bonds – there have long been rumours that the euro bonds might be offered. Remains to be seen.

Apart from what will be offered the question is when. Governor Guðmundsson vaguely talks about few weeks or few months. To Rúv minister of finance Bjarni Benediktsson said the new investment offers were being worked on. “We hope to conclude this part of the matter in the coming months. I would mention the first half of the year in this context. That is what all our work aims at but it would not be responsible to fix exact dates.”

Considering how tortuous the path towards lifting the controls has been so far, in spite of the optimism expressed by Benediktsson and prime minister Sigmundur Davíð Gunnlaugsson when they came to power, it is not advisable to hold one’s breath. However, if the government wants to maintain credibility and trust in these issues, home and abroad, it has to act resolutely and not too sluggishly.

In terms of securing the offshore ISK funds, hindering instability, the measures now are only half a step: these are the restrictions – the offer to go with it, the other half step, is still missing. Until that step has been taken the usefulness of this measure cannot be judged.

Steps so far

Interestingly, Benediktsson talked about the new measures as the “first steps” towards lifting the capital controls. It can be debated which measures have been towards lifting controls but there have definitely been other measures, which merit to be called “steps towards lifting the controls.”

The first plan to lift controls was published in the summer of 2009 in co-operation with the International Monetary Fund as Iceland was then in an IMF programme. The CBI published a new plan in March 2011. The CBI auctions, an important step intended to reduce the offshore IKS, ended now in February.

Another major step was the bonds agreement between Landsbankinn and the LBI, the estate of the old Landsbanki May 5 2014. Although the agreement had been long time in the making Benediktsson, who needed to grant the exemption from capital controls in order to complete the agreement, took until December 4 2014 to grant the exemptions needed. I have earlier pointed out that it seems to have been more the irritation of the UK government, notably (fearsome) Andrea Leadsom, which pushed Benediktsson to take that step rather than any political energy and initiative on the Icelandic side.

The political outlook

There have been certain discernible trends lately in the political debate on the capital controls. Prime minister Gunnlaugsson has lately neither talked about the exact sums, the ISK billions, he claims the state should gain from the estates nor has he talked about vulture funds, as he did earlier. His new reasoning is “fairness:” Iceland suffered from the collapse of the banks, i.e. the banks caused sufferings and now it would be only fair that the banks paid back to the state for the hardship caused.

Apart from this rather narrow retelling of the collapse saga – after all the SIC report gave a somewhat more nuanced picture of a wider failure of public institutions, politicians and banks – Gunnlaugsson has referred to practices abroad, that foreign banks have paid fines to make up for their misdeeds towards society. (In general, the prime minister has become well known in Iceland for his at time rather inaccurate grasp of facts and reality).

Gunnlaugsson has also recently said in an article in Fréttablaðið that the new banks are too big, they got too much assets on too favourable terms, again arguments for the state getting a cut of the estates (an echo of an earlier debate where an old industrialist, Víglundur Þorsteinsson has been making similar claims, see here). On the same day Gunnlaugsson’s article was published, four members of In Defence, the organisation formed to fight the Icesave agreement, wrote an article in Kjarninn.

The four asked if the state is really going to enable foreign investors to run off with the equivalent of a whole year GDP, partly the profit from resurrecting the economy, paid for with the great sacrifice of Icelanders and sky-high loans. Their suggestion is an exit tax of 60%, not the 40% they claim Benediktsson has mentioned (which he has not; on the contrary he has been unwilling to confirm exit tax and much less any percentage). Gunnlaugsson was at the time very close to In Defense, which has neither been seen nor heard for years until now. It is hardly a coincidence that the two articles appeared the same day.

Benediktsson has mentioned the cost to society of the banking collapse but he has never argued for great sums to be gained from the resolution of the estates. In a speech last October he made some general comments on the controls, the topic of an earlier Icelog: Benediktsson want to avoid risk of legal wrangling with creditors and prefers simple and straightforward solutions.

Eiríkur Svavarsson, who now has left the group of the government advisers, was a vocal part of the In Defence group and is said to be close to the prime minister. Svavarsson has not been replaced. There has been no official announcements of this change, nor has there been a formal announcement of the new member, Ásgeir Helgi Reykfjörð Gylfason.

The prime minister has recently expressed his opinion that not too much should be said about the lifting of the controls since that might feed valuable intelligence to creditors. Whether the names of advisers are part of this intelligence, which should be hidden from creditors, is not clear. It does however look strangely lackadaisical that there is so little stringency as to what is announced and what is not.

Lately, members of Parliament have complained about the secrecy regarding lifting the controls, claiming they are kept uninformed. The Ministry of Finance has now published the text of the contract all advisers have to sign, see the text here (in English) with relevant laws on insiders. Interestingly, there is now gardening leave stipulated at the end of the assignment.

Glenn Kim is still in charge of the group, at least in name; some observers close to the process claim he is increasingly distant and not much seen in Iceland lately.

Looking for a solution that cannot be found

In earlier Icelogs I have often referred to an alleged split between the two government leaders as to how to tackle the estates. The two have time and again denied these rumours but the rumours are still alive and kicking. There are also speculations in the Icelandic media that the underlying strive of the government is to be in the position of deciding to whom the banks are sold.

Both government leaders have talked about the need for a holistic solution. Exit tax on all cross border transactions has i.a. been mentioned. The problem here is that this tax would hit all cross border capital, also debt payment of Icelandic entities – and it will not reduce the core problem: the foreign-owned ISK assets in the estates. I have the feeling that this idea has been abandoned: it might in theory bring the much-desired funds to the state (which is actually doing rather well, thank you, and not much wanting, compared to many other European countries) but it is for many reasons unworkable.

As I pointed out to Reuters it seems that these conflicting views prevent the government from acting on capital controls. But it might me more than only conflicting views. After watching one group of advisers after the other working on capital controls I cannot avoid the feeling that the government is looking for a solution that does not exist. A solution that i.a. would bring funds to the state, make it possible for the government to decide who owns the banks and yet be simple and risk-free. Like the drunken Scot looking for his penny under the street lamp because the light is there, though he lost it elsewhere, the government has been using, or squandering time, on a solution nowhere to be found.

This is doubly regrettable because the problems Iceland faces are neither unique nor particularly hard to solve. That is if, instead of looking for a home-grown Icelandic solution, advisers would look for realistic solutions where the gain would be not billions to the state but the trophy of lifting the controls. Instead, while the search for the non-existing solution, Icelandic businesses are slowly being starved of oxygen as always happens in countries with long-time capital controls.

As far as I understand the two government leaders have not reached an understanding as to how to proceed. Their statements on the capital controls and the banks normally point in different directions. The closer to dealing with the estates the more difficult to iron out these divergences and the harder the political cohesion of the government will be tested. As the drunken Scot found out looking for a solution where it demonstrable is nowhere to found is never a promising approach.

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Both in Cyprus and Iceland foreign funds flowed into the islands, in the end forcing the government to make use of extreme measures when the tide turned. These measures are normally called ‘capital controls’ which in these two cases hides the fact that the measures used are fundamentally different in all but name. In Iceland, the controls contain the effect of lacking foreign currency, effectively a balance of payment problem – in Cyprus, the controls were a way of defending banks against bank run, i.e. preventing depositors to move funds freely.

It is a sobering thought that two European countries now have capital controls: Iceland and Cyprus; sobering for those who think that in modern times capital controls are only ever used by emerging markets and other immature economies. Cyprus has been a member of the European Union, EU, since 2004 and part of the Eurozone since 2008; since 1994 Iceland has been member of the European Economic Area, EEA, i.e. the inner market of the EU. – The two EEA countries were forced to use measures not much considered in Europe since the Bretton Woods agreement.

Although the concept “capital controls” is generally used for the restrictions in both countries the International Monetary Fund, IMF, is rightly more specific. It talks about “capital controls” in Iceland and “payment restrictions,” i.e. both domestic and external, in Cyprus.

Both countries enjoyed EEA’s four freedoms, i.e. freedom of goods, persons, services and capital. –Article 63 of the Treaty on the Functioning of the European Union prohibits “all restrictions” on the movement of capital between Member States and between Member States and third countries.

Both countries attracted foreign funds but different kind of flows. While the going was good the two islands seemed to be thriving on inflows of foreign funds; in Iceland as a straight shot into the economy, in Cyprus by building a financial industry around the inflows. Yet, in the end the islands’ financial collapse showed that neither country had the infrastructure to oversee and regulate a rapidly expanding financial sector.

It can be argued that in spite of the geography both countries were immature emerging markets suffering from the illusion that they were mature economies just because they were part of the EEA. As a consequence, both countries now have capital controls and clipped wings, i.e. with only three of the EEA’s four fundamental freedoms.

The “international finance centre”-tag and foreign funds

Large inflows of foreign funds are a classic threat to financial stability. At the slightest sign of troubles the tide turns and these funds flow out, as experienced by many Asian countries in the 1980s and the 1990s. Capital controls are the classic tool to resume control over the situation. None of this was supposed to happen in Europe – and yet it did.

Although not on the OECD list of tax havens Cyprus has attracted international funds seeking secrecy by inviting companies with no Cypriot operations to register. After the collapse of the Soviet Union money from Russia and Eastern Europe flowed to the island as well as from the Arab world. Even Icelandic tycoons some of whom grew rich in Russia made use of the offshore universe in Cyprus.

The attraction of Cyprus was political stability, infrastructure, a legal system inherited from its time as a British colony and the fact that English is widely spoken in Cyprus. By the time of the collapse in March 2013 the Cypriot banking sector had expanded to be the equivalent of seven times the island’s GDP. This status did also clearly limit the crisis measures: president Nicos Anastasiades was apparently adamant to shelter the reputation of Cyprus as an international finance centre arguably resulting in a worse deal and greater suffering for the islanders themselves (see my article on the Cyprus collapse and bailout here).

Iceland also tested the offshore regime. Under the influence of a growing and partly privatised financial sector the Icelandic Parliament passed legislation in 1999 allowing for foreign companies with no Icelandic operations to be registered in Iceland. Although it could be argued that Iceland enjoyed much the same conditions as Cyprus, i.e. political stability etc. (minus an English legal system), few companies made use of the new legislation and it was abolished some years later.

But Iceland did attract other foreign funds. Around 2000 a few Icelandic companies started their shopping spree abroad. The owners were also large, in some cases the largest, shareholders of the three main banks – Kaupthing, Landsbanki and Glitnir. The banks’ executives saw great opportunities for the banks to grow in conjunction with the expanding empires of their main shareholders and largest clients. By 2003 the financial sector was entirely privatised, another important step towards the expansion of the financial sector.

In addition, the Icelandic banks had offered high interest accounts abroad from autumn 2006, first in the UK, later in the Netherlands and other European countries, even as late as May 2008. Clearly, Icelandic deposits were not enough to feed the growing banks. They found funding on international markets brimming with money. In 2005 the three banks sought foreign financing to the amount of €14bn, slightly above the Icelandic GDP at the time. In seven years up to the collapse the banks grew 20-fold. In the boom times from 2004 the assets of the three banks expanded from 100% of GDP to 923% at the end of 2007.

The Icelandic crunch: lack of foreign reserve

At the collapse of the Icelandic banks in October 2008 Icelandic króna, ISK, owned by foreigners, mostly through so-called “glacier bonds” and other ISK high interest-rates products amounted to 44% of GDP. These products, popular with investors seeking to make money on high Icelandic interest rates, had been flowing into the country, very much like “hot money” flowing to Asian countries during 1980s and 1990s.

Already in early 2005 foreign analysts spotted funding as the weakness of the Icelandic banks. In. February 2006 Fitch pointed out how dependent on foreign funding the Icelandic banks were. In order to diversify its funding one bank, Landsbanki, turned to British depositors in October 2006 with its later so infamous Icesave accounts. The two other banks followed suit. In addition, the banks were supporting carry trade for international investors making use of high interest rates in Iceland.

Steady stream of bad news from Iceland during much of 2008 caused the króna to depreciate drastically. After the collapse foreigners with funds in Iceland sought to withdraw them. On November 28 2008 the Central Bank of Iceland, CBI, with the blessing of the IMF, put capital controls in place (an overview of events here). IMF’s favourable stance to capital controls was a novelty at the time; not until autumn 2010 did the Fund officially admit that controls could at times solve acute problems as indeed in Iceland.

It was clear that the CBI’s foreign reserves were not large enough to meet the demand for converting ISK into foreign currency. What no one had wanted to face before the collapse was that the CBI could not possibly be a lender of last resort in foreign currency.

The controls were from the beginning on capital, i.e. capital could neither move freely out of the country nor into the country. The controls were not on goods and services, hence companies could buy what they needed and people travel but investment flows were interrupted (further re the controls see here).

The migrating króna problem

The core problem calling for controls was and still is ISK owned by foreigners, i.e. offshore ISK, but the nature of the problem has changed over the years: the original carry trade overhang has dwindled down to 16% of GDP, through CBI auctions where funds seeking to leave were matched with funds seeking to enter. Now, the major problem is foreign-owned ISK assets in the estates of the three banks, i.e. owned by foreign creditors who, without controls, would seek to convert their ISK into foreign currency.*

As outlined in CBI’s latest Financial Stability report, published last September there is a difference between the onshore and the offshore ISK rate: 17% in autumn 2014, about half of what it was a year earlier. These and other factors indicate that the non-resident ISK owners, i.e. those who owned funds in the original overhangs, are most likely patient investors; after all, interest rates in Iceland are higher than in the Eurozone. Although these investors cannot move their funds abroad the interests can be taken out of the country.

The classic problem with capital controls as in Iceland is that the controls – put in place to gain time to solve the problems, which made them necessary – can also with time shelter inaction. With the controls in place the urgency to lift them disappears. Over time, controls invariably create problems as the CBI pointed out in its latest Financial Stability report: The most obvious (cost) is the direct expense involved in enforcing and complying with them. But more onerous are the indirect costs, which can be difficult to measure. The controls affect the decisions made by firms and individuals, including investment decisions. Over time, the controls distort economic activities that adapt to them, ultimately reducing GDP growth. 

The main ISK problem is now nesting in the estates of the three collapsed banks where the problem, as spelled out in the CBI’s last Financial Stability report , is that “…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. This is equivalent to the difference in the value of domestic assets that will revert to foreign creditors, on the one hand, and foreign assets that will revert to domestic creditors, on the other. The impact on the balance of payments is somewhat less, at 510 b.kr., or 26% of GDP.

The balance of payment, BoP, problem could be solved in various ways, i.a. through swaps between Icelandic creditors who are set to get foreign currency assets from the estates, sales of ISK assets for foreign currency and write-down on some of the ISK assets. In addition there are tried and tested remedies such as time-structured exit tax where those who are most keen to leave pay an exit tax, which is then scaled back as the problem shrinks.

The political stalemate

In March 2011, under the Left government in office from early 2009 until spring 2013, the CBI published Capital account liberalisation strategy, still the official strategy. The strategy is first to tackle the offshore króna problem outside the estates, which has been done successfully (judging by the diminishing difference between the on- and offshore ISK rate) through the CBI auctions. That part of the strategy has now come to an end with the last auction held on 10 February.

The next important step towards lifting the controls is finding a solution to the foreign-owned ISK in the bank estates. Their creditors are mostly foreign financial institutions, either the original bondholders or investors who have bought claims on the secondary market.

As indicated above there are solutions – after all, Iceland is not the first country to make use of capital controls while struggling with BoP impasse. However, as long as the political unwillingness, or fear, to engage with creditors prevails nothing much will happen.

When the present Icelandic coalition government of Progressive party (centre; old agrarian party) and the Independence party (C) came to power in spring 2013 it promised rapid abolition of the capital controls. So far, the process has been a protracted one with changing advisers, unclear goals and general procrastination. There has at times been an echo of the belligerent Argentinian tone, blaming foreign creditors for the inertia in solving the underlying problems; importantly, the Progressive party has promised huge public gains from the resolution of the estates, which it seems to struggle to fulfil.

In its concluding statement in December 2014 following the Article IV Consultation IMF points out that the path chosen in lifting the controls “will shape Iceland for years to come. The strategy for lifting the controls should: (i) emphasize stability; (ii) remain comprehensive and conditions-based; (iii) be based on credible analysis; and (iv) give emphasis to a cooperative approach, combined with incentives to participate, to help mitigate risks.” The “cooperative approach” refers to some sort of negotiations with creditors, which the government has so far completely ruled out.

It is important to keep in mind that the estates of the banks, by now the major obstacle in lifting the controls, are estates of failed private companies. The banks were not nationalised and the state has no formal control over the estates. However, as long as the ISK problems of the estates are unsolved the winding-up procedure cannot be finished and consequently there can be no payouts to creditors.

The winding-up procedure will either end with bankruptcy proceedings, which majority of creditors are against, or with composition agreement, which the majority seems to favour. Crucially, the minister of finance has to agree to exemptions needed for composition, which means that the government is indirectly if not directly responsible for the fate of the estates.

The political tension regarding the controls is between those who claim that solving problems necessary to lift the controls is the main objective and those who claim that no, this is not enough: the state needs and should get a cut of the estates.

Finance minister Bjarni Benediktsson has strongly indicated that his objective is to lift the controls whereas prime minister Sigmundur Davíð Gunnlaugsson has allegedly been of the latter view. He has recently been supporting his views by stressing the great harm the banks caused Iceland reasoning that pay-back from the banks would be only fair. This simplified saga of the banking collapse is in conflict with the 2010 report of the Special Investigative Committee, SIC, which spelled out the cause of the collapse as regulatory failure, failure of the CBI and political failure in addition to how the banks were funded and managed.

The government has Icelandic and foreign advisers working on these issues. But as long as the government does not make up its mind on what direction to take nothing moves. Meanwhile Iceland is effectively cut from markets, which makes the financing cost high, in addition to other detrimental effects of the capital controls.

The Cypriot crunch: bank run

The run up to the Cypriot banking collapse in March 2013 was a sorry saga of mismanaged banks, mismanaged country and the stubborn denial of the situation ever since Cyprus lost market access in May 2011. But contrary to Iceland, there has been no investigative report into the collapse, which means that in Cyprus hardly any lessons can be drawn yet from the calamities.

Data from the European Central Bank, ECB, shows that deposits were seeping out: in June 2012 they stood at €81.2bn. In January 2013 they were €72.1bn, down by 2%, in February at €70bn, 2.1% month on month and in March €64.3bn. According to the Anastasiades report (written at the behest of president Anastasiades, leaked to NYTimes and published in November 2014) €3.3bn were taken out of Cypriot banks March 8–15, the week up to the bail-in.

This was an altogether different situation from circumstances in Iceland ensuing from the collapsing banks. Cyprus, part of the Eurozone, was not struggling to convert euros to other currency but it was struggling to convince those holding funds in the Cypriot banks not to withdraw them and move them abroad.

As Iceland, Cyprus was trying to maintain a banking system far larger than the domestic economy could possibly support under adverse circumstances. By the end of 2011 there were 41 banks in Cyprus: only six were Cypriot; 16 were from EU countries and tellingly 19 were non-EU banks. It was clear to regulators that the size was a risk but they maintained that both regulation and supervision was conservative enough to counteract the risk, as bravely stated in a report by the Ministry of Finance on the financial sector in Cyprus. – Ironically, Cyprus had to seek help from the troika just a few months after these assertive words were written.

The controls were put in place with the full acceptance of the troika, i.e. the IMF, the EU Commission and the ECB. “The Enforcement of Restrictive Measures on Transactions in case of Emergency Law of 2013” as the capital controls measures were called by the Cyprus Central Bank, CBC, restricted i.a. daily cash withdrawal to €300 daily, no matter if directly or with a card, or its equivalent in foreign currency, per person in each credit institution. Cheques could not be cashed.

Trade transactions were restricted to €5,000 per day; payments above this sum, up to €200,000 were subject to the approval of a Committee established within the CBC to deal with issues related to the controls. For payments above €200,000 the Committee would take into account the liquidity buffer situation of the credit institution. Salaries could be paid out based on supporting documents. Those travelling abroad could only take the equivalent of €1,000 with them.

The roadmap for abolishing them came in August 2013, again with the full blessing of the troika. There was no time frame, only that the measures would be “in place for as long as it is strictly necessary.” They would be removed gradually and with prudence, always with a view on financial stability. First the restrictive measures on transaction within Cyprus would be abolished and only subsequently could the restrictions on cross-border transactions be lifted.

The controls have since gradually been eased and by May 2014 all domestic restrictions were indeed fully eliminated. On 5 December 2014 i.a. the limit for travel abroad was sat at €6,000, from previous €3,000 and business activity not subject to approval was sat at €2m. With the last change, on 13 February, those travelling abroad can now take €10,000 with them. Transfers of funds abroad were increased from the December limit of €10,000 to €50,000. The island’s pension funds are still subject to capital controls.

As in Iceland, abolishing, for unspecified time, one of the EEA’s freedoms was to be in place only for a short time. Until late 2014 it seemed as if the Cypriot capital controls might be entirely abolished by the end of that year. That did not happen. The last bit remaining is the politically tough one.

The task for Cyprus: overcoming the political hurdles

With the domestic restrictions abolished the IMF Staff report in October 2014 for the Article IV Consultation pointed out that the “external-payment restrictions” in Cyprus have to be relaxed in a gradual and transparent way. “…owing to the short deposit-maturity structure, significant foreign deposits (close to 40 percent of the total), large reliance of BoC (Bank of Cyprus) on ELA (Emergency Liquidity Assistance), and the lack of other market funding, external restrictions remain in place. While restrictions do not apply to fresh foreign inflows into Cyprus, they limit outflows, hampering trade credit and affecting overall confidence.” If the external restrictions remain in place they can damage investors’ confidence and consequently foreign direct investment, FDI.

As in Iceland, the main Cypriot problems stem from political tensions, which “could have adverse implications for confidence and the recovery,” according to the IMF. The key obstacle in Cyprus is lack of progress in addressing non-performing loans, NPL, staggeringly high in Cyprus at 37.9% of total gross loans in 2014. Debt-restructuring framework, including i.a. a foreclosure legislation and insolvency regime is still a lingering political problem. Further, banks need to restructure and build capital buffers, critical to lift the remaining restrictions.

Visiting Cyprus in early December I was told that the work on the NPLs was about to be finished and a new insolvency framework would be in place by the end of the year. It is still not in place, a sign that the politial tensions have not eased. In spite of all that has been done Cypriots have lost trust in their banking system: almost two years after the collapse it is estimated that the islanders keep up to 6% of GDP at home, under their proverbial mattresses or wherever people stash cash.

The political test for Cyprus and Iceland

Both islands face a political challenge lifting capital controls.

In 2012 the CBI published a report on Prudential Rules Following Capital Controls, thus outlining what is needed once the capital controls have been lifted. This is greatly facilitated by the fact outstanding work of the SIC. Consequently, life and prudence after the controls are lifted has been staked out.

Iceland is however struggling to throw off shackles of nepotism, even more so under the present government than for quite a while: personal connections seem to matter more not less than before. Lifting the controls will test the times, if they are new times with accountability, transparency and fairness or the old times of nepotism, opacity and special favours.

Cyprus stands harrowingly high on the Eurobarometer corruption index and it suffers from lack of stringent analysis of what happened, making it difficult to draw any lessons, i.e. on how regulation needs to be improved, failures at the CBC etc. Cyprus authorities have some way to go in order to win trust with the islanders. The fact that no public inquiry has been held into the collapse, no investigation, no report written adds fuel to the already low trust. I have earlier written that Cyprus with high unemployment and contracting economy bitterly needs hope.

Both Cyprus and Iceland will have to show that they understand what happened and how it can be prevented from happening again. The exit from capital controls for both these islands will depend on political decisions, which will shape their next decades.

*I have blogged extensively on Icelog on the capital controls in Iceland. Here is the latest one, on the politics. Here is one from end of last year, on i.a. the various possible solutions. I have at times blogged on Icelog on Cyprus or compared Iceland and Cyprus. Here is a collection of blogs on Cyprus, i.a. two on the topic of Cyprus, Iceland and capital controls. – This post is being cross posted on A Fistful of Euros.

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For the time being the topic of capital controls in Iceland seems shrouded in silence. Yes, recently yet another MP banker was added to the controls steering committee, the prime minister mentioned the controls in a speech without maligning creditors or talking about the billions the state could derive from the bank estates. In other words, so far so little, which means that little is changing from what it has been.

“Lifting the capital controls is the single most important issue for Iceland,” prime minister and leader of the Progressive party Sigmundur Davíð Gunnlaugsson said in a speech recently. Gunnlaugsson has mostly just made stray comments on the controls, lately far from his earlier so belligerent tone and no mention of the funds that could be derived from the estates.

The force minister of finance and leader of the Independence party Bjarni Benediktsson seemed to be putting into control-lifting late last year seems to have seeped out of him as he could not deliver on his promise: to present a plan by the end of 2014.

There is now little apparent energy behind this issue. Compared to same time last year the progress is that there are now foreign advisers working on capital controls and a new steering committee, the third such advisory group. In addition to hiring foreign advisers Benediktsson’s major achievement last year was pulling through the Landsbanki bond agreement. But instead of being the agreement being first it has remained the only step so far.

“I fully expect something to happen regarding the capital controls after the next election, in 2017,” was the wry comment from one Icelandic observer some days ago expressing the sentiment that this single most important issue seems to be devoid of all political urgency. The third Thursday in April is the Icelandic first day of summer when parents give their children something seasonal for summer presents such as a ball to play outside. Spring might also be the time when some next step might be taken towards lifting the capital controls.

The young and yet so lethargic power-players

The left government, in power from spring 2009 until spring 2013, surely got some things done such as targeted debt write-down for households, steering Iceland through an IMF program and dragging the country back to growth already by mid-2011. However, it was consumed by infighting and was its own worst enemy. Following this government an energetic government focusing on growth of opportunities and ideas, as well as growing the economy would have been a great asset.

A government led by two young coalition leaders – the youngest ever prime minister and a young minister of finance – seemed indeed very promising. However, in many ways the duo seems be heading towards the past rather than the future. The language of the prime minister’s tends to echo patriotic language harking back to the mid 20^th century. New appointments often seem to smell of nepotism and old ties.

The Icelandic media has at times focused on the prime minister’s somewhat erratic behaviour; apparently he often goes on un-announced trips abroad. He has the habit of making remarks that then turn out to be factually wrong or misleading. Words seem to come very easy to the prime minister but all too often the substance is doubtful.

With the prime minister as a comparison Benediktsson strikes a more serious and competent tone and demeanour. His approach is conciliatory and he seems widely liked, except by the old guard in the party who still mourns the, perceived by them, golden age of Davíð Oddsson. It has been apparent time and again that Morgunblaðið, with Oddsson as its editor-in-chief seems to side more with Gunnlaugsson than Benediktsson reflecting that the paper is owned 50-50 by companies with ties to the Independence party and the Progressive party. A powerful person in the latter camp is Þórólfur Gíslason, a relative of Oddsson. (If blood ties matter or not is unsure but most Icelanders will see this as relevant).

The two coalition leaders come from families at the heart of the Icelandic power structure. Benediktsson’s family is the core of the Independence party story of power. His namesake, the brother of his grandfather (if my genealogy does not fail me) was a legendary leader of the party from 1963 to 1970, the party’s glorious age. “It’s not enough just to carry this name,” one Independence voter remarked sardonically. Gunnlaugsson’s political family ties only goe back a generation: his father was briefly an MP and his business interests allegedly rose from political connections.

Political deadlock

Although the government tension is not apparent on the surface the tension shows in the fact that amazingly little seems to get done. The government is i.a. hovering as to breaking up the EU membership negotiation or not. A recent example is a draft proposal for a new Act on fishery management, expected to be introduced to Alþingi before its summer recess; the proposal’s course is now uncertain. Another topic is the Interconnector, i.e. a cable connecting Iceland to the UK: UK has shown interest in buying Icelandic electricity but the government seems unable to act on this interest, i.a. due to deep-running political and interest divergences on this issue.

On the whole, the government is seen as moving slowly, even remarkably slowly, considering that is has a strong majority and no internal opposition, at least not on the surface. It is also blessed with an opposition, which for a long time seemed to be waking up every day from a crushing defeat the previous night. Only recently the leaders of the Left Green and the social democrats have made a bit of a splash in the political debate.

There are no apparent explanations as to why the government is so lethargic. It is not so much words as action that “don’t come easy:” the prime minister is good at making speeches about the promising future of Iceland but moving beyond the words is difficult.

As one source in the Icelandic business community said there are plenty of examples in the world of countries with natural resources and other advantages that still do not manage to harness what they have. “Capturing the possibilities doesn’t happen automatically.” In Iceland, it seems not to be happening at all.

The latest polls show that the government now has support of 36.4% of the voters, compared to 34.1% end of January and 34.8% mid January. The top line figures are Independence party 25.5%, compared to 24.9% earlier and the Progressive party 13.1%, compared to 12.7%. Hovering around 25% is the Independence party’s destiny now, far from the around and above 40% at the time of Benediktsson’s namesake in power, last seen in the elections in 1999, 40.7%, under Oddsson’s leadership. – The fractioned opposition, four parties, are not moving the voters much.

Yet another committee

Following the meeting between the Winding-up boards and their advisers with the government’s advisers in December the feeling was one of cautious optimism among creditors. At the time, Benediktsson had for months boldly been announcing “a plan” by the end of the year.

Unofficial announcements following the meeting were that everything should be in place to proceed early in the New Year. In his end-of-year interviews and statements the prime minister, in his freewheeling mode, drummed up the optimism by first talking about “a plan” soon, then by the end of January. This has to be seen in context with statements after coming to power in summer of 2013 as to how easy and quick the lifting of the controls would and could be.

The only thing that January brought was a new committee. As earlier, Glenn Kim is the chairman. Others are Benedikt Gíslason, adviser to Benediktsson, and Eiríkur Svavarsson, by now veterans in this field, together with Sigurður Hannesson from MP Bank, a close friend of Gunnlaugsson and two from the CBI, Ingibjörg Guðbjartsdóttir and Jón Sigurgeirsson.

Gíslason used to work at MP Bank and now just recently MP bank’s chief legal officer, Ásgeir Helgi Reykfjörð Gylfason (this long names are uncommon in Iceland) has been added to the committee.* The CEO of MP Bank is Gunnlaugsson’s brother-in-law but as the bank stated in its press release on Gylfason it is proud that the bank’s expert are sought to work on such important issues.

Svavarsson, Hannesson and Gylfason are seen as close to the prime minister. Sigurgeirsson is close to the governor of the CBI, who shares a good understanding with Benediktsson. Apart from speculations of intimacy and allegiance, it is worrying that none of the Icelandic lawyers on the committee has any international experience.

This is the third group set up to work on the capital controls. The feeling is that previous groups have broken apart because of differences of opinion on how to approach the resolution of the three bank estates, a necessary step towards lifting the controls.

What could come next, apart from more procrastination?

Glitnir has made news in Iceland following a leak that Íslandsbanki might be sold to Middle Eastern investors. Earlier, Chinese interest had been in the air. Certainly, selling Arion, owned by Kaupthing, and Íslandsbanki would make a composition easier.

The estates have had plenty of time to calculate a positive outcome. Although no decision was announced for a next meeting after the December meeting it is expected that another meeting will or would follow soon.

Some weeks ago Víglundur Þorsteinsson, an old businessman who lost his company into bankruptcy following the banking collapse, made allegation about wrongdoing regarding the splitting up of the banks, i.a. that creditors had profited unduly. This was not the first time he stated these claims and he has never found any serious support for them. This time the prime minister sided with him, saying this should be investigated.

Brynjar Níelsson, an Independence party MP, got the task of reviewing the claims, which he did by utterly rubbishing them. It is not clear if the prime minister will see this case as a reason to move slowly regarding the estates, probably not, but his support to Þorsteinsson was much noted.

As far as is known the new group is working on proposals towards lifting the controls. The two coalition leaders have often spoken about a “holistic solution,” a “framework” etc. Considering the fact that the two estates ripe for composition, Kaupthing and Glitnir, have very different problems – Kaupthing with no ISK assets beyond its ownership of Arion but Glitnir with ca. ISK100bn in addition to Íslandsbanki – the framework might turn out to be of a general nature so as to accommodate tailored solutions for the estates.

The much discussed exit tax might be pressed for, in order to get the funds the prime minister seems to think can be had from the estates. However, as I have pointed out earlier exit tax does not solve the ISK problem, unless used in a targeted way, as did Malaysia in the late 1990s. Possible solutions have been dealt with in earlier blogs.

The business community is up in arms about the stalemate on controls but the voters do not really sense the effect of the controls, meaning there is only a moderate pressure on the government to act. As pointed out earlier it seems that the two coalition leaders do not proceed on the controls because they really are at loggerheads on how to go about it. There really is no longer anything unknown in this issue. It has all been mulled over, no stone is unturned. What is lacking are decisions, not more analysis etc.

At the core of that dispute is really if lifting the controls is a gain in itself or if Benediktsson is willing to help Gunnlaugsson find a way to lift the controls in such a way that he, the prime minister, can proclaim victory.

*As reported earlier, the appointment of Sigurður Hannesson was first announced by MP Bank, not confirmed by the government until days later. Now the saga is being repeating by appointment of Gylfason: the bank announced his secondment on February 13 but no official announcement has yet been made by the Ministry of Finance. Another indication of the lackadaisical attitude for formalities.

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After rumours on imminent changes or reshuffle of advisers working on capital controls it now seems that such movements are indeed about to happen.

According to DV (now owned by Progressive Party supporters who hired journalist Hörður Ægisson, previously at Morgunblaðið, a constant source of scoops from the CBI and the ministry of finance; media-ownership in Iceland is an increasingly intriguing saga, big changes there these days and weeks) Freyr Hermannsson, Eiríkur Svavarsson and the chairman of the (previous/present?) advisory committee Glenn Kim will not be continuing.

The new name is Sigurður Hannesson* from MP Bank, known in Iceland as a close friend of prime minister Sigmundur Davíð Gunnlaugsson and believed to have been a source of ideas for the PM over the years. Hannesson was a chairman of a working group advising on indexed loans, a topic close to the PM’s heart. Benedikt Gíslason, an adviser to minister of finance Bjarni Benediktsson and a member of the Glenn Kim committee, is also said to be part of the committee in spe. An alleged third member of the committee is not been named in DV.

If this move turns out to be true and the task of this group, manned only by Icelanders, will be to identify solutions to ease or lift the capital controls this spells two things: a) the solutions will be “home-brewed,” i.e. not formed in co-operation with anyone familiar with the international debt-scene b) the PM is strengthening his grip on the topic of capital control although it is formally under Benediktsson’s ministry. If this becomes too obvious it will make the already unhappy Independence party parliamentary group, feeling that their bigger party is continuously working on Progressive party policies and not their own, yet more unhappy.

The Glenn Kim group was the second group set up to work on the capital controls and its task seemed to be to find solutions to finally find ways to  lifting the controls. No plans have been made public in spite of Benediktsson repeatedly saying that such plans would be finalised by the end of the year. A refrain from the leaders, especially the PM, has been that creditors have to meet the expectations of the government and the interests of Iceland. It now seems that neither the first group nor the second have come up with the solution the two leaders expected them to. So the leaders might as well try their luck yet again.

Everything done so far has been marked by a lack of unity by the two coalition leaders. Another group seems a way of postponing action. With all the work done by the CBI, the first group and then the Glenn group it surely seems unlikely that much is left to discover. What is more likely is that the PM and Benediktsson still are, as is widely rumoured, at loggerheads on how to proceed. A new group would then be an exercise in can-kicking. As one source said: “As long as the two leaders have not negotiated a solution amongst themselves no solution is in sight.”

What could possibly focus the minds of the two leaders? One underlying issue is the future ownership of Íslandsbanki and Arion, owned respectively by Glitnir and Kaupthing, i.e. creditors. If the two leaders, both from wealthy families with ties in the business sector, want to influence who gets to own the banks their time to do it is limited; the next election is scheduled in spring 2017. Iceland, right now with a contracting** economy, is smarting from capital controls and the leaders are playing the fiddle – or at least fiddling with their advisers.

*Update: MP Bank has now confirmed that Hannesson will take a temporary leave from the bank to work as an adviser on capital controls to the government. Interestingly, neither the Office of the Prime Minister nor the ministry of finance have mentioned this new adviser. 

**Update: one Icelandic reader disagrees that the Icelandic economy is contracting pointing out that the stats for the first nine months shows less growth than previously but this is expected to change with the whole-year stats. This is indeed the general expectations among Icelandic economists; I’ve even heard that the reason for the unexpected dip are staff changes at the Icelandic Statistical Bureau. However, I spoke to one person with a keen insight into the Icelandic labour market whose impressions were in accordance with the stats. – Remains to be seen, more on this later.

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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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The Icelandic media is full of news of an apparently imminent exit tax though on what exactly is less clear. I’ve dealt with it before – it is a major difference if this will be solely on the ISK assets of the bank estates or if this will be, as the plan seems to be, on all capital movements in and out of Iceland. If an all-inclusive exit tax, there still needs to be some settlement regarding the ISK assets of the estates, notably Glitnir and Kaupthing.

In spite of optimistic words from minister of finance Bjarni Benediktsson on a plan before end of the year on lifting controls and a sentence in prime minister Sigmundur Davíð Gunnlaugsson’s speech at Progressive Party meeting on Saturday I still have the feeling not much is happening when it comes down to concrete, realistic on-paper decisions. My sense is that there is more legal writ-rattling among creditors as to possible court cases than there is plan-shuffling among Icelandic authorities.

I have wondered earlier that an exit tax might be the New Year crackers this year. But there is also an Icelandic tradition for giving summer presents on third Thursday of April every year. If nothing to fill the  New Year crackers then perhaps something for a summer present when the days start to get longer in Iceland.

More on all of this in greater detail later.

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Understanding constellations in Icelandic politics, not solely the economics, is the key in order to understand what could and might happen in Iceland regarding the capital controls. Although ex-prime minister Davíð Oddsson left office in 2004 he still seems to be the puppet master and king maker in Icelandic politics. Thus, Morgunblaðið, edited by Oddsson can be read like entrails in the olden times. Comparing the recent IMF report and what Morgunblaðið states provides some hints to what might come – and none of it is uplifting in view of general Icelandic interests.

On an Icelandic debate programme earlier this year one of the participants claimed that when it comes to the capital controls Icelanders are fighting to solve a problem of “hundreds of thousands of billions króna.” – None of the other participants corrected this. The Icelandic GDP 2013 was ISK1786bn, €11.5bn, which would make “hundreds of thousands of billions króna” a truly staggering, if not a hopeless problem to solve. Luckily, the problems are not quite that towering though in no way easy to deal with.

For control-watchers, reading Morgunblaðið like entrails, looking for hidden signs, is essential. A point in case is a recent article on Project Irminger.

Davíð Oddsson, its editor, used to run the country and his party, the Independence party in the 1990s, then switched over to run the CBI (needless to say a lawyer ex-prime minister turning governor of a central bank is unthinkable in all Western countries except Iceland) where he oversaw the collapse of the Icelandic economy and the CBI and from where he was ousted by public demonstrations in early 2009. As editor of Morgunblaðið he has overseen a steep fall in subscription but its owners – 50/50 a fishing-industry with Independence party ties and a Skagafjörður co-op traditionally linked to the Progressive party, thus miraculously mirroring the present coalition government – are more than happy to have him in charge, even after a recent gaff of staggering dimensions.*

The Morgunblaðið entrails and other signs could indicate that the lifting of the controls will be used to steer the two new banks – Arion and Íslandsbanki – into Icelandic ownership. And there needs to be something that looks like a victory for the Progressive-lead government. Prime minister Sigmundur Davíð Gunnlaugsson has time and again talked about the “inevitability” of the state profiting from lifting the controls.

While waiting for the next step towards lifting the capital controls appointing a new governor of the CBI will be a significant indication of the direction the government is heading into.

IMF: the orderly and the disorderly legal route

In its latest report on Iceland the IMF is worried about downward-tilted risks, i.a. in lifting or unwinding the capital controls: “A disorderly unwinding of capital controls could weaken the krona, lower reserves, and bring down market confidence and growth.” “An orderly lifting of capital controls, however, would prevent large capital outflows and disruptions to financial markets.” It is thus glaringly obvious what the IMF wants to avoid sternly warning the government of the dangers of actions leading to disruption and disorder. After all, Iceland very much needs continued access to financial markets.

Creditors cannot be paid out until the estates of the old banks are resolved, either by putting them up for bankruptcy or with a composition agreement. Here the IMF is also clear as to what constitutes an orderly route out of capital controls:

Two broad legal avenues are being discussed, one involving composition agreements that would provide an agreed roadmap for exit and the other involving bankruptcy proceedings (liquidation) with an uncertain exit from controls.

And then there is the reputational risk to keep in mind:

“Staff noted the importance of carefully considering the legal and reputational risks surrounding the strategy for addressing potential BOP pressures now locked in by capital controls, including the resolution of the old bank estates.” (My take on the IMF report is here.)

Project Irminger

The above-mentioned article in Morgunblaðið stated that the government kept the IMF thoroughly informed on every step. Consequently, the IMF was now aware of the government’s estimate of the problems and the avenues it believes passable. Further, according to the article, the IMF agrees with the government it is important not to exclude any possibilities; this was necessary in order to create incentives for creditors to bring to the table a solution fitting the Icelandic balance of payment.

Although the article was published weeks after the IMF report on Iceland the report does not figure in the Morgunblaðið article. On the contrary, the article creates the feeling that the IMF was equally in favour of the two legal routes and broadly in favour of what the government had in mind.

As can be seen from the quotes from the IMF report the Fund is indeed not mincing its words as to the best and most viable routes. Knowing from Morgunblaðið that the IMF is well informed there can be no misunderstanding when it i.a. clearly warns against the bankruptcy route that both the prime minister and minister of finance mention as an option every time they discuss publicly the capital controls and the estates.

The Morgunblaðið article states that the government is now working on a project called Project Irminger (named after an ocean stream that brings warm water to the South West coast of Iceland). The Irminger project seems to give no scope for negotiations with the creditors in spite of their attempts in that direction, at least since end of 2012 when both Glitnir and Kaupthing presented a draft of a composition agreement to the CBI.

Instead, possibly in September (unlikely soon, to my mind; every step announced by the government tends to take much longer than planned) according to the article, creditors will be presented with an analysis of Iceland’s economy, balance of payment etc after which they can adopt their composition agreement to this analysis. It does not seem there will be any negotiation but some sort of a “take-it-or-leave-it” analysis (more or less as the government has been saying from its birth last year: the creditors should understand and appropriately adapt to the reality, as defined by the government). The government will wait for no longer than three months or so and if nothing is forthcoming from the creditors the bankruptcy route will be taken, the article states.

The article is not clear about in what order things will be done. The CBI and the IMF have stressed the importance of resolving Glitnir and Kaupthing’s ISK assets and the Landsbanki bonds. The pension funds and other Icelandic investors are also seeking to direct investments abroad. The order of “exiting parties,” i.e. those allowed to take/convert ISK into fx is important. Whatever the order, the IMF has clearly indicated that the “exits” can only happen over some years and it favours letting the creditors out first; an advise that is easily turned into something anti-Icelandic in the Icelandic debate (see here on the interests of the pension funds in lifting the controls).

As so often with Morgunblaðið articles on hot political topics the Irminger-article seems to be a carefully crafted leak, published to warn, threat and mis-inform.

Rumours and sentiments as to what is in the making

Key issue in solving the ISK problem of Glitnir and Kaupthing is the sales of Íslandsbanki and Arion (more here). Some control-watchers claim that the government plans to instigate a disorderly and messy winding-up process for Glitnir and Kaupthing to ensure a fire sale of two new banks enabling a sale to investors close to the government (two banks, one for each party).

As to possible actions the ideas flying around are i.a. legal measures to isolate the estates from the economy so pension funds and other Icelandic entities can convert ISK to fx, i.a. for investing abroad, i.e. would exit from the controls before the estates. Again, such measures would not be a solution, only another hammock.

There are also tentative ideas that Eignasafn Seðlabanka Íslands, ESÍ (the CBI holding company) and some pension funds could form a joint venture to buy out the new banks. The fear is that none of this is thought through or creditors’ reactions taken into account; in short that these and other rumoured measure will not at all be the orderly route the IMF recommends.

The feeling all along has been that the aim of the government has been to get hold of the banks – to secure Icelandic ownership in Icelandic interest or in Icelandic special interests, depending whom to believe. Iceland is apparently the only country in Western Europe where no foreign banks operate and where domestic investors own all banks (apart from the accidental ownership of Arion and Íslandsbanki and foreign investors in MP Bank).

It is difficult to argue why it would be the end of Icelandic businesses if Glitnir and Kaupthing were sold to foreign investors, paying in fx – thus solving the estates’ ISK problems. Foreign ownership might possibly end banking the Icelandic way that played a big role in bringing down the Icelandic financial system but those who profited from that system might certainly want to reinstate it.

Glitnir and Kaupthing – but what about selling new Landsbankinn? Incidentally, that bank is owned by the Icelandic state but the bank cannot be sold until the problems of the Landsbanki bonds is solved. There is now an agreement in place and although it seems to be close to what the CBI had advised (and after all, it can hardly have been done against the wishes of the bank’s owner, the state) the government seems unwilling to take the steps needed to ensure the agreement. Intriguingly, new bank is at the mercy of its bondholder, the Landsbanki estate where the creditors from the two other estates wield power.

The frustrating thing is that possible solutions, in the general interest of Iceland and not narrow interests, are not that difficult to map out – complicated but not complex. There are even some Icelandic civil servants who would like to negotiate with the creditors, believing that beneficial solutions could be found relatively easily and fast: it is after all in the interests of not only creditors but also Icelanders to lift the controls though Icelandic politicians tend to speak as if Iceland can wait but the creditors are in a hurry.

Interestingly, civil servants have mostly been kept away from the plans of the present government, which instead makes use of a few trusted lieutenants. The government keeps appointing Icelandic “individual experts/advisers” as it calls them in press releases though then calling them a “group” when their role is discussed. It is not clear why this systematic mis-presentation of their roles but one reason might be that formal working groups are expected to be made up of men and women whereas the two capital controls “groups” have been all-male.

The importance of a(n independent) central bank

Lastly there is the importance of CBI in what ever will happen in Iceland, soonest regarding the Landsbanki bonds agreement.

In general, IMF is adamant about the importance of independent central banks. For good reasons, the IMF has been worried about the CBI and states in its last report on Iceland: “Maintaining a financially sound, independent, and accountable central bank is important for policy credibility and anchoring inflation expectations, which in turn supports stability and growth.”

It is most likely only a matter of days until the name of the next governor will be announced. As I have written earlier the feeling is that professor Ragnar Árnason is the government’s favourite for the position though the third leading candidate, professor Friðrik Már Baldursson might be a possible compromise. It would be a stretch to see CBI’s independence strengthened with Árnason who most recently has i.a. been the government’s representative on the CBI board and the chairman of an advisory council for the minister of finance, in addition to earlier services to the Independence party for more than a decade.

In addition to the present governor Már Guðmundsson the selection committee , which was called “bizarre” in a recent article in Central Banking, deems that both Árnason and professor Friðrik Már Baldursson are equally fit to serve as a governor. To put the three side by side as equally fit is quite remarkable, to say the very least, considering Guðmundsson’s experience and standing.

The governor of the CBI will be a key person when it comes to lifting the capital controls – and in the asset sale of the century, the sales of Arion and Íslandsbanki. Hardly anything re the capital controls and the estates can be decided on without assistance of the CBI, most notably the governor of the CBI.

If Már Guðmundsson will not be reappointed as a governor it sets in jeopardy any orderly route towards lifting the capital controls. Ousting Guðmundsson might well indicate that there are interesting times ahead in Iceland but not necessarily the best of times for financial stability and the interests of Iceland as a whole.

*The Oddsson/Morgunblaðið gaff: recently, Morgunblaðið published, in quotation marks, what it claimed was part of an email written by the Althingi Ombudsman Tryggvi Gunnarsson who was on the Special Investigative Commission. The email was published July 12 in a weekly column, called “Letter from Reykjavík,” traditionally unsigned but known to be written by the editor, now Davíð Oddsson. Morgunblaðið claimed Gunnarsson had sent the mail to many news outlets in January late at night, a claim Icelanders take as a hint that the email-writer was drunk. In the email Gunnarsson sided with the Brits (highly dubious in the view of Morgunblaðið) in using the so-called terrorism legislation to freeze Icelandic assets in the UK. Further, Gunnarsson spoke badly of the president of Iceland, who Morgunblaðið holds in high esteem after he hindered an agreement in the Icesave dispute. On the day Morgunblaðið published the Tryggvason email the paper published a correction on its website, stating that the email was a forgery only to admit later in the day, with apologies to the Ombudsman, that the letter was indeed written by a certain Tryggvi Gunnarsson, namesake of the Ombudsman and not the Ombudsman. The namesake is apparently known among Icelandic media people as a prolific email writer whose opinions are never reported; his email is a Hotmail address. There was absolutely nothing in the email to indicate that the Ombudsman had written it. The second, and no less interesting part of the “Tryggvason email” story is that the editor’s atrocious mistake has had no consequence for the editor who continues in his job, unchallenged as before. The gaff was like a stone thrown into a lake producing no rings on the surface; an airy phenomenon. – Journalist Egill Helgason notes on his blog that Oddsson is driven by such hatred that in attacking his enemies scrutiny of sources is easily forgotten. – The last thing to draw attention to Oddsson’s view of the world is that Morgunblaðið’s Letter from Reykjavík July 26 talks about “Barack Hussein Obama II,” characterizing him as “indeed a mulatto,” a word that is generally no longer used in Icelandic and has the same connotations as in English.

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