PRESS RELEASE FROM THE ICELANDIC PRIME MINISTER’S OFFICE:
Reykjavik, Iceland – 17 November 2008 – In the wake of the recent international financial turmoil, Iceland’s economy is facing a banking crisis of extraordinary proportions. The economy is heading for a deep recession, a sharp rise in the fiscal deficit, and a dramatic surge in public sector debt – by about 80%. Potentially substantial capital outflows could lead to a further large loss in the value of the króna. In the context of the high leverage in the economy, this would produce massive balance sheet effects and a substantial contraction in domestic activity. The immediate challenges are, therefore, to restore a functioning and viable banking system, and to stabilize the króna. Looking further ahead, the challenge will be to reduce a very high level of public debt, by embarking on a process of sustained fiscal consolidation.
Banking sector restructuring and insolvency framework reform
The Icelandic government is committed to progressing a sound and transparent process as regards depositors and creditors in the intervened banks. Constructive work is being carried out towards comparable agreements with all international counterparts for the Iceland deposit insurance scheme in line with the EEA legal framework. Under its deposit insurance system Iceland is committed to recognize the obligations to all insured depositors. This is done under the understanding that prefinancing for these claims is available by respective foreign governments and that Iceland as well as these governments is committed to discussions within the coming days with a view to reaching agreement on the precise terms for this prefinancing. Furthermore, it is recognized that the payment by the new banks of the fair value for the assets transferred from the old banks is a key factor in the fair treatment of depositors and creditors in the intervened banks. Accordingly, we have instituted a transparent process involving two sets of independent auditors to establish the fair value of the assets. More generally, the fair, equitable and non-discriminatory treatment of depositors and creditors will be ensured in line with applicable law.
The bank regulatory framework and supervisory practice will be reviewed to strengthen the safeguards against potential new crises. Previous senior managers and major shareholders in intervened banks who are found to have mismanaged the banks should not assume similar roles for at least three years.
The insolvency framework to manage deleveraging and recovery in the banking, corporate and household sectors in an efficient manner will be reviewed.
Fiscal policy
Preliminary estimates suggest that the gross cost to the budget of honoring deposit insurance obligations and of recapitalizing both commercial banks and the Central Bank of Iceland could amount to around 80 percent of GDP and the general government deficit will be 13.5 percent of GDP in 2009. Overall, gross government debt could rise from 29 percent of GDP at end-2007 to 109 percent of GDP by end-2009. The net cost will be somewhat lower on the assumption that money can be recovered by selling assets from the old banks.
In order not to exacerbate the recession, the fiscal deficit will be allowed to widen to the extent that this is driven by higher expenditures and lower revenues due to the effects of the economic cycle. But given the high financing need and the dramatic increase in public sector debt, a planned discretionary fiscal relaxation in 2009 will be significantly scaled back.
The intention is to reduce the structural primary deficit by 2–3 percent annually over the medium-term, with the aim of achieving a small structural primary surplus by 2011 and a structural primary surplus of 3½-4 percent of GDP by 2012. A thorough analysis of the fiscal framework will be conducted and recommendations made, including on how local government finances can be better aligned with the governments’ overall fiscal plans.
Monetary and exchange rate policy
The immediate challenge facing the Central Bank of Iceland is to stabilize the króna and set the stage for a gradual appreciation. It can be expected that the króna will face near-term risks of pressure when the normal functioning of the foreign exchange market is restored. Extraordinary measures are therefore needed to deal with short-term risks and prevent substantial capital outflows.
In the very short-run, we intend to adopt the following pragmatic mix of conventional and unconventional measures:
• To raise the policy interest rate to 18 percent. The Central Bank stands ready to increase it further, but it is unclear that higher interest rates alone will suffice to stem capital outflow.
• Tight control over banks’ access to Central Bank credits will be maintained to avoid excessive liquidity being drawn down through this route.
• The Central Bank stands ready to use foreign reserves to prevent excessive króna volatility.
• Furthermore, the Central Bank is willing to temporarily maintain restrictions on capital account transactions. Such restrictions have considerable adverse implications and the intention is to remove them as soon as possible.
This process of normalization and lower inflation and interest rates can start as soon as the króna stabilizes in the foreign exchange market, all demand for foreign exchange in respect of current account transactions is met in the foreign exchange market, and there is no longer need to support the market by drawing on the reserves. Following the above mention actions, the króna could strengthen quickly and annual inflation will have fallen to 4½ percent at end-2009. Additional strengthening of the króna and further disinflation is expected in 2010. This will allow us to begin to ease control over Central Bank’s credit volume and increasingly rely on the policy interest rate as the primary monetary policy instrument, in the context of a flexible exchange rate policy.
Incomes policy
It will be important to have a national consensus consistent with the objectives of the macroeconomic program. Historically, income policy in Iceland has been very effective, with past agreements supporting the economic adjustment when difficult circumstances demanded it. Social partners recognize the need to enter an agreement that is commensurate with the severity of the situation.
Publishing and Parliamentary Procedure
A Letter of intent was sent to the IMF on November 3, signed by the Minister of Finance and the Chairman of the Board of Governors of the Central Bank. The Executive Board of the IMF will put Iceland’s plan on its agenda on Wednesday November 19. At the same time IMF’s Staff Report will be published.
Today, November 17, the plan was put before the Parliament and will be discussed there later this week.
A special information Web Page has been opened as a part of the Web Page of the Prime Minister’s Office, http://www.forsaetisraduneyti.is/Aaetlun_um_efnahagsstoduleika/. Among its contents are the Letter of intent in Icelandic and English, explanatory texts on every article of the LOI and other relevant information.
[…] The Icelandic Government program with the IMF […]
I don’t understands the markets and the ISKr.
Are there reserves of ISKr being held by Foreign banks?
If so, are there any estimates of how much?
If they are going at 400kr/€ – possibly 600/€ for bulk purchase :)
would it not be sensible for the Ice gov to buy them back with borrowed Euro before they float the Kr?
“fish, tourism and aluminium”
I guess the Icenews team would like to see Actavis pharmaceuticals to be added to that list!
:D
And personally, I would add online games. But, ok, I don’t really know the volume of sales those EVE folks achieve.
@julia
You are right that there are massive deflationary forces at work. But on the other side, there could be also big inflationary pressure, as the krona carry trade unwinds. There could be a lot of krona around the world, which could flood into iceland to be converted back into EUR.
One cannot know exactly how large is this force, but it could be large, judging from the amount of overvaluation of krona in the past.
The problem is, for all their import needs – and iceland imports a lot, icelanders have only the krona to offer, and EUR which comes from fish, tourism and aluminium.
If icelanders reaction to massive devaluation of krona will be frugality and massive cuts in spending, then there will be little inflation, and the deflationary forces will bring the economy in more healthy equilibrium – e.g. so the beer will not be EUR 10, but more like EUR 2 or 3, in line with prices in mainland europe.
The price of the Króna in the open market was 322= 1 euro last time it was openly participating of it. when the króna is put again on the market it could get as far a 400isk= 1 euro. Though that situation will not be prolonged. The only smart thing to do it to let the króna fall and touch the bottom, any intent to rescue it will totally fail. With the króna like that a large part of the workers (as has happened in Poland) will have to left the country to look for jobs in richer nations. That would gradually bring some cash to the country.
It is inevitable that this nation will have to go through the same situation as many other countries before… It will take at leas 10 years for the icelandic economy to fully recover. That does not necessarily mean that things will be the same as they where. That would be making the same mistake again. Iceland needs new economic politics and approaches. Icelandic society needs to have a realistic understanding of what is to work, save and create wealthy. High living standers based on loans is nothing but building castles on the sand. And yes! GET into the UE ASAP!!
Jim; no, there are next to no hockey facilities over here – a couple of British National League-standard rinks, nothing more. The sport is not popular, unusually for this part of the world.
@Bromley86. Rounding – now I get it –
€20,000 = 0 ? :)
The main inflationary driver now is the rate of exchange.
Of course a further rapid slide of the Kronur will naturally cause a huge rise in every import price and we can spend much less.
The main bills to pay are property /car loans which will rise accordingly as the kronur sinks. Those repayments will absorb most of the money earned in Iceland. Those people who have their mortgages paid up will probably be supporting other burdened family members.
The consumer expansion has gone and it will slow down with brakes fully applied over the next weeks.
1000,s of people will need new employment.
The trade balance has to radically shift, gaining foreign currency through fish exports/ any tourists and Icelanders working abroad sending home remittances.
The balance will be more achievable with a welcome slump in consumer spending.
>You have an unique geographic location (invaded by US in WWII out of fear or German possession) that is quite strategic.
The invasion of Iceland was actually a UK triumph!
The US took over garrisoning it to free up UK troops.
Bravo Julia!! good comment
I fail to see why there should be further inflation if fiscal policy is implemented properly.
Arguments for DE-flation:
A large part of the population is going to struggle to repay their mortgages, car loans and other debts, especially those denominated in foreign currencies.
A good number of the highest earners will either lose their jobs or be forced to take pay cuts as companies fail.
The lower paid will have to economize greatly to make ends meet.
Unemployment will rise sharply.
House prices have fallen and will fall further. Liquidity in the house market has dried up as new loans are unavailable.
The rental prices are falling due to a glut of property.
People are using their cars less, creating less demand for fuel and other services.
The argument is that imported goods will increase in price. They will initially, as the already greedy importers who have had fat margins for years, and the supermarket cartel who have been overpricing food for years, try to keep their margins up.
But I don’t see this being sustainable. People will start to buy cheaper products and simply go back to eating cheaper foods. To reduce waste and spoilage, the supermarkets will have to cut their lines to focus on those cheaper more profitable products. All shops will be forced to discount more heavily in line with the discounting that is happening in other areas. Prices for everything will be open to renegotiation. The end result may look like initially like inflation, but in fact it won’t be.
Inflation in Iceland is what has been happening in recent years as people consumed too much, with no price sensitivity. They were over-employed, over paid and wanted to have it all right away. When it’s your own money you look more carefully at the price. When its a loan you can afford to be less price sensitive.
What the central bank in Iceland needs to do is
(1) reduce interest rates to reduce the cost of borrowing for Icelanders and stimulate the economy, and
(2) rapidly slide the krona down to a sensible support level. As virtually every other commentator here has said, it will be impossible to support the krona at its current level which is completely out of line with fundamentals. Whatever that realistic level is, that is the level at which it should be allowed to trade. Wasting the countries exchange reserves is just throwing good money after bad.
The main inflationary driver is the government’s own 18% policy rate which it vainly hopes will help it support the Krona. No interest rate will support the Krona, the market wants out.
Koben:”Now according to the central bank monetary bulletin, we can expect a “stabilized” rate of 210 to the Euro until at least 2011.”
So they are going to fix the exchange rate at 210 (very close to the ECB’s ‘rate’ and far from the free market rate of 285)?
That would explain how they intend to spend the 6billion loan – by subsidising imports and currency conversions.
>You have an unique geographic location (invaded by US in WWII out of fear or German possession) that is quite strategic.
Today it has little strategic importance, its location is convenient for air sea rescue, but we are not about to have any sort of war in the North Atlantic are we?
“get ready to welcome the tourists”
Boosting the tourists business would help, Icelanders working abroad and sending money back home, too, and don’t forget that the Internet holds chances for successful businesses without depending on high investments for startups (why can’t EVE online offer a fanatasy game too? They could call it “Geir, the barbarian” or “Evil Horde” or something like that).
Btw, what about the Aloca works? When will it start producing?
“Stabilizing at 150 and then rising only … a nice fairytale.”
Iceland had a negative trade balance in 2007, and in 2008 too, so far. If you export more than you import, why should there be a strong demand for kronas? Doesn’t make sense. Also, it has to be asked how man kronas are still waiting in European banks to be converted into real currency? No, even if Oddsson may manage to stabilize inflations, which he didn’t accomplish for years, this alone won’t settle the exchange rate.
What’s necessary are foreign investments for Iceland. But I guess the incompetent Haarde gang will make possible investors think twice. Iceland needs changes, and they have to start at the government.
This look not bright. Yes, I think a sharp fall in the Króna is to be expected. They simply cannot do anything about its volatility and are not able to maintain it to a desired rate.
Now according to the central bank monetary bulletin, we can expect a “stabilized” rate of 210 to the Euro until at least 2011.
Time for holidays abroad are over, now get ready to welcome the tourists with their maps and blue raincoats ;)
Our leaders and bankers all went to University of Iceland. Icelandic professors in finance and accounting and the leaders and bankers of Iceland definitely need to go to school again. Ok repeat after me 1+1=2. 2-0=0. Got it. It’s a bust. Instead of doing this fantasy of solving it with more borrowing and debt.
If you need foreigh investment, why don’t you take advantage of what you have? You have an unique geographic location (invaded by US in WWII out of fear or German posession) that is quite strategic. Iceland could be the natural host country for international events involving US and Europe. Think ice. US hockey teams opened the season in the Czeck Republic. There is more to come, perhaps interleague play between North Amerca and the European leagues if you had the facilities. Do you?
¨¨Previous senior managers and major shareholders in intervened banks who are found to have mismanaged the banks should not assume similar roles for at least three years.¨¨¨
Okey, and what about the president of the Central Bank??? He hasn´t any responsability in this matter???
This speech is not very clear to me.
The only thing that I can take from it is :
More taxes, more taxes, more taxes
Less money in health system
Less money in social system
Less money in education
Also ¨The Central Bank stands ready to use foreign reserves to prevent excessive króna volatility.¨
means: Put a lot of dollars and Euro just to try to save The Titanic. (Argentina after 2002 crisis, just in 2007 spend 3.2billion dollars to try to prevent excessive peso volatility.Goldman Sachs)
Is the Krona a icelandic treasure to try to save ??
Please people wake up!!!!!!
Enjoy the EU!! It´s nothing wrong with that!
:) . Rounding, i.e.
19.4 + 5.4 = 24.8
Icelandic accounting: $19bn + $5bn = $25bn.
I kid you not, it’s from paragraph 24 of the begging letter from Iceland to the IMF!
http://www.forsaetisraduneyti.is/media/Skyrslur/LOI.pdf
I don´t understand… I will be able to pay my house? I will keep my job? I will have a normal future in this country?………….. etc…
>is the Crown going to weaken further?
An economy that depends on importing, no confidence in the political or banking system, worldwide aversion to risk, massive falls in the currency – yes the Krona will fall.
How far is anybodies guess, but its could be pretty spectacular.
I read that the Icelandic banks themselves had a 5-6Billion short on the Krona. How nice.
[…] Source […]
Again, baloons of hot air.
Krona will not stabilize, until you let it to float, so it can find its real support, and then it may rise, depending on the seriousness of reforms.
Stabilizing at 150 and then rising only … a nice fairytale.
So what does this mean for thicko’s like me who cannot understand it?
is the Crown going to weaken further?
Guys,
simple not possible, I am suspended from work since 5 weeks the FSA took control over the foreign branch, I am no shocked but angry how ISLAND closed the door to Europe to help their foreign branches out of the mess. thanks a lot, so that s the way you threat bankers outside your island. I always used to say please concetrate on fishing and not on banking in the future…. I will be right.
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