Pressure mounts to ditch capital controls

SedlabankiThe incoming government of Iceland is speculated to ease and remove currency controls before the market becomes too distorted, reports Bloomberg.

The decision to ask for a debt write off of creditors of Iceland’s failed banks is now all but official, following remarks made by incoming prime minister Sigmundur Gunnlaugsson during his campaigning. This amounts to some $3.6 million krona.

But removing the controls is reckoned to be tricky, with the risk of capital flight or market upheavals. Some controls will have to be implemented to avoid currency speculation says the finance ministry.

It’s possible that Icelanders will, in the same way as other countries are contemplating, impose limits on derivative trades with the currency,” says Finance Minister Bjarni Benediktsson. He also said the nation may also “place a limit on Icelandic banks gathering foreign exchange in foreign branches. This can be considered as some kind of restriction on capital flows, but we can also view this as a normal part of managing the currency.”

A review at the International Monetary Fund has been ordered to monitor the strategic management of the lifting of currency controls. Keeping the controls in place much longer, they say, will distort markets. But efforts to target ‘hot money’ flows might hit the wrong money.

“The intentions may be right but the practical difficulties should not be underestimated”, said Jonathan Ostry, deputy director of the IMF’s research department in an interview. About $8 million is apparently trapped in the country by these controls.

Several experts and commentators have added their voice to a growing call for lifting of controls before they really begin to affect markets. The Central Bank in Reykjavik has maintained interest rates at 6 per cent as a preventative measure, but a creative solution is likely to be needed to carefully return to a more liberal international banking position. There’s plenty of speculation going around on how that might be done.