Iceland May Take Next Step in Capital Liberalization Program Within Weeks

Iceland may hold new currency auctions within weeks as the island scales back its defenses against capital flight, central bank Governor Mar Gudmundsson said.

“We’ll begin the auctions as soon as we get applications from the intermediaries and when the amounts are sufficient to permit an auction,” Gudmundsson said in an interview in Reykjavik. “I’m hoping that it will be in the next weeks.”

The island, whose banks defaulted on $85 billion in 2008, is moving into the final stages of its resurrection plan as the last vestiges of crisis management are gradually removed. Iceland’s decision, taken together with the International Monetary Fund, to impose capital controls three years ago was key to surviving the bleakest moments of the crisis and helped prevent an all-out run on the island’s assets, Gudmundsson said.

“Without the capital controls it would have been much more difficult to ensure stability in the exchange rate, calling for much higher interest rates and an inability to shelter the domestic economy as well as we did,” he said. “With the turbulence in the international markets lately, the capital controls have sheltered Iceland considerably, since there’s no way of doing a run on the financing of the Icelandic state or the financing of the Icelandic banks.”

The auctions are part of a first phase to free up offshore kronur. A second phase will deal with foreign investors’ holdings of onshore kronur, according to the central bank. That phase will start when the offshore and onshore rates converge. Offshore kronur trade at about 250 to the euro, according to Reykjavik-based brokerage HF Verdbref. The onshore rate was 159.35 on Nov. 18.

Outperforming Euro Area

Iceland’s economy will grow faster than the euro-area average this year and next, the IMF estimated in September. The cost of insuring against an Icelandic default, using credit default swaps, is lower than the average for the euro area.

Iceland’s economy will grow 2.5 percent this year and next, versus 1.6 percent in the euro area this year and 1.1 percent in 2012, the IMF said Sept. 20. Next year, Iceland’s current account surplus will widen to 3.2 percent of the economy and unemployment will be 6 percent, versus 9.9 percent joblessness in the euro area, the fund said.

The stabilization of the island’s economy has allowed the central bank to press ahead with capital liberalizations that the government estimates won't be fully dropped until 2013. The approach allows foreign investors eager to offload their krona holdings to transfer them to foreign or local investors willing to commit long-term to the island, according to the central bank.

Foreign Direct Investment

“This will show how much interest there is in direct foreign investment in Iceland,” Gudmundsson said. “This step will help us considerably in reducing the amount of offshore kronur and transferring them from those, who might unwillingly hold them, into the hands of those who are willing to use them in Iceland. That will have a great effect on how we’ll be able to move on to the full abolishment of capital controls.”

The process is the second step of the first phase in easing controls. The first step had allowed investors, via foreign currency auctions, to place kronur in long-term government bonds. The second step broadens the terms to allow investors to place their kronur in assets such as equities and real estate. The bank isn’t progressing according to a timetable, and announces each step once the economic and financial conditions are in place.

“How many weeks” it takes before the currency auctions start “and whether it will be less than a month or more than a month is hard to say,” Gudmundsson said. “There are no guarantees that this will take place before Christmas, and if not, then hopefully we’ll be able to have a strong beginning in 2012.”

To contact the reporter on this story: Omar Valdimarsson in London at valdimarsson@bloomberg.net

To contact the editor responsible for this story: Tasneem Brogger at tbrogger@bloomberg.net

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