Hedge Funds Get Reality Check From Iceland PM Bracing for Exit

  • Iceland says won´t impose draconian measures on carry trade
  • Premier says being outside monetary union key to recovery

Iceland’s prime minister expects hedge funds to pay their "fair share" as the country prepares to dismantle the final barriers to free capital flows.

After releasing $17 billion in cash for creditors in its failed banks, the government is preparing to free a further 290 billion kronur ($2.2 billion) trapped for bond investors in March. They will be given the option of swapping into foreign currency, exchanging into a long Eurobond or having the money placed in a non-interest bearing account.

Sigmundur Gunnlaugsson
Sigmundur Gunnlaugsson
Photographer: Arnaldur Halldorsson/Bloomberg

The government anticipates that most investors will go through the auction and do this at a "reasonable price," Prime Minister Sigmundur Gunnlaugsson said in an interview Thursday in Reykjavik.

"Let’s not forget that these investors have also had substantial interest rates while they’ve had their funds here in Iceland," he said. "So, it’s not a question of taking something away from somebody. It’s a question of making it possible for them to get their investments with interest.”

These investors were among those trapped as Iceland imposed controls on the krona in 2008 after its largest banks collapsed under an $85 billion debt mountain. Successive governments have since resurrected the economy, in part by shielding consumers from the financial turmoil.

Rising Rates

Iceland has raised its key rate three times since June, to 5.75 percent. Economic growth is now faster than the euro zone average, and the central bank says inflation will exceed its target this year as wage growth soars.

The premier said it’s important now to build on this success and avoid backsliding into the old habits of massive wage increases.

"We are getting out of this old system and we have been able to maintain stability for a couple of years now," he said. "But we would need to see that this is something that we can reasonably expect to continue in to the future.”

The success, which according to the premier is in part due to Iceland not being tied up in a monetary union, is recreating some of the conditions that caused fast money to flow into the island, eventually helping trigger the 2008 crisis.

This means the island will need to keep a level of control over its currency even as it moves to free up capital controls on households and corporations "quite fast," the premier said. As a bulwark against inflows, the government has also allowed pension funds to invest more abroad.

The krona has rallied about 19 percent against the euro from a low in early 2013. It rose 0.1 percent to 141.34 per euro as of 11:25 a.m. local time.

Still, the government won’t look at imposing any "draconian" measures to stem the carry trade.

"Iceland will definitely have a free floating currency to the same extent as other developed countries," he said. "But the question is: will the flow of currency be as free as it was prior to 2007? I’m not entirely sure that will be the case in the foreseeable future."

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