Bankers Start to Question Iceland’s Ballooning Currency Reserves

  • Central bank has raised currency reserves by 62% since 2014
  • Reserve build-up promotes stability as krona controls eased

As Iceland sets itself up for a final exit from capital controls, the nation’s bankers are starting to question the costs involved.

The central bank holds 760 billion kronur ($6.8 billion) in foreign exchange, up by more than 29 percent in a year and 62 percent from 2014. It’s buying the inflow of currency from a tourism boom, in order to keep the krona in check and to build buffers for when the last controls are removed. For now, that’s costing the country money, according Jon G. Omarsson, chief financial officer at lender Islandsbanki hf.

“When reserves are this big the imbalance can have an impact on the central bank’s equity and thereby the Treasury, indirectly,” he said in an interview. “The Treasury is taking an exchange rate risk with the reserves. There hasn’t been much discussion on how much exchange rate risk the central bank is allowed to have and for how long.“

The stockpiles it has amassed are more than adequate now for the bank fully dismantle capital controls, the CFO of the country’s second-largest bank said.

Iceland announced in August it was easing restrictions on investments abroad for households and that it would open up for outward direct investments. A slew of restrictions were also eased when parliament approved the governments bill on Oct. 21 and further steps will be lifted on Jan. 1. The central bank estimated that these first steps could result in outflows of 40 billion kronur to 165 billion kronur. 

For the central bank, the benefits are clear because the reserves promote stability, according to spokesman Stefan Stefansson.

"Its the objective of the central bank to maintain stability, as you know, so we have to evaluate potential gains against costs," he said. "This can be hard to evaluate -- there’s always some uncertainty."

But Omarsson said the bank could be overstating the problem.

Especially since instead of outflows from the economy alongside capital account liberalization, the $17 billion economy has experienced such inflows that the krona has risen 15 percent since the beginning of the year against the euro.

“There hasn’t been much movement in the market, which is positive and in line with the central bank’s expectations that this would be a non-event," he said. “We’re actually a bit surprised by how little the change has been -– we can hardly measure any movement.” 

The steps ahead now are clear, and they include removing some “bureaucracy,” according to Omarsson.

“By year-end they’ll take another step and if that goes as well as this step, they’ll soon be able to take even larger steps,” he said.

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