Iceland Seeks Monetary Policy Change as Krona Controls Ease

  • New three-party ruling coalition has a majority of one seat
  • Tuesday’s deal caps more than two months of cross-party talks

Iceland’s new center-right government will seek to overhaul the country’s monetary policy regime in order to stabilize the krona as it dismantles the last of the capital controls in place since the economic collapse of 2008.

"We made it," Independence Party leader Bjarni Benediktsson, who is set to become prime minister, told reporters in announcing a coalition deal that capped more than two months of cross-party negotiations.

Bjarni Benediktsson

Photographer: Arnaldur Haldorsson/Bloomberg

The three-party ruling coalition is planning to create a Norwegian-style wealth fund that will manage the revenue from its energy resources and use its proceeds to reduce economic fluctuations. It’s also aiming to reduce the state’s holdings in its banks, which were largely nationalized after they collapsed in 2008.

The krona slid on Tuesday’s news and was trading at 121.69 per euro at 10:18 a.m. local time Wednesday. The central bank has been cutting rates to damp a rally in the krona, which last year surged 15 percent amid a record inflow of tourist to the north Atlantic island. The government last year also introduced new rules to restrict fast money inflows into the economy as it also eased restrictions on outflows from pension funds and consumers.

Cracking down on tax evasion, tackling the national debt, boosting infrastructure investments and allowing parliament to debate a possible referendum on European Union membership are also among the measures included in a governing pact signed by the three party leaders in Kopavogur, a town outside the capital Reykjavik.

Populist Defeat

The Independence Party, which resisted a challenge from the populist Pirate Party to win the most votes in the Oct. 29 snap elections, replaced its traditional coalition party, the Progressive Party, with two new junior allies -- the Reform Party and Bright Future. The ruling coalition will control a total 32 seats in the 63-member parliament - giving it the slimmest of majorities.

"Just looking at the policies of the parties it’s clear that this government will focus on the business sector," Stefania Oskarsdottir, associate professor of political science at the University of Iceland, said in a telephone interview. "They’ll want a strong economy, restraint in the management of public finances and are likely to take a closer look at our currency."

Reform and Bright Future are two centrist parties that broadly back the Independence Party’s free-market stance.

The new cabinet will formally assume office on Wednesday at 1:30 pm local time, with Reform Party chairman Benedikt Johannesson set to become finance minister and Bright Future leader Ottarr Proppe taking over the Health Care Ministry.

Booming Economy

While Iceland’s economy is booming -- gross domestic product rose 10.2 percent on an annualized basis in the third quarter of 2016 -- the central bank has warned of potential overheating and has invited the next government to pursue a less expansionary fiscal policy.

Johannesson, a former book publishing executive, stressed on Tuesday how important it was to "show frugality in public finances." Plans are also being put in place to progressively reduce the Treasury’s holdings in Icelandic banks, he said.

Record tourist arrivals and the progressive relaxation of capital controls, in place since the banking collapse of 2008, have pushed up the value of the krona, kindling discussions on whether to peg the Icelandic currency to the euro.

The new government wants to change monetary policy in order to "increase exchange rate stability and reduce interest rates," Johannesson said, with the results of its review expected in the first year of government.

Iceland called a snap election last year following the resignation of Sigmundur David Gunnlaugsson, the most high-profile casualty of the so-called Panama Papers. His Progressive Party lost more than half of its seats in the Oct. 29 poll.

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