Transcript of a Conference Call on Iceland

with Julie Kozack, Mission Chief for Iceland, European Department,
Simonetta Nardin, Senior Press Officer, External Relations Department Washington, DC
June 6, 2011

MS. NARDIN: Good morning and thank you very much for joining us on this conference call. I am Simonetta Nardin from the External Relations Department of the International Monetary Fund and I'm here with our Mission Chief to Iceland, Julie Kozack. As you know, on June 3 the IMF Executive Board concluded the fifth review under the Stand-by Arrangement for Iceland. Julie will say a few words about the review and after that we will open for Q&A

MS. KOZACK: Thank you, Simonetta, and thank you all for joining in this call. As you know, the Executive Board approved the fifth review under the Standby Arrangement. Broadly speaking, Iceland is continuing to emerge from crisis. The economy is gradually recovering and growth is expected to turn positive in 2011.

Under the program there has been impressive progress in implementing policies, notably with respect to fiscal policy and putting public finances on a sustainable path. The exchange rate has stabilized and inflation has been brought down to low levels. There are some challenges going forward. These include an orderly lifting of capital controls, reducing the high level of unemployment, accelerating private sector debt restructuring and continuing to make progress in financial sector supervision and regulation reforms.

QUESTION: Given the challenges ahead and especially the task of lifting the capital controls, are you confident that Iceland won't need an additional rescue package from the IMF after August [when the current program expires]?

MS. KOZACK: You're correct that lifting the capital controls is a key challenge facing Iceland going forward. Determining whether Iceland would like to have any additional program with the Fund is a decision for the Icelandic authorities and that decision will be made by them in due course.

In any program that the IMF has, the decision in terms of whether to go forward with a program or a successor arrangement of any type is always under the purview of the authorities and not the IMF or not the staff. Again, this is really a question for the Icelandic authorities and the decision is completely theirs.QUESTION: But you don't take any assessment of the situation for this specific question?

MS. KOZACK: Our assessment is that whether there is a successor arrangement is a decision for the Icelandic authorities.

QUESTION: I have something similar. The question is having the Icelandic authorities already started discussions with you on a possible new program? If not, I was wondering if you think that Iceland might need to continue having financial help. You talk about fiscal constraints in your paper, and while the dispute is still unresolved, the risks of employment and specifically the issues of lifting of capital controls, would you think that it would be a good idea to continue or maybe to continue shoring up the economy with outside financing?

MS. KOZACK: Again the decision on a successor arrangement is one for the authorities. What I can say is that the program in Iceland is on track. The authorities have made tremendous progress in implementing the policies under the program. Growth is set to gradually return to Iceland this year. Turning back to the policies, there has been a tremendous success on fiscal policy, tremendous effort on fiscal policy. The authorities have taken 11 percent of GDP in fiscal measures since 2009 and public debt is now on a steadily declining path. The exchange rate which had depreciated significantly at the outset has now been stabilized and has been stable for some time. And inflation which was very, very high in early 2009 has now come down to low levels. So there has been tremendous progress made on policies.

Of course there are still challenges ahead for Iceland and one should not minimize the extent of these challenges, but there is a very sound basis for the authorities and the economy to begin to move forward and emerge from the crisis given all of the efforts that have been made so far.

QUESTION: A follow-up on Icesave, the fact that that is unresolved and you say it needs to be settled through legal channels. Are you not worried that that is going to continue to weigh on the economy in any way?

MS. KOZACK: That was one of the key issues that we assessed when we visited Iceland in late April, early May. We wanted to try to get a better picture of what the possible implications of the Icesave referendum could be on the investment climate, on the authorities' ability to tap international capital markets and our assessment was that there may be some effects but these effects at the moment appear to be relatively minimal. As you know, the authorities have announced that they are meeting with investors last week and this week to start thinking about issuing an international bond; the ratings agencies have reaffirmed Iceland's long-term foreign currency rating, so our assessment was that we don't see any impact on investment in 2011, that there are many investment projects that are underway in Iceland and that these projects are still well financed and will continue. Some of the most adverse effects that we were concerned about do not appear to have materialized.

QUESTION: Julie, I want to follow-up on further assistance from the IMF. I'm wondering whether the IMF is confident that Iceland can hold the course without further assistance, and I have a couple of more questions following that.

MS. KOZACK: Again I would point in this case to Iceland's very strong policy implementation under the program. As you know, this a very program with very strong ownership on the part of the authorities and they have achieved impressive progress under the program because of their commitment to strong policy implementation. And because of that we have quite a lot of confidence in the Icelandic authorities to stay the course going forward.

QUESTION: So you don't believe that Iceland is holding the course because it's in the program, but it's because the Icelandic government is determined to do it by its own means?

MS. KOZACK: Correct.

QUESTION: How soon does the IMF believe that Iceland needs to return to the bond markets?

MS. KOZACK: There is no specific timing that we have in mind. Obviously the sooner Iceland can return to markets the better. It's a very strong signal of a normalization of Iceland's relationship with international capital markets and that's an important signal and it's important for confidence going forward, but there is no specific timing that we see as critical.

QUESTION: How much does the IMF believe that Iceland should try to roll over in the first bond auction, all of the 2011 maturities or both the 2011 and the 2012 maturities?

MS. KOZACK: We don't have a position on that.

QUESTION: A final question. Does the IMF believe that Iceland's current foreign currency rating with Fitch is fair and that it's fair that Fitch now estimates that it will Iceland in the junk rating category for the next 2 years?

MS. KOZACK: Fitch's decisions are really a question for Fitch and not for us. Again, I would emphasize that from our perspective Iceland has achieved impressive progress under the program and that the strong ownership on the part of the authorities has underpinned this impressive progress that Iceland has made under the program.

QUESTION: Basically what you're saying is that the IMF's position to Iceland's rating is that it doesn't merit the junk rating?

MS. KOZACK: No, that's an issue for Fitch. How Fitch chooses to rate Iceland is an issue for Fitch. We don't have a position or a view on how Fitch chooses to undertake its ratings.

QUESTION: Does the IMF have any view on what would be a fair yield on Iceland's bonds and foreign currencies?

MS. KOZACK: No. That's up to the market to determine.

QUESTION: I'd like to follow on Icesave. You said adverse effects you feared from the nonresolution of the issue have not materialized in 2011. Are you concerned for next year if the program were to persist?

MS. KOZACK: What we know is that in our baseline macroeconomic assumption, investment led growth. So one of our concerns at the outset was that the uncertainty created by Iceland could affect investment plans and that this could have an adverse impact on growth. But in our assessment when we visited Iceland in April, what we found was that all of the investment that is already in the pipeline remains in the pipeline and remains well financed. That was particularly important for 2011 because that's where we know a lot about the specific projects, but at this stage going forward we have not reviewed our investment projections down and we're still confident that investment will continue going forward and that growth will be investment led in the coming years.

QUESTION: Coming back to the capital controls, of course Iceland was the first country with IMF-backed s capital controls under an IMF program. I was wondering if you can talk a little bit more broadly about that and how that worked because I follow the Fund and look at how its policies toward capital control have changed. I was wondering in the case also of Iceland what do you think the conditions are for slow conditions-based exit, making sure that there's not a strong pullout of money from Iceland? What guarantees you that this could work in this case?

MS. KOZACK: Taking the first part of your question first, in the case of Iceland, the size of the shock associated with the crisis was so large,, the amount of foreign money that could have potentially left Iceland, let alone potential resident capital flight during the crisis, and the potential for severe balance sheet effects on the economy led to the decision that capital controls in this case were appropriate. Going forward it's clear that the capital controls need to be removed and they should be removed as quickly as feasible, but that also means that their removal should not erode all of the stabilization gains that have been made so far particularly with respect to stabilizing the exchange rate which was a key objective under the program.

The authorities' strategy is a very cautious strategy, and appropriately cautious in our view. It is condition based, which again in our view is appropriate rather than time based. In terms of conditions based, what the authorities are doing is that as conditions improve, more of the capital controls can be gradually liberalized and there are certain conditions that need to be met before key steps are taking in the liberalization strategy. For example, to ensure that the country has sufficient international reserves, some key steps are conditioned on the Icelandic Treasury having access to international capital markets. The Treasury needs to be able to issue in the international markets to ensure that it can roll over its own debt and that reserves do not drop to alarmingly low levels during the liberalization process.

Other key conditions have to do with the health of the financial sector, ensuring that banks have sufficient liquidity that they withstand any deposit withdrawals that may arise as the liberalization process continues. So there are a number of these conditions that will need to be met as we get deeper and deeper into the strategy.

The other issue that I would raise is that at each key step the strategy envisages looking at or assessing the medium-term balance of payments outlook, ensuring that the outlook for the balance of payments is sufficiently strong to support continued liberalization and that it's sufficiently strong to support a particular pace of liberalization. All of this is embedded in the authorities' strategy and this gives us quite a lot of comfort that the pace of liberalization will be appropriate going forward.

QUESTION: Considering that the authorities have laid out this 2011-2014 borrowing strategy, I'm gathering that you're seeing that that strategy for lifting capital controls happening over that time if they can access the capital markets.

MS. KOZACK: Again the capital control strategy is not time based. It is conditions based. But it is very, very closely linked with the debt-management strategy. Clearly these two issues, debt management and lifting of capital controls, are intricately linked in part because the capital control liberalization strategy depends very much on the Treasury's access to international capital markets.

QUESTION: Considering what's going on in Greece and elsewhere, the borrowing costs right now for countries is pretty high. How do you think timing-wise that could be for Iceland to go back to the markets?

MS. KOZACK: One of the things that we track obviously on Iceland is its CDS spread. I haven't looked at it in the last 2 days, but Iceland's CDs spread has essentially been at post crisis lows. The last I looked I think it was at 210 basis points so this gives us again some comfort that Iceland may be able to issue at reasonable rates. But again this is an issue that the authorities will be looking at very carefully when they need with investors and Iceland has quite a lot of international reserves at the moment so there is not a lot of pressure for them to issue immediately if market conditions are not appropriate.

QUESTION: First of all, since we're talking about he capital controls, I see in your data that the first phase in lifting capital controls is release of the offshore korma holdings. In your visit in Iceland, did you get any feedback on how that phase is going, is the Central Bank doing enough to have these holdings released in the near future?

MS. KOZACK: It's correct that the first phase is the release of offshore krona according to the authorities' strategy. The first auction has been announced which is the first step in this first phase and we'll know the results of that auction tomorrow so that that will give us a lot of information on how much demand there is to leave Iceland and we'll obviously look very carefully at the pricing and the narrowing of the spread between the offshore and onshore rate. So that will be a first key indicator that we have in terms of the liberalization strategy.

QUESTION: Moving back to Icesave, can you clarify if the result of the recent referendum (rejecting the Icesave deal) lowers the debt or is the debt simply going somewhere else?

MS. KOZACK: I think there I should clarify. What we've done is we've changed a bit the way we've treated the Icesave debt because the issue will now be resolved through legal channels. But if you look at our debt sustainability analysis that is an appendix to the staff report, there we have different scenarios for what could happen if Iceland is found to have a sovereign obligation by the FTA court and we have some scenarios for what public debt and the fiscal balance could look like. But what we have done is we do not include the Icesave in our baseline debt figures any longer since the claim is now being settled through legal channels. So it's not that we're saying that public debt will necessarily be lower, rather, we've changed the way we've presented public debt and, rather, we've shown several different scenarios in the debt sustainability analysis that is an appendix to the staff report.

QUESTION: You say one of the most important things is to reduce the unemployment rate. In your opinion does the government have to do something more than they already have done to reduce the unemployment rate or are you simply counting that new investments will somehow reduce it when that comes?

MS. KOZACK: Let me first step back. From a broader perspective, Iceland is not alone in having a high rate of unemployment. This is unfortunately an issue that is confronting many, many countries in the aftermath of the 2008 crisis. This is a very, very challenging problem that we need to find a way to resolve. Obviously the key for reducing unemployment will be to have some positive growth in Iceland. Based on our analysis, growth should turn positive in 2011 and this will be the first key to helping reduce unemployment in a durable way in Iceland. Then obviously the government is undertaking a number of policies to try to help alleviate the situation for unemployed citizens, in particular the sort of apprenticeship program that the government has in place has met with quite a bit of success and I would also note that under the government's declaration associated with the wage agreements, there are some additional measures in terms of making access to education easier and trying to improve coordination between universities and employers to try to help reduce unemployment even more quickly. But again the key is to restart economic growth and to achieve a durable recovery from the crisis and that is ultimately what is needed to reduce unemployment going forward. It is a key challenge and we're obviously very aware that the crisis continues for people who are still unemployed so it is a critical challenge and the unemployment rate must be reduced.QUESTION : I have a question on the capital controls again. Is the IMF at all concerned about the capital controls being now a hamper to further economic growth?

MS. KOZACK: Obviously the controls need to be lifted, but the issue now is that the controls are in place and so how does one go about lifting the controls in a way that does not undermine the stabilization gains that have been made so far? We believe that the authorities' strategy strikes the right balance between moving cautiously and not eroding any of the gains made so far, which could undermine confidence and ultimately result in lower growth, and on the other hand being stuck with capital controls for much too long. So it is a very delicate balance, it's a very difficult challenge, but we believe the authorities' strategy will relieve the controls at an appropriate pace.

QUESTION: So that the IMF doesn't believe that it's currently hampering economic growth or it might actually have a negative on Icelandic pension funds or cause a bubble in the real estate market?

MS. KOZACK: We believe that the strategy for lifting controls is appropriate.



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