IMF Survey: Iceland Gets Help to Recover From Historic Crisis

IMF News, December 2, 2008

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IMF approved a $2.1 billion loan to Iceland to help recover from the financial crisis and restore confidence in its currency.
Package announced on October 24 under the Fund's fast-track emergency financing mechanism.
IMF Executive Board approved a two-year Stand-By Arrangement on November 19, making $827 million immediately available; the remainder to be paid in eight equal installments, subject to quarterly reviews.
IMF mission chief for Iceland: Poul Thomsen.
Iceland population cited as 300,000.

Banking system expansion: bank assets rose from being worth slightly more than 100 percent of GDP to being worth close to 1,000 percent of GDP after privatization completed in 2003.
Crisis dynamics:
- Within a week the three banks collapsed.
- The króna's value dropped by more than 70 percent.
- The stock market lost more than 80 percent of its value.
Small, import-dependent economy faced a crisis of huge proportions as confidence evaporated and investors pulled out.

Primary short-run goal: stabilize the króna and restore confidence in the foreign exchange market over the next couple of months.
Monetary and exchange rate policy to be used; short-run implication is higher interest rates.
Restrictions on capital outflows will remain in the near future; capital controls had been de facto in place since early October.
All restrictions on the current account have now been lifted as a first step.
Program envisages IMF loan filling about 42 percent of Iceland's 2008-10 financing gap; remainder to be met by official bilateral creditors.

In the first year, automatic fiscal stabilizers will be allowed to work in full.
Primary fiscal deficit projected to increase from about ½ percent of GDP in 2008 to about 8½ percent of GDP in 2009.
IMF is not advocating fiscal consolidation during the deep recession; consolidation to be implemented once the recession has bottomed out.
Estimated public sector cost of dealing with banking problems: about 80 percent of GDP.
Development of a strong medium-term fiscal consolidation plan to be launched in 2010 is included in the program.

Government strategy: new bank/old bank approach — new banks to service domestic needs; old banks to sort out most foreign liabilities.
IMF assistance will include:
- Valuation of assets of both new and old banks in line with international best practice.
- Compensation from new banks to old banks for discrepancies in fair value of assets and liabilities taken over.
- Recapitalizing new banks with the aim of eventual privatization.
- Maximizing asset recovery in the old banks.
- Overhauling bank supervision and regulation.
Commitment to recognize obligations to insured depositors and to fair and equitable treatment of depositors and creditors of intervened banks.

Near-term outlook: expectation that GDP could fall by 10 percent next year, with a possible further small decline in 2010.
Longer-term outlook: Iceland’s economy described as very flexible with potential for a fairly fast rebound after the sharp downturn.
Success would look like:
- Stabilization of the króna and normalization of foreign exchange operations so exporters and importers have access to the foreign exchange market within the next couple of months.
- Gradual reduction of interest rates in 2009 once currency stabilizes.
- Gradual lifting of capital controls and beginning to tackle fiscal problems.
- Expectation that by the end of the two-year program Iceland’s economy will be growing again.
Alternative without IMF financing (as articulated by mission chief):
- Further significant decline in the króna.
- Significant strain on households with mortgages fixed in foreign exchange.
- A wave of defaults in the corporate sector with loans fixed in foreign exchange.
- Much higher increase in unemployment and an even bigger decline in GDP than the 10 percent currently predicted.

Prevent further sharp króna depreciation by maintaining an appropriately tight monetary policy in the context of a flexible exchange rate policy; restrictions on capital outflows to remain in the near term.
Develop a comprehensive and collaborative strategy for bank restructuring by:
- putting in place an efficient organizational structure to facilitate the restructuring process,
- proceeding promptly with the valuation of banks' assets,
- maximizing asset recovery in the old banks,
- ensuring the fair and equitable treatment of depositors and creditors of the intervened banks,
- strengthening supervisory practices and the insolvency framework.
Ensure medium-term fiscal sustainability: allow automatic fiscal stabilizers to work in full during 2009 and develop a strong medium-term fiscal consolidation plan to be launched in 2010 to address the substantial increase in public sector debt related to recapitalizing the banking system and fulfilling deposit insurance obligations.

IMF Survey: Iceland Gets Help to Recover From Historic Crisis (IMF Survey Online, December 2, 2008).