Transcript of a Conference Call on Iceland

July 11, 2014

International Monetary Fund
Washington, D.C.
Thursday, July 10, 2014

MR. SILVESTRE: Good morning. My name is Bruno Silvestre. I’m with the IMF Communications Department, and this is a conference call on the fourth Post-Program Monitoring discussion for Iceland. With me today is Peter Dohlman, the Mission Chief for Iceland, who will have a few opening remarks before taking your questions. Let me remind you of two things: Number one, this call is on-the-record, and number two, there is still an embargo and the embargo is only going to be lifted at 12:30 p.m., Washington time, or 4:30 p.m. in Reykjavik. Peter, you have the floor.

MR. DOHLMAN: Thank you, Bruno, and thank you to the callers for calling in. I would like to make just a few remarks and then turn to any questions that you might have. Let me start by laying out three main messages that we would like to communicate.

The first one is that Iceland, what we see for Iceland, is a positive economic outlook. I’ll go into details in a moment, though we do see risks tilted to the downside. On fiscal and monetary policy, we see Iceland as broadly on the right track. But looking at the financial sector we see some areas that need to be strengthened, for example, on supervision. I think the third message is really the key challenge for Iceland --- and that is addressing capital account liberalization, which we believe will continue to need to remain conditions-based.

So turning first to the positive economic outlook, what we see for Iceland is strong growth prospects with annual real GDP growth in the range of 3 percent over the medium term. We expect inflation to be broadly consistent with the central bank target, though with some uptick in the near term, and this will be sensitive to the policies that are eventually undertaken. On the current account, we expect it to remain positive helped in large part by strong tourism.

But we do see some downside risks to the outlook. On the external side, there are questions about global growth and volatility—-and also what impact these might have on Iceland’s terms of trade. On the domestic side we see some fiscal risks relating to household debt relief and the housing financing fund, as well as how capital account liberalization is handled.

Let me turn to policies and let me start with fiscal policy. The authorities’ medium-term fiscal objectives of a balanced budget and lower debt received broad support from our Executive Board at the meeting on Monday. But to achieve them, we believe additional measures are needed over the next several years in the range of 1 to 1.5 percent of GDP. This would also help ease near-term pressure on inflation. It is important that this be undertaken in the context of a well-specified medium-term fiscal plan, and we believe that the organic budget law, which is now before parliament, will provide a solid institutional framework for achieving these objectives and measures.

Turning to monetary policy, our Executive Board expressed broad support for the central bank’s monetary policy stance, but urged the central bank to stand ready to respond to any price pressures stemming from factors such as wage formation, the fiscal stance, and the closing output gap. In the context of the current review of the central bank legislation and financing framework, our directors stressed the importance of maintaining a financially sound, independent, and accountable central bank.

Regarding financial sector policy, our Board took note of the stable conditions there and the high capital and liquidity buffers in place, but there was broad support for maintaining these strong buffers as the crisis legacies are unwound. There was also a strong sense that more is needed to strengthen banking supervision.

Let me say a few words about capital account liberalization, which is the key challenge for Iceland. I think it is important to first recognize the progress that has been made since the crisis: Public and private sector balance sheets have been strengthened due to lower debt and reduced mismatches; nonresident liquid Krona overhang has been gradually released and reduced through foreign exchange auctions; the authorities have paid down about 60 percent of the exceptional financing that was received in 2008-9 from the Nordics and from the IMF, tapping external markets on several occasions, all while maintaining adequate reserves and stability. We see a stable exchange rate and also a stable financial sector.

From the IMF side, we continue to support a conditions-based approach to capital account liberalization where the pace is dependent on: the size of the potential outflows and balanced payments prospects; on maintaining adequate levels of reserves; on a strong financial sector; and on maintaining stability.

In terms of what is needed for capital account liberalization, we think that the authorities should push ahead with their agenda. They need to finish the balance of payments assessment that they are undertaking. They are putting in place a new organizational structure, and they are hiring international advisers to help reconfigure and implement their strategy. We think it is too early to predict outcomes, but the authorities hope to make significant progress on this issue this year.

Finally, let me add that it’s important to continue, in the context of capital account liberalization, to pursue supportive macroeconomic and financial sector policies, and these have been detailed in our staff report.

Let me say one other brief word about the future. This is our fourth post-program monitoring discussion and later this year, around November, we expect to hold Article IV Consultations with the Icelandic authorities. And we will be reporting to our Board sometime in early January of 2015.

I’d be happy to take any questions that you might have.

QUESTIONER: Thanks a lot. I was just wondering a couple of points. You mentioned the 2009 reforms to the central bank act and that key reforms should be retained. I was wondering which in particular. I mean that was when the Central Bank of Iceland went to a single governor system from three governors. Well, was that one of the ones you thought was worth keeping? And then you say the government should stick to its strict procedures for selecting top professionals for the central bank, the current process of selecting a new governor or having the current governor reapply for his post. Does that fit that definition? Thanks a lot.

MR. DOHLMAN: Yes, the reforms that were taken in 2009 are, for the most part, worthy of continued support. I think one of the important elements there was putting in place a credible selection process and selection criteria for the governorship and that is one key element that we would like to see preserved.

I think another key element for us is the existence of, or creation of the monetary policy committee with external members. These external members provide an independent voice, which we think is important. The reform also brought enhanced transparency in reporting, which is also one of the pillars from our perspective of the current central bank legislative framework.

You mentioned the three versus one governor, and this is something that we think is up to Iceland as to how to organize that top tier of management. So that reform itself, that part of the reform, was not something that we have a strong position on, at least in terms of our advice in discussions with the authorities. I hope that answered the question.

QUESTIONER: I was wondering, the Finance Ministry has indicated that they want to finish up any sort of negotiations with the creditors of the failed bank this year and that the capital controls have now been in place too long. What is the IMF’s view on the hastiness of this whole process this year? What is your view on the fact that they seem to think that they really could get things going this year, and they will force the issue coming next year if nothing is happening?

MR. DOHLMAN: I emphasized in the opening remarks and we’ve said repeatedly in our staff report and elsewhere that we think it is very important that they maintain a conditions-based approach to liberalization. This has several components to it and one of them, of course, is the potential overhang, the potential outflow in the balance of payments (pressures). So that is, of course, one element of it and that I think the old banks are one significant part of that potential overhang. So those discussions, the outcome of whatever discussions happen there, will be very important.

I think the other element is the balance of payments prospects more broadly. There the authorities and the central bank in particular have made a lot of progress over the last months in reassessing that. And so I think preparatory work is happening, and they’ve done a lot of thinking themselves through the formation of various committees on the issue of capital account liberalization.

So in terms of the preparatory work and then the organizational changes --- which I mentioned and which, of course, the authorities have put out into the public domain ---these are all important elements of it.

Finally the hiring of international advisers, which I think is in the final stages of selection, could also be a contributory factor. And I think I mentioned at the very end of my opening remarks the importance of supportive macroeconomic and financial sector policies, and we think they’re probably on the right track there.

In terms of the timing, I come back to the very first part of my answer, that it should be conditions-based. I think that if those elements, the overhang and the balance of payments and the discussions with the old banks, if these come together then it could happen. But I think there are different paths that the authorities have put out and discussed and it is not clear to us, or at least at this stage it is too early to say, which path will be taken.

QUESTIONER: Do you think some sort of a forced bankruptcy situation would be wise if an agreement can’t be reached with the creditors?

MR. DOHLMAN: There are two broad paths that we understand are being considered, and one is the composition agreements for at least two of these estates and the other is more of a liquidation strategy. Which path they take is their decision. There are legal questions there and there are questions about what decisions are made by the old banks themselves at the end of the day.

But let me make one or two more general comments on this. One is that we’ve said in the past, in our staff reports -- and in their existing capital account liberalization strategy --- that it is important not only to have a path, but also to have incentives--incentives to participate. So, for example, in the current strategy there is an exit tax envisaged for the liquid Krona overhang. That strategy of having a well-grounded, well-laid out, path as well as an incentive structure, we think is an important element. So where it goes in the next months I think we’ll have to see.

QUESTIONER: I just wondered if you are concerned at all with the length of time that it’s taking to remove capital controls and what the risks are of this being drawn out even further. I appreciate that you say that there has been some progress, but I mean we are still a number of years past the crisis. What are your concerns?

MR. DOHLMAN: Yes. It’s a tough question. I think you’re right, five and a half years and the temporary capital controls are still in place. We haven’t done any formal analysis of this, but we are planning a bit in this area in looking ahead to our next Article IV Consultation. But there are many areas that we have certainly heard about and if you look at the situation where you have locked up liquidity, there are risks from lower interest rates. Interest rates might be lower than they would otherwise be in the absence of controls. This can create distortions. There are strict limits on outward foreign direct investment, and this prevents domestic entities from diversifying their own portfolios and this can have costs. And there may also be some inhibiting factor to inward FDI that you have to take into consideration --- and to the extent that this is happening, Iceland is forgoing foreign exchange inflows as well as possible technology transfer.

And I think --- coming back to the earlier question --- Iceland is a small open economy that is dependent on the rest of the world in many ways for its growth. Whatever solution they’re coming up with at the end of the day on the old banks and as part of their strategy for capital controls, it is important they look for something that would allow Iceland to continue to take advantage of the benefits from these external ties both on the trade, but also on the investment side. And I think we’ve emphasized many times the importance of a cooperative approach to dealing with the various challenges they have on the overhang.

QUESTIONER: Maybe if I can just add one question there. Do you see any possibility of a resolution for creditors in the near future or I mean even before the end of the year?

MR. DOHLMAN: You’re talking here about the old banks?


MR. DOHLMAN: You know, it’s something that is -- there are a lot of moving parts, and I don’t want to be in a position of predicting outcomes. These are private obligations -- and the government, of course, has a stake in the outcome because of the impact on the balance of payments. What the government is doing now is taking preparations, doing its assessment, putting in place an organizational structure, and pursuing supportive macroeconomic and financial sector policies. I think they are doing a number of things -- that I also mentioned at the beginning in my remarks --- and I think we would encourage them to continue to do this and also to continue their work that they have now started in updating the 2011 liberalization strategy. We think that it is important that it be conditions-based.

And so to predict an outcome in terms of timing, --- we have emphasized over and over that these things really should be conditions-based, and that extends to really all elements of the case. With the old banks there are these two broad possibilities and I think that is something that the old banks and the creditors and the other interested parties are going to have to sort out. And what we’ve heard is that there is hope for progress in the next few months, in this year. So we will continue to emphasize the conditions-based approach and that it be comprehensive and cooperative in nature with a strong incentive structure. We think that is also important.

MR. SILVESTRE: Well, there are no more questions, so this concludes our conference call on Iceland. I want to thank all the participants for being here. And I guess we’ll talk again for the fifth PPM and Article IV consultation.


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