Transcript of a Conference Call on the IMF's Executive Board Approval of a Stand-By Arrangement for Iceland

IMF News, November 20, 2008

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Iceland experienced the collapse of a significantly oversized banking system relative to GDP, "almost 1,000 percent of GDP."
The three main banks accounted for 85 percent of the banking system and collapsed within a span of less than a week.
Collapse led to severe turmoil in financial markets, effectively shutting down the foreign exchange market and causing a dramatic depreciation of the krona.
IMF mission assesses the economy is facing a relatively deep recession of 10 percent of GDP; elsewhere the contraction is expressed as "contracting by 10 percent."

Sharp depreciation of the krona risks severe balance-sheet effects and could trigger a wave of defaults because "a very large share of debt in Iceland is linked to the exchange rate or indexed to inflation."
Need to restore a functioning foreign exchange market and a functioning banking system—"we need to move fast to create a functioning financial sector."
Ensuring medium-term fiscal sustainability after bank restructuring transformed public indebtedness; a fiscal consolidation program is to be prepared to be launched in 2010.

Stabilize the krona through a combination of conventional and nonconventional monetary and exchange rate policies.
- Maintain "a relatively tight monetary policy" as part of the first line of defense.
- Continue restrictions on capital-account transactions in the near term to prevent disguised capital outflows.
- Supply some foreign exchange from the central bank to the market to absorb temporary demand pressures; "it's not a fixed exchange rate. It is a flexible exchange rate."
Implement a comprehensive bank restructuring program.
Delay discretionary fiscal consolidation until 2010 and "allow ... automatic stabilizers to work" in 2009, accepting an increase in the public sector deficit "of up to close to 10 percent of GDP" to cushion the recession.
Prepare detailed fiscal consolidation proposals with the Icelandic government; the decision on focus to be taken in the coming months and discussed in the first review early next year with a detailed program "in the middle of next year."

IMF loan support described in different statements:
- "the program is supported by a loan from the Fund in the amount of about $2.1 billion, and another $3.2 billion coming from other creditors, for a total cash support from that of $5.2 or $5.3 billion."
- elsewhere described as "the IMF will provide $2 billion. So we have to find $3 billion to $4 billion from other sources."
- a separate phrasing noted a "residual financing gap, cash financing gap of about $5 billion."
Cost of the IMF loan: "a little bit more than 4 percent" (noting that IMF borrowing cost "changes every two weeks" and is market-related).
Other bilateral and multilateral financing terms had not been finalized at the time of the call; assurances of participation (including from Russia) were reported but details confidential/not disclosed.
The accrual vs. cash presentation: an estimated $24 billion financing need (later corrected to "probably $21 billion or $22 billion") was explained as composed of:
- estimated cost of paying foreign deposits originally near $8 billion (now thought "closer to $5 billion, $6 billion"),
- an estimated $10 billion in arrears to private creditors (not being paid and subject to discussions),
- leaving a cash financing gap of about $5 billion.

Central bank policy rate at the time: "right now 18 percent."
The appropriate policy rate going forward is conditional: monetary policy must be "appropriately tight" to stabilize the exchange rate; an early return of confidence could allow "a gradual reduction in the policy rate."
The central bank can supply foreign exchange to prevent excessive depreciation, but "there are limits in the program on how much the central bank can supply to the market" (details confidential and "market-sensitive information").

Program subject to "exceptionally large uncertainty and significant risks" because of:
- unprecedented size of banking collapse relative to the economy ("almost 1,000 percent of GDP").
- large share of loans denominated in foreign currency or indexed to inflation, amplifying balance-sheet effects from krona depreciation.
- uncertainties about how balance-sheet losses translate into consumption, investment, defaults, and demand.
- incomplete information on the balance sheets of the restructured/new banking system complicates technical program design and implementation.
IMF best estimate of the contraction is 10 percent, but this is "subject to very considerable uncertainty."

IMF role described as collaborative: IMF experts will "discuss with the government what is the international best practice" on fiscal measures; the government makes social choices on expenditure vs. revenue.
Program conditionality: the total fiscal package must be "within the envelope agreed in the program."
Financing assurances were required before the IMF Board consideration; bilateral creditor commitments (notably the UK and the Netherlands) and other participating countries wanted clarity on how funds would be used before committing.

Transcript of the conference call, November 20, 2008.