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

November 20, 2008

With Poul Thomsen, IMF Mission Chief for Iceland and Deputy Director in the European Department
Petya Koeva-Brooks, Senior Economist in the European Department
Ángela Gaviria, Press Officer, IMF Media Relations
Washington, D.C., November 20, 2008

MS. GAVIRIA: Hello, everyone. I'm Angela Gaviria with the IMF's External Relations Department. Welcome to this conference call on the IMF's approval of a Stand-by Arrangement for Iceland. With me here are Poul Thomsen, Deputy Director in the European Department and Mission Chief for Iceland, and Petya Koeva-Brooks, a senior member of the mission for Iceland. Poul Thomsen will have some brief opening remarks, and then they both will be happy to take your questions. Poul?

MR. THOMSEN: Thank you. Perhaps I should just be very brief, and then you can ask questions.

As you know, Iceland is in an unprecedented situation, having seen the collapse of a significantly oversized banking system relative to GDP. It amounts to about almost 1,000 percent of GDP. The three main banks, accounting for 85 percent of the banking system, collapsed within a span of less than a week, creating very significant turmoil in the financial markets, in effect shutting down the foreign exchange market, and causing a dramatic depreciation of the krona.

What are the three concerns? The first concern is that the sharp depreciation of the krona could have severe repercussions on the real sector because a very large share of debt in Iceland is linked to the exchange rate or indexed to inflation, and therefore this depreciation is bound to have severe balance sheets effects and possibly trigger a wave of defaults in the corporate and household sector, unless we manage to stabilize the krona.

The second issue is, of course, that we need to have a functioning foreign exchange market, a functioning banking system. So we need to move fast to create a functioning financial sector.

And, third, because this bank restructuring has, essentially overnight, transformed Iceland from being a relatively low indebted country to be among the most highly indebted countries in Europe, as far as the public sector is concerned, Iceland now faces a difficult problem of ensuring medium-term fiscal sustainability. This means that they will have to undertake a fiscal consolidation program over the medium-term.

These are the three problems. These are the three issues we tried to tackle in the program. The immediate emphasis is therefore on stabilizing the krona through a combination of conventional and nonconventional monetary and exchange rate policies. Secondly, there's a comprehensive program of bank restructuring on the way. And, third, we will start preparing a program for fiscal consolidation to be launched in 2010.

Here, it's important to notice that in the short term, in 2009, we will allow what we call, in the jargon of economists, "automatic stabilizers" to work. The economy is facing a relatively deep recession of 10 percent of GDP. This will cause a significant increase in the public sector deficit, of up to close to 10 percent of GDP, because of lower revenues and higher expenditures.

Resisting that through belt-tightening in the midst of the recession would further exacerbate the recession, and we're not doing that. That's what we mean when we say we'll allow automatic stabilizers to work, that the increase in the deficit will have helped to cushion the recession, and delay these discretionary fiscal measures until 2010, when we expect the recession to have started bottoming out.

I think I will leave it there. Perhaps I should just add that, as you know, 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.

MS. GAVIRIA: Thank you, Poul. Now we're ready to take your questions.

QUESTIONER: I would like to ask Mr. Thomsen if he could provide some technical explanation of how the Iceland currency will be stabilized.

MR. THOMSEN: Well, the main issue in this is clearly to have a relatively tight monetary policy. What is our concern? Right now, we have a foreign exchange market where there are a limited amount of transactions. There are restrictions on current account transactions, on external current account transactions, and on capital account transactions.

The current account restriction restricting export/import is a particular problem. We need to move swiftly to liberalize these current account restrictions, meaning that we need to move swiftly to allow all demand and supply of foreign exchange pertaining to current account transactions into the foreign exchange market.

Doing so in the situation where obviously confidence has been shaken, where risk is causing capital outflows that are masked as a current account transaction, but really are capital account outflows. And that's one of our major concerns at this juncture.

One of the ways in which you can prevent that is to have a relatively tight monetary policy. If there's too much liquidity, it's too easy to finance capital outflows. So tight monetary policy is part of it, but is not the only instrument.

We are fully aware that in a situation like this, where confidence is weak, a high interest rate per se is not going to prevent people from taking money out of Iceland. It's just one part of the solution. Another one is simply to have restrictions on the capital account. By restrictions on the capital account, what I mean is that right now you will not be able to take out money out of Iceland on account of capital account transactions.

Third, we are supplying some amount of foreign exchange to the foreign exchange market. It's not a fixed exchange rate. It is a flexible exchange rate, but the central bank has foreign exchange at its disposal that it can supply to the market in order to absorb temporary demand pressures, preventing such temporary pressures from being reflected in a depreciation of the krona.

QUESTIONER: Further on the monetary policy, you talked, Mr. Thomsen, that we need a tight monetary policy. Can you tell me what the central bank interest rate needs to be during the next year?

MR. THOMSEN: No, I cannot tell you that because we do not know. What monetary policy needs to be is appropriately tight. What do we mean by appropriately tight? What is needed to stabilize the exchange rate, and that will depend on how things develop.

We think this is a strong program. We think it's a program that will help to bolster confidence. And if there is an early return of confidence, if we see that the krona starts stabilizing and appreciating soon, then I would expect that next year we have a gradual reduction in the policy rate of the central bank. You know that's right now 18 percent. The hope certainly is that we will see a gradual reduction in this rate, starting in a few months, but it's important not to have a premature relaxation before confidence has returned.

QUESTIONER: I'm wondering, can you predict the odds that the IMF loan and other financing will be used to maintain a high value of the krona or stop it from falling down?
MR. THOMSEN: The first line of defense is to have an appropriately tight monetary policy. It is possible, if there are temporary pressures, to supply foreign exchange to push or to prevent the excessive depreciation. But there are limits in the program on how much the central bank can supply to the market. That's a normal feature of an IMF program.

QUESTIONER: Can you explain what these limits are?

MR. THOMSEN: No. It's confidential information. These is market-sensitive information. We don't give that out.

QUESTIONER: Does the IMF see the krona as a viable currency for the future and, also, was there ever, in the discussions prior to this decision, any talk of doing away with the krona and taking up another currency? And I have another question as well.

When the krona is loaded, it will be more than 250 krona for every euro. Is that a fair assessment in your opinion?

MR. THOMSEN: On the first question, what the monetary arrangement in the future going to be, that has not been discussed. This program is focused on dealing with the problems at hand. The problem at hand is to stabilize the krona in the next couple of months and then hopefully have a gradual strengthening of the krona next year.

What should be the appropriate monetary and currency regime of Iceland over the medium term has not been discussed, and this lies well outside the focus of this program here.

As far as the value of the krona is concerned, I am confident that the krona is going to stabilize somewhere in the range of where it is trading right now in the onshore market, and soon start appreciating. So I would not agree with this forecast that you refer to.

QUESTIONER: About the fiscal plan to be launched in 2010, Mr. Thomsen, isn't it obvious that the Icelandic government has to do both, cut expenditures and raise tax rates?

MR. THOMSEN: You will see in the program that the decision on where to focus the fiscal consolidation will be taken in the coming months with a broad focus to be discussed in the context of the first review of this program. It will take place early next year, and the aim is to have a detailed program in place in the middle of next year.

I do not want to preempt anything. I think this is completely up to the Icelandic government. These are social choices made by Iceland, to what extent should be to reduce expenditures or increase taxes or a combination of the both. This is something that I have no comments on.

QUESTIONER: Will the IMF have a heavy hand in governing the Iceland economy?

MR. THOMSEN: No, I don't think that's a correct way of putting it. The government will develop some proposals, and we will discuss them. We will bring some experts in, experts in fiscal policy on both the expenditure and the revenue side, and they will discuss with the government what is the international best practice in doing these things. So it's a dialogue.

Our primary concern will be that the total package is within the envelope agreed in the program.

QUESTIONER: I would like to ask what is the cost for Iceland? How much does a loan from the IMF cost Iceland? And my second question would be what do the other loans that Iceland needs to take from other countries cost?

MR. THOMSEN: Under the IMF, the cost of the IMF loan actually changes every two weeks. It's market-related. It's recalculated every two weeks. I think right now it's a little bit more than 4 percent. But as I say the whole time, it's a little bit more than 4 percent.

The terms of the other loans have not been agreed yet. They are actually coming under discussion in the next couple of weeks. We have gotten assurances that governments are willing to provide the loan, but the actual terms of the loan are not known. We know that it's going to be medium-term loans with a grace period so it doesn't burden the balance of payments in the short run.

QUESTIONER: Just a follow-up question on the exchange rate following your details about the onshore rate. Are you talking about the onshore rate in Europe, where it is now about 230 krona for the euro, or in Iceland, where it is 177 krona?

MR. THOMSEN: I was talking about the onshore rate in Iceland.

QUESTIONER: Was there an agreement between Iceland and other creditors, not just Britain and Holland? For how long has it been a precondition of the IMF Board finishing this deal?

MR. THOMSEN: It was never a precondition. That's a misconception. Let me explain.

For us to take a program to the Board, the program has to be fully financed. As we said when we were in Iceland, there is a gap there of $5 billion to $6 billion. The IMF will provide $2 billion. So we have to find $3 billion to $4 billion from other sources.

We cannot launch a program without having it fully financed. I mean the program will obviously collapse if we did that. So we had to go and discuss financing from these other sources.

Other governments were keen on Iceland reaching an agreement in particular with the UK and the Dutch authorities, but also other countries where Iceland had been taking deposits, before committing to providing financing. So it was this linkage that other countries that were willing to support said, but we needed first to be sure that there is agreement on how to deal with his issue.

And that is pretty normal in the sense that if you want to contribute to the financing of a program, you want to understand it. In particular, you want to understand what is your money going to be used for. Is it going to be used for reserves or to repay others? It's a perfectly legitimate condition of other countries to stipulate that they want to understand the program in full, including what are the agreements with other countries, before they commit money.

So that was the situation we were in. We could not go to the Board because we did not have financing assurances before there was an agreement on this issue.

QUESTIONER: We heard on the news here, on the Icelandic radio this morning, that the spokesman of the Russian Minister of Finance did not know if Russia will lend Iceland €4 billion and he didn't know if there would be further talks between those two countries. Isn't the IMF expecting this loan from Russia?

MR. THOMSEN: Russia has given us indication that they will participate in the financing. I cannot give you any details, but we do expect Russia to contribute.

QUESTIONER: How sure are you that Iceland will get those $3 billion from other countries?

MR. THOMSEN: I'm confident that we will get the $3 billion. I'm very confident.

QUESTIONER: Mr. Thomsen, could you comment a little bit on what John Lipsky said in the press announcement yesterday evening, that the program is subject to exceptionally large uncertainty and significant risks? Could you explain a little bit these risks? What are they? How big are they?

MR. THOMSEN: The starting position here is that there is an unprecedented situation. We have banks accounting for almost 1,000 percent of GDP, almost 10-times the size of the economy, that collapsed within a few days. This is an extraordinary scale of the problem, relative to the size of the economy, and that poses difficult technical questions in drawing up a program.

The uncertainty is huge because we know that a very, very large share of loans are denominated in foreign currency or indexed to inflation. We know that the depreciation of the krona that has taken place already clearly will take a significant toll on balance sheets in both the corporate and the household sectors.

How that translates into and how that affects consumption, how it affects investment, how it affects demand, what is the risk of defaults -- these are very difficult questions to answer. So from that perspective, our best estimate is that the economy is contracting by 10 percent. But that's a perception that is subject to very considerable uncertainty. Just an example, there are lots of uncertainties throughout the program. Drawing on the monetary program when you essentially do not have the balance sheets of the new banks, the new banking system, is a daunting technical task.

QUESTIONER: In Article 24 of the Icelandic Letter of Intent, it is commented that there's a need for $24 billion until the year 2010. Can you explain this to us? What is this amount for and how does the IMF see this?

MR. THOMSEN: Yes, I can explain that to you. The $24 billion has three components. One component is the estimated cost of paying on the foreign deposits, which when this was drawn up it was estimated at close to $8 billion. With the information we have today, we think this is a significant overestimation. So probably it's closer to $5 billion, $6 billion, something like that.

That part of the financing is already assured in the sense that the concerned countries and particularly the UK and the Dutch have agreed to provide financing earmarked for the payments of these foreign deposits. So, of the $24 billion, or if we have the more recent, more realistic number of probably $21 billion or $22 billion, $5 billion to $6 billion is already secured through the commitment of the UK, Dutch and any other countries that will get payments to provide financing earmarked for this.

Secondly, there is an estimated $10 billion in arrears to private creditors. These are payments. When we calculated the $24 billion, or the corrected $21 billion or $22 billion, we assumed that all payments are being made. Now we know that these payments, this $10 billion, are not being made. So we have a counter item below the line of $10 billion of arrears that will be subject to discussions between the banks and those that are administering the banks now and the foreign creditors. That's also, so to speak, taken care of in the financing picture.

This leaves this residual financing gap, cash financing gap of about $5 billion. It's another way of saying, in the jargon of economists, when we do the balance of payments, we do it on an accrual basis, what is due. What is due gives you a financing need of $24 billion, that is $21 billion or $22 billion, corrected.

If we did all of this on a cash basis, the $24 billion would only be $5 billion, and that's the $5 billion we've been talking about.

I realize that this way of putting it sounds somewhat strange for somebody who is not in the IMF world, but this is the way we present it. We have to present the balance of payments on an accrual basis, what is actually due, not what are the actual payments taking place.

QUESTIONER: It seems like a few weeks ago we were talking about the possibility that Iceland would be getting help from China, Japan, the US. And, obviously, I guess Japan and the US would come under the rubric of the IMF, but China did not, in the end, contribute. It looks like it was intriguing that Poland and Russia stepped up to contribute. The number that was being kicked around was $6 billion before. Now I think you've said the package was the total cash available was about $5.2 billion. Could you just expand on how that came about?

MR. THOMSEN: I'm not quite sure I understand your question. If the question is why we went from $6 billion to $5 billion, that was simply because when we were up there the projections suggested $6 billion. Now, when we refined them, they were $5 billion.

About other countries, as far as I know, there have never been discussions with them for support. I'm not aware if there's been any discussion with several of the countries that you mentioned, but you know it's not for me to go into a discussion of why some countries participate and some do not.

This is a big package relative to the size of the economy, and I'm pleased that we have a large number of countries participating.

QUESTIONER: Let me ask you, is this the first time that Poland and Russia have contributed to an IMF bailout?

MR. THOMSEN: That I would be unable to answer.

MS. GAVIRIA: Thanks, everyone, for participating.


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