IMF and Iceland: Candid Discussions
IMF News, May 3, 2017
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- Published: May 3, 2017
Overview
- Publication date: May 3, 2017.
- Iceland is described as a Nordic country with a population of 340,000.
- In 2008, Iceland experienced a financial meltdown that led to capital controls, austerity, and a $2.1 billion IMF-supported program.
- Iceland recorded a growth rate of 7.2 percent of GDP in 2016.
Capital controls, external position, and financial stability
- Capital controls were largely lifted in mid-March (year not restated on page), marking a significant phase of crisis exit.
- Current stance on capital flows:
- "For all intents and purposes, capital flows are now free for businesses, households, pension funds, and financial institutions."
- A few legislative changes remain, but the process has gone "very well" with preserved stability.
- The original imposition of capital controls was a proposal that came from the IMF at the height of the crisis.
- The IMF engaged in good and helpful discussions on removing capital controls.
- Factors cited as strengthening resilience after controls removal:
- A relatively well-balanced economy and a current account surplus.
- Debt levels "much lower than they were prior to the crisis."
- Net external asset position: "from being net borrowers abroad, we now have more assets abroad than liabilities for the first time in the history of compiled data."
- High level of foreign exchange reserves of "around a third of GDP."
- Banks are described as "well prepared with regulations that can mitigate and reduce the risks associated with free capital flows and foreign exchange positions."
- Continued policy measures limiting hot-money inflows: "special reserve requirement on capital flows into the bond market and high yielding deposits."
- Risks and preparedness:
- Acknowledged possibility of "rougher seas" after lifting most capital controls, but authorities state they are "very well prepared."
- Vigilance against overvaluation of the currency and other risks associated with capital inflows.
Tourism, labor markets, and overheating risks
- Tourism has become Iceland’s number one industry, overtaking fishing.
- Outlook on tourism:
- The governor's view: "if you have a tourism boom of this magnitude, it is there to stay" though "there might be some ebb and flow."
- Emphasis on the need to "manage it well."
- Overheating concerns:
- "Yes, it is quite clear that there is a risk of overheating in the Icelandic economy."
- Labor market pressures: importing labor "on a significant scale"; tourism hiring competes with other industries; contributes to rising wages.
- Employment: "We are at—or above—full employment."
- Housing market pressures: home building collapsed during the crisis; construction sector focused on hotels, creating excess demand for homes though supply has begun to increase.
- Exchange rate pressures: tourism-generated foreign exchange has put upward pressure on the exchange rate; viewed as largely benign but with risk of overvaluation.
- Policy posture: "We are very vigilant in this regard" and "it is better to deal with challenges in good times."
Financial sector oversight and regulatory architecture
- IMF concluding statement suggested improving financial sector oversight as top priority.
- Central Bank position:
- "The Central Bank does not have an institutional view on it."
- The country has "done a lot to improve both regulation and the supervision."
- A "relatively new architecture of financial stability oversight" is in place; whether it is best remains to be seen.
- Changes to unify banking regulation and supervision under the central bank would require parliamentary legislation.
- The governor notes that "I think what the IMF proposes is in many ways good," but leaves ultimate decision to Parliament.
Banking sector reforms, performance, and IMF role in the crisis
- Crisis actions taken early on (before IMF program agreement) were crucial, particularly handling of failing banks through resolution.
- Banking sector characteristics and safeguards:
- Failed international banks previously held assets amounting to 10 times Iceland’s GDP.
- Those banks’ balance sheets were primarily denominated in foreign currencies.
- Authorities allowed failing banks to go into resolution and carved out three smaller domestically-oriented banks.
- These domestically-oriented banks are now "strong financial institutions" with strict regulation on the international asset side and "specific liquidity and funding requirements in foreign currencies."
- Banks are described as strong with capital adequacy rates "in the range of 25 to 30 percent" and "high liquidity buffers."
- The percentage of bad loans "has also been dramatically reduced."
- IMF’s role:
- IMF intervened in 2008 to help deal with the balance of payments crisis, the markdown in currency, and stabilizing the macroeconomy.
- The governor characterizes the IMF’s strengths as creating conditions for recovery and crisis management in a banking crisis.
- Relationship with the IMF was "good," featuring candid discussions and occasional disagreements; collaboration produced compromises ("we met in the middle").
- The governor describes the process as showing "a relationship of equals between the Central Bank and the IMF."
Key statistics and exact figures (as stated)
- Population: 340,000
- IMF-supported program size: $2.1 billion
- Growth rate in 2016: 7.2 percent of GDP
- Foreign exchange reserves: "around a third of GDP"
- Failed banks' assets pre-crisis: 10 times Iceland’s GDP
- Banks' capital adequacy rates: "in the range of 25 to 30 percent"
International Monetary Fund — May 3, 2017.