Public Information Notice: IMF Executive Board Concludes 2012 Article IV Consultation with Iceland and Ex Post Evaluation of Exceptional Access Under the 2008 Stand-By Arrangement
IMF News, April 12, 2012
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- Authors: Arrangement Each Public Information Notice
- Published: April 12, 2012
Background
- Economy: Iceland is gradually emerging from its post-crisis recession; the economy expanded by 3 percent in 2011 driven by a broad-based rebound in consumption and a gradual pick-up in investment.
- Labor market: Unemployment declined steadily and now stands at around 7 percent.
- External sector and reserves:
- Trade balance continued to post strong surpluses.
- The krona depreciated—in part reflecting repayments of foreign debt by the private sector.
- International reserves increased sharply on account of IMF program disbursements, international sovereign bond issuance, and the drawing of bilateral loans.
- Financial markets became more active, but remained dominated by the government bond market.
- Fiscal stance: Fiscal consolidation initiated in 2009 is continuing, but at a slower pace than previously expected; expenditure overruns materialized in 2011 and the primary deficit will now reach 1 percent of GDP (compared with ¼ percent of GDP expected previously).
- Inflation and monetary policy:
- Inflation increased in 2011 and now stands well above the central bank’s target of 2½ percent.
- Krona depreciation, wage and commodity price increases pushed inflation up and prompted the central bank to tighten policy twice in 2011.
- Inflation expectations have remained largely above the target and monetary policy remains accommodative with real policy rates in negative territory.
- Financial sector:
- Banks reported strong profits, high capital, and large liquidity buffers.
- The latest Supreme Court decision will likely have an adverse effect on banks’ capital position, but banks expect the impact to be manageable.
- Restructuring of household and corporate debt led to a decline in Non-Performing Loans (NPLs) from 40 percent in 2010 to 23 percent.
- Reserve management: In March Iceland made early repayments of repurchases of most of its Fund obligations falling due in 2013 (around 20 percent of the total). Reserve adequacy in 2012 and 2013 will be somewhat weaker compared with no early repayments, but the ratio of gross reserves to short term debt is projected remain well above 100 percent.
Executive Board Assessment
- Overall appraisal:
- Directors commended Iceland’s emerging recovery and significant achievements in restoring macroeconomic and financial stability.
- In March, Iceland made an early repayment of part of its obligations under the Stand-By Arrangement.
- Given persistence of external and domestic risks, strong commitment to prudent policies and focus on addressing remaining challenges remain crucial.
- Fiscal policy:
- Directors stressed the importance of completing the fiscal consolidation.
- They called for additional measures to put the medium-term fiscal path back on track, and for contingency measures to guard against implementation risks.
- They welcomed the authorities’ commitment to their medium-term fiscal plan and efforts to strengthen the fiscal framework.
- Monetary policy and framework:
- Directors supported a gradual tightening of monetary policy to help bring down inflation, anchor inflation expectations, and support capital account liberalization.
- They noted the impact that further wage increases could have on inflation and competitiveness.
- Regarding the future monetary regime, Directors supported near-term priority on strengthening the existing monetary framework, including through the introduction of macroprudential tools.
- Capital controls and liberalization:
- Directors underscored that lifting capital controls is a key challenge.
- Pace of liberalization should be guided by the balance of payments outlook, reserve adequacy, and the need to safeguard financial stability; additional time may be needed given continuing global uncertainties.
- Risks associated with prolonged maintenance of controls should be kept in mind.
- Directors noted recent removal of certain exemptions from controls to mitigate risks of rapid liberalization and underscored the need to publish the new rules on exemptions as quickly as possible.
- Debt restructuring and social policy:
- Directors welcomed progress on private sector debt restructuring and looked forward to its swift completion.
- They cautioned against additional untargeted household debt relief, which would not fully address needs of households in greatest distress and would strain public finances.
- Banking sector supervision and vulnerabilities:
- Directors called for further efforts to address remaining risks and vulnerabilities in the banking system.
- They welcomed progress in strengthening the banking system and reducing nonperforming loans.
- They underscored the need to continue to address legacy vulnerabilities and to monitor how banks recognize income, notably from restructured and nonperforming loans.
- They considered that dividend payments should continue to be disallowed to ensure banks maintain high capital buffers while vulnerabilities are being addressed.
- Directors encouraged authorities to further strengthen supervision, including by continuing to address supervisory gaps and preserving the independence of the Financial Supervisory Authority (FME).
- Ex post evaluation of 2008 SBA:
- Directors agreed with key findings of the ex post evaluation.
- They concurred that the program achieved its objectives, owing to strong ownership and good program design.
- They noted the program was flexible and managed risks well, including through bank restructuring that limited the public sector burden and through the use of capital controls.
- Agreement on a fiscal adjustment consistent with the authorities’ objective of preserving Iceland’s social model was key in easing the social impact of the crisis and fostering program ownership.
Iceland: Selected Economic Indicators, 2005–12 (highlights)
- Macroeconomic growth (percentage change, unless otherwise indicated):
- Gross domestic product: 2005: 7.2; 2006: 4.7; 2007: 6.0; 2008: 1.3; 2009: -6.8; 2010: -4.0; 2011: 3.1; 2012 Est. Proj.: 2.4
- Total domestic demand: 2005: 15.5; 2006: 9.1; 2007: 0.0; 2008: -8.6; 2009: -20.3; 2010: -2.3; 2011: 3.9; 2012 Est. Proj.: 3.7
- Private consumption: 2005: 12.7; 2006: 3.6; 2007: 5.7; 2008: -7.9; 2009: -14.9; 2010: -0.4; 2011: 4.0; 2012 Est. Proj.: 3.0
- Gross fixed investment: 2005: 34.4; 2006: 24.4; 2007: -12.2; 2008: -20.0; 2009: -51.6; 2010: -8.1; 2011: 13.4; 2012 Est. Proj.: 13.8
- Export of goods and services: 2005: 7.5; 2006: -4.6; 2007: 17.7; 2008: 7.0; 2009: 6.6; 2010: 0.4; 2011: 3.2; 2012 Est. Proj.: 2.9
- Imports of goods and services: 2005: 29.3; 2006: 11.3; 2007: -1.5; 2008: -18.4; 2009: -24.0; 2010: 6.3; 2011: 5.1
- Output gap (staff estimates, percent of potential output): 2005: 2.8; 2006: 2.0; 2007: 2.2; 2008: -1.9; 2009: -4.5; 2010: -1.0; 2011: -0.7
- Selected indicators:
- Nominal GDP (bln ISK): 2005: 1,025.7; 2006: 1,168.6; 2007: 1,308.5; 2008: 1,482.0; 2009: 1,495.4; 2010: 1,534.2; 2011: 1,630.2; 2012 Est. Proj.: 1,732.5
- Unemployment rate (percent of labor force): 2005: 2.1; 2006: 1.0; 2007: 1.6; 2008: 8.0; 2009: 8.1; 2010: 7.4
- Consumer price index: 2005: 6.8; 2006: 5.0; 2007: 12.4; 2008: 12.0; 2009: 5.4; 2010: 4.8; 2011: (value reported above)
- Nominal wage index: 2005: 6.5; 2006: 9.3; 2007: 0.5
- Nominal effective exchange rate (positive = appreciation): 2005: 10.2; 2006: -11.8; 2007: 2.5; 2008: -40.4; 2009: -34.2; 2010: -0.1
- Real effective exchange rate: 2005: 13.3; 2006: -7.1; 2007: -20.7; 2008: 6.4; 2009: 0.9
- Terms of trade: 2005: 3.4; 2006: 0.2; 2007: -9.3; 2008: -6.7; 2009: 6.1; 2010: -1.8
- Money and credit:
- Base Money: 2005: 32.2; 2006: 27.9; 2007: 190.7; 2008: -31.5; 2009: -19.4
- Deposit money bank credit (end-period): 2005: 76.0; 2006: 44.4; 2007: 56.6; 2008: -28.3; 2009: -17.8
- Deposit money bank credit to residents (end-period): 2005: 54.7; 2006: 33.6; 2007: 28.3
- Broad money (end-period): 2005: 23.2; 2006: 19.6; 2007: 56.4; 2008: 36.3; 2009: -10.0
- CBI policy rate (period average): 2005: 10.5; 2006: 14.1; 2007: 15.4; 2008: 13.7; 2009: 7.8; 2010: 4.4
- Public finance (percent of GDP, National accounts basis):
- General government revenue: 2005: 47.1; 2006: 48.0; 2007: 47.7; 2008: 44.1; 2009: 41.1; 2010: 41.5; 2011: 41.7; 2012 Est. Proj.: 41.8
- General government expenditure: 2005: 42.2; 2006: 41.6; 2007: 42.3; 2008: 44.6; 2009: 49.7; 2010: 47.9; 2011: 46.3
- General government balance: 2005: 4.9; 2006: -0.5; 2007: -6.4; 2008: -2.8
- Primary balance: 2005: 6.7; 2006: -6.5; 2007: -2.7; 2008: -1.1
- Balance of payments:
- Current account balance: 2005: -16.1; 2006: -25.6; 2007: -15.7; 2008: -28.4; 2009: -8.4
- Trade balance: 2005: -17.5; 2006: -10.1; 2007: 8.4; 2008: 10.1; 2009: 8.2
- Financial and capital account: 2005: 14.0; 2006: 43.3; 2007: 18.1; 2008: -66.9; 2009: -28.2; 2010: 52.9; 2011: 15.3
- Net errors and omissions: 2005: 2.6; 2006: -11.0; 2007: -19.5; 2008: 37.3; 2009: -37.7
- Gross external debt: 2005: 284.5; 2006: 433.5; 2007: 605.9; 2008: 564.7; 2009: 266.5; 2010: 289.7; 2011: 250.4; 2012 Est. Proj.: 207.1
- Central bank reserves (US$ billion): 2005: 1.1; 2006: 2.3; 2007: 5.8; 2008: 8.7
Source: Public Information Notice (PIN) No. 12/34, April 12, 2012, International Monetary Fund.