Bloomberg News

Iceland Tightened Krona Controls to Prevent Speculative Chaos

March 13, 2012

Efforts to ease capital restrictions are being tempered after the krona weakened 5 percent versus the euro this year. Photographer: Arnaldur Halldorsson/Bloomberg

Efforts to ease capital restrictions are being tempered after the krona weakened 5 percent versus the euro this year. Photographer: Arnaldur Halldorsson/Bloomberg

Iceland pushed through stricter capital controls yesterday to clamp down on speculative trading and support the krona as it seeks to emerge from its 2008 economic collapse.

“We were making sure that the controls wouldn’t be unwound in a chaotic manner which might lead to instability,” Arnor Sighvatsson, deputy governor at the Reykjavik-based central bank, said yesterday in a phone interview. Loopholes in the legal framework posed a risk that “was becoming too great and if we didn’t step in it could have become uncontrollable.”

Iceland tightened controls on inflation-linked debt and on creditors of Kaupthing Bank hf, Glitnir Bank (GLB) hf and Landsbanki Islands hf. The law, which was rushed through parliament after markets closed on March 12, is designed to avoid a krona sell- off as controls on other currency transactions are eased. It prevents the liquidators of the three failed banks from paying creditors in foreign currencies and blocks owners of Icelandic bonds from shifting annuity and interest payments into other currencies.

The move will compromise the credibility of the central bank’s liberalization strategy and deal a blow to the confidence in the island’s authorities, Islandsbanki hf said in a note to clients. It appears to be a “last-resort action” before a bond payout of as much 7 billion kronur ($55 million) on March 15, the Reykjavik-based bank said in the report edited by Ingolfur Bender.

Efforts to ease capital restrictions are being tempered after the krona weakened 5 percent versus the euro this year.

Always Risk

Iceland introduced capital controls and sought a $4.6 billion bailout led by the International Monetary Fund in 2008 after its biggest banks defaulted on $85 billion in debt, sending the krona plunging as much as 80 percent offshore against the euro and driving the economy into a recession. The country ended a 33-month program with the IMF in August.

Inflation-linked bonds slumped yesterday. According to prices on NASDAQ OMX (NDAQ) Nordic’s website, the 2014 bond fell 14 percent and the 2024 bond declined 1.89 percent.

“There’s always some risk of there being a negative short- term effect,” said Sighvatsson. “What matters more is that the rating agencies and the International Monetary Fund have emphasized that the capital controls be unwound in an orderly manner that doesn’t create instability.”

According to the government, annuity payments on the capital of the 2014 note might be as much as 42 billion kronur, until the final maturity in September in that year.

Rating Risk

Islandsbanki said the move may add pressure to the country’s debt rating.

“The positive development in Iceland’s sovereign credit rating could be placed at risk, as success in removing the capital controls was one of the key criteria for a rating upgrade,” Islandsbanki said. “Amending legislation after the fact will exacerbate political risk in Iceland, which is a key factor in the rating agencies’ assessment of a sovereign’s credit-worthiness.”

The country’s central bank last month signaled it’s ready to raise interest rates in order to cap inflation after consumer prices soared above the official target and the krona slid against the euro. Fitch Ratings in February raised Iceland to investment grade, with a stable outlook, and said the island’s “unorthodox crisis policy response has succeeded.”

Closing Loopholes

Iceland’s $13 billion economy, which shrank 6.7 percent in 2009, grew 2.9 percent last year and will expand 2.4 percent this year and next, the Paris-based Organization for Economic Cooperation and Development estimates.

Closing all the loopholes in Iceland’s capital controls, scheduled to be abolished by the end of 2015, may continue to pose difficulties as investors are likely to seek out other ways to repatriate their capital from Iceland.

“There will always be some people that will seek ways to circumvent the controls,” said Sighvatsson. “We are aware of many such ways, and some people will try to find them.’

To contact the reporter on this story: Omar R. Valdimarsson in Reykjavik valdimarsson@bloomberg.net

To contact the editor responsible for this story: Jonas Bergman at jbergman@bloomberg.net


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