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Iceland’s goal of joining the euro will depend on the debt crisis in Europe, where it remains to be seen what form the single currency will take once the turmoil is resolved, central bank Governor Mar Gudmundsson said.
His bank published a report yesterday offering an analysis of the benefits and disadvantages of a currency switch. The main conclusion was that Iceland, which started European Union membership talks in 2010, can’t contemplate a new currency regime until both the krona and the euro have stabilized.
A stable krona “will also be of use for us if the EU accession process leads to Iceland deciding that the country wants to join the euro zone,” Gudmundsson said in an interview in Reykjavik yesterday. “Of course, we won’t know what happens in that regard for at least two or three years, and by that time the euro zone may well be completely different from what it is today.”
The government has said that Iceland’s krona won’t be restored to a free float before a new currency regime is adopted. Capital controls, enforced after the island’s 2008 banking meltdown triggered an 80 percent offshore krona slump against the euro, have since prevented international investors from offloading $8 billion in krona holdings. The fate of those assets depends on Iceland’s choice of currency policy.
“Icelanders now have to seek clarification on two options,” Gudmundsson said. “Whether the euro zone manages to resolve its crisis, on the one hand, and whether Iceland manages to build a better framework around the krona. So this is a race between a better krona and a better euro.”
Europe’s handling of its debt woes has so far failed to resolve the crisis, which is now in its third year. While the European Central Bank’s pledge last week to purchase unlimited quantities of euro-zone bonds initially stabilized markets, yields on Spanish and Italian debt have started to rise again. In Greece, official creditors have yet to sign off on austerity efforts needed to keep bailout funds flowing, as the region’s most indebted nation continues to pose a threat to euro stability.
The euro weakened 0.2 percent against the dollar as of 8:29 a.m. in London before a German report forecast to show investor confidence hovered near its lowest level this year.
“Previously I’ve said that I’m inclined to believe that it’s better for us to connect to this larger currency union,” Thorarinn Petursson, chief economist at the central bank, said in an interview yesterday. “That doesn’t mean that the opposite opinion is wrong. You can’t calculate yourself to a definite outcome.”
Iceland’s handling of its crisis has won praise from Nobel laureate Paul Krugman and the International Monetary Fund as a model for economic resurrection. The government’s commitment to its bailout terms, its decision to require bank creditors to share losses and to safeguard welfare benefits to protect its citizens proved key in Iceland’s successful rebound from its turmoil, Daria V. Zakharova, IMF mission chief to the island, said in an interview last month.
Iceland’s economy will grow 2.4 this year, the Washington- based fund said in April. That compares with an estimated 0.3 percent contraction in the 17-member euro area.
The central bank left its benchmark interest rate unchanged at 5.75 percent last month, after raising rates five times over the previous 12 months. The bank is trying to ease capital controls in stages without weakening the krona and fueling above-target inflation. Currency auctions, designed to help foreign krona holders exit their positions, have coincided with a 7.6 percent krona depreciation against the euro since an Aug. 10 high. Inflation was 4.1 percent last month, compared with the bank’s target of 2.5 percent.
The krona’s weakness “still hasn’t reached a point where I lose any sleep over it,” Gudmundsson said. “We don’t have a certain exchange rate target, so to speak. We have an inflation target.”
The bank’s decision at its next rate meeting will be “not only based on the developments of the exchange rate but also based on developments of other matters,” he said. “We’ve always been aware of the fact that the krona may come under considerable pressure over the next weeks and months,” as companies and municipalities pay off debt they’ve been unable to roll over, he said.
“But as of now there’s no need for panic and I’m not panicking over this,” Gudmundsson said.
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