Iceland will need to keep capital controls through 2015 amid difficulties in reducing an overhang of kronur held by offshore investors, the International Monetary Fund said.
“It’s now assumed that capital controls will remain in place through 2015 because of the limited progress made so far in reducing the stock of offshore krona,” Washington-based IMF said today in a report.
Iceland’s central bank is seeking to phase out the controls by 2015 through dual currency auctions of kronur and euros. The program is designed to take pressure off the krona even as investors sell their holdings by offering financial benefits and the option of reinvesting in the island.
The auctions have released a “modest” amount of locked in kronur, equal to 4.5 percent of gross domestic product, the IMF said. The progress has been “partly offset” by coupon payments on offshore kronur and currency released by the estates from banks, leaving offshore kronur equal to about 23 percent of the economy, according to the IMF.
“One precondition for liberalization is reducing the overhang of liquid offshore krona,” the IMF said. “This process needs to be accelerated by improving incentives for offshore krona holders to exit via the channels in the authorities’ capital account liberalization strategy.”
Iceland imposed currency restrictions in 2008 following the failure of Kaupthing Bank hf, Glitnir Bank hf and Landsbanki Islands hf, which triggered an 80 percent plunge in the krona against the euro offshore. The country then sought a $4.6 billion bailout led by the IMF. Iceland emerged from the IMF’s 33-month economic program in August last year.
The island’s recovery is “taking root” and its fiscal consolidation is “broadly on track,” the IMF said in today’s report. The economy is estimated to expand 2.6 percent this year and 2.3 percent next year, according to the IMF.
The IMF also urged more tightening from the country’s central bank to bring down inflation. The report was made before the bank last week raised its benchmark rate to 6 percent.
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