Bloomberg News

Iceland Strategies Dodging Currency Shock Point to Euro

March 18, 2013

As Iceland maps out strategies to exit currency controls in place since the nation’s 2008 economic meltdown, joining the European Union, and then the euro, is emerging as the clearest path toward stability.

Policy makers in the $13 billion economy are trying to work out how to unwind capital restrictions that are blocking as much as $8 billion from exiting Iceland without triggering a currency crisis. A committee made up of officials from Iceland, the European Central Bank and the International Monetary Fund is now charting the nation’s options.

The group “is searching for ways to help us remove the capital controls and immobilize the offshore kronur overhang, to prevent it from changing into a catastrophe that floods Iceland’s economy,” Foreign Minister Ossur Skarphedinsson said in an interview from Reykjavik. “My personal opinion is we won’t be able to remove the capital controls or immobilize the offshore kronur overhang in a desirable manner without that being a part of our EU accession talks.”

Iceland, which is still recovering from the economic trauma caused by an $85 billion bank industry default 4 1/2 years ago, started EU membership talks in 2010. Removing the capital controls, imposed after the krona plunged as much as 80 percent against the euro in the offshore market, now marks the final goal post on the island’s path toward resurrection from its worst economic crisis in more than six decades.

Free Float

Finance Minister Katrin Juliusdottir and central bank Governor Mar Gudmundsson have both signaled that the removal of currency restrictions probably won’t be followed by a free floating krona regime.

Iceland holds parliamentary elections on April 27, four years after the Social Democratic-led government ousted its pro- deregulation predecessor following a wave of protests over economic mismanagement. Most polls suggest the government of Prime Minister Johanna Sigurdardottir won’t be re-elected. That’s unlikely to change the nation’s currency goals, Skarphedinsson said.

“All of Iceland’s political parties have said that they want to consider adopting another currency. Some of the solutions proposed have been a bit mysterious, such as the Canadian dollar,” Skarphedinsson said. “However, if you look into that matter seriously, there’s only one solution, and that’s adopting euro.”

The krona gained as much as 1.5 percent and traded 0.3 percent higher against the euro at 162.67 as of 2:14 p.m. in Reykjavik. The euro was down today against all major currencies tracked by Bloomberg, and fell to its lowest level against the dollar this year, after talks to rescue Cyprus resulted in an unprecedented levy on the island’s bank savings, threatening to reignite the crisis.

Deadline Dropped

Efforts to ease the krona controls have encountered a number of obstacles. Parliament agreed on March 9 to drop a 2013 deadline for lifting the restrictions. A second bill was also put forward, designed to make it more difficult for offshore investors to re-invest their kronur inside the island.

The krona has lost about 10 percent against the euro since an August peak. That’s spurred inflation in excess of 4 percent and left Icelanders worse off. Households owe the island’s banks 1.43 trillion kronur ($11.5 billion) in debt indexed to inflation, according to a statement the parliament’s website on March 7.

Won Praise

Yet the nation has won praise from the IMF for its approach in handling the crisis, in part because it put households’ wellbeing ahead of bank creditor claims and because of its use of krona controls. The country emerged from an IMF-backed program in August 2011 and is now outgrowing most of Europe. Iceland’s economy expanded 1.6 percent last year, according to the statistics office. The euro zone, now mired in its fourth year of fiscal crisis, contracted 0.6 percent in 2012, the European Commission said Feb. 22.

Though that’s cooled Icelanders’ eagerness to join the EU and the euro, membership in the bloc is inevitable, Skarphedinsson said. Delays in the talks, as Europe tries to deal with its debt woes and Iceland readies for elections, may even help smooth the accession process, he said.

“I’m very certain that eventually we’ll complete the talks and that a referendum will approve of Iceland becoming a member of the EU,” he said. “From my point of view it’s not undesirable that the talks have taken a little longer than first anticipated, as we, the proponents of EU membership, need the euro zone to have become stronger and that the EU is doing better. And that’s what is happening now.”

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

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


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