Eurozone Uncertainty May Prolong Iceland’s Capital Controls

on Jun 20, 2012
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Uncertainty about the future of the euro may also have an impact on the Icelandic króna and on Iceland’s economic recovery, with the Icelandic government indicating that plans to remove capital controls before the end of 2015 may have to be delayed.

On 18 June 2012, IceNews, a Reykjavik-based website for news from the Nordics, reported that according to Iceland’s Economic Minister Steingrimur J Sigfusson, the country may have to delay its plans for removing capital controls by the end of 2015, due to uncertainty in the Eurozone. While capital controls are a necessary measure for stopping assets from leaving Iceland, their gradual removal is nevertheless an important step toward normalising the economic conditions in the country.

Speaking with Morgunbladid, one of Iceland’s biggest selling newspapers, Steingrimur Sigfusson noted that the capital controls liberalisation strategy may have to be evaluated in view of the situation in Europe. He pointed out that the presence of capital controls reduced the chances of a run on the currency and a capital flight. IceNews quotes an estimate made by the Icelandic Arion Bank hf, indicating that capital controls have kept approximately $8 billion of investor assets from leaving the country.

!m[](/uploads/story/146/thumbs/pic1_inline.png)Iceland introduced capital controls after the collapse of the country’s three largest lenders in October 2008 so as to prevent large capital outflows, which would have led to yet further depreciation of the Icelandic króna. According to Bloomberg data, Iceland’s biggest banks defaulted on $85 billion in debt, sending the Icelandic króna plunging as much as 80 percent offshore against the euro and driving the Icelandic economy into recession.

Nevertheless, the Central Bank of Iceland (CBI) defines capital controls as an “unfortunate but indispensable ingredient in the policy mix that was adopted to stabilise the króna” and at the end of July 2009, the Icelandic Government approved a capital account liberalisation strategy. The strategy, however, does not include a timeline; instead, the pace of its execution depends on the evolution of the relevant economic conditions and the outcome of each liberalisation step.

Yet, despite the observed economic recovery, efforts to ease capital restrictions have been tempered after this year the króna weakened 5 percent against the euro. In March 2012, Iceland actually pushed for stricter capital controls so as to support the króna and close “loopholes” in the legal framework. As reported by Bloomberg at the time, the new law adopted by the parliament was designed to avoid a króna sell-off, as controls on other currency transactions were being eased.
Yet, according to the Reykjavik-based Landsbanki hf, stricter capital controls would compromise the credibility of CBI’s liberalisation strategy and could add pressure to Iceland’s debt rating. Bloomberg reported that in February 2012, Fitch Ratings raised Iceland to investment grade, with a stable outlook, noting that the country’s “unorthodox crisis policy response has succeeded”.
Yet, as noted by Bloomberg, closing all the loopholes in Iceland’s capital controls may continue to pose difficulties, with investors likely to seek out other ways to repatriate their capital from the country. A potential extension of the capital controls beyond 2015 on the other hand will hardly be welcomed by investors, considering that capital controls are generally viewed as a drag on foreign investment.

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