Iceland’s Fishy Capital Control Reel
Iceland’s new government elected on a household debt relief platform may also delay capital control lifting to almost a decade after the 2007 crisis prompting developed Europe’s first official rescue, according to the IMF’s August post-program analysis. They were imposed against a “vicious depreciation-inflation spiral” which has since improved with public debt consolidation and bank closure and restructuring as gross international reserves now exceed short-term liabilities. The currency initially plunged 40 percent but may currently be undervalued as output has yet to regain its pre-crash level. GDP growth has been in the 2 percent range despite good tourism, fishery and aluminum exports as domestic consumption remains depressed by deleveraging and unemployment and the slow capital liberalization pace. The two specialized channels involving the Landsbanki compensation bond and liquid offshore krona have yet to be opened before a broader elimination which could bring portfolio rebalancing around 30 percent of GDP, the Fund estimates. Inflation is on target for 2.5 percent after central bank interest hikes and exchange rate intervention, and the budget shows a small primary surplus. Dollar sovereign bond reentry has come with rating upgrades but household and corporate debts linger respectively at 170 percent and 110 percent of GDP. Judicial rulings on foreign currency-tied contracts have complicated resolution and the state mortgage lender is in poor financial position and additional forgiveness will entail new fiscal transfers. The three reorganized banks have an average 25 percent capital adequacy ratio and NPLs are below double digits, but earnings are thwarted from low demand and steep operating expense. For Emerging Europe as a whole outside Russia and Turkey slumping appetite continues to reduce cross-border funding according to the BIS and Vienna Initiative members with the biggest cumulative drops in Hungary and Slovenia, which has just established a central bad debt disposal unit awaiting the results of stress tests on NLB and its state-run peers. The tally notes that eight countries were in recession last year so that private credit increased only 1 percent in the first quarter. The group warns of further cutbacks following deteriorating securities market sentiment in May for a “double whammy.”
Cyprus has followed the original insolvent banking system and capital control route, with ratings agencies assigning selected default status after an extended maturity bond exchange and still predicting eventual Eurozone exit. Output may fall 20-25 percent over the medium-term, and the EU rescue has elevated debt/GDP to 85 percent. After a near 50 percent haircut on deposits above EUR 100,000 private accounts continue to decline and officials have resorted to tax amnesty in an attempt to lure back funds as external outflows and daily cash withdrawals remain subject to strict limits. Real estate prices have collapsed with credit only available for rescheduling as an independent investigation blamed “cultural rigidity” for the financial meltdown with a foul odor surrounding all parties.
