Iceland’s Molten Bond Rumblings

European debt crisis forerunner Iceland re-entered the euro-denominated sovereign bond space with excess orders for the EUR 750 million at a 100 basis point premium over Spanish yields, as the IMF cited the still perilous capital account liberalization path from post-2008 controls in a mid-year after-program update. The year-old coalition government has pressed further to resolve the banking crash legacy as tourism and fishing exports and private consumption enable 3.5 percent GDP growth, although 4 percent unemployment is above the historical average. Inflation rose just 1.5 percent as tighter monetary policy bit and the fiscal balance moved into surplus. Public debt remains at 90 percent of GDP and is almost double that amount including guarantees, and household burdens will be reduced under a new medium-term plan that is budget-neutral, according to the Fund. The strong trade position boosted the krona 2 percent against the euro in the first half on occasional central bank intervention as reserves stood at over $4 billion at end-2013 or 90 percent of short-term debt. Non-resident holdings frozen in place are 70 percent of the sum and domestic pension funds and companies barred from external transfer could likewise trigger large capital outflows with opening. Bank capital ratios were high last year, but net lending is negative on NPLs at 12.5 percent of the total. Annual Eurobonds are set through 2016 for refinancing when offshore liquid currency restrictions should also be removed. Global market volatility and delays in unwinding the old bank estates may complicate the timetable, as existing mechanisms for release via auctions remain slow, the report comments. Deposit insurance will be aligned with EU directives, but the housing finance fund continues as a big contingent liability which should be phased out under an indicative deadline, it suggests.

The latest small European country rescue in Cyprus was again reviewed after the March disbursement was approved and the primary deficit target was lowered to 1.5 percent of GDP. Another tranche was authorized despite “mixed compliance’ with structural benchmarks. Coops were successfully merged but the new social welfare system and Bank of Cyprus-Laiki audit and asset disposal procedures are pending. Debt/GDP is 140 percent and NPLs are at 40 percent of the combined portfolio. Deflation has set in although the economy may only shrink 3 percent. The island too managed a bond market return with the spread at 425 basis points as the stock exchange rebounded 15 percent from last year’s collapse. The current account balance should be positive as Russian and Ukrainian visits increase amid the border skirmishing at home. Kiev is on track to get the second installment of IMF cash as its current account deficit could come down to 5 percent of GDP on a 20 percent import drop outpacing exports hurt by the Eastern fighting. Bilateral and multilateral donors could stump up $10 billion this year but Fund repayment from the lapsed program and Gazprom arrear settlement will muffle the tectonic shift.