Fifth Review Under the Stand-By Arrangement, and Request for Modification of Performance Criteria and Rephasing of Access—Staff Report; Informational Annex; Staff Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Iceland.

The paper describes the impressive economic progress made by Iceland in implementing program policies, stabilizing the exchange rate, and bringing inflation down, under a program supported by a Stand-By Arrangement (SBA). The authorities noted that key challenges are to reduce the high level of unemployment, lift capital controls, accelerate private sector debt restructuring, and strengthen financial sector supervision and regulation. The full implementation of the economic program will create favorable conditions for economic progress based on sustainable public finances, private enterprise, and free markets.


The paper describes the impressive economic progress made by Iceland in implementing program policies, stabilizing the exchange rate, and bringing inflation down, under a program supported by a Stand-By Arrangement (SBA). The authorities noted that key challenges are to reduce the high level of unemployment, lift capital controls, accelerate private sector debt restructuring, and strengthen financial sector supervision and regulation. The full implementation of the economic program will create favorable conditions for economic progress based on sustainable public finances, private enterprise, and free markets.

I. Recent Economic Developments

1. The post-crisis recovery is underway, but remains fragile (Table 1; Figures 1 and 2). Exports increased and private domestic demand strengthened in the last quarter of 2010, and the economy stopped contracting on a year-on-year basis for the first time since the crisis. But import growth was particularly strong, turning GDP growth negative on a quarter-on-quarter basis and worsening the contraction to -3.5 percent on an annual basis—an adverse surprise. Short term indicators suggest continued modest growth in domestic demand in the first months of 2011, as investment activity continues to recover on the back of projects in the energy sector. Despite stronger-than-expected imports, the trade balance remained strong on account of a slight weakening of the krona and high commodity prices which kept exports high. Unemployment has declined on a year-on-year basis. The recent rise in commodity prices led to a moderate rise in inflation and inflation expectations in the first quarter of 2011.

Table 1.

Iceland: Selected Economic Indicators, 2005–11

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Sources: Statistics Iceland; Central Bank of Iceland; Ministry of Finance; and staff estimates.

GDP projections use chain linking to eliminate the statistical discrepancy that arises from aggregating components in constant 2000 prices.

Staff estimates. Actual minus potential output, in percent of potential output.

In percent of labor force.

A positive (negative) sign indicates an appreciation (depreciation).

Data prior to 2007 refers to annual rate of return. 2007 and on, refers to nominal interest rate.

National accounts basis.

Including face value of old banks debt before 2009. Related interest transactions are not included from Q4 2008 on.

Figure 1.
Figure 1.

Iceland: Recent Developments in Demand and Labor.

Citation: IMF Staff Country Reports 2011, 125; 10.5089/9781455272501.002.A001

Sources: Statistics Iceland; Bloomberg; and IMF staff calculations.
Figure 2.
Figure 2.

Iceland: Price and Exchange Rate Developments.

Citation: IMF Staff Country Reports 2011, 125; 10.5089/9781455272501.002.A001

Sources: Central Bank of Iceland; and IMF’s International Financial Statistics.

2. The Icesave dispute remains unresolved. The Icesave agreement was passed by a substantial majority in parliament in February, but rejected in a referendum on April 9. The dispute will now be settled through legal channels (see Section III.F. for a discussion of litigation risks).

3. The exchange rate has remained broadly stable (Figure 2). The trade-weighted krona depreciated modestly since mid-January because of seasonal fluctuations in the balance of payments, as well as tighter foreign currency positions after the CBI purchased €160 million from banks to reduce their foreign currency imbalances. The CBI has continued its regular weekly foreign exchange purchases (€1.5 million per week). Iceland’s CDS spreads have remained around 240 bps.

4. Financial and capital markets have remained stable, although there has been limited activity outside public and publicly-guaranteed bonds (Table 2; Figure 3). Given the capital controls, the latter have been the main investment instrument for pension funds and—together with bank deposits—for offshore krona holders locked in by capital controls. This demand has kept yields low, despite the outcome of the Icesave referendum and the threat of sovereign downgrades. Short-term interbank rates and bank lending rates are at historic lows, but credit has remained stagnant as household and corporate deleveraging continues. Corporate bond and equity markets are dormant, although new stock offerings have attracted considerable interest. Iceland recently completed another partial buyback of its Eurobonds falling due in 2011 and 2012, reducing the amount outstanding from €800 million to about €450 million.

Table 2.

Iceland: Money and Banking

(Billions of Krona, unless otherwise indicated)

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Sources: Central Bank of Iceland; and Fund staff estimates

Foreign liabilities include fx deposits of domestic banks and the government.

Net claims on banks is the difference between CBI’s lending to banks and banks’ holding of certificates of deposits

Base money includes currency in circulation (ex cash in vault) and DMBs deposits at the central bank in krona. Starting Feb 2009, the data also include oustanding government bonds held by the banks.

Figure 3.
Figure 3.

Iceland: Financial and Credit Market Developments

Citation: IMF Staff Country Reports 2011, 125; 10.5089/9781455272501.002.A001

Sources: Central Bank of Iceland; Datastream; and IMF staff calculations.

5. Public and external debt ratios have been revised down relative to the last review. The revisions reflect the fact that the Icesave dispute will not be settled through negotiation, as previously assumed, but through legal channels (Box 1). For gross and net general government debt, the estimated ratios at end-2010 remain broadly unchanged because the downward revision of the deficit was offset by the lower-than-expected 2010 GDP outturn. Gross external debt estimates for 2010 have been revised down to around 290 percent of GDP, reflecting the revised treatment of the Icesave liability, while net external debt is estimated at around 170 percent of GDP.

Treatment of the Icesave Dispute in the Fiscal and External Accounts

The treatment of the Icesave dispute has implications for the fiscal accounts and public debt, as well as the external accounts and external debt.

Previous staff reports included estimates of Icesave-related payments which the government had agreed to making in the context of a negotiated solution with the United Kingdom and the Netherlands. More specifically, the overall fiscal balance included estimates of Icesave interest payments associated with the the government’s guarantee of the loan to Iceland’s deposit insurance agency and public debt included the net present value of government’s estimated costs (interest and principal) under the guarantee, based on the terms of the latest available agreement. The external accounts included the Icesave liability as an external loan from the UK and Dutch governments to Iceland’s deposit insurance agency.

Since all sides now agree that the dispute will be settled through legal channels, the potential sovereign obligation is now a contingent liability of the Icelandic government.

  • For this reason, Icesave-related sums are no longer included in the baseline public debt and fiscal deficit figures. Instead, the contingent liability (and a range of possible terms under which it might be paid) is considered in the public and external debt sustainability analyses (see Appendix I). As a result of this change in treatment, the overall fiscal balance is higher and public debt lower than in previous reports.

  • The treatment of Icesave in external debt has also been modified. The estimate of gross external debt is lower than in the last review, reflecting the replacement of the loan to Iceland’s deposit insurance agency (associated with a negotiated agreement) with external obligations of the Landsbanki Resolution Committee (associated with asset recovery that will continue to take place). Whereas the loan appeared in external debt immediately, the Resolution Committee obligations accrue over time as assets are recovered from Landsbanki’s estate.

To facilitate comparability, the table below presents staff’s past projections—both including and excluding Icesave payments—and its current projections.

Table. Fiscal and External Sector Projections, 2010–11

(percent of GDP)

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Sources: Ministry of Finance of Iceland, and staff estimates.

Excluding write-offs and road construction projects

II. Outlook

6. The recovery is set to continue in 2011 but risks to the outlook have increased.

  • Growth in 2011 is projected to be 2¼ percent—slightly higher than at the time of the fourth review, but largely reflecting the lower base in 2010 (Table 3; Figure 4). The expansion is still expected to be largely driven by investment, with new investments in energy-intensive sectors offsetting scaled-down plans for road construction. Exports are also projected to be stronger, reflecting better prospects for marine products and tourism. Private consumption is set to recover gradually, receiving a boost from the projected increase in real wages (including strong increases in the tradable sector). Risks to growth are mainly on the downside, and stem from delays in investment projects, slower-than-expected progress in addressing the private sector debt overhang, shocks to external demand and commodity prices, and a possible deterioration in the investment climate. Unemployment is projected to decline as previously expected, helped by active labor market policies (Box 2).

  • Headline inflation is projected to be slightly above the central bank’s target of 2½ percent in 2011, mainly reflecting the impact of higher commodity prices. The slack in the economy and the broadly stable krona are expected to dampen inflation pressures over time. But risks to the inflation outlook have tilted to the upside: the likelihood of higher imports prices (mainly from higher food and fuel prices and possible exchange rate weakening associated with capital account liberalization measures) has increased and inflation expectations are on the rise. While the three-year wage agreement between the social partners has mitigated risks of very large wage increases in export sectors spreading to nontradables sectors, inflation risks are still heightened as it may be difficult for the nontradable sectors to accommodate even the agreed wage increases in profit margins.1

  • In 2011, the balance of payments is expected to be supported by a strong underlying current account surplus, the planned resumption of sovereign external borrowing, the realization of program financing, and disbursements from bilateral partners. With gradual steps towards capital account liberalization expected to be financed largely by new capital inflows in 2011, reserves are projected to increase to around $6¼ billion at end-2011.

Table 3.

Iceland: Medium-Term Projections, 2009–16

(Percent change, unless otherwise indicated)

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Sources: CBI; and IMF staff estimates.

Projections for 2010 use chain linking to eliminate the statistical discrepancy that arises from aggregating components in constant 2000 prices.

Contributions to growth.

In percent of potential output

In percent of labor force.

Excludes old banks transactions. Since 2009 also excludes accrued interest payments on intra-company debt held by a large multinational.

Includes interest payments due from the financial sector and income receipts to the financial sector.

Including face value of old banks debt before 2009. Related interest transactions are not included from Q4 2008 on.

Including old banks before 2009. Old banks’ total liabilities are excluded starting from 2009, but external debt includes TIF’s deposit liabilities, and accumulated recovered assets from both external and domestic sources before being paid out to foreign creditors. Once recovered, these assets are recorded as short-term debt.

Excluding short-term debt that are covered by external assets.

Gross external debt minus debt securities and other investment assets.

Figure 4.
Figure 4.

Iceland: Macroeconomic Outlook Compared to the Fourth Review and Other Crisis Cases

Citation: IMF Staff Country Reports 2011, 125; 10.5089/9781455272501.002.A001

Sources: Program documents and staff projections.Notes: Crisis year = 0. Advanced crisis countries include Finland, Norway, Sweden and Spain.Dates of the crisis defined as in Laeven and Valencia (2008) (2008 for Iceland).

Tackling Unemployment in Iceland

In the wake of the crisis, Iceland saw an unprecedented increase in unemployment (Figure 5). Job losses were concentrated in the construction sector, which experienced a swift reversal from the pre-crisis housing and investment boom. The official unemployment rate understates the severity of the downturn: outward migration, a rise in part-time employment, and a decrease in the participation rate (including through re-entering educational system) have dampened the rise in the official rate. Nonetheless, unemployment is still at its highest level in recent history, and its structure has become more problematic: unemployment among youth and low-skilled workers is significantly higher than for other groups, and duration is on the rise. The abundance of well-paid unskilled jobs before the crisis led many young people to bypass higher education and enter the labor market at a relatively early age. The result is significant youth unemployment and skill mismatches that require retraining and education.

The authorities’ response evolved over time as needs changed.

  • In the immediate wake of the crisis, the uptake of existing services was limited by a lack of information about the available services and by stigma, both related to a recent history of near-full employment. Thus, in 2009, the Directorate of Labor focused on expanding registration for unemployment benefits and educating the public about available options.

  • As the crisis wore on, the focus shifted to improving services for active job seekers. In late 2009, programs aimed at dealing with youth and long-term unemployment—already recognized as key problems—were introduced and continue to be implemented. These included job retraining, subsidized hiring for trial periods, study programs, subsidized hiring, and volunteer work.

  • Additional efforts will be made in 2011. To improve the availability and targeting of education, secondary schools will be opened to anyone under 25 years of age. There will also be increased emphasis on work-related education, and greater cooperation between social partners and the education system.

The authorities’ labor market programs have achieved a number of successes. The number of participants surged in 2010 and, while success rates vary, programs providing on-the-job training/apprenticeships or employment in specific projects seem to have increased chances of participants “de-listing” from the unemployment rolls (Table). Although data on the labor market status of de-listed participants are limited, information collected by the Directorate of Labor suggests that about half of unemployed youth found jobs after participating in the programs.

Active labor market measures

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Skill, job search, and other development courses, interest area evaluation, and financial consultations.

Basic unemployment benefits may be used to subsidise hirings in companies undertaking innovation projects (evaluated by the Directorate of Labour and Innovation Center Iceland).

Source: Directorate of Labor and Statistics Iceland
Figure 5.
Figure 5.

Iceland: Labor Market Developments.

Citation: IMF Staff Country Reports 2011, 125; 10.5089/9781455272501.002.A001

Source: Statistics Iceland.

7. The baseline medium-term balance of payments assumes that capital controls are gradually liberalized, in line with the authorities’ strategy (Table 4). The lifting of controls is assumed to take place in an orderly fashion. Some additional sovereign borrowing in international capital markets would help offset outflows. In addition, a combination of monetary tightening and modest exchange rate depreciation is assumed to limit the size of outflows by residents. Thus, gross reserves are expected to decline, but should remain above 90 percent of short-term debt over the medium term. Risks associated with the lifting of capital controls are discussed in Section III.F.

Table 4.

Iceland: Balance of Payments, 2008–16

(In billions of US dollars)

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Sources: CBI; and IMF staff estimates.

Actual data include old banks’ incomes.

Principal and interest transactions related to old bank original obligations are not included from 4Q08 on.

Includes inflows and outflows related to non-Icesave depositor obligations of Old Landsbanki.

Debt service payments on extraordinary financing appear in the financial account, except for Fund repurchases.

Excludes Polish loan (assumed to be converted into holding of Polish treasuries in zloty, which do not qualify as reserves assets).

Excludes old banks transactions. Since 2009 also excludes accrued interest payments on intra-company debt held by a large multinational.

Excludes short-term debt blocked by capital controls, and maturing loan with known matching assets.

Excludes resolution committee deposits at the central bank.

8. Both public and external debt ratios are expected to decline rapidly over the medium term. Gross external debt is projected to amount to about 240 percent of GDP at end-2011, but debt repayments, the release of captive nonresident krona holdings during the planned capital account liberalization, and ongoing asset recovery would reduce it to around 150 percent of GDP by 2016. General government debt is expected to peak at 100 percent of GDP in 2011 after the full disbursement of bilateral loans and the planned strengthening of the central government’s cash buffer. Larger projected cash buffers would also lead to a more gradual downward path for the debt ratio in the medium term compared to the fourth review.

Table. Public and External Debt Indicators

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Includes recapitalization of HFF and savings banks, and called guarantees transferred from the Government Guarantee Fund.

Includes government deposits at the CBI, other deposits, and claims on CBI from onlent exchange loans.

Excludes estimated foreign debt security, loan, and currency and deposit assets.

III. Policy Discussions

9. With key policies for the remainder of the program period largely in place, discussions focused on the revised strategy for lifting capital controls. Iceland has made significant progress with fiscal consolidation, strengthening the framework for household and corporate debt restructuring, and restructuring the financial sector. In each of these areas, the authorities and staff agreed that existing measures and policies must continue to be implemented and, in some cases, accelerated. The key remaining policy challenge is an orderly lifting of the capital controls. In this context, it was recognized that Iceland faces a particularly difficult task in releasing the sizeable stock of “locked-in” (largely nonresident) offshore krona at a time when risks to the global economy and financial markets are heightened. It was agreed that controls should be lifted gradually and in a manner that allows the timing of each step to adapt to circumstances. The authorities and staff concurred that, given the risks, a comprehensive assessment of the balance of payments outlook would be undertaken before moving to each next major step in the process.

A. Capital Controls

10. Iceland faces a formidable task in lifting its capital controls (Figure 6). Offshore krona holdings held captive by the existing capital controls are large (about 30 percent of GDP), and represent a considerable source of potential pressure on the currency and reserves.2 Thus, an orderly liberalization of capital controls requires that offshore krona holdings be reduced and that the spread between the offshore and onshore exchange rates be narrowed. At the same time, Iceland’s EEA obligations require nondiscriminatory treatment of residents and nonresidents, adding an additional layer of complexity to the liberalization process.

Figure 6.
Figure 6.

Iceland: Capital Control Liberalization challenges…

Citation: IMF Staff Country Reports 2011, 125; 10.5089/9781455272501.002.A001

Sources: Bloomberg; Central Bank of Iceland; and Datastream.

11. The authorities’ revised strategy for lifting capital controls is conditions-based and designed to address Iceland-specific challenges (LOI ¶15; Box 3). It begins with the release of offshore krona holdings and envisages lifting controls in stages, using a variety of liberalization methods. Once offshore krona holdings have been substantially reduced, (largely resident) onshore krona holdings would be released. In this regard, the strategy is appropriately conditions-based (rather than calendar-driven), as the pace of liberalization would be determined by an assessment of whether specific conditions have been met.

Key Features of Iceland’s Revised Strategy for Lifting Capital Controls

Capital controls, which were imposed in November 2008, have helped stabilize the exchange rate, permitted an easing of monetary policy, and reduced sovereign borrowing costs at a time of great uncertainty and financial stress. Nonetheless, in view of their distorting impact and their effect on the business climate, the authorities intend to lift controls as soon as conditions permit.

The authorities have prepared a strategy that is gradual, conditions-based, and involves liberalizing (largely non-resident) offshore krona before (largely resident) onshore krona. A fundamental premise of the overall strategy is that releasing offshore krona will support the lifting controls on onshore krona by narrowing the gap between the offshore and onshore exchange rates and allaying concerns that nonresident outflows could lead to a significant depreciation. Elements of the strategy aim to limit the near-term impact on reserves and government financing while encouraging FDI.

The First Phase: Release of Offshore Krona Holdings

“Tying up” offshore krona. The first step in the strategy aims to move offshore krona holdings (which are currently confined to repoable securities and deposits, and invested largely at the short end) into longer-term investments. Offshore krona holders will be permitted to sell their positions at a discount, while investors willing to take longer-term krona positions or to make qualifying longer-term investments will be permitted to purchase krona at a discount. One method will be auctions in which residents (notably pension funds) holding foreign assets will be allowed to buy krona at CBI-organized auctions for investment in long-term (non-marketable) government securities that will be held in closed-end funds for five years. A second method involves allowing investors to purchase offshore krona at CBI-organized auctions or use their own offshore krona to finance long-term investment. Investments would be structured into closed-end funds (with a five year lock-up period) that would serve as monitoring devices to prevent circumvention. Parties will have to commit to provide 50 percent of their investment in foreign currency to offset the outflows related to the import component of investment projects. Since the government bond market could lose funding when wider investment opportunities become available, the strategy conditions these steps on a robust budget financing framework with a large cash buffer, an extended maturity profile and, preferably, renewed access to international capital markets. To minimize the reserve impact, the auctioned amounts are to be limited and set commensurately with new foreign exchange inflow by long-term investors.

Release of remaining offshore krona. The strategy also aims to release offshore krona that is not “tied up” by the above methods. The release would be effected by: (i) small-scale auctions of foreign currency; (ii) conversions of short term krona-denominated government securities into long-term Eurobonds; and (iii) allowing offshore krona holders who did not take advantage of the other options to sell their krona on payment of an “exit levy”. The stipulated preconditions for these steps include government access to international capital markets, sufficient banking sector liquidity to withstand the withdrawal of offshore krona, and adequate reserves.

The Second Phase: Lifting Controls on Onshore Krona Holdings

The strategy does not provide details on how onshore krona would be released, as the authorities believe that the specific methods can be developed over time as the release of offshore krona proceeds. However, the strategy clearly indicates that the release of onshore krona will only begin after a comprehensive assessment of Iceland’s medium-term macroeconomic and balance of payments prospects is undertaken. Moreover, it specifies preconditions for the release of onshore krona. These include: (i) a sufficiently strong medium-term balance of payments outlook; (ii) international capital market access for the public sector and financial institutions; (iii) an assessment that the financial sector is able to withstand volatile capital flows; (iv) a significant reduction in non-residents’ krona holdings and other highly liquid positions; (v) substantial convergence of the offshore and onshore exchange rates; and (vi) stronger prudential rules. The strategy also states that the post-capital controls monetary framework should be defined before controls on onshore krona holders can be lifted.

12. The authorities and staff agreed that liberalization should proceed gradually, as preconditions are met (LOI ¶16). Progress in meeting the preconditions for liberalization has been made in a number of areas: public finances have been put on a sustainable path, the banking sector has been strengthened, and international reserves have risen. At the same time, sovereign access to international capital markets (which would boost international reserves and provide an alternative source of financing for the government) has not yet been achieved and the banking system remains vulnerable to both liquidity and balance sheet shocks. Because there is significant uncertainty about when the preconditions for the full lifting of controls will be met, the authorities are seeking an extension of the legislation on capital controls until end-2015.

13. The pace of liberalization will be calibrated to safeguard macroeconomic and financial stability. The authorities and staff agreed that it would be critical to avoid disruptions to the government bond market, the balance of payments, and the banking system as controls are lifted (LOI ¶16). The authorities emphasized that they intend to carefully calibrate the pace of liberalization to external, market, and financial conditions, and that they were prepared to slow (or stop) the pace of liberalization, if needed. In particular, to the extent that the outcome of the Icesave referendum leads to sovereign downgrades and reduces Iceland’s access to international capital markets in the coming years, the pace of liberalization would need to be slowed. Recognizing the significant challenges involved, the authorities and staff agreed that a comprehensive assessment of macroeconomic conditions, financial stability, and the adequacy of reserves would be undertaken before each major step in the liberalization process. It was also agreed that strict enforcement of the controls during the liberalization process would be critical. In this regard, staff strongly urged the authorities to ensure that the CBI has sufficient flexibility to quickly respond to leakages that may emerge during the liberalization process, including by ensuring that such flexibility is retained in new legislation on capital controls.

B. Monetary Policy

14. It was agreed that monetary policy should remain focused on achieving stable inflation and preserving exchange rate stability (Figures 7 and 8; LOI ¶18 and 19). With inflation expected to be slightly above target and nominal interest rates close to historically low levels, monetary policy has shifted to a neutral bias and policy rates have been kept unchanged in the last two meetings. It was agreed that the stance was appropriate in light of the forthcoming first steps toward lifting capital controls, the uptick in inflation expectations, and the decline in real policy interest rates. The authorities and staff concurred that the MPC would need to remain vigilant in the face of increasing risks to the inflation target.

Figure 7.
Figure 7.

Monetary Policy Operations and Liquidity Management

Citation: IMF Staff Country Reports 2011, 125; 10.5089/9781455272501.002.A001

Sources: Central Bank of Iceland; Datastream; and IMF staff calculations.
Figure 8.
Figure 8.

Iceland: Indicators of Monetary Stance

Citation: IMF Staff Country Reports 2011, 125; 10.5089/9781455272501.002.A001

Sources: Central Bank of Iceland; Bloomberg; Datastream; IMF staff calculations.

15. The authorities and staff concurred on the need to improve liquidity management in the coming months (LOI ¶19). Staff stressed that liquidity management will become increasingly important as capital controls are lifted. Ample liquidity conditions have kept short-term interest rates at the bottom of the CBI’s policy corridor. To help maintain interbank rates around the center of the policy corridor, the authorities intend to improve management of the stock of CDs, strengthen their liquidity forecasting capabilities, and, if needed, to engage in high frequency fine-tuning operations. In addition, it was recognized that the CBI may need to provide liquidity through exceptional operations as capital controls are lifted. In anticipation of this, the CBI has undertaken an evaluation of the availability and distribution of eligible collateral, and, jointly with the FME, an assessment of the banking system’s resilience to liquidity shocks.

16. The authorities reiterated their intention to purchase foreign exchange to increase non-borrowed reserves. Weekly purchase operations will be scaled up to help meet this goal when conditions permit (LOI ¶20). To ensure that reserves remain sufficient to ensure confidence in the krona during the process of capital controls liberalization, the authorities and staff agreed to use a range of indicators to monitor reserve adequacy.

17. Work on the contours of a post-program monetary policy framework is underway (LOI ¶21). The financial crisis has exposed the difficulties of implementing monetary policy in a small open economy like Iceland that is subject to large shocks and volatile capital flows. Because of the risks to financial stability, a strategic foreign exchange intervention and reserve management policy could prove useful in managing large capital flows, while also boosting Iceland’s reserves. The authorities underscored that the use of macroprudential tools to help avoid a repeat of the pre-crisis excesses will also be considered. They acknowledged that better coordination of monetary and fiscal policies, and improved institutional arrangements between monetary and supervisory authorities, will be critical to deal with potential challenges to financial stability. Staff stressed that these were areas of weakness that had been exposed by the crisis, and that additional efforts were needed to foster better coordination, particularly if the new monetary framework involved multiple objectives and multiple tools. The authorities are consulting with stakeholders to assess the relative merits of different monetary regimes, including in the context of EU membership discussions. The authorities and staff agreed to continue discussions on the new monetary framework in future missions.

C. Fiscal Policy

18. The 2010 fiscal target was met with a small margin (Tables 5 and 6; Figure 9). On the revenue side, corporate and capital income tax receipts exceeded expectations on account of the conservative projections embedded in the program. Moreover, expenditures were below target at the central government level (¼ percent of GDP), primarily as a result of the more appreciated krona. Thus, despite slippages in local governments’ fiscal performance (the primary deficit was ¾ percent of GDP compared with an expected zero), the general government primary deficit of 2½ percent of GDP was within the 2010 target (2¾ percent of GDP), and the overall balance improved by ¼ percent of GDP relative to the fourth review.

Table 5.

Iceland: General Government Operations, 2008–16 (GFS modified cash basis, percent of GDP 1/)

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Sources: IceStat, Ministry of Finance, and Fund staff estimates.

Historical data are semi-accrual; projections are modified cash.

Nominal measures have been allocated primarily toward revenue measures in 2012-13.

Excluding write-off claims on banks. Write-offs in 2008 are the result of central bank recapitalization and securities lending contracts that failed after the bank collapse. Write-offs in 2009 relate to an estimate of the NPV of depositor guarantees (liabilities not recovered by assets) and retroactive interest paid to new banks to compensate for late capitalization. Write-offs in 2010 reflect called guarantees of the State Guarantee Fund and recapitalization of the House Financing Fund. Write-offs in 2011 reflect savings bank recapitalization.

Includes bilateral loans to support foreign currency reserves at the Central Bank of Iceland (CBI). Loan from the Norwegian government directly to the CBI is excluded from general government debt. Includes the estimated net present value of the oustanding guarantee, net of asset recovery, on the UK/Dutch IceSave loans to the Icelandic Depositors’ and Investors’ Guarantee Fund. Does not include Fund liabilities.

NPV of the outstanding IceSave guarantee after asset recovery. It estimates, under given assumptions for asset recovery, the residual obligation for the government and growth thereof due to accruing interest.

Gross debt minus liquid assets at the CBI (including assets from bilateral loans to support CBI reserves, which are assumed to be liquid).

In percent of potential GDP. Structural estimates for 2009 were normalized to account for the impact of the asset bust price cycle. The deterioration in 2009 does not reflect the fiscal stance.

The 4th Review “Net Lending/Borrowing” has been corrected. The previous publication of the net lending did not include accrued interest on Icesave obligations in 2010.