The 2012 Article IV Consultation reports that Iceland’s fiscal consolidation is continuing, but at a slower pace. Moderate expenditure overruns materialized in 2011, which will partly spill over to 2012 and the medium term. A key priority is to put the medium-term fiscal path back on track, which can be achieved with additional fiscal measures of ½ percent of GDP. Lifting the capital controls remains an overarching policy challenge, given the significant locked-in funds.
Statement by the Staff Representative on Iceland Executive Board Meeting
April 6, 2012
This statement provides an update on developments since the Staff Report was issued. These developments do not alter the thrust of the Staff Appraisal.
On March 21, the Monetary Policy Committee (MPC) raised policy interest rates by 25 bps, in line with the tightening bias identified in the last two meetings and staff’s policy advice. The MPC voiced concern about the deterioration in the inflation outlook. The seasonal weakening of the krona, exacerbated by ongoing pressures related to the repayment of external debt, poses a risk to the inflation forecast, given the high exchange rate pass-through to prices in Iceland. Inflation expectations, measured by both breakeven rates and survey data, have also increased.
The Special Prosecutor, in coordination with the CBI’s Capital Controls Surveillance Unit, is investigating a fishing company for possible circumvention of the capital controls. Under the capital controls, exporters (including fishing companies) are required to repatriate their export proceeds. Monitoring compliance with this obligation is difficult partly because exporters have subsidiaries overseas, over which the Icelandic authorities’ jurisdiction is limited. This investigation is unprecedented and represents an intensification of the authorities’ efforts to enforce the capital controls.
The CBI is continuing to implement its capital account liberalization strategy. On March 28, it carried out the second in a sequence of planned auctions intended to match holders of offshore krona wanting to buy foreign exchange with investors willing to bring in foreign currency to invest in government securities or long-term investment projects in Iceland (the so-called “FDI route”). The CBI received bids for a total amount of euro 92.9 million, out of which euro 22.5 million were accepted. The bulk of accepted bids were under the FDI route while only modest amount were allocated to government securities. The variation in bids between this and the previous auction, together with the low acceptance rate for this round, illustrate the challenge in lifting capital controls.