This supplement provides information that has become available since the issuance of the staff report. The information does not alter the thrust of the staff appraisal in the Sixth PPM staff report.
Iceland announced its updated capital account liberalization strategy. Details are still emerging, but the updated strategy is broadly in line with staff expectations. The strategy takes a staged approach.
The first stage targets a reduction in the balance of payments (BOP) overhang—nonresident net claims on domestic assets—of the old bank estates, consistent with maintaining stability. Preliminary proposals have been put forward by key creditors of each old bank estate to release their assets from capital controls in exchange for voluntary ‘stability contributions’ to the government which will be used to retire debt. The next step will be votes by a qualified majority of creditors of each estate on composition agreement—a legal step where creditors agree on the terms of satisfaction of their claims and assets’ distributions, including “stability contributions”. The key elements of the composition agreements are expected to be in line with the tentative understandings reached by creditors’ groups with the authorities and will require formal approval of the central bank to be followed by approval by government. To provide incentives to finalize composition agreements, the authorities are seeking parliamentary approval of a ‘stability tax’ targeting the estates’ BOP overhang that would be assessed as of end-2015 on any old bank estate that has not reached composition by that date. If successfully implemented, the strategy will help accelerate the pace of liberalization.
The next two stages will address remaining offshore liquid króna (OLK) holders and then residents. An auction open to OLK holders is expected to take place later this year. The format for liberalization of residents will be elaborated at a later stage and will depend on conditions, though small amounts of resident outflows will be allowed for pension funds, outward FDI, and households.
Additional interim measures have been introduced in the context of the liberalization strategy. To prevent potential circumventions undermining progress in capital flow liberalization, the authorities have introduced certain measures including capital flow management measures, through amendments in the Foreign Exchange Act. The measures target principally the old bank estates and in particular they limit (i) cross-border intercompany borrowing-lending by the estates and (ii) FX purchases by the estates and other residents for the repayment of cross-border intercompany loans. The authorities believe that the measures will not have a significant impact on intercompany lending between residents and nonresidents as foreign exchange purchases for such purposes are trivial given that most resident borrowers use their own FX to repay such loans. Staff is currently assessing the details and implications of these measures and whether such measures may give rise to an exchange restriction subject to the Fund’s jurisdiction under Article VIII.
Wage negotiations are still ongoing, with possibilities of further strikes and disputes. While wage agreements have been reached for just over one-half of the private sector workforce—and are in line with staff baseline projections—negotiations are ongoing for remaining private sector and most public sector workers. Parliament has approved legislation to temporarily ban strikes by university educated public servants, including nurses—partly to alleviate the situation in the healthcare sector—to be followed by binding arbitration if no wage agreement is reached by July 1. Workers in other sectors have announced their intention to go on strike. The government submitted bills to Parliament targeting housing affordability in connection with efforts to facilitate wage agreements.
The Monetary Policy Committee (MPC) raised its policy rate by 50 basis points to 5 percent at its June meeting and signaled further ‘sizeable’ rate hikes in response to mounting inflation pressures. The MPC noted that recently negotiated wage increases were larger than what the CBI assumed in its May forecast and raised its expectations for the path of inflation. Inflation expectations have continued to rise. The CBI will release its updated macroeconomic forecast on August 19, in conjunction with the next MPC meeting.
GDP grew 2.9 percent y-o-y in Q1, supported by strong domestic demand. Private consumption rose 3.9 percent. Investment surged 23.5 percent—boosted by purchases of airplanes and by regular business investment—but residential construction weakened. Net exports subtracted from growth as tourism-driven and aluminum exports were outpaced by imports of airplanes and other goods.