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 The country is about to start the tricky process of removing the
capital controls that have been in place since what the central bank
governor, Mar Gudmundsson, calls "the third biggest bankruptcy in
the history of mankind".
With its economy recovering and interest rates at 5.75 percent
compared with virtually zero in the rest of Europe, concern is
growing about a destabilizing rush of cash coming in.
"The conditions are good for lifting capital controls - they have
never been better," Gudmundsson said in an interview with Reuters.
"A current account surplus, high level of reserves, a fiscal surplus
and, hopefully, inflation that is still not too high."
He expects the first stage of that process to come in the next few
months, which is to remove restrictions on foreigners' 'offshore
crown' funds, which are worth around 14 percent of Iceland's annual
economic output.
Once that it is done, the bank has said, it will use some of its
foreign exchange reserves to prevent any bad reaction, before taking
the more uncertain step of lifting controls for the wider
population.
"Possibly in the Autumn or hopefully at least before the end of the
year" controls on domestic residents can be lifted, Gudmundsson
said.
With interest rates higher in Iceland than in virtually every other
developed economy in the world, Gudmundsson said, it was unlikely
locals would be rushing to take their money out of their bank
accounts. It was more likely foreign investors will put more in.
Foreign cash flowing into the country's banks was one reason Iceland
got into so much trouble in the first place. It has introduced a
raft of measures to prevent those kind of problems. But now has a
different one: so many people are buying its government bonds that
interest rate increases are losing their effect. As a result, it is
drawing up some counter measures.
"We are working on designing certain tools that hopefully we do not
need to use often but are there on the shelf if capital inflows into
the bond market are making it very difficult for us to run our own
monetary policy," Gudmundsson said.
"Theoretically we can do it through a tax, so instead of having an
interest rate of say 6 percent, you are getting an interest rate of
3 or 4 percent in effective terms.
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"You can do the same with non-renumerated reserves. So when you come
in, part of what you are coming in with is put in reserves and then
you get it back when you leave, but you are losing interest in the
mean time," he added.
OUT OF A PLANE WITHOUT A PARACHUTE
The central bank's next meeting will be held in a couple of weeks.
It left rates unchanged last month. Falling oil prices since the
start of the year are helping counteract inflation pressure coming
from rising domestic wages.
"We paused in December and now monetary policy will be governed by
incoming data. But it is not as obvious where we are," Gudmundsson
said.
"We have had very strong wage growth, far in excess of what is
compatible with the inflation target in the long run. But this has
not resulted in inflation above the target because we are importing
deflation from the rest of the world."
The other issue confronting Iceland is the euro zone's new banking
union, which it says leaves countries with their own currencies at a
disadvantage. It also might clash with Brussels over the use of
macro prudential rules to combat issues such excessive capital
inflows.
"If we needed to introduce prudential rules to make it possible for
us to run our own independent monetary policy and ensure financial
stability, and those rules were deemed to be in contravention of EU
rules, then we would have to say OK, we have a problem here.
"If someone told me to take the risk to jump out of an aeroplane
without a parachute, I would say, no thanks, I would like to have a
parachute."
(Editing by Larry King)
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