Andersen, Camilla

Thomsen, Poul M.

Yale University

Yale University EliScholar – A Digital Platform for Scholarly Publishing at Yale YPFS Documents (Series 1) Browse by Media Type 12-2-2008 IMF Survey: Iceland Gets Help to Recover From Historic Crisis Camilla Andersen Poul M. Thomsen Follow this and additional works at: https://elischolar.library.yale.edu/ypfs-documents Recommended Citation Andersen, Camilla and Thomsen, Poul M., "IMF Survey: Iceland Gets Help to Recover From Historic Crisis" (2008). YPFS Documents (Series 1). 12960. https://elischolar.library.yale.edu/ypfs-documents/12960 This Document is brought to you for free and open access by the Browse by Media Type at EliScholar – A Digital Platform for Scholarly Publishing at Yale. It has been accepted for inclusion in YPFS Documents (Series 1) by an authorized administrator of EliScholar – A Digital Platform for Scholarly Publishing at Yale. For more information, please contact elischolar@yale.edu. Bank RestructuringTypical street scene in Santa Ana, El Salvador. (Photo: iStock)IMF SURVEY INTERVIEW (/EN/NEWS/SEARCHNEWS?TYPE=NEWS%20ARTICLE&CATEGORY=IMF%20COUNTRY%20FOCUS)IMF Survey: Iceland Gets Help to Recover From Historic CrisisBy Camilla AndersenIMF Survey OnlineDecember 2, 2008• IMF Executive Board agrees $2.1 billion loan for Iceland• Official bilateral creditors also expected to help• Program aims to restore confidence in the Icelandic krónaThe financial crisis now engulfing the world claimed Iceland—which has a population of just 300,000—as one of its earlyvictims.Related Links       IMF NEWSSearchABOUT RESEARCH COUNTRIES CAPACITY DEVELOPMENT NEWS VIDEOSDATA PUBLICATIONS COVID-19IMF Survey: Iceland Gets Help to Recover From Historic Crisis https://www.imf.org/en/News/Articles/2015/09/28/04/53/soint111908a1 of 4 4/20/2022, 9:30 AMCars parked in Iceland's capital Reykjavik, wheredespite the crisis, the economy remains flexible.(photo: Gavin Hellier/Corbis).• Iceland and IMF (/external/country/ISL/index.htm)• IMF press release (/external/np/sec/pr/2008/pr08296.htm)• Video: Restoring confidence (/external/mmedia/view.asp?eventID=1329)• IMF talks to crisis countries (/external/pubs/ft/survey/so/2008/new102208a.htm)• Quick, cooperative action needed (/external/pubs/ft/survey/so/2008/NEW100908A.htm)• Stress hits emerging economies (/external/pubs/ft/survey/so/2008/POL110908A.htm)• Iceland video briefing (/external/mmedia/view.asp?eventID=1328)In response, Iceland formulated a comprehensive program to tackle the fallout from the crisis, for which it requested IMFsupport. On October 24, an IMF package totaling $2.1 billion was announced under the Fund's fast-track emergencyfinancing mechanism.The IMF's Executive Board approved (/external/np/sec/pr/2008/pr08296.htm) the two-year Stand-By Arrangement forIceland on November 19, making $827 million immediately available to the country and the remainder to be paid in eightequal installments, subject to quarterly reviews. Iceland's economic program envisages that the IMF loan will fill about 42percent of the country's 2008-10 financing gap. The remainder will be met by official bilateral creditors.In this interview (/external/mmedia/view.asp?eventID=1329), the IMF's mission chief for Iceland, Poul Thomsen, talks aboutthe crisis and the country's plans for dealing with the repercussions.IIMF  Survey  onlliine::  What  went  wrong  iin  IIcelland?Poull  Thomsen:: Iceland allowed a very oversized banking system to develop—a banking system that significantlyoutstripped the authorities' ability to act as a lender of last resort when the system ran into trouble. Only a few years ago,Iceland had a banking system that was the normal size. But after the privatization of the banking sector was completed in2003, the banks increased their assets from being worth slightly more than 100 percent of GDP to being worth close to1,000 percent of GDP.When confidence problems intensified this fall, Iceland was one of the first victims because the market realized that thebanking system was far too big relative to the size of the economy. As investors started to pull out, it quickly spilled overinto trouble for the Icelandic króna. Within a week the three banks collapsed, the króna's value dropped by more than 70percent, and the stock market lost more than 80 percent of its value. For a small economy that is totally dependent onimports, this was a crisis of huge proportions.IIMF  Survey  onlliine::  What  iis  the  IIMF-backed  program  hopiing  to  achiieve?Thomsen::  In the short run, the program is narrowly focused on stabilizing the króna. Iceland still has a highly leveragedeconomy. Most of the debt is either denominated in foreign exchange or indexed to inflation, so when the krónadepreciates, debt servicing becomes much more expensive. If we don't stop the decline of the króna, we will probably seea wave of defaults in the corporate and household sectors, and that would further harm the economy.That is why the IMF-backed program is proposing to use monetary and exchange rate policy to restore confidence in thekróna over the next couple of months. In the short run, this will mean higher interest rates. Iceland will also haverestrictions in place on the movement of capital. We are advising the government not to lift these restrictions beforestability returns to the foreign exchange market."I suspect that after this relatively sharp downturn, the economy could rebound fairlyIMF Survey: Iceland Gets Help to Recover From Historic Crisis https://www.imf.org/en/News/Articles/2015/09/28/04/53/soint111908a2 of 4 4/20/2022, 9:30 AMfast."IIMF  Survey  onlliine::  IIsn''t  iit  unusuall  for  the  IIMF  to  agree  to  capiitall  controlls?Thomsen::  Capital controls have de facto been in place since the three banks collapsed in early October as only paymentsfor priority imports and other current account transactions have been permitted since then. It is a priority under the IMFprogram to eliminate all restrictions on both the current and capital accounts so that Iceland can return to the freelyconvertible currency it had for many years. Indeed, all restrictions on the current account have now been lifted as a firstimportant step towards normalization.But to prevent large capital outflows from causing a further sharp drop in the króna, existing capital account restrictionswill remain in place in the near future. With this in mind, the authorities legally formalized the existing de facto regimeduring the last week of November to make it more effective, rules-based, and transparent. It is an important goal under theIMF-supported program to lift all capital controls during the program period, as confidence improves.IIMF  Survey  onlliine::  IIs  the  IIMF  askiing  IIcelland  to  cut  back  on  spendiing?Thomsen::  We are not telling Iceland to tighten its belt in the middle of a recession. During the first year of the program,automatic fiscal stabilizers will be allowed to work. This means there will be an increase in the primary fiscal deficit fromabout ½ percent of GDP in 2008 to about 8½ percent of GDP in 2009. We in the IMF are not suggesting resisting thisdeterioration because we think it is wrong, in the face of a deep recession, to embark on fiscal consolidation.Having said that, Iceland will need to consolidate its finances once the recession has bottomed out. Because of thebanking crisis, Iceland has gone overnight from being one of the lowest indebted countries in Europe, to being among thehighest indebted advanced countries in Europe: Taking care of the problems in the banking sector will probably cost thepublic sector about 80 percent of GDP. How exactly the government achieves this consolidation—through eitherexpenditure cuts or higher revenues, or a combination of both—will be up to Icelandic authorities to decide.IIMF  Survey  onlliine::  What  wiillll  the  IIMF''s  rolle  iin  restructuriing  the  banks  be?It is important to acknowledge that Iceland has expressed its commitment to recognize the obligations to insureddepositors, and also to a fair and equitable approach in the bank restructuring process. The government's strategy fordealing with the banking problems has been to adopt a new bank/old bank approach—the "new" banks were allowed toservice domestic banking needs whereas the "old" banks would deal with the difficult task of sorting out most of theforeign liabilities.The IMF will help Iceland restructure the banks within this broad framework. The strategy includes plans for valuation ofthe assets of both new and old banks in line with international best practice, compensation from the new banks to the oldbanks for any discrepancy in the fair value of assets and liabilities taken over, recapitalizing the new banks with the aim ofeventually privatizing them, and maximizing asset recovery in the old banks. Bank supervision and regulation will also beoverhauled to make sure a banking crisis of this magnitude never happens again.IIMF  Survey  onlliine::  So  what  does  the  future  holld  for  IIcelland?Thomsen::  There is no doubt that Iceland will face a couple of years of hardship. This is a dramatic and unprecedentedshock. It could be the most expensive bank restructuring that the world has ever seen relative to the size of the economy.We expect that, even if we succeed in stabilizing the króna, GDP could fall by 10 percent next year, and there might evenbe a further small decline in 2010.The good news is that the Icelandic economy is very flexible. Because of its dependence on fishing and aluminum, Icelandhas been exposed to rather big shocks in the past, but it has always been able to adjust very effectively. So I suspect thatafter this relatively sharp downturn, the economy could rebound fairly fast.IIMF  Survey  onlliine::  What  woulld  success  llook  lliike?Thomsen:: Success would look like this: within the next couple of months, the government succeeds in stabilizing thekróna and normalizing the country's foreign exchange operations so that all companies that export and import have accessIMF Survey: Iceland Gets Help to Recover From Historic Crisis https://www.imf.org/en/News/Articles/2015/09/28/04/53/soint111908a3 of 4 4/20/2022, 9:30 AMto the foreign exchange market.Once the currency has stabilized, the government should be able to gradually reduce interest rates in 2009, gradually liftthe capital controls, and begin to tackle the fiscal problems.The potential for success is very good because the economy is so flexible. I expect that by the end of the two-yearprogram, Iceland's economy will be growing again.IIMF  Survey  onlliine::  What  woulld  have  happened  iif  the  IIMF  had  not  stepped  iin  wiith  fiinanciing?Thomsen:: The alternative would have been, I am convinced, further significant decline in the value of the króna.Significant strain on household that have their mortgages fixed in foreign exchange; a wave of defaults in the corporatesector that has loans fixed in foreign exchange; a much higher increase in unemployment; and an even bigger decline inGDP than the 10 percent currently predicted.Poul Thomsen is a Deputy Director in the IMF's European Department.***********************************************************Program  summaryThe program with the IMF focuses on addressing the key challenges at hand:•  Preventiing  further  sharp  króna  depreciiatiion  by maintaining an appropriately tight monetary policy in the context ofa flexible exchange rate policy. Restrictions on capital outflows will remain in the near term.•  Devellopiing  a  comprehensiive  and  collllaboratiive  strategy  for  bank  restructuriing by (i) putting in place an efficientorganizational structure to facilitate the restructuring process, (ii) proceeding promptly with the valuation of banks' assets,(iii) maximizing asset recovery in the old banks, (iv) ensuring the fair and equitable treatment of depositors and creditors ofthe intervened banks, and (v) strengthening supervisory practices and the insolvency framework.•  Ensuriing  mediium-term  fiiscall  sustaiinabiilliity. While automatic fiscal stabilizers will be allowed to work in full during2009, the program includes the development of a strong medium-term fiscal consolidation plan to be launched in 2010.This effort is needed to deal with the very substantial increase in public sector debt that is likely as a result of the budgetarycost of recapitalizing the banking system fulfilling the deposit insurance obligations to depositors in foreign branches ofIcelandic banks.Read further details: http://www.imf.org/external/np/sec/pr/2008/pr08296.htm (/external/np/sec/pr/2008/pr08296.htm)Comments on this article should be sent to imfsurvey@imf.org (mailto:imfsurvey@imf.org)IMF Survey: Iceland Gets Help to Recover From Historic Crisis https://www.imf.org/en/News/Articles/2015/09/28/04/53/soint111908a4 of 4 4/20/2022, 9:30 AM

IMF Survey: Iceland Gets Help to Recover From Historic Crisis

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IMF Survey: Iceland Gets Help to Recover From Historic Crisis

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