Tuesday, 13 March 2012

Capital Controls in Iceland Strengthened

The Icelandic parliament made a move yesterday and boosted the capital controls. Policy makers made sure not to disturb the market and waited until 4pm yesterday to get the Committee on Economy and Business together to get the bill going. The opposition in the parliament promised not to interfere so the bill would be passed before the reopening of markets this morning. It was passed around 3am this morning.

The owners of government bonds. Only the government bonds are shown here, the bonds of the Housing Financing Fund are not, but the graph nevertheless shows well how foreign parties have stacked up their holdings of bonds of short maturity. The T-bill pie chart below shows the same thing.

Pie chart showing the owners of T-bills. Nicked from Market Information.

The strengthening is mainly in the form of including certain payments from the receiverships of the old banks. Repayments of bonds in the ownership of foreigners are also included. It doesn’t matter if the bonds are issued by private or public enterprises. Recently, foreigners have been moving into the bonds on the short end of the maturity, waiting to be able to get repaid in order to get their funds out of the country. Also, since there is a difference of the value of the Icelandic krona is 30-40% (or thereabouts) between the Icelandic currency market and outside it, there is a massive incentive to buy krona outside the economy, bring it to Iceland, buy bonds with short maturity, wait for the day of repayment and get paid according to the exchange rate in Iceland. One has to make hefty losses for the gamble not to be profitable.

The timing of the boosting of the capital controls isn’t a coincidence either. Tomorrow, Wednesday, a repayment of the HFF14 bond is due, roughly 6-7billion ISK (36-41 million EUR, according to the Central Bank of Iceland exchange rate). In May, another massive outflow is due. My old mates in the Research Team of Arion bank back home said it best in their Market Comment last Friday, from where this graph is nicked from. Good timing lads!

The Research Team of Arion bank made a rough estimate of the outflow of foreign reserves due to maturity and repayments of government bonds and government-guaranteed bonds. The loans of private parties are not included. 2012 only. Amounts in billion ISK.

So in short, the Central Bank is afraid of the early outflow of foreign reserves. The remedy is to erect the capital controls even higher than before in order to stop or mitigate the leakage of precious foreign currency and keep the country liquid. 

In the meanwhile, the Bank considers increasing the policy rates to fight inflation, even though higher interest rates cause more foreign reserves to flow out of the country. Furthermore, the captains of the Central Bank of Iceland do not realise that allowing banks to expand the pool of mortgages, fuelling a speculation boom in the housing market, causes outflow of foreign reserves.

The governor of the Central Bank of Iceland, Mar Gudmundsson, is one of the principal authors of today’s Icelandic monetary policy. Only the former governors of the Central Bank were sacked after the crisis in 2008, while their underlings were promoted to fill their places. One of those underlings, today’s deputy governor Arnor Sighvatsson and former main economist of the Bank, publicly “admitted” last week during the hearings of the case against the ex Prime Minister Geir Haarde that the Bank had been very concerned about the size of the Icelandic banking system already back in 2005, when its size was only 520% of GDP. The banking system doubled in size before it finally collapsed, right under the very nose of the Central Bank, creating in the meanwhile, amongst other things, a current account deficit of 25% of GDP in 2007 alone.

Those are the men we entrust to abolish the capital controls and preserve financial stability. Let us hope they know what they are doing.

The maturity profile of government debt. Nicked from Market Information.

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