Tuesday, 2 October 2012

The Optimistic GDP Forecasts and IMF's Turnaround

Islandsbanki published its economic forecast for the Icelandic economy late in September. Their expectations: 3.2% growth in 2012 and increasing after that.

I sat down and looked at some other forecasts in comparison to get a feeling for the realism behind them. I cannot say that any of them is realistic for 2012 except the IMF one. And funny enough, IMF is in fact turning around on its policy on Iceland and the problem we have on "offshore" kronas. IMF isn't as optimistic about its wunderkind as they used to be when they threw that "Iceland and IMF" conference one year ago.

GDP forecasts range from 2.4% (IMF) to 3.2% (Islandsbanki) in 2012. CBI stands for Central Bank of Iceland.

OK, so the range for 2012 is 2.4% to 3.2%. That compares to 2.4% GDP growth the first 6 months of 2012 compared to the same period the year before. That means that to reach 3.2% growth (Central Bank of Iceland (CBI) and OECD expect 3.1% growth in 2012) the economy needs to grow by 4.0% in the second half of 2012.

4.0%. Right. Well, that's not going to happen. Islandsbanki's 3.2% expectation is way off, we can immediately write their 2012 forecast off. Same really goes for CBI's and OECD's 3.1% forecast.

The most interesting forecast is IMF's. It's interesting not only because it is the most realistic one but it also signifies a turnaround on IMF's behalf when it comes to Iceland.

IMF in 2011: "We nailed it!"
In August 2011, IMF projected 3.1% GDP growth in Iceland. It expected 2.5% growth for the full year 2011, which compares to the latest estimate of 2.6%. Well done! IMF generally expected "a tentative economic recovery": the inflation was rising, the krona depreciating slowly and uncertainty was (and is) still high due to the Icesave dispute. However, "access to international capital markets [had] been regained" and "outlook was for a moderate expansion" while "concerns persist about the sources of medium-term growth." IMF constantly mentioned the growth in private consumption, an economic factor that practically caved in in 2009 and 2010.

But the most prominent IMF position was that of the handle of the crisis. A whole conference was set up in October to celebrate the good job done and famous international economists came to Iceland to check out the crisis Wunderkind. In November 2011, IMF's eyes to the possible unorthodox handling of the crisis had opened and Iceland's case suggested "alternative way out of crisis."

Iceland had basically taught IMF that atypical "we must save the creditors!" policies weren't the only one available. Good stuff, very important that IMF realised this.

IMF in 2012: "We nailed it BUT..."
Now, IMF has realised that it may have to extend even further the Icelandic case of "let the creditors drown". The reason: the offshore kronas.

The offshore kronas are funds, denominated in krona, that are stuck in the economy behind the capital controls. Their sources can be of any kind, ranging to the Glacier bonds issued during the 2004-2007 Party to normal households' savings that are eager to get out of the economy on expectations alone that the value of the krona will collapse the instant the capital controls are lifted. Estimates of the whole offshore krona amount run from 400-1,000 billion ISK (25%-60% of GDP or thereabouts).

On 28 September, IMF issued a Concluding Statement. There, we can see IMF arguing that "significant reduction (or elimination) of the “overhang” of liquid offshore krona" is one of the preconditions for lifting the capital controls. That was always known. What is a turnaround is the way IMF is now willing to do it:

"To accelerate [reducing the stock of liquid offshore krona] it is necessary to strengthen the incentives for holders of liquid offshore krona to participate in the liberalization strategy. A key step will be to curtail expectations that capital controls will be lifted soon, including by removing a reference in legislation to a terminal date for the controls. In addition, the strategy should clarify that the conditions under which liquid offshore kronas are allowed to exit will become less favorable over time

And they continue:

"Once incentives are in place, the authorities could open the next channels envisaged in their strategy—bond swaps and an exit tax. The objective of the bond swaps would be to reduce the stock of offshore krona before introducing an exit tax and ultimately lifting the controls. Swapping short-term krona-denominated assets into long-term euro-denominated bonds would distribute the pressure on the balance of payments over several years."

This is a turnaround. IMF is now accepting the not-so-unlikely possibility that in order to ever lift the capital controls in Iceland, the Icelandic authorities basically have to fry the creditors even more. IMF padded Iceland on the back for not rescuing the banks in 2008 and thereby let the creditors of the banks take the hit. Now, they are directly saying that Iceland would need to take one more step and straightforward threaten the holders of liquid offshore krona: "the strategy should clarify that the conditions under which liquid offshore kronas are allowed to exit will become less favourable over time."

IMF changing?

The funny thing is that those ideas are old. One of the MPs of Iceland, Lilja Mosesdottir, has for a long time urged a more critical stance on the offshore krona issue. She has spoken about a German-1948-type adoption of a "new krona" (assets in ISK redenominated in a new currency, which's exchange rate is a function of the nominal value of the asset being redenominated, e.g. 1:1 for low amounts, wages, etc. but 10:1 for high amounts and offshore krona) and an "exit tax" if offshore krona owners want to swap them out for EUR or any other foreign currency. She in fact used to be in the government but went rogue due to what she felt was the government's softness towards IMF. 

Now, IMF has basically taken up her stance.

And why? Maybe because they are afraid that their Wunderkind isn't in the good shape they hoped to.

But maybe because they are generally accepting the fact that "debt that cannot be repaid, won't be repaid" and creditors should simply accept it. That would be the most wonderful thing if IMF finally realised that and actively applied that policy in its future bailouts.


  1. Dr Mr Margeirsson
    I am a first year business student in Ireland, I have been given an assignment on the macroeconomics of a country and have chose Iceland. I have read your blog and found it most interesting. I wonder could you give me some advice and tips re same. I would be very greatful for any help
    Kind regards

  2. Email lindam1303@gmail.com (typing error above)