Iceland prepares to phase out capital controls

8/6/2015

Richard Milne in Copenhagen and Jeremy Grant in London

Iceland laid out plans to lift its much maligned capital controls after nearly seven years as the Nordic island took a big step towards repairing the damage from the financial crisis.

Iceland was plunged into economic and financial difficulties when its three largest banks collapsed in 2008 with combined assets of ten times the size of its economy.

Now Iceland will impose a one-off tax of 39 per cent on the assets of the failed banks as part of its plans to lift the capital controls, blamed by local business for low investment and fuelling asset bubbles as they restricted the flow of foreign currency.

Sigmundur David Gunnlaugsson, Iceland’s prime minister, told the Financial Times: “It is enormously important for the economy. It is the last step in putting a firm footing under the Icelandic economy again after the financial crisis.”

Iceland has been hailed internationally for letting its banks fail and prosecuting and jailing some of their chief executives as part of its clean-up. But the continuing presence of capital controls, imposed in 2008, was seen by many as undermining that success.

Jon Danielsson, the Icelandic-born director of the Systemic Risk Centre at the London School of Economics, hailed the government’s plan as a comprehensive and fair solution.

“The pernicious effect of capital controls is that it almost signals you are a village idiot among countries,” he said, pointing to the likes of Venezuela and Cyprus. He added: “A country needs to be able to have a currency without capital controls to be taken seriously, and it’s a precondition to get investments.”

Capital controls were put in place to stop foreign owners of Icelandic assets, including the creditors of the failed banks, converting their krone into foreign currency. That would have put further pressure on a currency that had already collapsed in the wake of the financial crisis.

Mr Gunnlaugsson urged creditors of Iceland’s failed banks — 90 per cent of whom he said had bought in after the collapse — to accept the offer but admitted that legal action was a possibility. He added, however, that Iceland had been “legally prudent” with its proposals.

He said the small Nordic island of 320,000 people would now work on attracting new foreign investment. “We are able to start looking to the future instead of dealing with the problems of the past.”

Iceland has returned to growth and has one of the lowest unemployment rates in Europe with the International Monetary Fund hailing its “strong” average growth rate of 2.25 per cent in the past three years. But capital controls and a continued huge household debt burden have stopped many Icelanders from feeling that the crisis was over.

Creditors of the failed banks face a choice under Iceland’s plans to deal with about IKr1,200bn ($9bn) of problem assets. They can try to reach agreement by the end of the year on “composition” — whereby the assets of the failed banks are liquidated without bankruptcy — in which case they will be subject to so-called stability conditions.

If they do not reach agreement, a one-off stability tax of 39 per cent will be imposed on the failed banks’ assets. Both approaches would result in payments to Iceland of about IKr680bn after deductions, the government said.

Iceland will use the proceeds to pay down government debt rather than reduce household indebtedness as had once been mooted.

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