EMTA SPECIAL SEMINAR: ICELAND'S GLOBAL OUTLOOK AFTER CAPITAL CONTROLS
Thursday, September 15, 2016
Sigtún 38, 105 Reykjavík
How do today’s political decisions impact tomorrow’s economy?
With the recent introduction of legislation that would begin lifting capital controls on individuals and businesses, Iceland seems poised to complete its recovery from the 2008 financial crisis. Iceland has a great opportunity at this critical juncture to affect meaningful change in its financial standing on the international stage. With tourism booming and other economic indicators better than before the crisis, this EMTA Special Seminar will examine what stands between Iceland’s current state of affairs and its potential future as a hub of foreign investment and new partnerships for growth and development.
Questions to be discussed among panelists include:
8:30 a.m. Registration
9:00 a.m. – 11:00 a.m. Panel Discussion
Aviva Werner (EMTA) – Moderator
Arturo Porzecanski (American University)
Daniel Gros (Centre for European Policy Studies)
Aldo Abram (Liberty & Progreso)
Full Buffet Breakfast Will Be Provided During Registration
Registration fee for EMTA Members: US$25 / US$50 for non-members / Credential Media Complimentary
EMTA’s Foray in Iceland
EMTA hosted a Special Seminar, “Iceland’s Global Outlook After Capital Controls”, on September 15, 2016 at the Grand Hotel Reykjavik in Iceland, following its earlier panel in NYC in June. Aviva Werner (EMTA) moderated the panel, with the following panelists: Arturo Porzecanski (American University), Daniel Gros (Centre for European Policy Studies) and Aldo Abram (Liberty & Progress).
How do today’s political decisions impact tomorrow’s economy? With the recent introduction of legislation that would begin lifting capital controls on individuals and businesses, Iceland seems poised to complete its recovery from the 2008 financial crisis. Iceland has a great opportunity at this critical juncture to affect meaningful change in its financial standing on the international stage. With tourism booming and other economic indicators better than before the crisis, this EMTA Special Seminar examined what stands between Iceland’s current state of affairs and its potential future as a hub of foreign investment and new partnerships for growth and development.
Questions discussed among panelists included:
Werner opened up the panel discussion by remarking that, while not every single country is an Emerging Market, and Iceland may be a good example of not being an Emerging Market, it is still useful to learn the lessons of EMs and their crises, so the market can respond to the next event, crisis or otherwise, armed with the history of how events unfolded. She noted that Time magazine dubbed Iceland the #1 peaceful country in the world, as manifested by its low rate of violence, terrorism and political instability, and she welcomed the panel of experts from abroad (who have had very different, personal and unique experiences with capital controls in other parts of the world), as well as the audience, to EMTA’s first event in Iceland.
Porzecanski, critical of Iceland’s capital controls and knowledgeable about Uruguay’s efforts to manage its currency, provided a background piece on the history of Iceland’s capital controls and the current state of affairs (the full text of his remarks can be accessed by Clicking Here). He posited that the Icelandic economy has “more than fully recovered from the financial crisis of 2008, but the normalization of its international financial relations has been needlessly delayed, and recent policy decisions are taking the country down a path of counter-productive confrontation with foreign investors”. He explained how stringent capital controls were first imposed in late 2008 in order to prevent large-scale capital flight and a complete collapse of the exchange rate. They were intended as a short-term measure to be removed as soon as possible, and in any event by November 2010 (expiration of the IMF program). He remarked with dismay that almost eight years later the stringent capital controls were still in place, “despite the fact that the banking crisis has been resolved to the government’s satisfaction and Iceland has exhibited a more vigorous economic recovery than most Nordic countries…most of [its] vital indicators are looking healthier today than they did before the crisis”. With many of the preconditions for dismantling the capital controls being met, the country has “come up with a coercive and punishing scheme for the so-called offshore krona investments [officially estimated 319bn krona], which have been trapped inside Iceland by the rationing of access to foreign exchange”.
Foreign krona investors were recently given a one-time chance to exit their positions and access foreign exchange by agreeing to a stiff departure tax on their holdings. To encourage foreign investors to “swallow such a bitter pill after eight years of waiting, the authorities have announced their intent to imprison any remaining funds and to bleed them slowly over time. As per legislation passed in late May, all residual offshore krona funds are to be segregated into accounts subject to a 100% compulsory requirement to purchase krona-denominated deposit certificates, issued by the CBI, paying a miserly interest rate of 0.5% per annum – a fraction of the 5.25% interest rate that the CBI currently pays on seven-day bank deposits. Foreign investors spurning the auction were warned by the authorities to expect to languish in these creditor prisons for ‘many years’”.
“The irony is that the government has recently admitted that there are foreign investors wanting to come into Iceland. These potential investors could generate the foreign exchange inflows to compensate for whatever outflows, on account of liberated offshore-krona balances, the authorities would countenance. And yet, rather than welcoming them to Iceland, in June the government requested, and the Icelandic parliament readily agreed, to pass a law authorizing the CBI to impose a reserve requirement of up to 75%, for a period as long as five years, to discourage such capital inflows into domestic bonds and bank deposits. In other words, instead of making progress on capital liberalization, the authorities in Reykjavík are phasing in new capital controls on capital inflows ahead of phasing out the capital controls on outflows”.
He continued that the mistreatment of offshore krona investors appears to violate several of Iceland’s obligations under the European Economic Area Agreement and, according to its Article 4, ‘any discrimination on grounds of nationality shall be prohibited’; “and yet the Icelandic legislation knowingly targets foreign investors, who according to the government’s own estimates account for at least 85% of the total funds in question. Further, as per the Agreement’s Article 43, protective measures in the field of capital movements may be taken ‘[i]f movements of capital lead to disturbances in the functioning of the capital market’. But the punishment of offshore krona investors is being applied in the absence of any such market disturbance. The leading investors…have expressed to the government their willingness to depart from Iceland in a gradual, orderly and agreed manner over a period of several years. They have also reportedly offered to exchange their krona holdings for a new government bond denominated in dollars, rather than insisting on cash up front. In other words, while the offshore krona investors have offered to make concessions that have the potential to prevent market disturbances, the authorities have spurned them”.
He posited that the reason Reykjavík has been so hostile toward offshore krona investors is not for the stated reason that “the foreign exchange market and economy could not possibly cope with a liberalization of capital controls which was not preceded by a reduction of the overhang of offshore krona trapped inside Iceland, [a] reason [which] may have been valid years ago, but it is not valid now”. Rather, “one must look to political or other explanations, especially since the government is now taking litigation and reputational risks which it avoided when dealing with the estates of the failed banks”. He recounts the hypothesis he heard – “the authorities, as part of a political shift towards greater nationalism and populism, want to punish these offshore creditors because they view them as having contributed to the country’s banking crisis of 2008. Such an attitude would be based on prejudice or ideology rather than facts, however. Before 2008, the offshore krona investors were courted by the government and the private sector: they were solicited to buy government and corporate bonds and to acquire other Icelandic financial assets, such as stocks and bank deposits. There is no evidence that they were directly or indirectly responsible for the banking crisis…Indeed, these investors became, and ought to be regarded as, victims of the negligence of the Icelandic private banks, regulatory institutions, technocrats, policymakers, and elected officials responsible for the crisis. They should not be held for ransom”!
Abram addressed the experience of Argentina as it relates to capital controls and default (the full text of his remarks can be accessed by Clicking Here, and his PowerPoint presentation can be accessed by Clicking Here). In his view, Argentina is the “Bible of case studies of economic crises, a Bible of lost opportunities for progress”. Learning from that country’s mistakes would aid Iceland in the present day. He predicted that Iceland will have high political and economic costs for its decision and that it has underestimated the consequences of its decision to maintain capital controls.
He recounted how, in May 2003, Kirchner took office “in a country that had declared itself in default in 2001, but which was beginning to recover from the crisis and was also beginning to benefit from an international context of high liquidity and good export prices...it was on the cusp of a period of strong economic growth”. The “unilateral offer” in 2005 (later extended in 2010 to bring the participation rate to 90%) was based on the Lock Law, which prevented future swaps to be recognized by the government. The rationale for such law was that buyers of Argentine debt purchased the debt cheaply and were thus not entitled to a better deal. “This was absurd, as it implied a failure to recognize that a bond is a contract in which someone, in this case the Argentine State, voluntarily assumed certain commitments to the holder of that paper [so] whoever sells that bond to someone else is transferring all the rights which are implicit therein, not a proportion of it depending on whether it has been collected or not”.
“The first Argentine lesson for other countries [is that] history has shown that problems must be solved in times of plenty when the cost can be mitigated in prosperity, because when lean times arrive the sacrifice becomes much greater and nobody wants to do it. The international crisis and the loss of credibility of the Argentine government led to increased capital flight; this in turn led to the imposition of capital and exchange controls in late 2011. In Argentina, the exchange and capital control was called the ‘clamp’; as it clamped down or restricted the purchase of foreign currency by individuals and businesses. However, it was shown that it was also a clamp on capital and foreign credit inflows; so it effectively clamped the economy and constricted growth within a straitjacket”.
Abram publicly warned against these because Argentina had more than twenty programs with capital controls in the past seven decades and all had a bad ending, using neighboring Venezuela’s experience as one of his rationales. Argentina proceeded into various recessions, loss of reserves and high inflation, “seriously jeopardizing its solvency”. With the new government in 2015, Argentine was able to lift the clamp relatively easily and quickly. “The reality is that all the deadlines that had been scheduled as part of the clamp removal strategy were brought forward and now there is no longer any restriction on purchasing foreign exchange”. Another lesson from Argentina’s experience is that “delaying the exit from a clamp involves assuming an increasing economic cost and the risk of having to do it at the wrong time and messily, as will surely happen with Venezuela. [With] the will and conviction, you can implement a safety net that allows controls to be dismantled in a short period”. He believes that Iceland’s economic and fiscal situation is much better than that inherited by the current Argentine government, thus allowing them to implement even a more successful capital controls exit.
Argentina was one of the countries that fell most sharply in terms of institutional quality, 87 places down so far this Century to rank 142nd among the 192 countries surveyed; since 2008, Iceland has dropped 16 places to rank 21st and this is a trend that should be reversed. “If Iceland is able to learn from the experience of others, it could exit the current controls in a very short time, respecting the rights of all those affected, rebuild credibility and recover the institutional quality it has lost. This would lead to conditions for progress and an improvement in well-being which would be sustainable over time”.
Gros discussed the cost of capital controls, economic, moral and otherwise (the full text of his remarks can be accessed by Clicking Here). While on the Iceland Supervisory Board when the capital controls were implemented, he can’t understand why they have not been lifted by now. His main points are the following: the current crisis has been overcome and a comparison to Latvia, which also had a financial crisis (but with a less stable export base than Iceland) yields to the realization that that Latvia did better because it did not use capital controls.
The expected benefits of capital controls, namely lower macroeconomic volatility and better growth, have not been realized in Iceland, with a mixed growth record (especially in comparison to Latvia). This mixed growth record is surprising as foreign debt disappears, this should have had a radical effect on improved growth.
One of the key costs of capital controls is a deterioration in the quality of governance. The costs of capital controls include allocation of capital (which is difficult to quantify) and, more importantly, distortions, interference with the market and temptation of corruption (in short, a deterioration in the quality of governance). Iceland was #1 on the (anti) corruption meter; now it has decreased 12 places to #13 (mid-rank among other European countries). Capital controls might be justified in ‘disorderly’ market conditions when liquidity constraints and herding distort the market, but there is no rationale for keeping them for eight years. There are long-term costs (need to maintain a bureaucracy that controls and makes many arbitrary decisions) with large incentives to evade controls and occasions for corruption.
He concluded with the following: capital controls were clearly kept too long; there is little evidence that they fostered growth through stability; they corroded society and quality of governance; it is not consistent to prepare controls on inflows and cloister remaining foreign ISK holdings (it doesn’t make sense to have the brake and accelerator operating at the same time); and, if there is a fear of instability due to real factors (variable terms of trade), then create a sovereign wealth fund!
Some audience participants were not convinced, claiming that the recent Iceland credit rating upgrade does not reconcile with the story told by the panelists and that there was no relevance to the Argentine experience or the Latvian comparison. Porzecanski responded that this was an opportune time to negotiate an orderly exit plan in a non-confrontational manner, rather than to provoke creditors and foreign investors into protracted litigation. He explained the rating upgrade as an analysis relating to a government’s ability to pay foreign debt, not a judgment on its willingness to service domestic debt (and he also believed that the rating agencies see this as a residual issue). And, in any event, an A- rated country shouldn’t be imposing capital controls (it’s like being put “in solitary confinement”). “End it honorably now, out of the newspapers,” was his advice, along with “reputations take a long time to build and seconds to destroy” and shock treatment at this point was better than gradualism. He concluded with this observation of capital controls – “it’s like putting sand in a machine; it won’t stop the machine, it just would work more smoothly without it”. Abram responded that Argentina was upgraded and then downgraded quickly, so one can’t necessarily trust the ratings anyway. Gros agreed, noting that with the type of economy Iceland has it should have an even higher rating, as well as higher interest rates.
Relevant articles relating to Iceland can be accessed by Clicking Here.