By David Ibison in Stockholm
Published: October 29 2008
Iceland raised interest rates to a record 18 per cent from 12 per cent yesterday as a “condition of a proposed $2bn loan from the International Monetary Fund” to help rescue the stricken island.
Iceland applied to the Washington-based organisation for the emergency loan after its banking system collapsed and is seeking another $4bn (€3.2bn, £2.6bn) from some Nordic and other central banks.
The application will be presented to the IMF’s board tomorrow and the central bank said a condition attached to the loan was for a rate rise to 18 per cent.
The move reversed a 3.5 per cent rate cut announced just two weeks ago by David Oddsson, central bank governor, underlining the influence the IMF now has over policymaking in Iceland.
Brian Coulton, managing director at Fitch Ratings, the credit rating agency, said Iceland’s central bank had “no choice but to work very closely with the fund”.
Following the collapse of the banking system, the Icelandic economy is expected to contract by up to 10 per cent, unemployment to rise at about 8 per cent and inflation to hit 20 per cent or more, economists say.
“Putting up interest rates means they are going to go through the mother of all recessions, but the key is stability,” Mr Coulton said.
The IMF-led rescue represents an important breakthrough for Iceland as it strives to stabilise its economy by clearing the way for other countries to come to its aid. But it has come at the price of agreeing to the organisation’s demands.
The IMF conditions at-tached to the loan are to restore confidence in the economy and stabilise the Icelandic krona, restore fiscal sustainability, and reestablish a viable banking system. Yesterday’s rate rise was an important first step towards boosting the credibility of the Icelandic krona, which lost 70 per cent of its value during the crisis before trading dried up amid the uncertainty.
The IMF and Icelandic government have agreed that the currency should refloat within a matter of weeks, regarded as a vital step in restoring Iceland’s international credibility and helping the international payment system to restart.
“It is of overarching importance to restore stability in the foreign exchange market and support the exchange rate of the crown,” Sedlabanki, the central bank, said in a statement.
The huge interest rate rise came as Iceland continued to try to rally international sup-port for multi-billiondollar loans to bolster its foreign exchange re-serves, a move that should also help support its currency once it resumes trading.
The office of Geir Haarde, prime minister, told the Financial Times yesterday Iceland had sent an application for funds to the US Federal Reserve and the European Central Bank and had also been in contact with the Bank of Japan via its embassy in Tokyo.
The Icelandic krona is expected to be floated again as soon as is practical, possibly within the next two weeks, once the IMF’s board has approved the $2bn loan.
The interest rate increase is way out of line with any logic. That is one of the reasons I don’t trust the IMF. Their Conditions. They dictate to those in need. 18% is ridiculous. This is helping Iceland how?
That kind of interest rate is insanity.
Nordic nations work on Iceland bail-out
By David Ibison in Stockholm
November 5 2008
Officials from four Nordic central banks and finance ministries held a private meeting in Stockholm on Wednesday to discuss their contributions to a $6bn rescue package for Iceland.
The gathering at the Ministry of Finance was a strong sign that Denmark, Sweden and Finland are drawing closer to announcing a multibillion euro package of loans after Norway agreed a €500m ($648m, £405m) advance last week.
Iceland hopes to be told on Thursday or Friday that its application to the International Monetary Fund for a $2bn (€1.54bn, £1.25bn) loan to support its economic revival has been approved.
Once official approval of the IMF loan has been secured, the way is clear for the Nordic countries to start considering how much they are prepared to offer, central banking officials said.
Iceland is seeking a total of about $6bn, which it will use to bolster its foreign exchange reserves to try to restore the credibility of its currency after its banking system collapsed last month.
The island’s government has also sent an application for funds to the US Federal Reserve and the European Central Bank and has been in contact with the Bank of Japan through its embassy in Tokyo, it said.
The four Nordic nations have said they are willing to support Iceland but only after it agreed to design and implement an economic stabilisation plan in association with the IMF. That plan was agreed in late October and comprises stabilising the Icelandic krona, restoring fiscal sustainability and re-establishing a viable banking system. It should also be approved by the IMF on Thursday or Friday.
The meeting at the finance ministry was attended by Ingimundur Fridriksson, one of three governors of Iceland’s central bank; Audun Gronn, the head of the international department at Norway’s central bank; Barbro Wickman-Parak, deputy governor of Sweden’s Riksbank; and similar level representatives from the central bank and finance ministries of Finland and Denmark.
Any commitment by the Nordic nations to support Iceland alongside the IMF would be an important development as the island strives to stabilise its economy. But securing approval for the loans does not mean that Iceland will have immediate access to the funds. Norway’s loan requires approval from parliament, as would others.
Following the collapse of Iceland’s banking system, its economy is expected to contract up to 10 per cent, unemployment is forecast to spike to about 8 per cent and inflation is set to reach 20 per cent or more, according to economists.
Iceland raised interest rates last week from 12 per cent to a record 18 per cent.
Some European Union member states are said to be of the opinion that Iceland should not be granted a loan from the International Monetary Fund (IMF) until an agreement with Britain in regards to the deposits of Icelandic banks has been reached.
These same EU member states allegedly also believe that Iceland should not be granted a loan from the union’s emergency fund until the dispute surrounding the deposit accounts has been solved, Fréttabladid reports.
Icelandic Committee Members of Parliament of the European Free Trade Association (EFTA) Countries (CMP) said they had been given a clear message in that regard from EU officials during a meeting in Brussels earlier this week.
“I believe that extortion is involved,” said MP for the Left-Greens Árni Thór Sigurdsson, who is on the CMP. “[EU officials] said that a loan from the IMF would not happen unless we reached an agreement with Britain. They have influence in the fund and can set terms like that, which is known as extortion.”
Katrín Júlíusdóttir, an MP for the Social Democrats and chairman for the Icelandic division of the CMP, said Iceland’s representatives on the CMP had pointed out that Iceland intended to respect laws and regulations but that they disagreed with Britain on the interpretation of some legal issues.
Júlíusdóttir said Iceland’s representatives in the committee had also pointed out that there should not be a connection between international financial aid and a dispute on insurance for deposits.
British authorities have offered a loan to the Icelandic state so that Icelandic authorities can honor their obligations to Landsbanki account holders in the UK. However, a prerequisite for such a loan is an agreement with the IMF.
According to Fréttabladid, British Chancellor of the Exchequer Alistair Darling emphasized that a loan to Iceland would not be granted otherwise in an interview with the Dow Jones news agency on Monday.
Icelandic banks Landsbanki and Kaupthing, both of which have now been nationalized, accepted deposits through their subsidiaries in some European countries, primarily in the UK and the Netherlands. Landsbanki’s Icesave is an example of such a subsidiary.