Iceland economy ponders testing currency markets

Bloomberg

Iceland, the world’s tiniest developed economy, is now pondering whether it has the might to take on the currency markets.
The center-right coalition that took office this month wants an overhaul of Iceland’s monetary policy framework, which could lead to fixing the currency or letting it trade within a band, Finance Minister Benedikt Johannesson, 61, said. The review could also lead to a less intrusive move, namely continuing the current managed intervention. It could also result in the most drastic action of all, abandoning the krona for another currency, he said.
The abundance of options is possible thanks to Iceland’s stockpile of foreign currency reserves, equivalent to about 36 percent of GDP, the finance minister said. But fixing a currency doesn’t come without risks and has bedeviled bigger nations than Iceland, most recently Switzerland.
The krona was little changed
at 120.4 per euro as of 8 a.m. local time. Johannesson, a former publishing executive who took over as finance minister this month, says the government’s priority is to gain control of the currency, even as concern grows the economy is overheating.
“I’m more worried about the strengthening of the krona,” he said. “The instability in the exchange rate has a dangerous impact on corporations, but also, when we have a currency that fluctuates so much, there’s a danger that interest rates need to be set higher than otherwise.”
The krona has rallied about 30 percent against the euro from a 2013 low, driven by Iceland’s economic boom and government steps last year to dismantle capital controls in place since 2008. The appreciation reverses some of the damage done in the aftermath of Iceland’s financial collapse, which effectively gutted the currency.
Now, the country is planning to remove the last of its currency restrictions, but that probably won’t go “hand in hand” with a monetary policy shift, said Johannesson. “I think it will take longer to change the monetary policy than to remove the capital controls,” he said.
The country is much better equipped to withstand shocks now than in 2008, he said. The banks aren’t doing business abroad and their equity ratios are “much stronger.”
While Iceland’s economy is booming — GDP rose an annual 10.2 percent in the third quarter of 2016 — the central bank has warned of potential overheating and invited the government to pursue a less expansionary fiscal policy.
Johannesson said he’s aware of the risks that come with government overspending. “We’re working with the central bank and others to make sure there’s a surplus during the upswing,” he said. “There was GDP growth last year and we’re expecting considerable growth this year.”