1. The Icelandic Economic Programme
July 2009
Department of Economic Affairs and International Finance
Prime Minister’s Office

2. The Onset of the Financial Crisis
Government Reaction
IMF Assistance and the Economic Programme
Going Forward

3. Libor-OIS spread reflects risk aversion in international markets
Nearly Entire Banking System Collapses
Landsbanki, Kaupthing and Glitnir, Iceland’s three largest banks collapsed following intensified credit crunch in September.
Collapsed banks represented around 85% of banking system.
A banking system with liabilities of over 10x GDP.
Additional small institutions later collapsed or requested government assistance – representing nearly the complete banking sector.
The Central Bank of Iceland was unable to act as a lender of last resort in the required currency due to the large size of the banks’ foreign liabilities despite rapidly rising reserves from 2006.
Libor-OIS spread reflects risk aversion in international markets

4. Deep Financial and Currency Crises
95% of the stock market wiped out.
The Icelandic krona, the world’s smallest free-floating currency, went into a free-fall.
Iceland facing a Twin-Crisis in both banking and currency markets.

5. The Onset of the Financial Crisis
Government Reaction
IMF Assistance and the Economic Programme
Going Forward

6. Focus on Continuous Domestic Banking Service
Primary focus on securing payments system and continued domestic banking services.
Government guaranteed all domestic deposits.
Early problems with payments system with abroad rectified.
Emergency legislation passed 6 October 2008 enabled the Government to intervene extensively in Iceland’s financial system and make deposits priority claims.
The FME, the Financial Supervisory Authority of Iceland, took control of Landsbanki and Glitnir on October 7 and Kaupthing the following day on the basis of the new emergency legislation.
Three new banks established on October 19 and 20 holding all domestic deposits and loans from the old banks.
Secured continued domestic banking and financial services.

7. Economic Programme Implemented with the IMF
IMF assistance sought immediately after the onset of the financial crises.
Negotiations started quickly with a 2-year Stand-by Arrangement agreed by the IMF board on 19 November.
Economic programme outlined in a Letter of Intent. To be reviewed every quarter.
All “performance criteria” listed in the LoI and published with explanations on websites.
“Considerable progress” has been made towards completing the first review in late May. Expected to be approved by the IMF’s Executive Board in August 2009.
External financing provided to bolster central bank’s currency reserves.
Eases the macroeconomic adjustment
IMF to provide USD 2.1 bn in financing over 2 years.
The Nordic countries, Russia and Poland to provide USD 3 bn.

8. The Onset of the Financial Crisis
Government Reaction
IMF Assistance and the Economic Programme
Going Forward

9. Three main areas of economic programme
Stabilizing the exchange rate and rebuild confidence in monetary policy
Review and revise fiscal policy with the aim of maintaining a manageable level of public sector debt and debt service in spite of lost revenues and increased expenditures.
Bank sector restructuring and reform of the insolvency framework in accordance with transparent, internationally recognized principles.

10. Need to stabilize the Icelandic króna
Currency stability the primary priority:
Large exposures by homes and corporations to foreign denominated and indexed linked debt.
Monetary Policy tightened:
Policy rate at 18%. Later reduced to 12%
Limits on CB credit.
Temporary capital controls imposed on 28 November in full cooperation with the IMF.
Rules do not affect trade or direct investment.
Have been modified and surveilance increased.
Some easing of restrictions expected late 2009.
Bolstered currency reserves used to minimize volatility.
Close connection between currency stability and fiscal and banking policies.

11. Tough debt burden in the short run
Gross central government debt to jump from 23% GDP in 2007 to over 125% at end-2009.
Costly recapitalization of banks and Central Bank.
Large budget deficits.
Loans to strengthen currency reserves.
Cost from overseas deposit insurance (Icesave) not included.
Net debt more manageable 60% of GDP. Government also owns stocks (mostly banks and energy corp.) for around 40% of GDP
Gross debt could be reduced quickly:
Debt level closer to OECD average in the medium-term.

12. Consolidation of Government Finances
Automatic stabilizers allowed to respond in 2009.
Fiscal consolidation from 2010 of 3.5% of GDP per year to bring government finances back into surplus by 2013.
Balanced expenditure and revenue measures, with higher taxes playing a larger role in the short run.
Plans for presented in June with final four three-year plan with 2010 budget in fall 2009.
Fiscal rules strengthened and expanded to cover the whole public sector by mid-2009.
Government and social partners have signed a stability pact setting out common macroeconomic and fiscal goals and extending private sector collective bargaining contracts until November 2010 with minimal wage increases.

13. Bank Restructuring
“New” banks set up in October with full Government ownership.
New banks buy domestic assets from old banks following negotiations by 17 July.
Government will recapitalize the new banks by 17 July.
The Icelandic Government is committed to progressing a sound and transparent process as regards depositors and creditors.
Old banks in hands of Resolution Committees that are to maximize their assets and guide them through the liquidation process.

14. Financial Sector Reform and Governance
Government holdings in financial institutions to be transferred to a holding agency at arms-length from political process. Based on the Norwegian model from the late 1980s earli 1990s.
Asset management company to be set up to assist banks in the massive restructuring process ahead. One of the largest share of non-performing loans in any financial crises.
A review of the bank regulatory framework and supervisory practices to strengthen safeguards against potential new crises. Work based on a report by Mr. Kaarlo V. Jännäri, a renowned Finnish financial supervisory expert.
Reasons for the crash and possible wrongdoing being studied by a special expert parliamentary committee and a special prosecutor.

15. The Onset of the Financial Crisis
Government Reaction
IMF Assistance and the Economic Programme
Going Forward

16. Deep Recession GDP to fall by over 10% in 2009
25% drop in private consumption.
40% drop in investment.
GDP of around in real terms.
Unemployment to surge to around 10%.
Positive trade balance largely on falling imports.

17. Effects already being felt
Unemployment around 9%.
Real wages down 10% year-on-year.
Private consumption collapsing.
Consumer confidence low.
But inflation subsiding.

18. ...but not all doom and gloom
Young and well educated workforce.
Stable institutions.
Fully funded pension system.
Abundant inexpensive clean energy.
Economy to recover quickly from onwards on the back of these very positive long-term attributes.

19. Further information to be found at…