31 October 2009

First stage of capital account liberalisation

The Central Bank of Iceland has taken the first step in the sequenced removal of the capital controls by permitting inflows of foreign currency for new investments and potential outflows of foreign currency that may derive from such investments in the future. This means that investors are authorised, without restrictions, to convert into foreign currency the sales proceeds from assets in which they invest after November 1, 2009. Previously, non-residents were fully authorised to transfer foreign currency deriving from interest and dividends on investments in Iceland.

Foreign exchange inflows for new investments will be converted into Icelandic krónur by financial undertakings operating under the supervision of the Financial Supervisory Authority. If the subsequent transfer of that capital out of Iceland is to be authorised, the new investment must be registered with the Central Bank of Iceland. This will enable the Bank to track inflows and strengthen the foreign exchange reserves through market intervention if circumstances permit.

In addition to the above-specified amendments, the Rules on Foreign Exchange have been revised with the aim of enhancing consistency and closing loopholes that have been used to circumvent the capital controls. The most salient amendments are the following:

• Exemptions granted to various parties – including municipalities and publicly owned undertakings, undertakings with investment contracts, and other parties – have been revised; cf. Article 14 of the Rules on Foreign Exchange.
• Movements in krónur have been specially restricted in order to facilitate enforcement and prevent abuse of the Rules; cf. Article 2, Paragraph 3.
• The authorisation to reinvest has been expanded and the exercise of that authorisation facilitated; i.e., as regards reinvestment of dividends and capital gains; cf. Article 5, Paragraph 1.
• Increased restrictions are placed on investments in other assets in order to limit opportunities to circumvent the Rules; cf. Article 6.

As opportunities for foreign exchange transactions related to movement of capital are expanded, new possibilities for circumventing the remaining capital controls may emerge. As a result, it is necessary to strengthen surveillance of the controls. The Central Bank has already done this by restructuring and reinforcing its Capital Controls Surveillance Unit, as was announced in the Bank’s press release no. 30/2009. In order to reduce the risk of circumvention, the authorisation to re-transfer capital out of Iceland does not extend to certain types of investments; for example, leveraged derivatives contracts.

The Central Bank will publish guidelines for the Rules and will update them as necessary.

The capital controls imposed on November 28, 2008, were considered necessary in order to stabilise the economy in the wake of the financial crisis that struck Iceland in October 2008. The conditions necessary for the initial stage in removing the controls, in accordance with the capital account liberalisation strategy presented by the Bank on August 5, 2009, have now developed. A long-term fiscal consolidation programme has been prepared, as has the National Budget bill for 2010, which entails considerable restraint. Conditions for exchange rate stability have improved. The First Review of the macroeconomic programme of the Icelandic Government and the International Monetary Fund has taken place, ensuring that the Central Bank has access to increased foreign exchange reserves.

The next phase of capital account liberalisation – the removal of restrictions on capital outflows – will be determined by the success of this phase and the progress made under the macroeconomic programme.

Further information can be obtained from Ingibjörg Guðbjartsdóttir head of the Capital Control Surveillance Unit of the Central Bank of Iceland, at tel (+354) 569-9600.

No. 33/2009
October 31, 2009