27 August 2016

Assessment of possible outflows upon capital account liberalisation

Central Bank of Iceland

On August 17, 2016, the Government presented a bill to Parliament on the next steps in the liberalisation of capital controls (see https://www.ministryoffinance.is/news/increased-freedom-liberalisation-of-capital-controls for the main elements of the Bill).

The Central Bank of Iceland has analysed possible capital outflows as these steps are taken. Outflows can be expected, owing to an increase in firms’ foreign direct investment and to firms’ and individuals’ interest in diversifying risk in their asset portfolios. However, the risk of substantial outflows is mitigated by a wide interest rate differential with abroad, a stronger economy in Iceland than in trading partner countries, low inflation, and trade-related capital inflows with the associated appreciation of the króna.

Nevertheless, it is clear that if outflows resemble those shown in the scenario providing for the largest outflow, the strain on the foreign exchange market, financial institutions, and the economy as a whole would be on a scale that would make it imprudent to open the way for additional liberalisation measures before markets have normalised once again.

The main results of the assessment are shown in note available here:
Assessment of potential outflows upon capital account liberalisation, 19 August 2016.