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Regional Outlook

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					Iceland’s Economic Outlook
          Presentation to the
Icelandic Financial Services Association




            May 14, 2009



         Franek Rozwadowski
       Resident Representative
     International Monetary Fund
                     Overview

I.     Background to the crisis

II.    The crisis

III.   The recovery program

IV.    Where does the program stand?
I. Background to the crisis
                    A build up of large external
                           imbalances...
       Current Account Deficit, Average 2005-07                            Gross External Debt
25                                                600
     (percent of GDP)                                    (percent of GDP)
20                                                500

15                                                400

                                                  300
10
                                                  200
5
                                                  100
0
                                                   0
            Latvia
     New Zealand
            United




         Portugal
             Spain

        Lebanon
        Lithuania

            Serbia

          Estonia
           Ireland

        Australia
          Croatia




         Bulgaria
          Iceland
        Romania

         Jamaica




                                                         2000

                                                                   2001

                                                                           2002

                                                                                   2003

                                                                                          2004

                                                                                                 2005

                                                                                                        2006

                                                                                                               2007
              CPI Inflation, first half 2008
     Source: IMF and Central Bank of Iceland.                              Real House Prices
12                                                 250                                                                250
     (percent)                                                  Index (2000=100) 1\
10                                                                        UK
                                                   220                                                                220
                                                                          Sweden
 8
                                       ... and internal imbalances.

                      Average Inflation, first half 2008                                                                                  Real House Prices
12                                                                                                                     250                                             250
      (percent)                                                                                                                 Index (2000=100) 1\
10                                                                                                                                       UK
                                                                                                                       220                                             220
                                                                                                                                         Sweden
 8                                                                                                                                       Iceland
                                                                                                                       190               Spain
                                                                                                                                                                       190
 6
                                                                                                                                         Ireland
 4                                                                                                                     160               Norway                        160
                                                                                                                                         USA
 2                                                                                                                     130                                             130
 0
                                                                                                                       100                                             100
                                                                              Norway
                                              Italy
                                                      Sweden




                                                                                             New Zealand
                                    Germany



                                                               UK



                                                                                       USA
             Canada
     Japan




                                                                    Iceland




                                                                                                           Australia
                           France
                      EU




                                                                                                                             2000 2001 2002 2003 2004 2005 2006 2007




                                              Exchange Rate                                                                                      CPI Inflation
200 Source: IMF.                                                                                                       18
     (krona per euro)                                                                                                        (percent)
180                                                                                                                    16
                                                                                                                       14
Banks’ balance sheets expanded out of
    proportion to the economy...
                                                          1000
     The three largest banks: Total assets as % of GDP
                                                          900
                                                          800
                                                          700
                                                          600
                                                          500
                                                          400
                                                          300
                                                          200
                                                          100
                                                          0
       2003           2004           2005   2006   2007

    Source: Icelandic Authorities.
          ...while vulnerabilities also built up on
        corporate and household balance sheets.

         Iceland: Household Borrowing from the Credit System                         Iceland: Corporate Borrowing from the Credit System
                         (In percent of GDP)                                                         (In percent of GDP)

140.0                                                                        300.0

120.0                                                                        250.0

100.0
                                                                             200.0
 80.0
                                                                             150.0
 60.0
                                                                             100.0
 40.0

 20.0                                                                         50.0

  0.0                                                                          0.0
       03


                 04


                         05


                                 06


                                         07


                                                   1


                                                               2


                                                                        3




                                                                                    03


                                                                                             04


                                                                                                      05


                                                                                                               06


                                                                                                                       07


                                                                                                                                  1


                                                                                                                                  2


                                                                                                                                  3
                                                   Q


                                                             Q


                                                                        Q




                                                                                                                                 Q


                                                                                                                                 Q


                                                                                                                                 Q
    20


              20


                      20


                              20


                                      20


                                                 08


                                                           08


                                                                      08




                                                                                 20


                                                                                          20


                                                                                                   20


                                                                                                            20


                                                                                                                    20


                                                                                                                               08


                                                                                                                               08


                                                                                                                               08
                                              20


                                                        20


                                                                   20




                                                                                                                            20


                                                                                                                            20


                                                                                                                            20
         FX      Indexed      ISK non-indexed          Other       Leasing               FX       Indexed       ISK non-indexed   Leasing



        Source: Central Bank of Iceland.
II. The crisis
                               The crisis
                                                                          Government
                               Global financial turmoil                 intervened and
                                                                         guaranteed all
                                                                       deposits, creating
                                                                         large external
                            Three largest Icelandic banks               obligations and
                             collapsed in October 2008                large fiscal burden


                     Collapse in investors’ confidence in Iceland



Pressure on the            Collapse             Large capital           Country risk
     krona             in asset prices            outflows          premium skyrocketed



                 Impact on the real economy: sharp contraction
   Impact on the ability to pay external obligations: large external financing gap
  Immediate pressure on the currency and inflation.
            Some signs of stabilization.


360                                             22
                                                       CPI Inflation, q/q annualized,SA
320            On-shore rate
                                                17
               Off-shore rate
280

240                                             12

200
                                                7
160

120                                             2

80
                                                -3
      Jan-08




      May-08
      Jun-08




      Jan-09
      Nov-07
      Dec-07

      Feb-08




       Jul-08




      Nov-08
      Dec-08

      Feb-09
      Mar-08




      Mar-09
      Oct-07




      Oct-08
      Sep-08
      Aug-08
      Apr-08




      Apr-09                                         05Q1 05Q3 06Q1 06Q3 07Q1 07Q3 08Q1 08Q3 09Q1



      Source: IMF and Central Bank of Iceland
                         A sharp contraction of GDP.
             International experience--recovery could come soon.

20                                                         160 10
        Recent Indicators                                                                    GDP
15                                                                                           (annual % change)
10                                                                5
                                                           120
 5
                                                                  0
 0
                                                           80
 -5              Groceries turnover
                                                                  -5
-10              (LHS)
                 Payment card
                                                           40
-15              turnover (LHS)
                                                                 -10                  Iceland (IMF proj)
                 Gallup confidence                                                    Median (emerging)
-20
                 index (RHS)
                                                                                      Median (advanced)
-25                                                        0     -15
      06Q1    06Q3    07Q1     07Q3   08Q1   08Q3   09Q1               -5   -4   -3     -2   -1    0       1   2   3   4   5



      Source: IMF and Central Bank of Iceland
                     The trade balance has improved
                      and should remain in surplus.
30,000                                                        10
          Balance on Trade in Goods (NSA, mln ISK)                       Trade balance/GDP
20,000                                                         5         (%)


10,000                                                         0


     0                                                         -5


-10,000                                                       -10
                                                                                                     Median (emerging)
-20,000                                                       -15                                    Median (advanced)
                                                                                                     Iceland (IMF proj.)
-30,000                                                       -20
      Jan-05    Jan-06      Jan-07     Jan-08        Jan-09         -5   -4   -3   -2   -1   0   1     2     3    4        5


    Source: IMF and Central Bank of Iceland
III. The recovery program.
     Financing and adjustment policies
                 The IMF Program
                            Adjustment
    Financing
                              policies


 Two-year IMF Stand-by      Monetary policy
Arrangement totaling $2.1
   billion; $827 million
upfront, and remainder in
   8 equal installments.     Fiscal policy

    Official bilateral
  creditors commit an
                            Financial sector
 additional $3.2 billion.        policy
                                        Program financing
                       Expected Official Financing                                          External Debt
10                                                                    200
                Bilateral loans                                             (percent of GDP)
                Loans related to deposit insurance obligation         180
8               IMF                                                   160
                                                                      140
6                                                                     120
                                                                      100
4                                                                      80
                                                                       60
2                                           (in USD billion)           40
                                                                       20
0                                                                       0




                                                                             2008


                                                                                     2009


                                                                                               2010


                                                                                                      2011


                                                                                                             2012


                                                                                                                    2013
         2008



                      2009



                               2010



                                         2011



                                                   2012



                                                               2013

     Source: Central Bank of Iceland and IMF Staff projections

      • External debt sustainability is robust to a variety of shocks. Key factors:
                  High current account surpluses (fed by improvements in competitiveness)
                  Asset recovery in the banking sector (conservative assumption made)
Monetary policy: Stabilization then support

• Stabilization:
    stabilize the exchange rate                      CPI Inflation (IMF Projection)
                                   20
    stabilize financial markets   18       (percent)
    Largely accomplished          16
                                   14
                                   12
• Support recovery:                10
    Normalize the regime           8
        Remove capital controls    6
                                    4
        Reduce interest rates      2
    Keep inflation low             0

                                        2008Q1


                                                  2009Q1


                                                            2010Q1


                                                                     2011Q1


                                                                              2012Q1


                                                                                       2013Q1
                                   Source: Central Bank of Iceland and IMF Staff projections
More on Normalizing the Monetary Policy Regime

Interest rate strategy:
    – Balance sheet considerations require continued focus on exchange rate stability
    – Fiscal consolidation and debt restructuring may in time create more room for
      reductions--but this is not evident now.

Capital control strategy:
    – Pre-conditions for easing: financial system stability and adequate reserves
    – Current forecasts suggest that the process must be gradual
    – To maximize benefits to Iceland, focus first on new investment, then gradually release
      legacy non-resident holdings (approach used in other countries)

Interactions between rates and controls:
    – Despite capital controls, interest rate policy is still needed to: (i) encourage exporters to
      repatriate in foreign exchange; (ii) encourage reinvestment of interest earnings; and (iii)
      contain capital control circumvention.
    – Interest rates must be high enough when new investment is liberalized to prevent large
      net outflows.
              Fiscal policy: Gradual consolidation and
                      reduction of public debt
                             Fiscal Balance                                           Public Gross Debt
10                                                                  120
      (percent of GDP)                                                    (percent of GDP)
  5                                                                 100

                                                                    80
  0
                                                                    60
 -5
                                                                    40
-10                                                                 20

-15                                                                  0




                                                                          2006

                                                                                 2007

                                                                                          2008

                                                                                                 2009

                                                                                                        2010

                                                                                                               2011

                                                                                                                      2012

                                                                                                                             2013
       2006

               2007

                      2008

                                2009

                                       2010

                                              2011

                                                     2012

                                                             2013



                External Financing Needs                                                External Financing Gap
27                                                                  150
24                                       (billions of US$)                                              (in percent of GDP)
21                                                                  120
18                            Gross Requirements
15                                                                  90
                       Expected financing
12 Source: Ministry of Finance and IMF Staff projections
                     Restoring the banking system
 Before                                                                                   Other savings
                                        Three large banks                                and investment
 the crisis                                                                                   banks



                    Old banks                                        New banks           • Intervene
At present
                with foreign assets     Financial instrument    with domestic assets     weak banks
                   and liabilities                                  and deposits         • Recapitalize
                                                                                         viable banks
                In moratorium and           Compensate
                                                                    Operating for        • Settle claims
               bankruptcy procedure           for excess           domestic clients      in failed banks
                                                assets
                                             transferred

Policies and   • Maximize asset                                • Recapitalize
measures         recovery                                      • Clean up the balance
               • Settle claims fairly                          sheets via transferring
                  equitably                                    some assets to AMC
                                                               • Address imbalances


Supporting
                                 Household and corporate debt restructuring
measures
                                   Strengthen regulation and supervision
IV.   Where does the program stand now?
Policies
Monetary policy:
Significant easing in last two months. Preconditions not yet in place for
       further easing. Need to monitor conditions.


Fiscal policy:
Authorities defining measures to effect fiscal consolidation


Financial sector:
Asset valuation done. Next steps are to define instrument of
      compensation, recapitalize, address imbalances, cut costs, and
      define asset management strategy.
Work towards the next IMF disbursement

• Program has quarterly reviews
• Discussions on first program review ongoing
• The next tranche to be disbursed after IMF executive board
  approval of the review

				
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