international monetary fund (imf) iceland financial crisis

INTERNATIONAL MONETARY FUND (IMF)

ICELAND FINANCIAL CRISIS

Professor CastilloECON 490 Global Economics

Group Members

David Vera-

Historical Background of IMF Policies & Activities

Karen Urbina-

Iceland’s Position & IMF Assessment

Maria Ayala-

Outcomes of the Bailout

Historical Background of the IMF Policies &

Activities

History

Great Depression of the 1930s

Breakdown in International Monetary Cooperation

The Bretton Woods Agreement (BWA)

IMF was formed through the BWA:

BWA was conceived in July 1944

International Monetary Fund (IMF) formal existence

was in December 1945

Par value system

The End of the BWA

End of Bretton Woods system (1972–81) :

The system dissolved between 1968-1973.

Since the collapse of the Bretton Woods system, IMF

members have been free to choose any form of

exchange arrangement they wish

IMF Becoming a Universal Institution:

The fall of the Berlin wall in 1989

Expansion to fulfill responsibilities

Soviet Block Transition

Debt relief for poor countries

IMF Organization

MF is an organization of 185 countries

Their primary purpose is to preserve the stability of the

international monetary system

Helps the governments of these countries manage

economic difficulties and benefit from opportunities of

globalization

IMF’s Current General Arrangements to Borrow (GAB )

The GAB enables the IMF to borrow specified

amounts of currencies from 11 industrial countries at

market-related rates of interest.

The potential amount of credit available to IMF

under the GAB totals $25.7 billion in Special

Drawing Rights (SDR) and an additional SDR 1.5

billion from Saudi Arabia.

Current Challenges for the IMF

Continued Globalization (2005-present):

The current financial crisis and the food and oil price

shock

A sharp rise in private international capital flows

Speed of capital account crises

Icelandic Financial Crisis

Iceland’s PositionExecutive Board of IMF

Assessment

Iceland’s Fast Growing Economy

The long economic expansion:

initiated by aluminum sector investments

sustained by a boom in private consumption

fueled by ready access to external financing Negative Contributions:

macroeconomic imbalance and financial vulnerabilities

Iceland Economic Activities

In 2001, banks were deregulated

Households took on a large amount of debt

Investors overestimating the true value of the króna.

Iceland’s GDP in 2007

What Caused the Crisis

the country built up a massive current account deficit by borrowing beyond its means

banking sector was eight times the size of the overall economy

Icelandic banks found it increasingly difficult or impossible to roll over their loans in the interbank market Collapse of Landsbanki, Glitnir & Kaupthing

Insufficient reserves to repay banks debt

Currency Exchange Rate

Steps to Shore up Confidence

The Central Bank of Iceland (CBI) tightened the

policy rate

Enhanced liquidity provision to reduce pressures in

foreign exchange and domestic markets

improved its foreign exchange liquidity access by

entering into currency swap agreements with other

Nordic central banks.

Iceland Bailout

$2.1 Billion Loan Plan

Stand-By Arrangement

$827 million immediately available

$155 million remainder in eight equal installments

Iceland Bailout Agreement Terms

  Performance Criteria Indicative Targets

  December-2008 Ceiling/

Floor 1/ March-2009 Ceiling/Floor 2/

June 2009 Ceiling/Floor 3/

(In billions of króna)    

1. Floor on the change in the central government net financial balance.4/ -12 -55 -55

2. Ceiling on the change in net credit of the Central Bank of Iceland to the private sector. 5/ 25 50 50

3. Ceiling on the change in the domestic claims of the Central Bank of Iceland to the central

government 25 25 25

(In millions of US dollars)    

.. 5. Ceiling on the level of contracting or guaranteeing of new medium and long term external

debt by central government 7/ 4000 4075 4150

6. Ceiling on the stock of central government short-term external debt 7/ 8/ 650 650 650

7. Ceiling on the accumulation of new external payments arrears on external debt contracted

or guaranteed by central government from multilateral or bilateral official creditors.8/ 9/ 0 0 0

Iceland Bailout Objectives

3 Main Objectives:

To stabilize the exchange rate

Restructure the Banking System

To Create a mid-term fiscal sustainability

Outcomes of the Bailout

Positive Bailout Results

Objective 1: Stabilizing the Exchange Rate for

Iceland:

Restoring the interbank foreign exchange market.

Appreciating currency by lifting capital controls and

reducing interest rates

Restoring confidence

The key near-term objective of stabilizing the króna

is being met as it continues to strengthen

Positive Bailout Results (cont.)

Objective 2: Bank Restructuring

Assist in fair valuation of new and old assets

maximize asset recovery in the old banks

strengthen supervisory practices

Strengthen the bankruptcy framework

Fair treatment of depositors and creditors

Positive Bailout Results (cont.)

Objective 3: Mid-term Fiscal Sustainability

IMF will ensure that Iceland can continue to pay

its foreign creditors ; short term debt.

A strong plan for 2010 to cut expenditures and/or

to raise taxes.

IMF loan will fill about 42 percent of the country's

2008-10 financing gap, the remainder by official

bilateral creditors.

Negative Results from the Bailout

Out migration of Icelanders may be an issue in the

short-term possible impacting future growth.

Additional request for bailouts

bailout programs have already been announced for

Hungary, Ukraine, Serbia and Pakistan

IMF has created a credit line of as much as $100

billion for healthy countries with liquidity shortages

Iceland's Future

Iceland: Selected Economic Indicators

  Projection

  2005 2006 2007 2008 2009

Real Economy (change in percent)    

Real GDP 7.4 4.4 4.9 1.6 -9.6

Domestic demand 16 9.9 -1.5 -9.1 -19.7

Unemployment rate (in percent of labor force) 2.1 1.3 1 1.4 5.7

Gross domestic investment (in percent of GDP) 28.4 33.7 27.6 23.9 18.2

General Government Finances (in percent of GDP)    

Financial balance 4.9 6.3 5.5 -0.2 -13.5

Balance of Payments (in percent of GDP)    

Trade balance -12.2 -17.7 -10.1 0.1 10.3

Gross external debt 285.7 445.9 551.5 670.2 159.5

Iceland's Bright Future

The countries endowment:dynamic, technology driven society with a young and

well educated workforceAbundant natural resources such as rich fishing grounds,

vast renewable energy sources, clean water a natural environment and culture that draws tourists

Other major strengths of the economy include:diverse export industriesflexible labor marketstrong fiscal positionHigh anticipation of exports

Future of IMF

IMF was headed down hill after five years of inactivity,

accusations of issuing poor advice, questioning of its

relevance and usefulness, Facing a deficit of its own &

Inability to sell its gold reserves

IMF is gaining relevance once again :

being considered to take on a sovereign wealth fund role to

avoid a repeat of a global credit crisis

Increased regulation & surveillance of the financial system

Conclusion

With the IMF, Iceland can continue to pay its

foreign creditors in the near term and avoid

national bankruptcy

the economy is expected to enter into a recession in

2009-10 although expected to rebound by 2011

Recommendations for IMF & IcelandIceland: Iceland must focus on allowing the Financial Supervisory

Authority to assist them in assessing their financial stability so that preemptive measures can be put in place.

Strengthen their ties with Britain, Sweden and Denmark.

IMF: IMF needs to put in place preventive measures for

economic crisis They will have to adapt at a much faster pace than ever

before because of economic integration & the effects of globalization

Questions?

Resources

• http://www.telegraph.co.uk/finance/comment/edmundconway/2787581/Fear-of-Iceland-bail-out-could-signal-new-future-for-the-IMF.html

• http://www.iht.com/articles/2008/11/20/business/imf.php

• http://www.imf.org/external/pubs/ft/survey/so/2008/new101608a.htm

• http://www.imf.org/external/pubs/ft/survey/so/2009/INT022409A.htm

• http://www.vi.is/files/The%20Icelandic%20Economic%20Turmoil_925879388.pdf

• http://www.imf.org/external/pubs/ft/survey/so/2008/car102408a.htm

• http://www.imf.org/external/np/sec/pr/2008/pr08296.htm• http://www.imf.org/external/np/loi/2008/isl/111508.pdf• http://www.statice.is/?

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