Iceland weighs plan to peg krona to another currency

Iceland’s finance minister has admitted it is untenable for the country to maintain its own freely floating currency, just days after it lifted capital controls imposed in the wake of its near financial collapse in 2008.

Benedikt Johannesson told the Financial Times that the Nordic island of just 330,000 people would look at options to link Iceland’s krona to another currency, most likely the euro or pound.

“Is the status quo untenable? Yes. Everybody agrees on that. We’d like to have a policy that would stabilise the currency. It’s really not good when a currency fluctuates by 10 per cent in the two months since we took over,” said Mr Johannesson, who became finance minister in January.

Iceland was one of the countries hardest hit by the 2008 financial crisis. Its three largest banks collapsed and it was forced to introduce capital controls to protect its currency.

Restrictions on the krona were finally lifted in March as a boom in tourism led Iceland’s economy to recover sharply. Growth in gross domestic product reached 11 per cent in the fourth quarter of 2016. Concerns are mounting about the economy overheating, with the krona strengthening significantly as Iceland’s relatively high interest rates lure in foreign capital.

Mr Johannesson said stabilising the currency was “the next big issue” for Iceland.

He dismissed previous suggestions of pegging the krona against the Canadian dollar or Norwegian krone as “absurd ideas”, noting that both currencies had depreciated recently while Iceland’s had appreciated by 20 per cent in the past year.

“The main thing is if you want to peg against a currency, do it against a currency where you do business. Once you decide on a currency, that will also change the future. You will do more business with that area,” he added, pointing to Denmark’s experience of doing more business with Germany after pegging its currency first to the Deutschmark and then the euro.

Mr Johannesson tried to downplay concerns about overheating, saying he did not think that tourism was “something that will explode”, even though the number of tourists visiting Iceland has risen almost fivefold since 2010.

The finance minister said the government was running a large budget surplus and paying down its debt in an effort “to stem a potential boom”. The government is also planning to raise valued added tax for tourism next year.

The strong economic growth has attracted foreign investors anew to Iceland with Arion Bank, one of the successors to the trio of failed banks, selling about one-third of itself in March to three hedge funds and Goldman Sachs.

Frank Brosens, co-founder of one of the hedge funds, Taconic Capital, said Iceland had enjoyed “a remarkable story” in recent years. He admitted “the public remains slightly suspicious” but said “a lot of concern is unfounded” as Taconic was not seeking a board seat or to influence the bank. Taconic owns 9.9 per cent of Arion and, together with the other investors, has an opportunity to increase its stake before a probable stock market listing this year.

Mr Johannesson acknowledged there was public scepticism in Iceland over the role of publicity-shy hedge funds in the financial sector. He said a balance was required between the desire for international investors and the need for transparency from those investors.

He said there were still divisions in Iceland despite the economic recovery. “People did suffer a lot. Socially, we have not recovered. Economically, we have. People are still angry. They are sceptical of business, of the banks, of politicians.”