Cooperation with the IMF
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The IMF approved on November 19 a USD 2.1 bn Stand-By-Arrangement with Iceland
based on an economic programme outlined in a Letter of Intent. Iceland is to receive
additional loans of USD 3 bn from the Nordic countries, Russia and Poland.
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The programme was formulated by the Government and Central Bank of Iceland in
close consultation with the IMF.
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The programme focuses on three main areas:
 Stabilizing the exchange rate and rebuild confidence in monetary policy.
 Review and revise fiscal policy with the aim of maintaining a manageable level of
public sector debt and debt service in spite of lost revenues and increased
expenditures.
 Bank sector restructuring and reform of the insolvency framework in accordance
with transparent, internationally recognized principles.
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The programme outlines a number of quantitative and qualitative performance criteria
that the authorities have to fulfill. These focus mainly on monetary tightening (raising
the policy rate and curtailing central bank lending), fiscal consolidation (including
medium-term plans and a floor on changes in the net financial balance) and timing
and methods regarding the banking sector restructuring.
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Government Policy
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The government’s economic policy is based on
the economic programme outlined with the IMF.
Recent actions include:
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Approving the 2009 budget within targets set in the
programme.
Work in progress to establish and Asset Management
Company that will take over companies facing
restructuring by the banks of special social or
economic importance to Iceland.
Work on medium-term fiscal consolidation in train to
be approved by mid-2009.
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Why did the banks collapse?
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The fall of Lehman Brothers in September caused
extensive problems for the Icelandic banks.
The banks had grown extremely rapidly since 2004.
Their foreign currency lending had increased
exponentially.
In September/October, international credit markets
virtually closed. The Central Bank was unable to serve as
the banking sector’s lender of last resort as support was
mainly needed in foreign currency.
With liabilities of more than 10X Iceland’s GDP, the
government of Iceland was unable to give the banks
support to a similar extent currently being done in other
countries.
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Foreign expertise sought

The Government decided to seek assistance from the IMF immediately after the onset of the
financial crises as the enormity of the crises became clear.
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A “fact finding mission” from the IMF was in Iceland as the banks were taken over by the FME.
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Negotiations started quickly with an agreement and an economic programme finalized by October
24.

Negotiations over deposit insurance for branches of Icelandic banks abroad delayed the
process of attracting needed additional financing for the programme.

Financial support sought from Iceland’s closest neighbours and friends, with the largest bulk of
assistance coming from the other Nordic countries, in addition to Russia, Poland and the Faroe
Islands providing funding.

Reputed international experts hired to advise on restructuring of the banking sector (Mats
Josefsson from Sweden) and review of the financial market legal framework (Kaarlo Jännäri from
Finland).

Assistance received from reputable international advisory firms, i.e. JP Morgan, McKinsey and Co.
and Oliver Wyman. Deloitte is valuating the banks.
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Additional assistance sought to strenghten international best practices for the Icelandic economy
and financial assistance from IMF experts and use made of OECD expertise.
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Foreign expertise sought
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The ISK went into a free-fall in early October as the financial crisis intensified.
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Currency stability the first priority:
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90% of corporate debt in foreign currency, household debt largely index-linked or in foreign currency and
foreign goods representing more than 1/3 of the consumer price index.

Foreign investors hold around 400 bn.ISK, or 25% of GDP, in liquid ISK assets. Large-scale sales of these
assets in a short period of time could result in a further shock to the currency market.

The fall of the banking sector and subsequent currency market guidelines issued by the Central Bank (CB) caused
the currency market to being initially divided into a domestic (on-shore) and a foreign (off-shore) currency markets.
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The CB conducted daily “on-shore” currency auctions for the domestic banks due to lack of other avenues to
secure the payments system.
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New temporary currency controls were imposed on November 28, focussing on capital account transfers. These rules
do not prevent current account transactions and were initiated in full cooperation with the IMF.
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The rules have since then been amended and certain excemptions given.
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IMF programme stipulates that the controls are to be lifted before the programme expires in November 2011.
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Other steps:
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CB raised policy rate to 18%. Policy rate will be lowered relatively quickly as soon as inflation and inflation
expectations fall and currency stabilizes.
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CB restricts access to credit.
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Bolstered currency reserves used to minimize volatility.
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