Iceland banks rescued by $2.1bn
The financial crisis that has engulfed the entire world initially claimed Iceland as one of its first victims, and the small nation of 300,000 is only now starting to restore outside confidence in its economy. Funded by cheap foreign money, Iceland's banks expanded dramatically and quickly eclipsed more traditional industries, such as fishing and tourism. When the credit crunch started biting, the highly leveraged banks were hit hard. Iceland soon turned to the International Monetary Fund (IMF) for help and a rescue package totaling 2.1 billion US dollars was announced.There are three main objectives of the IMF-supported program: To contain the negative impact of the crisis on the economy by restoring confidence and stabilizing the exchange rate in the near-term; to promote a viable domestic banking sector and safeguard international financial relations by implementing a sound banking system strategy that is nondiscriminatory and collaborative; and to safeguard medium-term fiscal viability by limiting the socialization of losses in the collapsed banks and implementing an ambitious multi-year fiscal consolidation program.
Iceland's economic program envisages that the Fund's Stand-By Arrangement will fill about 42 percent of the country's 2008-2010 financing gap. The remainder will be met by official bilateral creditors.
Following the Executive Board discussion on Iceland, Mr. John Lipsky, First Deputy Managing Director and Acting Chairman, said:
"Iceland is in the midst of a banking crisis of extraordinary proportions. The three main banks, accounting for about 85 percent of the banking system, collapsed within a time span of less than one week. The krona fell sharply, the equity market plummeted, and severe disruptions in the external payments followed. As a result, Iceland is facing a severe recession, given the high debt level in the economy and significant dependence of the private sector on foreign currency and inflation-indexed debt.
"In response to these challenges, the authorities' program, supported by a Stand-By Arrangement and substantial access to Fund resources, has three key objectives: (i) to stabilize the exchange rate, (ii) to develop a comprehensive and collaborative strategy for bank restructuring, and (iii) to ensure medium-term fiscal sustainability.
"Exchange rate stabilization is an immediate priority in order to contain the negative impact of the crisis on output and employment. To this end, the program includes an appropriately tight monetary policy and continued restrictions on capital outflows in the near term.
"A comprehensive banking sector strategy will guide bank restructuring. The strategy contains measures to achieve fair valuation of assets, maximize asset recovery, strengthen supervisory practices, and ensure the fair and equitable treatment of depositors and creditors of the intervened banks. This is needed to promote a viable domestic banking sector and safeguard Iceland's integration into the international financial system.
"Medium-term fiscal sustainability will be restored. In 2009, the fiscal balance will be allowed to worsen due to the effects of the economic cycle. But the program also includes the development of a strong medium-term fiscal plan—to be launched in 2010—to cut expenditures and/or to raise taxes. This effort is needed to deal with the very substantial increase in public sector debt (of about 80 percent of GDP) due to bank restructuring.
"The road ahead is difficult. The program is subject to exceptionally large uncertainty and significant risks, reflecting the unprecedented magnitude of the banking sector collapse. With this in mind, the authorities remain committed to maintaining a resolute policy implementation, and stand ready to adjust policies as circumstances change, working closely with the Fund. At the same time, Iceland's long-term growth prospects remain favorable, buttressed by its very strong fundamentals of a highly educated labor force, a favorable investment climate, and a rich natural resource endowment," Mr. Lipsky said.
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