Iceland, the IMF agreement used as an example for Argentina

RIO DE JANEIRO, BRAZIL – Within the framework of the International Monetary Fund (IMF) and World Bank Joint Annual Meeting, the two negotiating groups found in the agreement signed by Iceland with the international financial organization in 2008 an example to follow.

Particular interest focuses on a special chapter in which Argentina is interested: the maintenance of foreign exchange restrictions on access to foreign currency, under certain strict conditions.

The issue is particularly sensitive for Argentina, and the first joint efforts to reach an agreement on this chapter point to the authorization to maintain a certain level of “tightening” over the coming years, under the condition of an annual increase of reserves at a rate of US$5/6 billion per year and the effective narrowing of the gap between the official dollar and the financial versions.

The background for accepting these restrictions is based on the Icelandic case in 2008, where the IMF and some European countries came to the rescue of the country after its banking system collapsed. That year Iceland suffered a devaluation of the Icelandic króna, unemployment tripled, public and private foreign debt grew and the country entered a severe political crisis.

The European Central Bank (ECB), the Nordic countries of the European Union (Denmark, Sweden and Finland) and the IMF, which contributed some US$2.5 billion, came to the rescue.

Given this situation, the country appealed to different organizations to lend a hand and avert the country’s bankruptcy, so it turned to a group comprising the IMF, ECB, European Union, Russia, Poland, Nordic countries (Denmark, Norway, Sweden, Faroe Islands and Finland), as well as Germany, the Netherlands and the United Kingdom.

The latter countries were involved in a dispute over the Icesave funds that had vanished overnight due to the collapse of banks and, since they were foreign deposits, were not subject to collateral. One of the keys to the agreement was the implementation of a rescue plan for banks, injecting almost 20% of Iceland’s GDP into the country’s financial system, but on the condition that the money would not be transferred into foreign currency.

The specific chapter on restriction stated that the Icelandic government would take control of the capital injected, with measures that included the ban on individuals trading freely in foreign currency for amounts over US$2,800, as well as the prohibition of using them to transfer money abroad. This was intended to stabilize the exchange rate and offset the devaluation of the Icelandic króna, which went from 90 against the euro to 189 in one year.

The restrictions would be maintained until the country’s reserves reached a significant level, which would allow the Icelandic government to obtain a sufficiently powerful leverage to prevent currency runs based on sound tools.

It should be recalled that the goal was achieved, but Iceland had to implement a severe public spending reduction plan to bring the fiscal deficit to 0 in 2 years. The Icelandic government cut the budget for health, education, pensions and state administration by 3% of the country’s GDP (more than 40 billion kronur) in a country where the public sector is already small and where salaries are lower than in the private sector.

Finally in September 2011, the IMF-backed program was cancelled early, and the country was released from the adjustment plan.

The agreement with the IMF generated a major political crisis in a state accustomed to welfare and to not going through major political instability. There were large popular mobilizations in the streets in protest, and the Icelandic government decided to call a referendum on debt repayment. This was rejected by a large majority.

The Icelandic government then renegotiated the debt with private parties with a term of 37 years and a general interest rate of 3%. The result of the crisis shows the following statistics: in 2009 the Icelandic GDP fell 6.67%, the króna was devalued by 100%; but the IMF bailout started to pay off a year later. GDP grew 2.9% per year on average, with sustained exports, fiscal balance and a growing domestic market.