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Lifting of capital controls: Smaller step than expected
On Friday, the Central Bank of Iceland (CBI) announced its next step in the easing of capital controls, but the step is clearly considerably more timid than had been expected, at least in the short term. Over the coming months, the CBI will hold foreign exchange auctions in which the bank will buy foreign currency in exchange for Icelandic króna to be used for long-term domestic investments. This is the so-called 50/50 investment option. Auctions that enabled the holders of offshore króna to sell their króna for foreign currency, such as the foreign currency auctions that were held last summer, will not be held in the near future, but only later when circumstances permit in the CBI's estimation. This strikes a new tone, since the general expectation was that the CBI would continue with these auctions. As has been mentioned, the bank's current step is considerably more timid than anticipated, but nonetheless consistent with how slow the CBI has proceeded in the easing of capital controls.
This step is in line with the CBI's capital account liberalisation plan, which was announced on 25 March. According to the plan, the first phase of the capital account liberalisation plan is focused on measures that are designed to lower the position of offshore króna held by investors in difficulty and to direct them towards the Icelandic economy, without accessing the CBI's currency reserves.
High level of complexity and many side constraints
Under the investment or so-called 50/50 option, an investor who wants to invest in Iceland in foreign currency can buy Icelandic króna with part of the foreign currency at the foreign currency auctions of the Central Bank, on condition, however, that he buys at least a corresponding amount of króna in normal transactions. For every euro that an investor puts into buying króna at the auctions, he has to buy króna for more euro, calculated at the local exchange rate, from a domestic financial undertaking. Another condition is that all amounts have to be long-term investments in Iceland and the funds are committed for a period of at least 5 years. Moreover, investors who have held offshore Icelandic króna since the financial collapse will be allowed to choose this option, as well as investors who have bought króna under the CBI's new investment programme, provided the investment is made for the minimum term of 5 years. In light of the fact that the lion's share of offshore króna can be presumed to have changed hands since the financial collapse, the number of people who can avail of this option is nonetheless limited.
Naturally, this step could reduce the volume of offshore króna, which is currently estimated at over ISK 400 bn., but the high level of complexity and side constraints involved may be somewhat limiting. As the process is presented in its current form, it will be a long time before investors show any interest in participating and therefore before these króna are channelled into domestic investments. In light of the fact that other avenues can be used to bring offshore króna into the country, it is safe to say that investors will have to be very patient and determined if they want to follow this path. Other available options include, for example, the new investment option, which is considerably simpler in its implementation, although in that case all of the króna are bought at the domestic exchange rate. According to the CBI's press release, the first auction of this kind will be announced later and is therefore likely not to be held until next year. Christmas is now approaching and, according to the CBI's notification procedures, auctions have to be announced several weeks before they are held.
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