Sunday, November 23, 2008

IMF Approves Loan to Iceland To Aid Faltering Economy

Sources: International Monetary Fund, Iceland Gets Help to Recover From Historic Crisis; International Monetary Fund, Transcript of a Conference Call on the IMF's Executive Board Approval of a Stand-By Arrangement for Iceland

As previously reported on this blog, Iceland has been waiting for the IMF's Executive Board to approve a $2.1 billion stand-by agreement that the country's government submitted to the Board in late October. The Executive Board has recently approved the agreement and will make $827 million immediately accessible to Iceland. The rest of the money will come in the form of eight equal installments over the next two years. The IMF expects that the loan will help Iceland make up for about 42% of its financing gap for 2008-2010. Iceland will also be receiving $3.2 billion from other creditors.

Poul Thomsen, the IMF Mission Chief for Iceland, has said that the foremost goal of the recovery program is to stabilize the Krona, Iceland's currency. How will this program help? Thomsen believes that the key to stabilizing the Krona is to enforce a "tight" monetary policy. By that, Thomsen means that Iceland is going to try to prevent people from withdrawing funds from accounts in Iceland's banks. To Thomsen, Iceland can do this by either raising interest rates or placing restrictions on accounts so that people literally cannot remove capital from their accounts.

Part of the reason for enacting this policies is that, with the onset of the global crisis, investors are so nervous that they have been, and will probably continue to, withdraw funds from banks all over the world. Iceland's banks have been among those that have suffered most from these developments-the country's GDP is down by 10%, the Krona's value has dropped by 70%, and the stock market's value has dropped by over 80%. For now, Thomsen says it is impossible to predict just how "tight" the monetary policy needs to be to mitigate the damage. When questioned about the technical details of Iceland's new policies, he has said that all the IMF and Iceland know is that policies must be "appropriately tight."

The approval of the stand-by agreement has also raised questions as to what extent the IMF will be involved in the development of Iceland's new policies. To these questions, Thomsen has replied that there will be a dialogue between the IMF and Iceland, and that it will be up to the country's government to formulate major proposals. As to the delay in the program's approval, Thomsen has said that those working on the agreement had been unable to take the proposed agreement to the Board until they were sure that other creditors would finance portions of the program that the IMF could not cover.

Discussion Questions:

1- Do you think that, going forth, the interaction between Iceland and the IMF will really be a "dialogue"? Given the circumstances that have resulted from the crisis, and the vulnerable state that Iceland is in, do you think that it is possible for a country to assert its decision-making power in front of the IMF?

2- Do you think that raising interest rates or enacting restrictions will keep nervous investors from withdrawing their funds from Iceland's banks?

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