27 April 2018

Progress of the Plan for Removal of Capital Controls
This report is published by the Minister of Finance and Economic Affairs as provided for inParagraph 2 of the Temporary Provision I in Act No. 87/1992 on Foreign Exchange, whichreads as follows:
The Minister shall make public a report on the progress of plans to remove restrictions
on cross-border capital movements and foreign currency trading at six-month intervals
until such restrictions are finally removed. The report referred to in the first sentence
shall be published for the first time within six months of the entry into force of this act.
Former reports are available at the website of the Ministry of Finance and Economic Affairs 1.
Successful liberalisation of capital controls in March 2017
Short-term exchange rate volatility increased temporarily following the liberalisation ofcapital controls on individuals, businesses and pension funds in March 2017. Such volatility
was anticipated to an extent, as investors increased the share of foreign assets in theirportfolios after a long period of capital controls. The short-term volatility receded in theautumn of 2017 and 30-day volatility in the króna is currently at a similar level as in 20142016 before the capital controls were lifted, as can be seen in the figure below. Since theliberalisation of capital controls in March 2017, there have been moderate outflows ofsecurities investments abroad, but they have stemmed mainly from foreign investment by thepension funds, which amounted to around 120 b.kr. in 2017.
Standard and Poor‘s (S&P) raised the credit rating on Iceland to A on March 17 2017 on
lifting of capital controls. As a sovereign rating, the ratings on Iceland are subject to certain
publication restrictions, including the publication in accordance with a pre-establishedcalendar. March 17 2017 was not on S&P‘s pre-established calendar, however, under the EU
CRA Regulation, deviations from the announced calendar are allowed only in limited
circumstances and must be accompanied by a detailed explanation of the reasons for thedeviation. In this case, the reason for the deviation was that Iceland‘s move to lift capital
account restrictions and the conclusion of agreements with the owners of the liquid krona
overhang reduced balance of payments risks for the Icelandic economy and strengthened its
external profile, with an immediate positive effect on the sovereign‘s creditworthiness. S&P
had previously raised Iceland‘s credit rating in January 2017. Sovereigns‘ credit rating arerarely revised upwards twice in such a short time span, and the fact that Iceland‘s rating wentfrom BBB+ to A in only two months supports the conclusion that the liberalisation of capital
controls in March 2017 was successful.

1

https://www.government.is/topics/economic-affairs-and-public-finances/progress-of-plans-to-remove-capitalcontrols/27 April 2018
Figure 1. 30 day exchange rate volatility
30.00%
25.00%

Important steps taken toliberalise the capital
account→← Liberalisation of capital
controls on individuals
businesses and pension
funds

20.00%
15.00%
10.00%
5.00%

2.1.2014
17.2.2014
2.4.2014
23.5.2014
11.7.201427.8.201410.10.2014
25.11.2014
14.1.2015
27.2.2015
17.4.2015
8.6.2015
23.7.2015
8.9.2015
22.10.2015
7.12.2015
25.1.2016
9.3.2016
28.4.201615.6.2016
2.8.2016
15.9.201631.10.2016
14.12.2016
30.1.201715.3.2017
5.5.2017
22.6.2017
8.8.2017
21.9.20176.11.201720.12.2017
7.2.2018
23.3.2018

0.00%

Improved credit rating following the liberalisation of capital controls
Fitch raised the credit rating on the Icelandic Treasury from BBB+ to A- on 7 July 2017 andthen again from A- to A on 8 December 2017. The agency‘s news release from December
stated that the Icelandic economy has been resilient to the lifting of capital controls between
October 2016 and March 2017 and that international investor demand for Icelandic krona
assets has resulted in capital inflows, which more than offset portfolio rebalancing capitaloutflows. Among factors that could lead to a positive rating action is a build-up of a trackrecord in resilience of the economy to external shocks, in the context of a more open capital
account. However, excessive capital outflows leading to external imbalances and pressureson the exchange rate could put a downward pressure on Iceland‘s credit rating.
On 30 June 2017 and again on 22 December 2017, S&P affirmed its credit rating of theIcelandic Treasury. Following the liberalisation of capital controls in March 2017, the agency
had raised the Treasury‘s credit rating to A. S&P‘s news release from December stated thatIceland‘s monetary policy flexibility had improved following the March 2017 lifting ofcapital controls and given the adherence to a broadly flexible exchange rate arrangement.
Full liberalisation of capital controls
Despite the lifting of capital controls on individual, businesses and pension funds just over ayear ago, the capital account has still not been fully liberalised and the remaining restrictions
on capital movements and foreign exchange transactions are mainly twofold:
1. Offshore króna assets, which remain subject to special restrictions according to Act
no. 37/2016. Remaining offshore króna assets amount to 87 b.kr., i.e. 3.4% ofIceland‘s 2017 GDP.
2. Restrictions that are necessary in order for the Central Bank‘s special reserve
requirement to achieve its objective, including restrictions on derivatives trading for
purposes other than hedging.
Restrictions on hedging-related derivatives trading in connection with foreign issuance of27 April 2018
króna-denominated bonds are among those that fall under the second item above. The
issuance of such bonds led to an accumulation of non-residents‘ short-term króna positions a
decade ago with the associated macroeconomic and financial risks and, thus, it wasconsidered appropriate to take action before such positions accumulated again. Therefore,Rules no. 200/2017 on Foreign Exchange were amended on 27 June 2017 so the exemption
for hedging-related derivatives trading does not apply to derivatives trading in connection
with foreign issuance of króna-denominated bonds. If such trading were not restricted, theninvestors could conduct carry trade without their investment being subject to the special
reserve requirement according to Rules on Special Reserve Requirements for New Currency
Inflows, no. 490/2016. Further discussions on the amendments to the Rules on Foreign
Exchange can be found in the report on the progress of the plan for removal of capital
controls from October 2017.
The appointment of a working group, which will be tasked with making proposals for aholistic revision of Act no. 87/1992 on Foreign Exchange, is being prepared. Proposals
concerning how offshore króna assets will be liberalised will be a part of that review.