ENP Newswire -
Release date- 23052014 - A mission from the
This visit is part of the Post-Program Monitoring of
The Fund has published on its website the concluding statement of the mission containing the highlights of the past two weeks' discussions.
Iceland-Concluding Statement of the
Economic Outlook and Risks
The economic outlook is positive. Domestic demand is recovering gradually and is expected to support lower unemployment. We estimate medium-term growth will average around 3 percent as private sector balance sheets recuperate and confidence is rebuilt. Inflation has fallen below the central bank target, but the economy is close to capacity and inflation is expected to pick up next year.
Risks to the outlook are tilted to the downside. Slower trading partner growth could lower exports and dampen investment, and reduce growth. Global market volatility could also increase
Capital account liberalization-moving forward
Monetary policy-keeping inflation in line with the target
Monetary policy has been appropriately cautious. Inflation has fallen to the central bank target. Higher real interest rates in turn have tightened real monetary conditions. However, the output gap is closing, imported disinflation is expected to dissipate, wage pressures could build, and long-term inflation expectations remain above the target. Given these factors, along with uncertainties about the 2015 budget stance, rates should remain on hold.
The recently launched review of the CBI's legislative framework should preserve the financial health, independence, and accountability of the bank. The review should maintain the key governance reforms implemented in 2009, including the
Fiscal policy-continuing the adjustment
Fiscal consolidation is expected to continue in 2014. Buoyant revenues and one-off factors, including expected dividends of around 2 percent of GDP, will contribute to a general government surplus of just under 2 percent of GDP. This implies a structural adjustment of just under 0.5 percent of GDP over 2013.
The government's medium-term objectives of a balanced budget and debt reduction are appropriate, but further effort will be needed to achieve them beginning next year. Hitting the government's objective of a balanced budget over 2015-16 will require another 1 to 1 1/2 percent of GDP in specific and durable measures, placed in the context of a well-specified medium-term fiscal plan. There are downside risks to this scenario, including from potentially higher losses at the HFF generated by household debt relief and potential for expenditure slippages. Given downside risks and uncertainties, additional contingency measures should be identified.
The draft Organic Budget Law now before parliament broadly matches best practice and deserves support. This legislation will establish a new system of fiscal rules which will improve transparency and accountability in fiscal policy making. The legislation also contains important reforms in the area of public financial management which will address deficiencies in fiscal reporting, establish requirements for a statement of fiscal policies and an annual update of the medium-term fiscal plan. These reforms will strengthen Parliament's
role in setting and overseeing fiscal policy and, more generally, will improve budget execution.
The recently approved debt relief program will strengthen household balance sheets and is fiscally neutral, but poses budgetary risks. The budget-supported component is expected to be fully covered by earmarked revenues from the expanded bank levy, though these resources could have been used for other pressing needs. The Pillar III-funded component of debt relief provides households with some choice over the form of savings, and generates small but prolonged annual budget costs. Care should be taken to preserve future pension contributions for their intended purpose, while alternative schemes could be considered to facilitate long-term savings towards home purchases. The debt relief program poses additional risks to the budget, including from possible losses from accelerated prepayments on HFF loans and potential litigation over the bank levy.
Financial sector policy-preparing for the future
Capital and liquidity buffers in banks should be maintained. In 2013, banks progressed with the loan restructuring and regained access to international financial markets. To cope with financial uncertainties surrounding the unwinding of crisis legacies, dividend distribution should be limited and banks should seek more term funding. The financial supervisor (FME) should introduce strict rules on loan classification and provisioning, providing for a conservative prudential treatment for restructured loans.
Micro and macro-prudential supervision need to be reinforced. The FME should enhance internal procedures and industry rules for risk assessment, and invest more in staff training and systems development. To carry out its tasks effectively, the financial independence of the supervisor should be secured and supervisory powers strengthened. The establishment of a
Recent proposals for resolving the HFF are a positive step forward. The design of the orderly runoff of the HFF should be mindful of fiscal and financial stability risks. Pending a permanent solution, HFF lending and bond issuance should be stopped, its operational management refocused, and a thorough asset quality review completed. Agreement should be reached on the main social objectives of mortgage lending before any government-sponsored successor program is put in place.
We thank the authorities and other counterparts for their warm welcome, excellent cooperation, and candid and constructive discussions during this visit.
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