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Icelandic fund selectors want to join euro

Although the Icelandic economy is back on a steady growth path, with GDP growth at 1.9% in 2014, strict capital controls, a relic of the banking crisis which struck the country in 2008, are still in place. Since autumn 2008, Icelandic investors have not been able to move any of their capital out of Iceland. Iceland’s central bank initially introduced these measures to stem a slide in the exchange rate of the national currency, the krona.

Bubble fears

However, they have been in place until this very day. Local investors are aware that something

 

needs to happen. Several interviewees mentioned that as the economy keeps growing, and with them the local pension funds, there is a risk of an investment bubble, so they feel the central bank could have its reasons to ease its stance on the capital controls.

Most of Iceland’s fund selectors acknowledge nevertheless that these controls can never be lifted completely, as that would spark massive capital outflows, not only from Icelandic investors who take the opportunity to finally increase their exposure to foreign assets (see chart on the right), but mainly by foreign investors who still have billions of kronur locked in Icelandic assets.

Joining the euro: a feasible option?

So considering investment constraints would remain if Iceland kept its own currency, interviewees overwhelmingly suggested a radical option: to join the euro. Though understandable from an investor point of view, the interests of the financial sector in Iceland seem to be at odds with wider political sentiment in the country: the Icelandic government decided to withdraw the country’s application to join the EU in 2013. EU membership is a prerequisite to join the eurozone, and our interviewees realised the adoption of the euro, and complete abolition of the capital controls, remains a far-flung fantasy for now.  

Part of the Bonhill Group.