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North by Northwest
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The króna question

To peg or not to peg?

Analysis | Tying the value of Iceland’s króna to a major currency could stabilise the country’s economy. Talking about such a move is disrupting its politics, however

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The economy of Iceland has continued on an upward trajectory since the start of this year, buoyed greatly by a tourism boom that shows no signs of slowing down.

Last month, plans were announced to implement higher taxes on the country’s tourism industry, including hotels and tours, in July 2018 as a way of better controlling inflation. It was reported by Hagstofa Íslands, the national statistics bureau, that the country’s economy grew a staggering 7.2% in real terms in 2016. Iceland’s financial spreadsheet last year also included negligible unemployment rates, low inflation, a housing boom, a jump in immigration and soaring investment figures.

Confidence in the island nation’s on-going financial health, which was badly battered after the 2008 banking crisis, was well demonstrated this March when the government announced the removal of the currency controls that had been put into place in the wake of the crisis to prevent further shock devaluations of the króna.

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The controls, which restricted the amount of currency that could enter and exit the country, represented an unwelcome hangover from the dark days of the financial turmoil almost nine years ago, in which all three of the country’s main banks collapsed under untenable debt loads.

However, there are still many economic questions facing the government despite the cavalcade of good news. The prospect of the economy growing too much, too fast has led to considerable discussion about how a ‘soft landing’ can best be achieved. Connected to this is a stubborn question that has preoccupied policymakers and economists alike, namely the future status of the króna as an independent, floating currency.

Its exchange rates versus the greenback and the euro have still been subject to considerable fluctuations during the recovery period, and the boost in tourist arrivals has helped push the value of the króna higher over the past 12 months, ranging from a peak of 125 króna to the dollar in late June to about 107 króna to the dollar in early March of this year.

While there was a drop in value at the start of this month due to the removal of the currency controls, debate continues over whether the Icelandic currency’s current ‘floating’ status can be maintained. The rising currency has already produced a backlash against Iceland’s iconic fishing industry, prompting worries that the country’s seafood exports are becoming less competitive in global markets. This week, debates began to resurface in policy circles over whether the status of the króna should be changed, including potentially pegging the currency to the euro.

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The idea of pegging the króna is hardly new, and there was a haphazard attempt by the central bank to implement a peg of 131 króna to the euro at the start of the crisis in October 2008, but the policy lasted barely 24 hours before being abandoned. Currency reform was then furiously deliberated in the years after the financial crash.

One of the main reasons why Iceland originally opted to open negotiations with the European Union for potential membership was the side benefit of discarding the then-enfeebled króna in favour of the euro. However, when Iceland opted to withdraw its EU membership bid in May 2015, the path towards adopting the euro was also closed.

Public support for EU membership in Iceland remains low, with the latest poll (in Icelandic) taken by MMR, a pollster, on March 13 suggesting over 52% of respondents being against membership and only about 24% in favour. Recently, the opposition Píratar party called for a referendum next year to ask the public whether they would support a restart of EU negotiations, but there has been little support of that initiative from the government.

There have also been other options mooted in order to replace or stabilise the króna, including a short-lived debate in 2012-2013 over whether Iceland should adapt the Canadian dollar, which at the time was riding high on rising global prices for commodities and fossil fuels. That proposal has since been discarded.

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This week, another chapter in Iceland’s currency saga may have opened after the remarks made by Benedikt Jóhannesson, the finance minister, to the Financial Times that the current “status quo” of the króna may not be “tenable” and that a currency peg, such as to the euro or the pound, may be an alternative.

Such a measure could, in theory, stabilise the value of the króna and dispel fears that the country’s economy may be overheating. However, not only did it remain to be seen whether there would be public support for such a move, but there also appeared to be significant disagreements within the governing coalition itself as to whether a peg was being seriously considered as a policy option.

Bjarni Benediktsson, the prime minister, in an interview with Bloomberg, a news outlet, shortly after the finance minister’s comments were published, made clear there were no plans to peg the króna to the euro or any other currency at this time.

Stating that there were no “magic bullet solutions”, he also noted that although the rapid fall of the króna in 2008-2009 was a major factor in the Icelandic economic crisis, maintaining the currency was essential for the recovery process, including bolstering the country’s exports.

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The PM, along with his centre-right Sjálfstæðisflokkurinn party, has been cool to the idea of deepened relations with the EU. It was Sjálfstæðisflokkurinn that, in 2015, at the time in government with Framsóknarflokkurinn, the party of the prime minister, that had called for a halt to further EU talks. Mr Jóhannesson subsequently sought to clarify his comments (in Icelandic) to the Icelandic press, noting that he was commenting on options, and not stating government policy.

Other individuals within the coalition government have also recently deviated from Sjálfstæðisflokkurinn’s stance in interviews. For example, Þorgerður Katrín Gunnarsdóttir, the fisheries minister, offered her support (in Icelandic) for a potential pegged currency, as a financial stabilising policy, in local Icelandic media. As well, Jóna Sólveig Elínardóttir, chair of the national assembly’s Foreign Affairs Committee, stated in a recent interview with the Washington Times that she supported her country’s eventual membership in the EU.

These differing views reflect the fact that the current government coalition, which includes Sjálfstæðisflokkurinn along with Viðreisn, a centrist party headed by Mr Jóhannesson, and Björt framtíð, a centrist, environmentalist and pro-European party led by Óttarr Proppé, looks at EU policy in different ways. Both Viðreisn and Björt framtíð are much more sympathetic to EU engagement, and indeed the Viðreisn was formed partially due to concerns over Sjálfstæðisflokkurinn’s increasingly Eurosceptic stance.

The divergent policies of the three coalition government parties during the campaign had to be discreetly downplayed during the long negotiating process to form a stable government after the October 2016 elections, and so the upcoming discussions about the future of the króna and its relation to the euro, and indeed any further talk about Iceland-EU relations, will be a delicate affair at best.

The author is a senior lecturer at the Centre for Defence and Strategic Studies (CDSS) at Massey University, Auckland, New Zealand.

Photo: Marc Lanteigne