Iceland's $2.1 Billion IMF Loan Wins Board Approval

By Tasneem Brogger and Helga Kristin Einarsdottir

Nov. 20 (Bloomberg) -- Iceland won approval for a $2.1 billion loan from the International Monetary Fund to help resurrect the island's economy after the failure of its biggest banks and the collapse of its currency.

The country will receive $2.1 billion from the IMF with up to $3 billion in additional secured from Denmark, Finland, Norway, Sweden, Russia and Poland. The Faroe Islands will lend $50 million.

``With the IMF agreement in place, we can commence our recovery program with full force and bring our economy back on track,'' Prime Minister Geir Haarde said in an e-mailed statement. ``I thank those countries who also contributed to the loan package.''

The loan aimed at stabilizing Iceland's currency, shoring up its banks and restoring confidence, the IMF said. The country, which had the fifth-highest per capita income in the world last year, needs the financing to pay for imports and to create enough foreign reserves to support a free-floating currency.

``The participation of the IMF in rebuilding the Icelandic economy is very important. It gives us a solid platform for re- establishing the credibility which will be necessary in restructuring a viable Icelandic economy,'' Foreign Minister Ingibjorg Solrun Gisladottir said in the statement.

Approval of the loan had dragged out after Iceland was unable to reach agreement with U.K. and Dutch officials on how to cover foreign deposits held at one of the island's bankrupt lenders, Landsbanki Islands hf. The country struck a deal ending that dispute on Nov. 16. The IMF said about $827 million would be made available immediately and the rest in eight installments of about $155 million, subjected to quarterly reviews.

Import Dependent

Raising foreign reserves will allow the central bank to restore the currency to a free-floating regime, a necessary step to reviving the economy given its reliance on imports and capital inflows, according to Handelsbanken economist Thomas Haugaard. Imports made up 45 percent of gross domestic product last year, according to the statistics office.

``Iceland is in the midst of a banking crisis of extraordinary proportions,'' John Lipsky, first deputy managing director of the IMF, said in a statement. ``Iceland is facing a severe recession, given the high debt level in the economy and significant dependence of the private sector on foreign currency and inflation-indexed debt.''

Currency's Decline

Since the collapse of the banks last month, official trade in the krona has been limited to daily central bank auctions. The krona traded at 171.5 against the euro at the auction on Nov. 17, at which 3.1 million euros were exchanged, according to the central bank's Web site.

That compares with an offshore rate of about 215 against the euro, according to Handelsbanken. The central bank said on Nov. 14 that offshore and onshore krona rates were converging.

Defense of the krona will be a priority of the central bank, the government said on Nov. 17. That means policy makers may raise the benchmark interest rate from the record 18 percent it was lifted to on Oct. 28.

A free float may ``trigger a massive currency outflow,'' the central bank said on Nov. 3. The bank estimates that foreign investors hold about 400 billion kronur ($2.9 billion) worth of government-backed bonds.

Foreign Investors

While Iceland has reached an agreement on how to cover Icesave deposits, the country isn't guaranteeing foreign investor debt holdings at the failed banks, Prime Minister Geir Haarde said Nov. 17.

Today's loan won't be used to repay depositors in Landsbanki's Internet unit, known as Icesave, Haarde has said. Financing for Icesave will be agreed in separate negotiations, Foreign Minister Ingibjorg Solrun Gisladottir said on Nov. 17, without giving details.

The currency slumped after Kaupthing Bank hf, Landsbanki and Glitnir Bank hf collapsed under the weight of their debt last month.

To contact the reporters on this story: Tasneem Brogger in Copenhagen at tbrogger@bloomberg.net;