Iceland Needs Rate Cuts Before Freeing Capital, Sigfusson Says

By Tasneem Brogger

Feb. 20 (Bloomberg) -- Iceland’s central bank should lower the benchmark interest rate before removing capital restrictions to help households and local businesses, Finance Minister Steingrimur Sigfusson said.

“It’s very, very difficult for us to run at such high interest rates in times of economic contraction and rising unemployment,” Sigfusson, 53, said in a telephone interview from Reykjavik yesterday. “The quicker interest rates start to come down, the better.”

The central bank, whose chairman, David Oddsson, is under government pressure to resign, kept the key rate at a record 18 percent on Jan. 29 after bowing to International Monetary Fund demands. The island’s economy capsized in October after the biggest banks couldn’t fund short-term debt, crippling the currency and forcing Iceland to seek an IMF emergency loan.

“To lower interest rates comes first,” Sigfusson said. “Everyone would like to see capital restrictions removed, but if I were to choose between the two, I would prioritize lowering interest rates and then look at removing capital restrictions.”

Iceland imposed the restrictions at the end of November, after coming under IMF economic management, to protect the krona, which lost more than two thirds of its value against the euro last year.

The economy will shrink 9.6 percent this year, the severest contraction since World War II, led by a 24 percent slump in household spending and a 34 percent drop in fixed investments, the IMF estimates.

‘Unfair, Unjust’

The island, whose gross domestic product is about $10 billion, has been promised $5.1 billion in loans from the IMF, the Nordic countries and Poland, to rebuild its economy. Icelanders have also been saddled with about $6.3 billion in debt in the form of loans granted by the U.K., Germany and the Netherlands to cover foreign deposit guarantees of Iceland’s commercial banks.

“People are very dissatisfied that we will have to bear the burden of the activities of private companies abroad,” Sigfusson said. “This is really very unfair and unjust and the outcome of it is terrible for Iceland. But we are where we are.”

Sigfusson, who heads the Left Green Movement, the junior coalition partner in the Social-Democrat-led government of Johanna Sigurdardottir, said the island’s debt to depositors abroad should be “settled in a civilized and good manner.”

“We will take this very seriously,” Sigfusson said. “It is really a matter of life and death for Iceland to settle this in a manner that is bearable for us and is fair and just.”

‘Still There’

The coalition ousted the government of Premier Geir Haarde, following weeks of protests, after the island was forced into IMF administration. Elections will be held on April 25 and polls show the coalition would win.

The government wants to pass a bill allowing it to remove Oddsson from office. Oddsson, who was prime minister between 1991 and 2004 and spearheaded the privatization of the banks, has said even if the bill is passed he can remain governor. The chairwoman of a committee reviewing the bill, Alfheidur Ingadottir, said yesterday that standpoint was “a great misunderstanding.”

“It’s very difficult to re-establish trust if people who were central during the years when all this was piling up leading to the collapse are still there,” Sigfusson said.

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