Removal of capital controls on holders of offshore krónur and reduction of special reserve requirement on capital inflows
Act no. 14/2019, which amends the Foreign Exchange Act, no. 87/1992, and the Act on the Treatment of Króna-Denominated Assets Subject to Special Restrictions, no. 37/2016, was published in the Law and Ministerial Gazette (Stjórnartíðindi) on 4 March 2019; cf. the notice on the Law and Ministerial Gazette website. The amendments entailed in the Act were announced in a press release posted on the Central Bank website on 7 December 2018, when the bill of legislation was introduced. The Act will enter into force tomorrow, 5 March 2019.
Amendments to Rules
Because of amendments to the Foreign Exchange Act and the Act on Special Reserve Requirements for New Foreign Currency Inflows, the Central Bank plans to set new Rules on Special Reserve Requirements for New Foreign Currency Inflows and Rules on the Treatment of Króna-Denominated Assets Subject to Special Restrictions. The Rules include new provisions and necessary amendments due to the aforementioned amending legislation. The new Rules on Special Reserve Requirements for New Foreign Currency Inflows will also lower the special reserve ratio (SRR) provided for the previous rules from 20% to 0%. It is assumed that, pending Ministerial approval, the rules will be issued tomorrow, 5 March 2019, and will take effect the day after, 6 March 2019.
Reduction of special reserve ratio from 20% to 0%
The planned reduction in the special reserve ratio marks a turning point in the application of the SRR, which was imposed on capital inflows into the bond market and high-yielding deposits in June 2016. The objective of the SRR is to temper and affect the composition of foreign capital inflows into the domestic bond market and high-yielding deposits, and to strengthen the monetary policy transmission mechanism. The SRR was lowered from 40% to 20% in early November 2018. Conditions have now developed that permit lowering the SRR to 0%, because the likelihood of substantial inflows leading to an overshooting of the exchange rate and to severe disturbances in the monetary policy transmission mechanism has subsided significantly, at least for the present. Capital flows to and from Iceland are now better balanced than they were at the time the SRR was introduced. In the recent past, there have been outflows of new foreign investments in bonds.
It should be noted that because of the above-specified amendments, funds that have been tied up in special reserve accounts will be available for withdrawal or other disposition, in the same manner as when the SRR was reduced from 40% to 20% in November. It should also be noted that if the SRR is increased in the future, the newly passed legislation states unequivocally that the special reserve amount shall remain unchanged throughout the holding period. The new arrangements for the SRR will enable the parties involved to release their funds through market transactions, however.
Legacy issues relating to the capital controls
With the above-mentioned amendments to the Foreign Exchange Act and the Act on the Treatment of Króna-Denominated Assets Subject to Special Restrictions, a separate offshore market for krónur no longer exists and the vast majority of the capital controls introduced in November 2008 have been lifted. The restrictions that remain have the primary objective of ensuring that the SRR achieves its purpose, including restrictions on derivatives trading for non-hedging purposes. Those restrictions will be examined in connection with a comprehensive review of the Foreign Exchange Act. At the same time, it will be necessary to examine the permanent arrangements for the SRR.