Foreign Investment in Treasuries on the Rise
As the Icelandic government prepares to abolish capital controls, it is not unexpected that people worry about the impact of such an action. Interestingly, however, the worries now seem to focus more on the prospects of excessive capital inflow following the capital account liberalizaton rather than too much outflow. The Central Bank is now looking into alternatives for dealing with potentially destabilizing capital inflows. This is quite a reversal from only a year or two ago, a reversal that can be traced largely to the strategy for lifting capital controls announced by the government in early June of last year and robust economic growth prospects.
A major piece of the government‘s strategy involved solving the problem concerning the failed banks‘ estates and the success of this phase of the strategy is perhaps best measured by the fact that Iceland‘s net foreign asset position has not been as favorable for decades. The next piece in the government‘s strategy are FX auctions for off-shore krona owners which are expected to be announced soon and to take place by the middle of the year. While the government is likely to follow a cautious approach to lifting the controls, as advocated by the International Monetary Fund, easing of restrictions on pension funds, corporations and households is expected to follow shortly.
Given the above, favorable economic forecasts and yields on Treasuries close to 6%, it is perhaps no surprise that since the government‘s announcement, inflows into Treasuries have risen substantially and the Icelandic krona strengthened by about 8% versus a trade-weighted currency basket despite the Central Bank‘s considerable FX purchases (amounting to 13% of Iceland‘s GDP in 2015). The graph below shows foreign ownership of Treasuries from the end of 2013 until the end of March 2016. Having lingered at between USD 1,300 – 1,400 million from year-end 2013 until mid-year 2015, the ownership by foreign investors took quite an upturn in the latter half of last year. This upturn has continued steadily in the first quarter of this year with foreign investors now holding close to USD 2,000 million of Icelandic Treasury bonds and bills.
Nominal value of Icelandic Treasury bonds and bills held by foreign investors