17 July 2009

Written statement from the Central Bank of Iceland on the Icesave agreements and information on the debt service burden of foreign loans

The Parliamentary Budget Committee requested a written statement from the Central Bank of Iceland on the Icesave agreements and information on the debt service burden of foreign loans. The request was received by the Bank on July 6. The Central Bank of Iceland has compiled an opinion, which is divided into two sections: a discussion of Iceland’s external debt position and a legal opinion on the Government guarantee of the Depositors’ and Investors’ Guarantee Fund’s (DIGF) obligations.

A calculation of Iceland’s external debt with reference to the Icesave agreements is subjected to considerable uncertainty about the recovery ratio for Landsbanki assets, which are assumed to cover the majority of the obligations of the DIGF. There is also considerable uncertainty about developments in GDP growth, which will affect the Treasury’s revenue-generating capacity, and about export revenues, which will affect the size of the trade account surplus, and therefore the effect of increased debt service burden on the exchange rate of the króna. The exchange rate of the króna in and of itself also affects the debt service burden as a proportion of GDP in króna terms. All of these uncertainties are highly dependent on global economic developments, which themselves are still very uncertain. It should be stressed that decisions related to domestic economic policy will also make a substantial impact on developments in GDP growth during the loan period under discussion.

The following are the main conclusions regarding Iceland’s external debt:

  • The economy will be fully able to fulfil the Icesave agreements. An assumed 75% recovery ratio on Landsbanki assets, prudent economic policy, and a sizeable trade surplus during the period 2009-2018 will further enhance this capability. There should be an ample margin in the foreign exchange reserves for the entire period.
  • It is assumed that, by year-end 2015, all of the old Landsbanki’s assets abroad will have been sold and the debt accruing to the Icelandic Government as a result of the agreement will total 340 b.kr., based on a 75% recovery ratio. The present value of this amount, assuming 5.55% interest, is 240 b.kr., the equivalent of 17% of estimated GDP for the year 2009. This amount is to be paid over a period of eight years; that is, 30 b.kr. per year, or 2.1% of estimated GDP for 2009.
  • It is assumed that the first payment, in 2016, will amount to 3.1% of GDP for that year; however, that proportion is estimated to fall rapidly thereafter, both because accrued interest will decline as the outstanding balance declines, and because it is assumed that GDP will rise in line with the GDP growth premises of the forecast. In the final year – that is, 2023 – it is assumed that the payment will total 1.4% of GDP for that year.
  • During the period 2009-2018, liabilities as a proportion of GDP are estimated to decline from 143% to 87%, and assets rise from 69% to 71% of GDP.
  • If Iceland begins to put funds aside immediately in order to pay the Icesave obligation, it will be necessary to save just under 1.2% of GDP per year for these 15 years.
  • The Central Bank of Iceland has calculated two alternative scenarios; that is, how the situation will appear if developments prove less advantageous than in the baseline example, and if developments are more advantageous than in the Bank’s baseline scenario.
    • The negative scenario, for instance, assumes 0% GDP growth for the entire period, a 50% recovery ratio, unforeseen (and undefined) foreign-denominated obligations amounting to 500 b.kr. in 2009, a 5% deterioration in terms of trade, and a 2% annual appreciation of the British pound against the króna throughout the period. Under these circumstances, the first Icesave payment would correspond to 6.2% of GDP in 2016. This is a very pessimistic scenario and should not be considered realistic. Nonetheless, it is considered that the Icesave obligations, together with other obligations that are assumed in the forecast, will not result in an unsustainable debt position.
    • The more optimistic alternative scenario assumes that GDP growth will be 1 percentage point greater than in the baseline scenario; that the recovery ratio of Landsbanki assets will be 75%, as in the baseline example; and that global economic developments will result in a 5% improvement in Iceland’s terms of trade over and above the Bank’s baseline forecast. Under these circumstances, the first Icesave payment would correspond to 2.9% of GDP in 2016.


·       It is clear that the domestic and foreign liabilities of the Treasury and the Central Bank have increased in the wake of the banking crisis. Offsetting this, however, is the fact that assets have increased, due in part to the strengthening of the foreign exchange reserves and new assets. The total assets of the Treasury and the Central Bank amount to 1,840 b.kr. for the year 2009, and liabilities amount to 2,418 b.kr. The net position is therefore negative by 580 b.kr., or roughly 40% of GDP.

  • Raising the value-added tax brackets from 7% to 7.88% and from 24.5% to 27.57%, respectively, and saving the tax revenues thus generated will yield an amount similar to the Icesave obligation over the period of the loan. This example is an illustration only, and should not be viewed as policy advice.
  • The three major credit rating agencies have been made familiar with the substance of the Icesave agreements. It is clear that both Moody’s and Fitch have said publicly that they consider the agreements positive because they eliminate a given uncertainty about the status of domestic economic affairs.


The main conclusions on the legal aspects of the agreements are as follows:

  • The comments in the legal opinion apply to the circumstances that could arise in the event that the Treasury could not fulfil its obligations, which the Central Bank considers highly unlikely. For maximum caution, and to ensure that the information is available to the Committee, the Bank has decided to share its viewpoints on the issues related to the Government guarantee.
  • The agreement is a civil contract, and it contains provisions that are not generally found in the conventional loan agreements to which the Government is a party. It would have been desirable if the Icelandic Government’s status as an international entity had been better protected.
  • Should the Icelandic Government attempt to review the agreements, such a measure would be dependent on an assessment, according to the most recent Article IV Consultation by the IMF, that the Government’s debt sustainability had deteriorated substantially in comparison with the IMF’s assessment of November 19, 2008. Adjustments related to the agreed Brussels guidelines from November 2008 do not give a similar option.
  • The Central Bank is of the opinion that it would have been desirable had the provision on the treatment of Landsbanki creditors been more explicit, as it is not clear what is meant by this section.
  • The lenders are guaranteed the same rights as potential future lenders involved in financing depositors’ claims on Icelandic banks, if those subsequent terms are more advantageous than those in the Icesave agreements. If that provision is put to the test, it could result in an amendment to the terms set forth in the loan agreement.
  • On the positive side, the definition of equitable treatment of Landsbanki depositors indicates that it may be permissible to treat those who became depositors of NBI hf., on the one hand, and depositors of Landsbanki, on the other, in different ways.
  • It would have been desirable to clarify the definition of the obligations that could result in the termination of the agreement, as it appears as though the Icesave agreement could be terminated and the loan called in, in the unlikely event that other obligations for which the Government is a guarantor are called in.
  • It is notable that British law and jurisdiction apply not only to disputes that may arise directly from the agreements, but also to matters arising in connection with them, whether they may be contractual or non-contractual. Furthermore, to the extent allowed by law, the lender is authorised to initiate concurrent proceedings in any number of jurisdictions.

The waiver of sovereign immunity as regards jurisdiction and enforcement is broader than is conventional. The Central Bank and its assets, however, enjoy immunity under British law. The Icelandic Government also enjoys immunity according to the 1961 Vienna Convention on Diplomatic Relations. Under the Convention, the general rule is that diplomats and assets that are necessary for embassy operations are protected from interference or enforcement.


No. 23/2009

July 17, 2009


Written Statement from the Central Bank of Iceland (pdf)