Iceland Receives Emergency $2.3 Billion to Aid Krona

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By Robin Wigglesworth
May 16, 2008 (Update4)

May 16 (Bloomberg) -- Iceland received an emergency loan facility from Nordic central banks to shore up the krona and avert an economic collapse.

The currency, which has tumbled as much as 26 percent against the euro this year, rallied 4.7 percent after Denmark, Sweden and Norway agreed to provide the loan facility of 1.5 billion euros ($2.3 billion).

``Iceland must be thrilled,'' said Lars Christensen, senior emerging markets strategist at Danske Bank A/S. It will ``help stabilize the financial markets, but not the basic imbalances of the Icelandic economy.''

The loan will effectively almost double Iceland's foreign currency reserves, enabling it to shore up the currency and halt a series of interest rate increases that the central bank forecasts will push the economy into recession next year. The inflation rate rose to an 18-year high of 11.8 percent in April, even after Sedlabanki pushed its key rate to a record 15.5 percent.

The global credit crunch has driven down the krona on concern the Atlantic island's commercial banks may seek help from Sedlabanki, which doesn't have the funds to bail them out. Its foreign currency reserves totaled 206.8 billion kronur ($2.8 billion) at the end of April.

The country's three biggest banks have combined assets of 11.4 trillion kronur, or nine times the size of the economy. At the biggest lender, Kaupthing Bank Hf, foreign currency holdings made up 87 percent of assets.

More to Come

``People have been speculating on whether we were capable of doing something if the unexpected happens, so this will hopefully relieve any doubts,'' Icelandic Finance Minister Arni Mathiesen said in a telephone interview from Reykjavki.

The central bank plans to further raise its reserves through other loan facilities or government bond sales, said Sturla Palsson, director of Sedlabanki's international and market operations department.

``It's definitely important to bolster the reserves further,'' Palsson said. ``The bank will announce what it has decided to do after further agreements have been signed.''

The timing of any new loans ``will depend on the situation,'' Mathiesen said.

The loan facility announced today won't be used immediately to buy krona on the open market.

``We're not likely, and have no intentions, to draw on this facility at this stage,'' said Palsson. ``The central bank has a hands-off policy when it comes to intervention in the forex market.''

Krona Slump

The krona fell to as low as 128.002 to the euro on March 19, six days before an emergency 1.25 percentage point increase in the benchmark rate to 15 percent at an emergency meeting of the Monetary Policy Committee. Two weeks later it raised rates again. The increases failed to reverse the slump in the krona.

The krona rallied to 115.00 to the euro as of 1:27 p.m., the strongest in more than two weeks.

``Of course if there's a strengthening of the currency this has a direct impact on inflation,'' Pallson said. ``The short-term effect is of course very positive.''

Sedlabanki makes its next announcement on interest rates on May 22.

The global credit crisis and record interest rates will lead the economy to contract 2.5 percent next year and 1.5 percent in 2010, Sedlabanki forecast on April 10. The recession will be accompanied by inflation of 5.9 percent in 2009 and 2.8 percent in 2010, it said.

``In times of uncertainty and turmoil the central banks have a responsibility to cooperate,'' Riksbank Governor Stefan Ingves said in a statement. ``The swap agreement is aimed at supporting Sedlabanki in its task of safeguarding macroeconomic and financial stability.''

To contact the reporter on this story: Robin Wigglesworth in Oslo at wigglesworth@bloomberg.net
Last Updated: May 16, 2008 09:29 EDT