Iceland central bank - time is ripe to lift capital controls

By Gwladys Fouche

REYKJAVIK (Reuters) - Conditions "have never been better" to end Iceland's capital controls, with the central bank shoring up its foreign reserves to boost confidence and in case it needs to intervene once they are lifted, the central bank governor told Reuters.

The controls were adopted when Iceland went into financial meltdown in 2008 and undoing them is a delicate affair.

With the economy expected to grow 4.5 percent this year, and with interest rates at 5.75 percent compared with zero or negative rates in the rest of Europe, the worry is a destabilising rush of cash coming in.

But another, opposite concern is that there could be a disorderly exit of some 300 billion Icelandic crowns ($2.4 billion) by foreign investors selling the crown-denominated bonds, nicknamed Glacier bonds, bought before the crisis and trapped in Iceland ever since.

"The conditions for lifting the capital controls have probably never been better since the crisis," Mar Gudmundsson said in an interview at the central bank.

"We have a current account surplus, we have a well balanced economy, we have strong growth, we have relatively high foreign exchange reserves."

AUTUMN LIFTING

Capital controls for Icelanders are now expected to begin to be lifted in the autumn, he said. Earlier, the timeline was for around the end of the year.

But to prevent any headwinds - with the worst-case scenario being a currency collapse - the central bank is getting ready to intervene and is "buying and buying" foreign reserves.

"At the moment we are building reserves ... Going forward, in more normal conditions, we will be using foreign exchange intervention more occasionally, either to reduce excess volatility in the currency or even, in more exceptional cases, in order to mitigate misalignments of the currency."

The bank was not targeting a specific currency exchange level, he said.

Iceland must make some crucial changes before it goes ahead with the plans.

One of them happened on Sunday, when parliament passed a bill allowing foreign investors to sell Icelandic crowns at a rate of 220 crowns for one euro - lower than the latest offshore exchange rate of 196 crowns.

Another is a currency auction, now scheduled for mid-June, when foreign investors can try to sell their Icelandic crowns.

"From now until Nov. 1 anybody is free to leave at that rate (of 220 crowns to the euro)," Gudmundsson said. "They can also participate in the auction. They are likely to get a more unfavourable rate, but the higher the participation, the more the rate will be favourable."

He repeated that the central bank was ready to use other tools to control incoming cash, such as a tax on bond buys.

Regarding interest rates, the bank left its rate unchanged at 5.75 percent at its last policy meeting on May 11. Looking ahead, Gudmundsson said, rates would probably need to rise.

"We think it is more likely that we need to tighten somewhat further," he said. "But this is far from certain. It depends on what happens with inflation expectations, and these have been coming down a bit."

Inflation has been below the central bank's target of 2.5 percent since 2014. Despite an overheating economy and wage growth of nearly 12 percent, low crude and commodity prices have dampened inflation. The next rate meeting is on June 1.

"It is more likely that inflation will go up in the course of this year and will be above target next year," he said.

(Editing by Louise Ireland)