Tuesday, January 11, 2011 Publisher: Íslandsbanki Research - greining@islandsbanki.is - Resp.Editor: Ingólfur Bender

Fourth IMF review approved
Yesterday the Executive Committee of the International Monetary Fund (IMF) approved the fourth review of Iceland's economic programme, releasing the fifth tranche of the IMF loan facility, which amounts to USD 160 million, or ISK 19 bn. To date, the IMF has disbursed USD 1.7 bn (ISK 176 bn) of its loan facility to Iceland. The Icelandic authorities are now eligible for the latter half of the Nordic loan facility in the amount of EUR 890 million. Iceland has already drawn the first half of the Nordic loan. The time limit for drawing the remainder has been extended until year-end 2011. Moreover, the loan from Poland, in the amount of EUR 162 million, is now fully accessible. A third of that amount has already been drawn. Following the fourth review, the Central Bank's foreign exchange reserves (less current obligations) have increased by over EUR 4 bn, the equivalent of over ISK 600 bn. Iceland's foreign exchange reserves have never been larger. That being the case, it is safe to assume that the foreign reserves are large enough to justify the resumption of capital account liberalisation. The Central Bank is expected to publish a revised liberalisation strategy in March 2011.

New focus
The Government-IMF programme appears to be changing in the wake of the fourth review. Until now, the programme has been based on three pillars: exchange rate stability, development of a sound financial system, and sustainability of national and municipal finances. According to the announcement appearing on the website of the Ministry of Economic Affairs, the programme is now based on four pillars. The first two are as before: the development of a sound financial system and the establishment of fiscal sustainability. Now, however, exchange rate stability objectives have been pushed far enough into the wings to allow for the addition of long-term monetary policy objectives and further steps in capital account liberalisation. And a fourth pillar has been added: implementation of household and corporate debt restructuring, with the active participation of credit institutions. It will be interesting to see how these additional criteria are put into play. In the days to come, the IMF will publish its staff report on the fourth review, and in the near future the Government will release its letter of intent for this phase of the programme.

The IMF programme is just over half-finished. Three quarterly reviews remain, and if the programme remains on track, Iceland's collaboration with the Fund will be formally concluded in August.

Treasury bill auction on Thursday

According to yesterday's announcement from Government Debt Management (GDM), the monthly auction of Treasury bills will take place at 11:00 on Thursday. In accordance with GDM's new Treasury bill issuance structure, Thursday's auction will feature six-month bills maturing on 15 July 2011. As before, the lowest accepted price (and therefore the highest yield) will determine the sale price for all accepted bids.

Changed issuance structure
As is mentioned above, GDM has changed the structure of its Treasury bill issuance. According to Government Debt Management Prospect 2011, the aim of the change is to meet the needs of investors building up portfolios with short-term securities. It has therefore been decided to increase the number of issues and change the maturity of Treasury bills. Instead of issuing four-month Treasury bills on a monthly basis, GDM will issue six-month bills with a reissuance option three months prior to maturity. The change implies that the number of bills outstanding at any given time will increase from four to six. GDM does not rule out the possibility that it will issue bills with other maturities, however, as it is important that the Treasury have the flexibility to respond to transitory fluctuations in revenues and expenditures within each year. Because no Treasury bills are scheduled to mature in May and June, three-month bills will be issued in February and March. Furthermore, GDM aims to reduce the amount of outstanding bills by about ISK 12 bn by year-end 2011; therefore, it can be expected that each series will be smaller than those issued in 2010.

Investors interested in Treasury bills
Investors demonstrated keen interest in the December Treasury bill auction, the last held in of 2010. A total of 36 valid bids amounting to ISK 25.5 bn nominal value were submitted for Treasury bill series RIKV 11 0415, and GDM decided to accept bids for ISK 21.7 bn nominal value at a flat rate of 3.4%. As a result, the yield fell by 80 points from the November Treasury bill auction, and the Treasury obtained the most advantageous funding yet available in the domestic market. The Treasury can be well satisfied with these results - and actually, with its overall short-term domestic Treasury bill funding in 2010. Participation was generally good in the monthly Treasury bill auctions, and the flat rate tended to decline with each auction, following the trend set by the Central Bank's policy rate.

Non-residents and mutual funds prominent
According to GDM's January issue of Market Information, non-residents were prominent in the December Treasury bill auction, as we had anticipated. Non-residents purchased some 66% of sold bills, for a total amount of ISK 14.3 bn. And once again, on the domestic front, the largest purchasers were mutual funds, with approximately ISK 4.5 bn. These two investor groups - non-residents and mutual funds - are the largest owners of Treasury bills. As of end-November, non-residents owned over 48% of Treasury bills, while mutual funds held 32%. We expect both groups to show a strong interest in this Thursday's auction, as they have in the recent past.

Pension fund assets increase in November

According to figures released by the Central Bank (CBI) yesterday, Icelandic pension funds' net assets for payment of benefits totalled ISK 1,893.5 bn at the end of November, after increasing by ISK 41.2 bn during the month, or 2.2%. This is an unusually large month-on-month increase, as the average for the last 11 months was just under ISK 10 bn per month. The startling rise is due in large part to the increase in pension fund holdings of Housing Financing Fund (HFF) bonds, which rose by ISK 50 bn MoM. The pension funds' foreign securities holdings declined by ISK 27 bn in November, however. Presumably, this change is due to their purchase of the so-called Avens package of Icelandic bonds appropriated by the Banque centrale du Luxembourg after the banks failed in 2008.

By end-November, the funds' net assets had grown by just under ISK 145 bn year-on-year. Of that amount, domestic securities holdings increased by ISK 190 bn and foreign securities by ISK 28 bn. The pension funds' assets have therefore risen by 8.3% YoY in nominal terms, whereas their real value has increased by 5.5%. It should be borne in mind, however, that pension fund contributions are much higher than paid-out benefits and third-pillar pension fund withdrawals combined. Consequently, the funds' real return is lower than the above figures indicate. It should be noted that the final valuation of pension fund assets remains uncertain, and any estimate of net assets should be interpreted with caution.

OMX ICEX, 1/10/2011
Category Volume
Equities 10,863
Bonds 37
Total 10,899
Icelandic Bonds, 1/10/2011
ID Vol. Yield Day.ch.
HFF150914 27 2.09% 35
HFF150224 807 3.16% 11
HFF150434 628 3.32% 4
HFF150644 741 3.35% 4
LSS150224 98 4.18% 0
RIKB 11 0722 4,108 1.94% 2
RIKB 12 0824 28 0
RIKB 13 0517 789 3.06% 8
RIKB 16 1013 689 4.96% 8
RIKB 19 0226 1,051 5.83% 16
RIKB 25 0612 257 6.18% 8
RIKS 21 0414 1,638 3.26% 6
REIBOR Market, 1/10/2011
O/N 3.50% 3.75%
SW 3.75% 4.00%
1M 4.00% 4.50%
3M 3.90% 4.15%
6M 3.70% 4.05%
12M 3.50% 3.75%
Exchange Rates, 1/10/2011
  pr.ISK 3m.Libor 3m.fwd.
USD 118.36 0.30% 1.1
GBP 184.16 0.77% 1.5
Vt. ISK 209.28 0.90% 1.6
EUR 153.20 0.93% 1.2
JPY 1.42 0.19% 0.0
Currency Crosses, 1/11/2011
GBP 0.832    
USD 1.294 1.556  
CHF 1.255 1.509 0.970
JPY 107.531 129.262 83.077
NOK 7.726 9.287 5.969
SEK 8.892 10.689 6.870
Icelandic Equities, 1/10/2011
ID Vol. Yield Day.ch.
ICEAIR 33 3.09 -2.52%
MARL 3 107.50 -0.46%
FO-BANK 0 140.00 -1.41%
OSSR 0 200.50 0.00%
FO-AIR 0 116.00 0.00%
Volume in ISK m.
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