Guðmundur Árnason, permanent secretary, Ministry of Finance and Economic Affairs, Iceland: Exclusive Interview

By on 10/07/2015
Guðmundur Árnason, the top civil servant in charge of Iceland's finance ministry.

Iceland has recently announced a concrete plan to lift its capital controls. Guðmundur Árnason, the permanent secretary of its finance ministry, explains why it took almost seven years to come this far, what the next steps are and how the country’s budget processes have changed over the years

Iceland does not traditionally hit the headlines very often. With a population of just 320,000 it is smaller than most major cities in the UK and, for decades, it has had a stable economy based mostly on fishing, energy intensive industries and tourism. But since the global financial crisis hit in 2008, many economists’ attention has been focused on this small Nordic island which has, according to the International Monetary Fund, suffered the biggest banking failure in history relative to the size of an economy.

Iceland is widely seen as a success story: it has been hailed internationally for letting its banks fail instead of bailing them out, and prosecuting and jailing some of their chief executives. And while many countries are still finding their way out of long-lasting recessions, Iceland seems to be back on track: its economy is expected to grow over 4.5% this year according to the Icelandic Central Bank and unemployment is 3.1% – lower than in both the European Union and the United States.

But a lot of interest has also been directed at the country’s controversial decision in 2008 to impose capital controls, whose continuing presence is seen by many as undermining the country’s economic success. So the government’s recent announcement to remove these controls was big news. It had drafted a a comprehensive strategy aiming to eliminate capital controls in early 2012, but it wasn’t until 8 June 2015 that the government announced how it concretely intends to lift them. Guðmundur Árnason, permanent secretary of Iceland’s Ministry of Finance and Economic Affairs, tells Global Government Forum that, when the government imposed the controls, “it was with the expressed intention that they would be lifted within half a year.”

Getting a full picture

So why did it take so long? Because, Árnason explains, establishing the extent of the crisis took years longer than expected. When the crisis hit, the government set up new banks, as well as separate resolution committees in charge of managing the assets of the failed banks. These committees, later replaced by winding-up boards, Árnason says, faced difficulties in establishing “precisely the value of assets and the composition of assets within the estates of the fallen banks.” This information, he adds, was “essential for the government, and the central bank, to be able to realise the scope of the problem, because when you aim to lift capital controls, you need to ensure that you can manage the outflow that takes place after the lifting, and that was essentially the delicate part.” Getting a full picture of what the fallen banks had and what they owed – “what their assets and liabilities were and how their distribution might impact on the balance of payments” (BOP) – the difference in total value between payments into and out of a country, in the end took years.

Establishing these facts took so long, “primarily because the fallen banks’ assets were impaired as a consequence of the financial crisis and their resolution has taken longer than expected,” Árnason says. Eventually and after continuous quarterly assessments of the fallen banks’ assets and liabilities by the winding-up boards, the task at hand for the government gradually became better definable, and provided a solid basis for updating the government’s capital account liberalisation strategy. The next two stages will address remaining offshore liquid Króna holders, using an auction format, and then residents. If successfully implemented, the updated strategy will help speed up the pace of liberalisation.

Iceland’s prime minister Sigmundur Gunnlaugsson said on 8 June that “we cannot wait any longer”, to start lifting the controls, in order to lay “foundations for better living conditions, less debt, less leverage and … better conditions for growth.” Indeed, many a critic has said that capital controls have stifled the economy, since they prevented Icelandic multinationals and start-ups from expanding abroad. And local businesses have blamed them for low investment and fuelling asset bubbles as they restricted the flow of foreign currency.

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The downside

while Árnason says that the controls were inevitable to limit damage to the economy, he acknowledges that their negative consequences were significant. “It has been manifested over the last few years that capital controls are per se very undesirable,” he says. “They create market interferences and distortions, and they are not compatible with the objectives of operating an open, free market economy. They have a tendency to become more and more entrenched, as people will find ways of trying to circumvent capital controls, so just ensuring that they are properly maintained becomes ever more challenging over time.”

Generally, he adds, “they lead to misallocation of resources and waste: investors hesitate to invest in an economy under capital controls because of the uncertainty they create. Investors and the public at large are weary and skeptical as to whether they will be able to exit with their assets at the time they prefer, as they would want to do under normal circumstances. So there are many direct and indirect damages which the retention of capital controls causes. ”

So would he do it all over again? “I think it is generally acknowledged that the Icelandic authorities had no choice but to impose capital controls in 2008,” he says diplomatically. “If they hadn’t, then the repercussions of the meltdown of the financial system would have become much worse than they actually were. The capital controls allowed us to contain the situation.”

However, he adds that “the lesson to be learnt is that everybody should realise that imposing capital controls “is a relatively simple thing to do”. But, “removing them or even loosening them is something that is complicated and will take time, and, the difficulty associated with lifting capital controls will increase over time. Countries that are having to impose capital controls should bear in mind that when they are put in place, a realistic time frame and a careful strategy for how to ease them again needs to be in place, and the conditions that are necessary and indispensable to lifting capital controls need to be created.”

The core challenge for the Icelandic government, Árnason explains, “is to ensure that the lifting of capital controls does not put financial stability at risk and to avert negative repercussions on the balance of payment”, which could, in turn, affect the rate of the national currency. To reduce these risks, Árnason says, “the Icelandic parliament last week adopted a bill of law on a so-called stability tax of 39% on assets of failed banks and financial firms.”

“There are no easy options to control and reduce such risks”, Árnason argues, and “if those Krónas were to be allowed to be traded, then that would have potentially disastrous and quite dire consequences for the economy.” According to the legislation adopted last week, creditors can escape the taxation if they are granted an exemption from currency control restrictions by the Central Bank. Such exemptions would be based on them voluntarily surrendering their Króna assets through a “stability contribution”.

Asked how long it will take for the controls to be completely removed, he gives a cautious response: “It’s difficult to tell. But if the stability tax – or alternatively, the stability contribution – delivers on the objectives it is meant to deliver on, then the rest will become much, much more manageable. However, we will always have to monitor the balance of payment accounts very actively.”

It’s complicated

Árnason’s way to becoming the leading official in Iceland’s finance ministry has been anything but typical: it is, in his words, “a rather complicated story.” Having completed his academic studies in Britain, Árnason started his career in government in the Office of the Prime Minister of Iceland and later worked for the Nordic Development Fund in Helsinki. Shortly after returning to Iceland he was appointed permanent secretary at the Ministry of Education and Culture, where he had been working for six years when the crisis hit. But, the Prime Minister’s Office (PMO), which was, he explains, “responsible for coordinating the overall response to the financial crisis, including the dialogue between the new banks and the winding-up boards of the old banks,” asked for his help. So he was granted a six-month long leave of absence from the education ministry to help deal with the crisis at the centre of government.

Why did the prime minister pick him? It could have something to do with the fact that he had previously worked as government coordinator within the PMO, but Árnason refuses to speculate and says merely: “It’s not for me to say.”

What followed on from the financial crisis was what Árnason describes as a “profound political and a social crisis”: in February 2009, the coalition of the Conservatives and the Social Democrats broke down and an interim government of the then opposition parties took over. They remained in power until April 2009 when a general election was held, which is when Árnason returned to his post at the Ministry of Education. But, less than a month later, he was asked by the new finance minister to start work as permanent secretary of the Ministry of Finance, which he agreed to.

His movements were made possible because according to Iceland’s system, once civil servants are appointed permanent secretaries – usually for five-year terms – they can switch departments at ministers’ request.

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Reforming fiscal planning and budgeting

The outlook in 2009 was daunting and the finances of the state were hit hard by the crisis. Iceland entered a stand-by arrangement with the IMF which aimed to stabilize the economy, restore public finances and rebuild the financial system.

During his time at the finance ministry, he has headed a steering committee charged with a comprehensive revision of Iceland’s legislative framework around budgeting. The Icelandic parliament is currently considering a new bill on organic budget law, which aims to put greater emphasis on longer-term fiscal policy-making. “Preparing this bill has taken almost three years, but it has been a rewarding effort,” Árnason says.

“Fiscal planning in a small open economy, which is by definition prone to volatility caused by external factors or ill-controllable variables, requires discipline and it is therefore all the more important to achieve a political consensus on the systemic principles of budget planning”, Árnason says. Whilst focusing on the broader context of fiscal policy and its implementation, the bill also includes a clause on a long-running initiative to promote gender equality in the budgeting process.

Gender and budgets

Gender budgeting is defined by the European Council as “a gender-based assessment of budgets, incorporating a gender perspective at all levels of the budgetary process and restructuring revenues and expenditures in order to promote gender equality.” It seeks to make government policies’ impact on the genders visible, so that it becomes possible to respond and re-evaluate policies, expenditures, and sources of income to promote gender equality. The government wants gender budgeting to be integrated into all policy- and decision-making, and its every day work.

The new Organic Budget Law now includes a proposal, which states that the finance minister, “in consultation with the minister responsible for gender equality, leads the formulation of a gender budgeting programme, which shall be taken into account in the drafting of the [annual] budget bill. The budget bill shall outline its effects on gender equality targets.”

Gender budgeting, Árnason says, “raises awareness on matters which may not be that obviously linked to gender issues and highlights that it is extremely important to make gender issues part of the all formal considerations when formulating, assessing and presenting policy, regardless of which area it is in.”  He adds: “It is clear that the allocation of an entire budget can have a very direct and profound impact on the stature of men and women, and can have a very direct material impact on the position of men and women. It is therefore necessary to be aware of any gender-related considerations that these decisions and policies may affect.”

“You’d be surprised to see how somehow the issue of gender equality is often not recognised as part of discussions and considerations regarding the formulation of policy,” Arnason says. Asked to name an example, he cites a case from the Ministry of Agriculture: as part of a pilot project to measure policies’ impacts on gender equality, the ministry realised that government subsidies – included in every year’s budget – were primarily directed towards male farmers, “whereas the farmer’s wife, or the farmer who is a woman, would be much less likely to be the titleholder of subsidies.” The ministry, he adds, “found that the tendency to direct subsidies to the male rather than the female farmer was not entirely justified. So that’s now being reacted to, and the ministry has a policy on how subsidies are paid, and who is entitled to such subsidies, accounting or adjusting for the gender factor.”

Iceland’s policies seem to be working: it has topped the World Economic Forum’s (WEF) charts for the seventh consecutive year as the country with the smallest gender gap between men and women, taking into account four key measures: political empowerment; educational attainment; economic participation and opportunity; and health and survival. Iceland is followed by Finland in second, Norway in third, Sweden in fourth and Denmark in fifth place.

Nordic countries, Árnason says,“have been advanced in promoting and securing equality among men and women over a long time. They generally acknowledge better than many other countries the importance of doing so, and how much sense it makes economically to ensure that there is equality between men and women: It is an intelligent economic policy to ensure that women are not put at a disadvantage to men.”

It is a smart policy to aim for. Yet, many other advanced economies lag behind these Nordic nations: In WEF’s ranking, Germany came 12th, New Zealand 13th, Canada 19th, the U.S. 20th, the UK 26th, Singapore 59th, Italy 69th, Brazil 71st, Russia 75th, China 87th and Japan 104th. But with the question of women in leadership posts becoming increasingly prominent on countries’ agendas it seems likely that decision-makers around the world are set to learn from their Scandinavian colleagues.

In April 2015, the Global Government Finance Summit took place in Singapore, and was attended by Guðmundur Árnason and heads of financial ministries from 13 other countries. Download a summary of the key learning points from their important discussions.

About Winnie Agbonlahor

Winnie is news editor of Global Government Forum. She previously reported for Civil Service World - the trade magazine for senior UK government officials. Originally from Germany, Winnie first came to the UK in 2006 to study a BA in Journalism & Russian at the University of Sheffield. She is bilingual in English and German, and, after spending an academic year abroad in Russia and reporting for the Moscow Times, Winnie also speaks Russian fluently.

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