NAC files, lot 60D137
Memorandum by the National Advisory Council Staff Committee to the National Advisory Council
Subject: Proposed International Bank Loan to Iceland
The Problem
The IBRD is considering a loan to the Government of Iceland of the equivalent of about $1,008,000 in European currencies. The U.S. Executive Director of the Board of IBRD has requested the advice of the NAC concerning this proposal.
Nature of the Proposed Loan
1. The Government of Iceland has requested this loan from IBRD to finance agricultural development in Iceland. A plan has been drawn up aiming at increasing agricultural production, particularly that of animal products. Cement, steel, timber and other building [Page 510] materials and grass seed and fencing must be imported to fulfill some of the requirements of the project, and the loan will be disbursed to pay for these materials. The equivalents in Kronur will be paid into a special fund to be set up by the Agricultural Bank and used for loans to farmers to further the project.
2. About two-thirds of the loan will be spent in sterling and part of the proceeds of the Bank’s sterling bond issue will be used for this purpose. The remainder will be spent in other European currencies, and the member governments concerned will be asked to approve the use of their 18 percent capital subscription to the Bank for this purpose. To the extent that they do not do so, the Bank will use the proceeds of the Bank’s sterling bond issue.
3. The terms of the loan will call for repayment over a period of 18 years, the first semi-annual payment falling due December 1, 1956. The rate of interest will be 4½ percent, and there will be a commitment charge of ¾ of 1 percent.
International Economic Position
A. Foreign Assets and Liabilities
No detailed picture of Iceland’s foreign exchange position can be presented with any degree of confidence, but the approximate position can be examined. At the end of July 1951, Iceland’s overall foreign exchange holdings were apparently about $7.2 million. This was an increase of about one-half million dollars over the July 1950 figure. Of these exchange holdings, European currencies accounted for $3.3 million, dollar currencies were $1.9 million and other currencies amounted to $2 million. In addition to this, Iceland has about $1 million in gold which it held against the currency in circulation and has not varied over the last decade.
B. Balance of Payments and Foreign Aid
Iceland was able to draw on reserves accumulated during World War II to meet balance of payments deficits in the first postwar years. ECA assistance programs, together with sterling and Danish loans, have met most of the payments gaps since 1948. The country has been allotted a total of $17.8 million in ECA assistance through fiscal year 1951. Of this, some $10 million was in direct grants, $4.3 million was in loans, and $3.5 million in the form of conditional grants. The availability of these foreign exchange resources has permitted Iceland to import more than before the war and thus to maintain a large investment program and a standard of living far above prewar levels.
A large percentage of Iceland’s trade is with Western Europe. Fuel, textiles and capital equipment constitute the bulk of the country’s imports. Fish and fish products comprise about 95 percent of exports. The fish catches vary greatly from year to year and [Page 511] consequently the country’s foreign exchange position is subject to rather wide swings. The overall deficit has varied from $37 million in 1947 to $7.2 million in 1948, $15.4 million in 1949, and $6.2 million in 1950.
C. Exchange Rates
During the war the krona was maintained at a rate of 6.5 to the dollar. When other sterling area currencies were devalued in September 1949, the Icelandic government devalued the krona by 30.5 percent, keeping the krona’s relation to sterling unchanged and establishing a dollar rate of 9.365 to the dollar. In March 1950 there was a further devaluation, this time by 42.6 percent, bringing the dollar rate to 16.32, and bringing the sterling rate to 34.676 kronur to the pound.
Subsidies to the fishing industries were discontinued following this second devaluation and while some measures were taken to counteract inflation, the rise of domestic prices was not completely halted. In order to avoid reintroduction of the direct subsidy system, a foreign exchange and import certificate system was established in February 1951.
International Economic Situation
A. Public Debt
Total public debt of the Icelandic Government was 345 million kronur ($21.1 million) at the end of 1950. Of this about 138 million ($8.5 million) was held externally. Besides ECA loans of $4.3 million, there were debts to the United Kingdom and Denmark, and an IBRD loan of about $2.4 million was granted in June 1951.
B. Iceland Budget
In 1950, for the first time since the end of the war, Iceland managed to balance its budget. An ordinary surplus of Kr. 34.1 million almost completely offset a deficit of Kr. 34.3 million on capital account. However, an adjustment for items which have no financial impact and for funds used for debt retirement results in a surplus of approximately Kr. 9 million.
In the first half of 1951, Iceland ran a surplus on current account of Kr. 39.3 million. Much of this surplus was accompanied by a balance of payments deficit, as import duties constitute a major source of Government revenue. A capital account deficit of Kr. 22 million offset much of the current surplus, as both expenditures and receipts on capital account far exceeded the levels scheduled for the entire year.
C. Monetary Situation
The total money supply has increased steadily since the end of the war, and rose 16 percent between December 1950 and August 1951. Note issue rose 12 percent between the end of 1948 and the [Page 512] end of 1950 but has not increased during 1951. Bank demand deposits have risen 37 percent during the first eight months of 1951 while bank loans rose by 28 percent.
D. Investment Program
Since the war the fishing industry has been reoutfitted with new trawlers and ships; fish processing equipment has been installed; housing, commercial and public building construction has proceeded at a rapid rate; communication and transportation systems have been modernized; and hydroelectric power plants and a nitrogenous fertilizer plant are being constructed.
During the five years ending 1950, gross investment totaled more than $300 million—an average of $60 million per year. Although national income statistics for Iceland are not very reliable, it has been estimated that investment has been at the high average rate of 35 percent of GNP, varying from 40 percent of GNP in 1947 to 25 percent in 1950. Relatively, this is one of the heaviest investment programs undertaken by any Western nation.
E. Price and Wage Levels
There is no over-all cost of living index for Iceland. An index compiled for the city of Reykjavik indicates that in the sixteen months for which this index is available, through August 1951, there has been an increase in the cost of living of 44 percent.
Economic Prospects for the Future and Ability to Repay
Import volume, especially the volume of capital goods imports, has varied with the amount of foreign exchange available. Foreign exchange receipts depend largely on exports, and exports of Iceland vary greatly from year to year, depending on the fish market and the size of the catch. The wide changes make the Iceland balance of payments quite difficult to forecast. During recent years herring runs in Iceland waters have been below expectations and export receipts, consequently, have been low.
Perhaps as important as the Icelandic supply of fish are the uncertainties of future markets for fish. The development and protection of a domestic fishing fleet in Western Germany will apparently preclude much dependence on future sales there. Prospects in the important United Kingdom market are uncertain. Since the last devaluation, Icelandic frozen fish has been able to compete successfully in the U.S., and if recent experiments in shipping frozen lobster and shrimp to the United States are successful, dollar export prospects will be good.
During the next two or more years, the U.S. and other NATO powers will probably make sizeable military expenditures in Iceland. A substantial share of these payments will be spent for Icelandic [Page 513] labor. This can be expected to provide an important source of foreign exchange for Iceland during the next few years.
Increases in Icelandic agricultural production that are expected to result from this loan should bring about savings in dollar imports. Thus, while the loan is in sterling, the hard currency exchange position of Iceland would be improved, thereby strengthening its capacity to service its outstanding dollar debts.
As the present heavy investment program is completed, and the most urgent needs for investment are satisfied, it should be possible for Iceland to reduce substantially the importation of investment goods. Since these investment goods imports have, in the past five years, averaged more than half of the total volume of imports and even in 1950 may have exceeded one-third of total imports, significant reductions in the import levels should be possible. This means that it should be possible for Iceland to balance its current payments at a satisfactory level of imports as long as fish catches and fish markets remain moderately good.
Including the proposed loan from the IBRD, Iceland’s obligations to service its total foreign debt would involve a payment of something less than $900,000 per year at the maximum. This level would not be reached until 1957. With service payments at this low level, it seems clear that Iceland should have adequate capacity to service the contemplated loan. If it is assumed that Iceland will adjust its level of imports to the availability of foreign exchange, the servicing of the proposed IBRD loan would probably require an adjustment of less than one percent in the total volume of imports.
The people of Iceland have tended to take their financial obligations seriously. There is no record that the country has ever defaulted on an external debt, and during World War II, Iceland was able to repay all the external obligations which were outstanding at the time.1
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The action sheet attached to this memorandum, also dated October 26, stated that the National Advisory Council offered no objection to a loan of about $1,008,000 in European currencies to finance agricultural development in Iceland.
On November 1, the International Bank for Reconstruction and Development authorized the loan of $1,008,000 to Iceland for 22 years at an interest rate of 4½ percent.
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