FRANKFURT - The Central Bank Of Iceland must remain "vigilant in the face of increasing risks to the inflation target," the International Monetary Fund said Monday, noting that inflation expectations are "on the rise."
In its fifth review under the stand-by arrangement with Iceland, the IMF also warned of downside risks to growth: "The weak fourth quarter outturn raises concerns about the resilience of the recovery."
Headline inflation is expected at +2.8% this year, above the central bank's target of +2.5%, mainly due to higher commodity prices, the IMF said.
Economic slack and a stable krona should reduce price pressures moving forward, the Fund said.
"But risks to the inflation outlook have tilted to the upside: the likelihood of higher imports prices (mainly from higher food and fuel prices and possible exchange rate weakening associated with capital account liberalization measures) has increased and inflation expectations are on the rise," the report added.
GDP growth is projected at 2.3% this year, with investment expected to be a key driver, the IMF said. Exports are also seen improving, while private consumption should recover slowly.
The main risks to this projection stem from investment project delays, slow progress in addressing the private sector debt overhang, external demand and commodity price shocks, and deterioration in the investment climate, the IMF said.
The authorities are gauging a gradual withdrawal of controls to the country's balance of payments outlook and financial stability -- which could be key in restoring strength to the krona currency.
For example, Kozack said, authorities will ensure there are sufficient international reserves, conditioned on the treasury having access to the international capital markets, and that banks have sufficient liquidity.
Nevertheless, she said, the controls, which were integrated in the IMF's $2.2 billion 2008 bailout program for the country, "need to be lifted."
Asked in a conference call with reporters whether capital controls were hampering Iceland's economic growth, Kozack replied that the government faces a "very delicate balance" aimed at preventing a selloff of the krona.
The central bank plans to test the currency's strength on Tuesday with an auction to repurchase 15 billion krona (132 million dollars) held in private accounts offshore with euros.
Kozack said the auction results would be an important indicator of demand for Iceland's currency.
She recalled that the IMF exceptionally had deemed capital controls "were appropriate" in the 2008 bailout after the collapse of three banks sent Iceland's economy and currency into a tailspin.
"The sooner that Iceland can return to the markets the better," Kozack said.
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