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ECONOMIC
STATISTICS
QUARTERLY
ECONOMIC STATISTICS
Vol. 3. No. 1. February 1982.
Published quarterly by the Economic Department of the
Central Bank of Iceland, P.O.Box 160, 121 Reykjavik, Iceland.
Bank, the price compensation factor is reviewed at 1st 1980 the banks began to offer fully indexed 2
three month intervals. The inflation rate is evalu- year time deposits carrying an interest rate of 1 per
ated on the basis of known and projected 6 month cent p.a. In early 1981 these accounts were changchanges in the cost of living and building cost, and ed to 6 month deposits, but the interest rate reaccording to a formula which weighs together the mained unchanged.
cost of living (2/3) and the building cost indices
As shown in table 5 on page 8, the principal
1
savings
alternatives presently offered by the banks
( /3).
are,
on
the
one hand, general savings deposits and
In accordance with the stipulations of the Eco3
and
12
month
time deposits, which all carry a
nomic Policy Act, the Central Bank calculates
relatively
high
nominal
interest rate, and, on the
monthly a special credit terms index (see page 24),
other
hand,
fully
indexed
6 month accounts carryto which the nominal values of long term obligaing
a
very
low
nominal
rate
which is roughly the
tions may be linked. It is not computed indereal
rate
at
the
same
time.
pendently from raw price data, but is rather a
A technical problem accompanies high nominal
composite index of the cost of living index (2/3)
interest rates, given the usual practice to calculate
and the building cost index (1/3).
proportional interest rates for periods shorter
than one year and to give no consideration to
Implementation of the present policy.
The fundamental component of the policy compounding. The reaction of the Central Bank
adopted was that, following its implementation, has been to set different nominal rates for time
the base rate and the price compensation factor on periods of differing lengths. In line with this the
three month time deposits should together main- nominal interest rates on 3 and 12 month time
tain the real value of the original deposit. As inter- deposits were lowered slightly on March lst when
est rates lagged significantly behind inflation at it was announced that interest on those accounts
the time of passage of the Economic Policy Act, it would be entered twice a year, leaving the annual
was decided that the target of fully value linking yield roughly unchanged.
bank loans and deposits should be reached in
several steps over a period of a year and a half and Impact of policy.
be attained by the end of 1980. Anticipations were
At the beginning of the 1970's the ratio of total
that the target would be reached from both sides, bank deposits to GNP was roughly 35 per cent. In
i.e. by higher nominal rates and lower inflation. subsequent years it fell continuously, down to
During the adjustment period, interest rates were 21.5 per cent in 1978. In line with the sharply
raised four times and real interest rates rose quite improved real returns on savings after 1978, the
strongly, particularly in 1980 as the rate of ratio began to rise again, reached 23.6 per cent in
inflation decelerated. Towards the end of that 1980 and an estimated 27 per cent in 1981 with a
year, inflation began to gain momentum again, still further increase being projected for the
and thus the adjustment period of interest rates current year. Changes in the term structure of dewas extended through 1981. In response to easing posits reflect the vigorous interest rate policy as
inflationary pressures in 1981, interest rates were well. Time deposits, which offer the highest relowered slightly twice (see the August and turns, amounted to 28 per cent of total bank deNovember issues of Economic Statistics 1981).
posits at the end of 1970, fell to 24 per cent at the
end
of 1975, but rose again to an estimated 32.6
In August of last year, the real interest rate on
per
cent
at the end of 1981. Since the introduction
12 month time deposits was estimated at 1.9 per
of
the
interest
premium scheme in 1976, the ratio
cent and 0.2 per cent on 3 month deposits, implyof
time
deposits
to GNP has risen continuously.
ing that the target of the interest rate policy had
been reached. In the last few months, however,
the rate of inflation has risen again resulting in
falling real interest rates as no rate changes have
been implemented recently.
Following the passage of the Economic Policy
Act in 1979, the banks were permitted to grant
fully indexed loans of a minimum of 4 years maturity, which was shortened to 2 years in early
1981. The interest rate on this type of loans is 2
per cent p.a. (on top of the indexation). On July
as most of the credit granted by the so-called investment credit funds is fully index-linked.
Furthermore, as mentioned at the outset, homebuilding loans granted by the State Building Fund
have been index-linked more or less since 1955,
and in recent years credit granted by the pension
Towards the end of January, the Prime Minister delivered an economic policy declaration to the
Aling (Parliament). The outlook for 1982 is less
favourable now than envisaged in October when
the national budget was presented. One reason is
the slower than expected recovery of economic
activity in the world economy. In October,
exports were projected to rise by 3-4 per cent in
1982. At present, however, it seems that the
growth of export revenue will probably stagnate
this year. Consequently, real GNP will at best remain unchanged from last year and real GNI may
fall. The more pessimistic export projections are
the result of continuing difficulties in the alumin-
ECONOMIC STATISTICS
Vol. 5.3. August 1984
Published quarterly by the Economic Department of the
Central Bank of lceland, P.O. Box 160, 121 Reykjavk, lceland.
d.m.b.'s at the Central Bank. High and gradually increasing penalty rates are applied. Experience has
shown that this system has not had the intended
effect. The recent change in the system puts less
stress on the penally rates but more on directly
excluding overdrafts. Here follows a short description of the possibilities that exist for the deposit money
banks for a short term accomodation in the Central
Bank after the new rules have taken effect.
The Central Bank allocates monthly discount bill
quotas to the deposit money banks according to their
size. The deposit money banks can themselves decide the duration and amount of bills they sell each
time, but generally the quota amounts to 1 per cent of
deposits at the beginning of the year. This credit facility can be used to meet an unexpected deterioration
of the liquidity position without resorting to an overdraft in the Central Bank. Commercial banks and
savings banks have open accounts in the Central
Bank. Overdrafts on the accounts are not permitted,
but can emerge in emergency situations and is then
subtracted from the discount bill quota at the next allocation. The Central Bank supervises very closely
accounts in debt and calculates daily a.o. the average debt the last 10, 20 and 30 days. If the averages
exceed respectively 8, 3 and 1 overdraft brackets",
it is considered totally unacceptable. The Central
Bank will in such cases notify the institution concerned and demand rectification or else close the account. Such a closure would paralyze the institution
a.o. because the accounts are used for check clearing between the banks. Overdraft bracket are assigned to each bank by the Central Bank. Currently
one overdraft bracket amounts on average roughly
to 0.6 per cent of deposits of deposit money banks.
The brackets were first created at the 1st of November 1982 and amounted then each to 1 per cent of
deposits. They were increased by 40 per cent at the
1st of June 1983 but have been unchanged in terms
of krnur since.
These rules on maximum overdrafts are much
stricter than those that have been in force before.
When they went in force on the 21st of August considerable overdrafts existed on the accounts of all
commercial banks and some savings banks. To
extinguish the overdrafts the banks can apply for discount bill loans from the Central Bank. These loans
will only be granted on certain conditions concerning
ceilings on lending during the next months.
Contracts on this are made with each bank, which
enlists the penalties applied if the credit ceilings are
not adhered to. The contracts already made involve
that a breach results in the liquidation of one third of
the discount bill quota, that otherwise would have
been allocated to the bank next month. In this way
the Central Bank is attempting to check the credit
expansion.
The increase in real interest rates can partly be explained by the overheating of the economy that occAverage real interest rate on unindexed
ured in 1987 and partly by a new system of interest
general bank loans - ex post measure.
rate determination. From November 1986 the banks
have been free to set their own interest rates. The
Central Bank and the government had until then the
formal power to set interest rates, but had de facto
surrendered much of that power to the banks in the
middle of 1984.
Average nominal interest rates on unindexed bank
loans were around 3 6 % at the beginning of this year.
They then fell to 3 2 % at the end of May. This fall in
interest rates was partly caused by an underestimation of the underlying inflation rate, that jumped during the second quarter due to new wage settlements
Real interest rates are, at the time of writing, 7%
and two devaluations in February and May. Ex post on indexed Treasury bonds with six years maturity
real interest rates on unindexed bank loans fell there- and 8% with 2-3 years maturity. Real interest rates
fore considerably during the second quarter. The on indexed bank loans are 9.1 % on average. Interest
banks consequently raised interest rates, which rates on bank securities are higher, or 9-9.5%, sereached 41 % at the end of July. Real interest rates curities issued by leasing companies bear 10.5have therefore risen again from the second quarter. 11.5% interest rates, and issues of industrial and
Nominal interest rates have been falling recently, commercial companies 11.2-12%. It is not expected
and are around 25% at the beginning of September. that these interest rates will fall significantly until the
Improved prospects for inflation (see article above) current economic disequilibrium is brought under
explain this fall.
control.
Coverage
Long term loans which are financed domestically are
all or almost all fully indexed. At the end of 1990 the total
financial assets of the consolidated Credit System were
some 532 billion kr. It is estimated that one half of the viously this limit was set at shorter maturity and in the
total is indexed to the CTI, one third linked to foreign case of deposits the banks may offer indexation on 6
currencies and some 17 per cent withcut any such link- months or longer time deposits.
age but carrying nominal interest rates. The Credit
The most commonly used index is the credit terms
System, as defined here, consists of all domestic fin- index, but it is also allowed to apply the so-called SDR
ancial institutions in lceland and that part of the external index and ECU index. The three indices are all calcusector which provides loans to the economy.
lated monthly and their new values, which are published
At the end of 1990 some 40% of the DMBs' total credit by the Central Bank in the fourth week of each month,
and holdings of securities were indexed and 25% linked become formally effective as of the first day of the follto foreign currencies. The lower percentage of indexed owing month. In fact the SDR and ECU indices are
assets in the banking sector than in the Credit System merely the exchange rates of these "currencies" on the
as a whole reflects the short term character of its assets. 21st day of the month in which they are published. The
The opposite is true for the pension funds, the financial composition of the CTI is more complicated as described in a separate section of this article.
assets of which are indexed up to more than 90%.
The determination of interest rates is no longer reguThe numbers above show the importance of indexation in lceland. It should be noted that indexation is lated so that the level of interest rates applied on top of
also applied outside the Credit System i.a. in medium the indexed principal is determined by the parties to the
and long term loans between individuals or non-fin- respective contract, whether these are banks or nonancial entities. It should also be mentioned here that the banks. Bank loans (and deposits) usually carry variable
monetary base is indexed to a considerable extent. interest rates, while debt securities sold on the market
Since 1987 the reserves, that DMBs are required to hold usually carry fixed interest rates.
with the Central Bank, have been indexed.
The issue of transferable debt securities in the domestic market has played an important role in the last five Technical facts.
To describe how indexation is performed in lceland
years or so. In the case of short term instruments like
Treasury bills or bank bills, there is no indexation in- an example is given below. Table 1 shows the figures
volved. But medium and long term securities are indexed. involved when we assume that a bank loan amounting
In terms of volume the state owned House Building to 1,000 kr. is repaid with four annual installments. We
Fund is the most active issuer. It issues the so-called assume that the loan was granted in January 1987 so
house bonds, which now are important in secondary that the index numbers in the table are the actual Janutrading of securities. The repayment of house bonds ary CTI numbers in 1987 through 1991. For the sake of
takes place through quarterly drawings during 25 years. simplicity we assume that the interest rate is fixed at 5%
Each house bond earns compound interest to be paid per annum, but as indicated above indexed bank loans
together with the loan principal and the price compen- in lceland usually carry variable rates.
sation at the date of drawing. The issue of the traditional
To give another example we shall look at one issue of
Government bonds (savings certificates) is also import- Government bonds that recently matured. The date of
ant. Presently the primary issues of Government bonds issue was January 18, 1988; it had 3 years and 13 days
available in the market, have a maturity of 5 and 10 to maturity (3.0361 years) and it carried compound intyears. Banks, leasing companies, municipalities and erest fixed at 8.5% per annum. The base index was the
others frequently issue indexed securities to be sold on CTI of January 1988 which was 1913. At the date of matthe market, and also traded on the secondary market. urity, February 1 st. 1991, the CTI was 3003. At that
These usually have a maturity of 3 to 5 years.
date, when redeeming a bond with a nominal value of
Some of the secondary trading of securities takes 10,000 kr., the owner got 20,109.20 kr. which included
place at the Securities Exchange of lceland. The the nominal value, the compound interest and the price
information published by the Exchange includes the compensation involved:
implicit yield in each trade of debt securities, which is
defined as the yield in addition to the appreciation acc10,000-1.085 3.0361 = 12,810.55
ording to the change in the CTI. The debt securities
12,810.55
3003/1913 = 20,109.20
listed on the Exchange are the house bonds, the
Government bonds and UCITs' units, while banks and
others have not applied for a listing of their issues in the
This example shows that the owner gets a full price
last four years.
compensation if the index is an adequate measure of
the price level from his point of view. The price risk element of financial obligations is thus eliminated. It should
Present regulation.
According to the present regulation it is not allowed to also be noted that the 8.5% "nominal" interest rate also
index loans with shorter maturity than three years. Pre- turns out to be the real return.
Table 1.
Number of
payments
left
Loan
principal
left
(a)
(b)
Explanation:
Index
numbers
base
at date
of payment
Loan
principal
adjusted
Installment
Interest
payment
Total
payment
(c)
(d)
(e)
(f)
(g)
(h)
bd/c
e/a
0.05e
f+g
see i
4
3
2
1
1000.00
916.77
728.11
442.65
1565
1913
2279
2771
1913
2279
2771
2969
1222.36
1092.17
885.30
474.28
305.59
364.06
442.65
474.28
61.12
54.61
44.27
23.71
366.71
418.67
486.92
497.99
Loan
principal
left
(i)
e-f
916.77
728.11
442.65
0.00
0.33
the table may inform the reader about the inflation in the
economy and the chances in the exchange rate of the
krna.
Table 2.
Per cent changes from the beginning to end of year
(first value each year compared with first value next year)
Indices
Exchange
rates
CTI
CLI
BCI
USD
GBP
SDR
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
52.6
47.6
60.5
73.4
18.9
35.6
14.7
22.2
19.1
21.6
7.1
59.8
41.1
63.6
70.8
23.1
34.2
12.8
26.1
18.3
23.7
7.3
57.3
45.2
63.0
55.1
19.5
34.8
17.2
17.4
20.6
27.3
7.2
58.0
51.1
92.4
58.6
41.9
3.1
-4.5
-10.3
33.7
28.0
-10.9
68.4
17.5
68.2
40.5
13.0
30.1
-2.2
12.3
31.4
12.9
7.5
52.0
19.0
94.2
63.8
32.9
15.4
6.8
2.4
29.3
23.5
-2.5
Average
32.4
33.1
31.9
27.0
25.4
27.9
Present policy.
Indexation has been the means by which monetary
authorities were able to maintain positive real rates of
interest in spite of high and variable inflation during the
last decade. This has reduced the disruptive impact of
inflation on the financial system. Domestic financial savings have increased. Total deposits and bonds issued
by banks have, e.g., again exceeded 40% of GDP.
Pension funds' assets and other financial savings have
been protected against inflation. A lively market for long
term debt securities has evolved, something which
would have been inconceivable without the confidence
in the market created by the indexation.
There are two main problems with the indexation that
have been pointed out. They are of quite different character. One is that indexation, performed in the way
described above, involves a certain accommodation.
The rise in the index is not added to the interest rate, so
as to increase the interest payment each time, but
instead it raises the loan principal and is paid in accordance with the original plan to repay the principal. One
interpretation of this method is that the borrower receives a new loan each time there is a rise in the index. Thus
the impact of high real interest rates on credit demand
may be reduced or at least delayed. From the point of
view of the monetary authorities, however, this drawback is negligible compared with the problems created
by the alternative of incurring negative real interest
rates.
The other problem to be mentioned here is seen from
the point of view of the borrower, whether it be the
Government or others. Under indexation the probability
of gaining an inflation tax is nil. It has of course become
more difficult for home buyers and other borrowers to
service their debt than it was under negative real interest rates. The problem becomes even more severe at
times of decreasing real wages. This has created longer
arrears with the domestic financial institutions.
With the lowering of inflation last year the policy of
reducing the use of indexation has gained momentum.
To some extent this objective has already been fulfilled,
but a program introduced by the Ministry of Commerce
last year contains the policy of deregulating the area of
indexation in the next two years so that the market will
be left to decide whether to use indexation, and in that
case which index or composition of indices, to use.
period. The government's rationale was that indexation based on the consumer price index, with a
sound legal basis, would be more permanent and
credible than the current form, also in the light of
the fact that it is the most common form in other
countries where indexation is offered in the financial market.
The legislation stipulates that indexation of
deposits and lending is allowed against either the
consumer price index or indices of foreign currencies calculated and published by the Central Bank.
The consumer price index which is calculated and
published for a given month will be used for financial indexation during the next month. The Central
Bank can with the consent of the Minister of
Commerce allow other officially recorded indices to
be used for the purpose of indexation. Already
issued financial obligations that are indexed with
the credit terms index will from April onwards be
indexed with the consumer price index, and a
linked index of the two will be published for that purpose.