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Icelandic economy's strength to limit pension fund outflows, says central bank

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Icelandic pension funds are unlikely to move substantial amounts of money overseas once the government liberalises capital controls in place since 2008, with the Central Bank of Iceland predicting outflows of ISK80bn (€604m) from next year.

In a report by the central bank, released as the Icelandic government published its draft bill to relax capital controls introduced in the wake of the country’s banking collapse, the bank noted that the pension sector had less “pent-up need” to invest overseas following several exemptions offered since last summer, which will allow a total of ISK80bn to flow out of Iceland by the end of September.

The bank predicted that annual overseas investment by the pension sector would amount to ISK60-80bn from 2017 onwards, and cited the range of domestic investment opportunities as the reason for the relatively low level of outflows.

“The interest rate differential with abroad and good investment opportunities in Iceland, particularly in domestic mortgage loans, greatly reduces expected outflows related to the pension funds’ foreign investment,” the bank’s report said.

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Iceland’s pension sector is among the largest in the world when measured against the size of its local economy, with its ISK3.3trn in assets equating to more than 160% of GDP – second only to Denmark, according to the OECD.

Since capital controls were introduced eight years ago, the sector has seen its overseas exposure decline markedly, and only ISK726bn, or 22% of assets, was invested overseas at the end of 2015 according the Icelandic Pension Funds Association.

While the relaxation of capital controls will see Icelandic citizens able to invest more freely, such as removing restrictions on foreign capital purchases, pension funds will remain subject to specific exemptions granted by the central bank.

The draft legislation released by government said that once controls were completely lifted, it would also review the law governing pension fund investment and their level of risk diversification.

Again referencing the size of the pension sector relative to GDP, the bill added: “In such a large asset portfolio, risk diversification is of key importance to the economy and works against distortion of domestic asset prices.”

Iceland’s capital controls have seen the pension sector forced to invest in domestic assets, and has led to the creation of a domestic private equity industry, and increased exposure to real estate.

The funds were allowed to maintain their existing overseas holdings when capital controls were introduced in 2008, with any proceeds from the holdings also exempt from repatriation.

The central bank first began granting exemptions for the pensions sector in June 2015, and relaxations of capital controls were first signaled this May, when the government introduced a bill on the treatment of króna owned by investors outside Iceland. 

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