Foreign investors could participate in Treasury financing in three ways:
- By buying króna-denominated bonds
- By buying foreign-denominated bonds
- Through lending from multinational credit institutions.
It would probably be most favourable to spread financing efforts over all three of these options.
Foreign investors have at times been prominent holders of króna-denominated Treasury bonds, but their holdings are currently limited. According to the most recent figures from Government Debt Management, non-residents held ISK 72bn worth of ISK-denominated Treasury bonds at the end of August, and if recent reports in the media are any indication, these holdings have shrunk quite a bit since then. In comparison, non-residents held nearly ISK 111bn in Treasury securities at the beginning of 2019.
For foreign investors, there are two main factors that determine whether ISK-denominated Treasury bonds are an attractive option: the interest rate differential between the ISK and major currencies, and the ISK exchange rate. Both of these factors should make Treasury bonds quite appealing once pandemic-related uncertainty starts to recede. For example, the yield on 10-year US Treasury bonds is currently 0.8%, and for 10-year German bonds investors pay nearly 0.6% in negative returns. When this is compounded by the argument that the ISK probably has some room to appreciate once tourism recovers, the calculus should start to look reasonably favourable for those foreign investors that are willing to invest in small currencies.
Furthermore, the Icelandic Treasury is considering issuing foreign-denominated bonds and using the proceeds to finance deficit operations. In recent years, the currency obtained through such issues has been held in the CBI’s international reserves, and the Treasury currently holds the equivalent of about ISK 220bn in such deposits with the CBI. It would be possible to tap these deposits to some degree, and presumably, the authorities are considering issuing foreign-denominated bonds and converting the proceeds to ISK. In addition to the purchases themselves, both of these options would boost the supply of foreign currency in the market and could therefore support the ISK exchange rate. Given that the authorities seem to think the ISK is on the weak side and further depreciation detrimental, it could be appropriate to embark on such financing sooner rather than later.
An investment initiative like the one being planned will significantly expand the assets side of the Treasury balance sheet. It could therefore be sensible to divest a few other assets instead of relying entirely on debt financing during a period of deficit spending. The fiscal plan notes that it could be effective to cover a portion of the financing need by selling the State’s holdings in the banks later in the term of the plan. The book value of the Treasury’s share in the two banks was entered in the 2019 Government accounts at ISK 340bn, an amount that would quickly make a difference if the holdings were sold by the middle of the decade.