Inactive market
Clearly the FX market is currently anything but efficient, its turnover a mere fraction of its former self. Turnover YtD, for instance, is not quite ISK 8.3 billion (bn), or ISK 1.2bn on average each month. By comparison, during the same period of 2008, turnover on this market was ISK 5,615bn, or an average of ISK 802bn monthly. This year¿s turnover YtD is therefore only 0.15% of what it was in 2008. The comparison shows clearly the transformation of the FX market and how closed the economy has become to transactions which, prior to the banks¿ collapse, comprised this market and determined the ISK exchange rate.

Little change in ISK exchange rate
The ISK has remained practically unchanged during July. The TWI is steady at just over 214, its level at the beginning of this month. The situation in July has been similar to that of June, and a striking change from the strong ISK appreciation against most trading partner currencies in May, when FX market trading was livelier than it has been for some time. In May, the currency appreciated by 5.4%, in interbank FX trading of over ISK 3bn.

Possible impact of Central Bank's upcoming FX purchases
The doldrums on the interbank FX market appear to be a summer phenomenon, with activity at many enterprises at a minimum these months. Another possible explanation could be the announcement by the Central Bank of its plans to begin regular FX purchases in coming months, to build up its non-borrowed currency reserves and alter their composition. According to its statements, the bank intends to commence these actions this autumn. The grounds for such purchases were discussed in the government's statement following the second review of its economic recovery programme agreed with the IMF, and reiterated in the words of the Central Bank¿s Monetary Policy Committee in its latest interest rate announcement on 23 June this year. It should be pointed out that the Central Bank has not intervened in the FX market since 6 November last year.

Recent sharp USD weakening
Leading currencies have been rather volatile this summer. The EUR has strengthened considerably against the USD after a major depreciation earlier this year and has now reached a two-month high against the dollar. A EUR now costs USD 1.29, as it did at the beginning of May, up from its low of USD 1.19 at the beginning of June. It would appear that investors¿ concerns at high debts of Eurozone states have decreased, while recent US statistics have caused the USD to weaken. A USD now costs ISK 122 and a EUR just over ISK 158.


Sizeable Treasury deficit

Central government revenues in 2009 amounted to close to ISK 440bn, or equivalent to 29.3% of GDP. This is a considerable YoY drop of over ISK 32bn, equivalent to 6.9% in nominal and 16.8% in real terms. Expenditure proved to be ISK 579bn in 2009, equivalent to 39% of GDP for the year. While this is a considerable YoY drop, it should be pointed out that 2008 expenditure was unusually high due to extraordinary measures taken by the state as a result of the banks' collapse and financial market turmoil.

Treasury financing needs lower than forecast
According to original estimates, the Treasury borrowing needs in 2009 were equivalent to around 25% of GDP, but in the event proved to be much lower, at around 11%. Most of the discrepancy results from an agreement by the Treasury with the Central Bank of Iceland to purchase collateralised loans and security claims totalling some ISK 134bn, together with lower costs of refinancing the banks. Treasury borrowing was therefore much lower, with net new borrowing during the year close to ISK 200bn, of which ISK 179bn was ISK debt and ISK 21bn in foreign currency. The Treasury position improved by ISK 42bn during the year. Net cash at year-end was ISK 227bn, and deposits with the Central Bank ISK 163.1bn.