Iceland's deperate move to defend its currency

--Risk of capital flight spurred Iceland to raise interest rate by 6% to 18%, no comparable to Sweden's move in 1992, from 16% to 78%, and to 500% in the end. --heavily depended on import , Iceland needs a functioning currency-exchange market... Iceland's central bank raised its benchmark interest rate by six percentage points to 18%, and Hungary agreed to take a $25.1 billion loan package organized by the International Monetary Fund, as the two countries tried to rescue their currencies. The IMF on Tuesday night announced an aggressive funding package for Hungary, which had initially tried to avoid that step. The main IMF loan is for $15.7 billion, while the European Union said it would lend $8.1 billion and the World Bank promised $1.3 billion, the IMF said. Reuters Iceland Prime Minister Geir Haarde arrives in Helsinki for the Nordic Prime Ministers meeting. Hungary, which has been talking with the IMF for days, last week raised its key rate three percentage points to bolster a wilting forint. The IMF portion of Hungary's aid is expected to be formally approved in early November and "includes measures to maintain adequate domestic and foreign currency liquidity, as well as strong levels of capital, for the banking system," said IMF Managing Director Dominique Strauss-Kahn, in a statement. Iceland, which depends heavily on imports, desperately needs a functioning foreign-exchange market so Icelanders can use their kronur to buy euros or dollars, and with them the goods they need. Rate increases are generally used to cool overheating economies and lower the risk of inflation. When the economic outlook is bleak, rates are usually cut to spur investment and growth. Getting the foreign-exchange market going again comes with a big risk: Investors could use the opportunity to dump kronur and take capital out of the country. A further collapse in the krona would also kick up inflation, already running at 16% annually. The size of Iceland's rate move is extraordinary, but not record-setting. In September 1992, amid strains in the European Exchange Rate Mechanism, Sweden's central bank raised rates to 75% from 16% to ward off a run on its currency. A few days later it took them all the way to 500%. Amid other signs that countries are eager for currency stability, Poland's government approved a timetable that calls for the country to adopt the euro in 2012. President Lech Kaczynski has resisted the move, but on Tuesday he said the "finance minister made some strong arguments in favor of fast euro adoption," including that Poland would have been better insulated from the fall in Hungary's currency. The Polish zloty has lost ground against the euro since midsummer. Iceland's prime minister was in Helsinki on Tuesday, talking with his Nordic counterparts about further assistance. He is seeking $4 billion in addition to the $2 billion IMF loan, and he told reporters in the Finnish capital that Iceland also has requested help from the U.S. Federal Reserve and the European Central Bank. IMF and Icelandic officials have been worried about the krona, which slid after beginning the year at 92 to the euro. It touched 156 to the euro, according to the ECB, on Oct. 3. It has since effectively stopped trading. Investors off the island aren't much interested in holding kronur, and Iceland recently imposed restrictions on selling kronur for foreign currency. To provide a value for the krona, Iceland's central bank has been holding a local foreign-exchange auction. On Tuesday, the currency was set at 152.50 to the euro. But analysts say the krona could dramatically weaken, perhaps to 250, as offshore trade starts again. The IMF wants to avoid that. The "immediate objective" of the IMF's plan, which could be approved by the agency's executive board in coming days, is to "stabilize the krona," said Poul Thomsen, head of the IMF's mission to Iceland, in an interview Monday. "There is a substantial risk of capital flight." The rate increase is designed to encourage investors to hang on to Icelandic assets and keep krona deposits in local banks. The central bank said it believes contracting demand will swing Iceland's current-account deficit into balance or into surplus. That would boost the krona, and quell inflation. Then, "if forecasts materialize, the policy rate will be reduced," the bank said. Mr. Thomsen said the IMF wouldn't insist on immediate fiscal belt-tightening in Iceland, but would delay such measures until perhaps 2010. That is because Iceland came into the crisis with relatively low levels of government debt. Analysts say, though, that the country will have to assume, in some fashion, a portion of the debt incurred by its collapsed banks. That will change the fiscal picture. The IMF may be stricter with other countries that are seeking aid, such as Ukraine and