OREANDA-NEWS. April 13, 2016. The political crisis in Iceland, in which the prime minister was replaced after public protests, does not in itself have implications for Iceland's 'BBB+'/Stable sovereign rating, Fitch Ratings says. But it increases uncertainty about the future direction of macroeconomic policy at a time when domestic imbalances are building.

Agriculture minister Sigurdur Ingi Johannsson took over from Sigmundur David Gunnlaugsson as prime minster after the latter's former co-ownership of an offshore company emerged in the leaks from Panamanian law firm Mossack Fonseca, prompting large public demonstrations. The governing coalition of the Progressive and Independence parties won a no-confidence vote on Friday, and near-term policy continuity is likely.

Finance minister Bjarni Benediktsson and central bank governor Mar Gudmundsson both said last week that the authorities would proceed with planned measures to facilitate the removal of capital controls after nearly eight years. The process of removing the controls is well advanced and we assume it will continue as planned.

Other developments may have longer-term political consequences. Members of the coalition have said that legislative elections could be brought forward to autumn this year from April 2017, which would increase uncertainty if the level of popular discontent reflected in the recent protests in Reykjavik persists.

Our assessment of any potential impact on Iceland's sovereign credit profile would focus on whether political changes led to shifts in macroeconomic policy that increased growth and inflation volatility and the risk that the economy overheats.

For example, the "stability contributions" from the estates of Iceland's failed banks will provide a large fiscal windfall to the sovereign. Current legislation requires these to be used to pay down debt. But if this was reversed and these funds used to fund further fiscal expansion, overheating risk would rise.

We think this risk is already emerging. The 2016 budget included expansionary fiscal measures, while wage settlements are putting upward pressure on inflation and have exceeded productivity growth in an economy that has a closed or positive output gap and low unemployment. The Central Bank of Iceland raised rates by 0.75pp in 2H15, and reiterated that "a tighter monetary stance will probably be needed" when it kept its key rate at 5.75% in March.

One indicator of the degree of political unpredictability, and therefore potential policy uncertainty, is the fact the Icelandic Pirate Party, which was formed in 2012 and advocates direct democracy and freedom of expression, and has no official leader, is leading opinion polls.

The Pirate Party's macroeconomic policies have not been set out in detail. For example, Bloomberg quoted one Pirate Party MP last week as saying regarding capital control liberalisation that it is "unlikely [to] take the work that's been carried out and turn it upside down," but that others in party might not share this view.