Economic Studies
Iceland

Iceland

Population 0.3 million
GDP per capita 52,315US$
A3
Country risk assessment
A1
Business Climate
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Synthesis

major macro economic indicators

  2013 2014 2015  2016(f)
GDP growth (%) 4.4 2.0 4.0 3.8
Inflation (yearly average) (%) 3.9 2.0 1.6 1.8
Budget balance (% GDP) -1.8 -0.2 0.7 0.3
Current account balance (% GDP) 5.8 3.6 4.3 4.1
Public debt (% GDP) 84.9 82.5 67.6 56.1

 

(f) Forecast

STRENGTHS

  • Healthier banking sector
  • Gradual decline in the public debt
  • Rich and renewable energy (geothermal, hydroelectricity)
  • Oil and gas reserves
  • Strong tourism potential
  • High foreign reserves
  • Dynamic household consumption

WEAKNESSES

  • Small economy
  • Growing inflationary tensions
  • Risks associated with the lifting of capital controls
  • High external debt
  • Concentration of production and exports (aluminium and sea products)
  • Russian embargo on Icelandic seafood products
  • Arrears resulting from the collapse of the three major banks

Risk assessment

Growth supported by household consumption

After accelerating in 2015, activity is expected to slow in 2016. Private consumption will benefit both from the strong increase in real wages observed in 2015, which helped increase household purchasing power, and the low unemployment rate (2.6% in June 2016). Investment will continue to be hampered by rising wage costs (productivity is increasing more slowly than real wages). Meanwhile, exports linked to fishing (about 25% of total exports) will benefit from the free-trade agreement signed with China in July 2014. On the supply side, tourism, which is booming, is likely to again contribute positively to economic activity, thanks to the government's goal of increasing investment in the sector.

Several downside risks will also hamper growth in the short term: long-term modest growth in the euro zone, an even more accommodative policy from the ECB (depreciation of the euro, appreciation of the Icelandic krona which will impact negatively on the price-competitiveness of Iceland's exports), low oil prices and the liberalisation of capital controls in place since 2008. Liquid assets hold by non-resident investors represents around 10% of GDP and are still blocked since 2008. The Central bank proceeded a series of auctions in order to allow investors to convert their assets in foreign currency. Finance ministry announced mid-August 2016 progressive liberalisation of almost all capital controls’ restrictions. A first set of measures will be lifted as soon as the bill will be passed by the Parliament, then other restrictions will be lifted as of 1 January 2017. According to Finance ministry estimates, the easing could result in a capital outflow of about 40 billion kronur (€0.3 bn representing 2% of GDP) to 165 billion kronur (€1.2 bn representing 8% of GDP) in first and second steps.

 

Improved budget position and announcement of capital account liberalisation

Iceland is expected to post a slight budget surplus in 2016, as in 2015. The public debt will, therefore, continue to decline but will remain well above its pre-crisis level (28.5% of GDP in 2007). Government revenues in 2016 are expected to fall due to the government's measures to support consumption (removal of customs duty on imports, cuts to income tax). With regard to spending, measures to support older people, the unemployed, the disabled and children have also been implemented.

The current account surplus is expected to narrow slightly in 2016. This is explained by a slight weakening in the balance of goods and services (import values are increasing faster than those of exports thanks to lively internal demand) and the financial account (lower direct investments). Seafood products and aluminium will still account for almost 75% of total exports and European countries will continue to be the main trading partners (especially the Netherlands and the United Kingdom).

Iceland's three major banks are well capitalised, with comfortable levels of equity capital and the ratio of non-performing loans is declining (7.9% of total loans). Lending, however, remains relatively weak and central bank tightening could restrict it even further. The country's largest bank, Landsbanki, is still publicly-owned, but the government plans to sell 30% of its shares, which would help it to reduce the public debt. Finally, the central bank has high levels of foreign exchange reserves, which will ensure a more stable transition to the liberalisation of the capital account.

 

New Prime Minister following the sidelining of Gunnlaugsson, pending elections by year’s end

Following the revelation of the so-called “Panama papers” tax fraud scandal, Prime Minister Gunnlaugsson resigned (but however remains the Progressive Party’s leader), replaced by former Minister of Agriculture and Fisheries, Sigurdur Johannsson. Parliamentary elections will be held on October 29, 2016. The appointment of a historian and political novice as President (honorary post) in July 2016 illustrates the loss of confidence by the population in traditional parties. In this context, Pirate Party is leading polls. A new pro-European Party, Reconstruction, emerged following political turmoil of the beginning of the year and stood at 10% in latest polls. The next elections could therefore see a more fragmented Parliament than usual and a new leader.

Definitive withdrawal of candidature to join the EU in March 2015 has not worsened relations with the EU, as evidenced by its support during the Ukrainian crisis. By contrast, this support damaged relations with Russia (Iceland's fifth largest trading partner), which decided to place an embargo on Icelandic products, mainly seafood products.

 

Last update : July 2016

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