Economic Studies
Iceland

Iceland

Population 0.4 million
GDP per capita 59,643 US$
A3
Country risk assessment
A1
Business Climate
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Synthesis

major macro economic indicators

  2019 2020 2021 (e) 2022 (f)
GDP growth (%) 2.4 -6.5 3.1 4.0
Inflation (yearly average, %) 3.0 2.9 4.5 4.0
Budget balance (% GDP) -1.5 -7.3 -9.9 -5.9
Current account balance (% GDP) 5.8 0.9 0.1 1.6
Public debt (% GDP) 61.5 69.1 76.0 80.1

(e): Estimate (f): Forecast

STRENGTHS

  • Very high standard of living
  • Low inequality in the society
  • Abundant renewable energy (geothermal, hydropower)
  • Flexible labour market with high openness to immigrating workers

WEAKNESSES

  • Volcanic risk
  • High regulatory burdens for FDI
  • Small and very open economy: constrained monetary policy
  • Concentration of production and exports (aluminium and seafood products accounted for 77% of all goods exports in 2020)
  • Volatile activity due to the dependence on tourist inflows (23% of GDP and 22% of employment before the pandemic in 2019)
  • Wage growth higher than productivity growth

Risk assessment

Outlook stands and falls with tourism

Iceland has managed the pandemic well with high vaccination-rates. This led to an early opening of the economy in spring 2021. The opening of the economy had a positive effect on private consumption, but majorly boosted exports of services as, in June 2021, the borders were opened for all tourists (including from the U.S., who account for 23% of all visitors). Despite this boost, total numbers of touristic overnight stays remained 30% below 2019 levels in the summer-holiday season of 2021. In 2022, tourism numbers should further improve, but will probably not reach pre-COVID-19 levels, as the pandemic’s development in some of the home countries could weigh on the outlook (the main home countries are the U.S., UK, Germany, France, China and Poland). Furthermore, exports (36% of GDP) should be boosted via record high catches of fish (e.g. capelin) that are expected for this fishing-season (mid-October 2021 to mid-April 2022). Combined with a still high level of aluminium exports and higher intellectual property services exports, they should foster a dynamic recovery in 2022. Private consumption (53% of GDP) should benefit from the tourism recovery, but also from the increase in the monthly wage by ISK 17,250, thanks to the 4-year-wage agreement of 2019. The labour market recovered fast in 2021 and even reached pre-COVID-19-levels in the third quarter of 2021. While some of this improvement was pushed by hiring subsidies that were in place between May and December 2021, the unemployment rate should decrease further in 2022, but at a slower pace and will remain very dependent on the development of tourism. However, purchasing-power gains coming from the labour market are limited due to a high level of inflation that reached with around 4.8% in late 2021, a 9-year-high. While the inflationary pressure should diminish somewhat in 2022, the level of inflation will remain elevated and noticeable, above the Central Bank of Iceland’s inflation target of 2.5%. Faced with very high inflation and strong signs for recovery, the Central Bank lifted its key interest rate (7-day deposit rate) by 50 basis points in 2021. Because of a relatively stable ISK, market interventions of the Central Bank were limited. Due to the still high inflation expectations, further rate hikes are probable in 2022; however, the interest rate level will remain far below its pre-COVID-level of 3%. Governmental support should decrease a bit from the still very high levels of 2021, as several COVID-19-support measures will terminate and could therefore induce risks to the financial positon of some corporations. Nevertheless, the government will retain high expenditures to invest in the welfare system, infrastructure projects, digitalization and green economy projects.  

 

Current account surplus improves, but increasing public debt ratio remains a concern

The current account surplus decreased further in 2021 to the point of getting nil, due to a very negative first semester, as the goods trade deficit reached a new record high (goods imports increased much faster than exports also because of  higher input price-pressure). In the second half of the year, the stronger increase in tourism receipts somewhat equalized this bad start thanks to a stronger services trade balance. In 2022, this development should continue, while the goods trade deficit should return to normal levels thanks to higher fish exports. Further support could also come from overseas investment income, which should remain high. The public deficit should decrease somewhat in 2022, but remain on an elevated level (it will be the third consecutive high deficit in a row). The public debt ratio was upward revised due the inclusion of several state-owned entities. The high public budget should push the debt ratio even higher to around 80% of the GDP in 2022.  

 

Grand Coalition keeps on

In the September 2021 parliamentary election, the parties of the Grand Coalition have increased their share in the parliament (37 out of 63 seats). The liberal-conservative Independence party (16 seats, unchanged) remained the biggest party in the parliament, followed by the agrarian Progressive party (13 seats, + 5 seats) and the Left-Green Party (8 seats, -3 seats) of Prime Minister Katrín Jakobsdóttir. Although the parties differ a lot in their political ideology, it is the first Grand Coalition that was confirmed by votes for a second term, probably due to the very successful management of the pandemic and the recession in 2020. Although Jakobsdóttir’s Left-Green party lost votes and is the smallest party, Katrín Jakobsdóttir is leading the government again. It will focus on the topics of the operational viability of the healthcare system, fighting the climate change and strategies to diversify the economy. The next general election should normally take place in 2025.  

 

Last updated: February 2022

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