Estudios Económicos
Iceland

Iceland

Population 0.3 million
GDP 74,515 US$
A3
Country risk assessment
A1
Business Climate
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Synthesis

major macro economic indicators

  2017 2018 2019 (e) 2020 (f)
GDP growth (%) 4.5 3.8 1.9 -4.0
Inflation (yearly average, %) 1.8 2.7 3.0 2.5
Budget balance (% GDP) 0.6 0.8 -1.1 -7.1
Current account balance (% GDP) 3.8 3.1 4.1 0.9
Public debt (% GDP) 42.9 42.3 44.3 51.2

(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 immigrant workers

WEAKNESSES

  • Volcanic risk
  • High regulatory burdens for FDI
  • Small and very open economy: constraint monetary policy
  • Concentration of production and exports (aluminum and seafood products)
  • Volatile activity linked to dependence on tourist inflows
  • Wage growth higher than productivity growth

Risk assessment

Tourism is the recession driver

COVID-19 is the main economic topic of 2020. The first case in Iceland was diagnosed at the end of February. The pandemic peaked in early April. From early-May onwards, new daily infections were limited to single cases, but since mid-July, the numbers have increased again from a low level (status: 28.07.20). 1,857 cases were reported (0.5% of the population) with 10 deaths. The health system was sufficiently prepared to cope with the pandemic. The government reacted fast, but the measures were softer in European comparison. There was no official lockdown and most businesses kept operating except for restaurants, hotels and public places. All educational institutions (excluding primary schools) closed from mid-March to early-May and gatherings of groups above 20 people were banned for a few weeks. On 20 March, the government closed the borders. Since mid-June, the country slowly opened up again for tourists, visiting from EU/EFTA (although for most tourists, a negative COVID-19 test or a 14-day quarantine is required). For U.S. tourists, the main market (21%), borders were still not open at the end of July 2020.

 

The coronavirus pandemic and the restrictions around it have had a deep impact on the Icelandic economy. In 2020, we expect the strongest recession in a single year since 1920. The year started with a substantial negative GDP growth for the economy (Q1 2020: -7.0% QOQ, because of the strong rebound in Q4 2019: 4.8%). In the second quarter, the downturn should be even more severe, with a decrease in private household consumption, private investments and a strong plunge in exports due to the abrupt absence of almost any tourism. Foreign tourism accounts for 18% of GDP. The government introduced over twenty measures in March and April, which will cushion somewhat the economic contraction. From the second half of 2020 onwards, we expect a modest recovery of economic activity, depending on the development of the pandemic and the further opening of borders. Alongside the government, the central bank of Iceland reacted fast to the recession and lowered its key interest rate by 2 percentage points to 1% (the inflation target of 2.5% was reached in May 2020). Furthermore, the central bank decreased the minimum reserve requirements, as well as financial institutions’ capital requirements in March, and began to buy treasury bonds on the secondary market in May. In total, ISK 150 billion (5.1% of 2019-GDP) should be purchased within this program, starting with ISK 20 billion in Q2 2020.

 

External and fiscal balances shrink

The external balance should shrink but remain positive in 2020. On the export side, the lack of tourism was the main drag, but the exports of fishing products also decreased since restaurants in many export destinations were closed for months. As industry in the main export destinations (like the Eurozone, UK or China) is in recession, the demand for aluminum from Iceland (one of the main export products) should be low as well. However, the depreciation of the Islandic Krona by 16% vs. USD between end-February and end-May will soften this negative trend via higher domestic prices for imports and lower external prices for exports. Moreover, imports have also decreased (although not as much as exports), as demand from the tourism sector was very low, and the balance on investment income should remain positive. Conversely, the government’s public balance should fall further in the negative territory. The government announced measures amounting to ISK 352 billion or around 11.9% of 2019 GDP. They comprise mainly of government-guaranteed bridge loans and support loans for businesses, the deferral of tax payments and part-time employment options. These measures should have a direct effect on the fiscal budget of up to 4.2% of GDP. Combined with the effect of automatic stabilizers on expenditures (increase) and revenues (decrease), the deficit should shoot up. Nevertheless, with a relatively low level of public debt, the public finances in Iceland should remain sustainable in 2020.

 

Tensions within the patchwork coalition remain high

Since the last general election in October 2017 Prime Minister Katrín Jakobsdóttir is leading a Grand Coalition out of the centre-right Independence Party (16 seats), Jakobsdóttir’s Left-Green movement (11 seats) and the centrist agrarian Progressive Party (7 seats). The government got a lot of praise internationally and domestically for the quick, comprehensive and successful measures to fight COVID-19. However, the political ideologies remain very divergent in the coalition and can always lead to renewed tensions in the government, especially when the recession further materializes. Therefore, it is unsure if the Grand Coalition will continue until the next regular election in October 2021.

 

Last updated: August 2020

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