Economic studies
Iceland

Iceland

Population 0.4 million
GDP per capita 67,857 US$
A3
Country risk assessment
A1
Business Climate
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Synthesis

major macro economic indicators

  2018 2019 2020 (e) 2021 (f)
GDP growth (%) 3.9 1.9 -8.2 2.5
Inflation (yearly average, %) 2.7 3.0 2.9 2.9
Budget balance (% GDP) 0.8 -1.6 -9.4 -9.2
Current account balance (% GDP) 3.8 6.4 0.3 1.2
Public debt (% GDP) 46.2 47.4 60.8 66.5

(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: constraint monetary policy
  • Concentration of production and exports (aluminium and seafood products)
  • Volatile activity linked to the dependence on tourist inflows (23% of GDP and 22% of employment in 2019)
  • Wage growth higher than productivity growth

Risk assessment

Tourism remains the key for growth

The economic outlook for 2021 is mainly characterized by a slow and weak recovery after the deep COVID-19 induced recession in 2020. After the virus hit Iceland in early spring 2020, the government reacted fast, but moderately in European comparison. There was only a limited lockdown as most businesses kept operating, except for restaurants, hotels or public places (like libraries). Borders were de-facto closed from late-March to mid-June. Since then, tourists from the EU/EFTA can enter, but only with two negative COVID-19 tests (within a 5-day quarantine) or with a normal 14-day quarantine. These measures helped in limiting the spring outbreak, but could not prevent the second wave that hit in late summer of 2020. Even with mild restrictive measures, the economic damage was strong in Northern European comparison. The Icelandic economy contracted by around 8% in the first half of 2020 compared to the second half of 2019 (seasonally adjusted). The lack of tourism activity became particularly obvious in the second quarter (tourism dropped by 75% compared to 2019). The travel restrictions prevented U.S. citizens (23% of all tourists in 2019) from visiting the country in 2020. Exports of marine products (the second important economic sector in Iceland) remained stable, while aluminium exports had more trouble due to the lack of demand from the industry during the spring. An own trade agreement with UK helped also to prevent any trade distortions in early 2021. The development of the pandemic and, with it, the possible or impossible comeback of tourists, will be the main determinants for the growth dynamic in 2021. Private consumption and private investment should be the main supports to economic growth. The average monthly wage will increase moderately by ISK 15,700 thanks to the wage agreement of 2019. However, with a still high unemployment rate, as many jobs are in the tourism sector, its effect should be limited for the overall economy. A trade agreement Government support measures (two packages, ISK 352 billion, 11.9% of GDP) were mostly concentrated on cushioning the recession in 2020 via tax cuts, increased unemployment benefits and state-guaranteed loans. For 2021, fiscal support will aim at restarting the economy via public investment projects, tax incentives for real estate improvement and temporary tax relief for the tourism sector. Although the inflation rate should remain above the target of 2.5%, the Central Bank of Iceland has room to further decrease the key interest rate in 2021, from its current record low of 0.75%. Its government bond purchasing program worth ISK 150 billion (5.1% of 2019 GDP), with maximum purchases of ISK 20 billion per quarter, could be extended in 2021.

 

Current account surplus will still suffer from ailing tourism

The current account surplus could show a small comeback depending on the dynamic of tourism in 2021. A supporting factor will be the investment income from abroad, which should remain high. Conversely, the trade in goods deficit will remain a negative factor, as it decreased in 2020 due to a steeper fall in imports compared to exports, and could increase again given the revival in domestic demand. Despite its drop, with the concomitant free fall in tourism receipts, it could not be exceeded by the services surplus like in normal times. In 2021, the situation should remain unchanged. The public deficit in 2021 should remain as high as in 2020, as a lot of tourism-related tax revenue will still be absent. These two large deficits will bring the public debt to a new record at above 60% of GDP.

 

The limited recovery will be the touchstone for the Grand Coalition

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). For the quick and successful measures implemented to fight COVID-19 in the spring of 2020, the government got a lot of praise at first. However, with rising unemployment and increasing public frustrations because of renewed restrictions on travel, social gatherings and a lack of tourism, this support has been decreasing. While the Independence Party is still leading in the polls, Jakobsdóttir’s Left-Green movement is only fourth in the polls (behind the Social Democrats and the Pirate Party). This could still lead to renewed tensions in the government, where the political ideologies remain very divergent. Therefore, it is not sure if the Grand Coalition will hold until the next regular election in October 2021.

 

Last updated: March 2021

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