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 (%) 4.7 2.6 -6.7 3.1
Inflation (yearly average, %) 2.7 3.0 2.9 4.2
Budget balance (% GDP) 0.9 -1.5 -7.3 -6.0
Current account balance (% GDP) 3.8 6.4 1.1 1.9
Public debt (% GDP) 42.0 43.1 46.6 59.0

(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 (aluminum and seafood products)
  • Volatile activity linked to 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 volatile recovery after the deep COVID-19 induced recession in 2020. To fight the pandemic, Iceland mainly used travel limitations in combination with mild domestic restrictions. This helped to contain the pandemic in 2020 and 2021 very effectively. By mid-August 2021, only 2.6% of the population had been infected and the death ratio did not even reach 0.01%. Together with a fast vaccination campaign (in mid-August almost 75% of the population were fully vaccinated), the management of the pandemic stood out positively. The costs of this strategy were, however, very high. While the borders were open since mid-2020 for EU/EFTA tourists under the conditions of two negative COVID-19 tests (within a 5-day-quarantine), this was not practical and therefore tourism remained very low. Fully vaccinated people from the EU/EFTA region have been allowed in without further tests only since March 2021. From mid-June onwards, all vaccinated and tested tourists, including the U.S. (U.S.-citizens have a share of 23% of all tourists in 2019), were welcomed again. The year 2021 started with a strong fall in economic activity, which is not unusual. The main drag was a strong reduction in foreign inbound tourism, partly due to the pandemic’s development outside of Iceland. Furthermore, investment decreased, particularly because there was only a limited bridge-agreement for trade between Iceland (as a member of the European Economic Area, EEA) and UK after the realization of the Brexit at the beginning of the year. However, economic activity has picked up noticeably since spring. A new Free-Trade-Agreement between the EEA and UK was signed in July 2021 giving Icelandic traders more security for their investments and fishing rights in the North Sea. The strong vaccination campaign enabled the government to lift almost all COVID-19 restrictions and should slowly bring consumption back to 2019 levels. Moreover, domestic tourism has picked up and was, in the summer months, even 176% above pre COVID-19 levels. Foreign tourism surged too, but remained behind 2019 numbers. Private consumption should benefit from the tourism recovery, but also from the increase in the monthly wage by ISK 15,700, thanks to the wage agreement of 2019. The labour market recovered in the first half of 2021, but will not reach pre COVID-19 levels this year. However, purchasing-power gains are limited due to a high level of inflation that reached, with 4.6% in April 2021, an 8-year-high. Furthermore, the aluminium industry should benefit from the increase in global demand for industrial input goods and seafood exports should remain stable. Governmental support should remain high in 2021 with measures aiming at restarting the economy via public investment projects, tax incentives for real estate improvement and temporary tax relief for the tourism sector. Due to the very high inflation rate and strong signs for recovery, the Central Bank of Iceland increased its key interest rate by 25 basis points to 1% in May 2021. Further rate hikes are possible, depending on the economic and pandemic development, especially with possible outbreaks of the Delta variant. 

 

Current account surplus improves slowly

The current account surplus could show a muted comeback as the increase of the service trade surplus, due to the slow recovery of foreign tourism, will more than level out the unchanged structural deficit of the good’s trade balance. Further support for the current account will also come from investment income abroad, which should remain at a high level. The public deficit should decrease somewhat in 2021, but remain on a very high level. This should push the public debt ratio to almost 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). In 2020, the government got a lot of praise for its successful management of the pandemic. In 2021, however, the focus of the election campaigns turned to the high level of public debt and its reduction. Other main topics are ensuring the operational viability of the healthcare system, the funding of nursing homes, fighting climate change and whether or not formally adopting a new constitution written in 2012. From the polls, the current coalition could sharply miss the majority. The formation of another Jakobsdóttir-cabinet after the election in September 2021 is therefore not sure.

 

Last updated: August 2021

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