Tue. Jun 8th, 2021

June 8, 2021

Washington, DC: On June 4, 2021, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Iceland.

Iceland entered the COVID-19 crisis from a position of strength and stands favorably in its handling of the pandemic . Net and gross public debt have declined by more than 50 percentage points of GDP since the Global Financial Crisis, private and external debt have declined by 200 percent of GDP, and international reserves have reached around 30 percent of GDP. Banks’ balance sheets have been strong, with significant capital and liquidity buffers. The available policy space allowed for a prompt and substantial policy response to the pandemic, with fiscal, monetary, and macroprudential measures alleviating the impact on households and firms. The COVID-19 cases were contained fast, and vaccinations have progressed as planned, with more than 60 percent of the population above age 16 having received at least one dose.

Nonetheless, the impact of the pandemic on the economy has been significant. The collapse in global tourism flows has affected Iceland’s engine of growth, which relies heavily on contact-intensive sectors. Real GDP declined by 6.6 percent, unemployment rose sharply, the current account surplus declined, and inflation rose above the notification band in 2020. A modest recovery is projected to take hold in 2021, with GDP projected to reach its 2019 level the following year. Scarring arising from an expected slow tourism recovery is projected to keep GDP below its pre-COVID trend by 3 percent in 2026. Risks to the outlook are significant, mainly stemming from uncertainty in the path of the pandemic domestically and abroad and the prospects for global tourism revival.

Executive Board Assessment [2]

Executive Directors commended Iceland’s handling of the severe impacts of the COVID-19 pandemic, thanks to the strong policy framework and prudently accumulated buffers. Looking ahead, Directors highlighted the challenging medium-term economic outlook, and encouraged sound macroeconomic policies and structural reforms to enhance sustainable growth, financial stability, and economic diversification.

Directors concurred that the budgeted fiscal support this year would help prop up domestic demand, mitigate scarring, and provide insurance against downside risks. Directors also assessed that Iceland’s medium-term fiscal policy plans would balance well the ongoing need for support to the economy with fiscal sustainability considerations. They noted these plans appropriately refocused fiscal policy from lifeline support toward active labor market policies and investments in physical and human capital. Maintaining the highest fiscal transparency will be crucial to preserve confidence in the fiscal framework.

Directors stressed that data-driven monetary policy rate decisions would remain essential to support confidence and mitigate inflation risks given the high degree of uncertainty. With the external position aligned with fundamentals and desirable policies, Directors advised the CBI to continue reducing its foreign exchange market presence as the effects of the pandemic subside. They also called for completion of the ongoing foreign exchange legislation reform to solidify the liberalization of the foreign exchange system and clarify the conditions for a potential use of capital flow management measures.

Directors stressed that emerging corporate vulnerabilities and housing market risks should be addressed to preserve the strength of the financial system. They recommended close monitoring of pandemic impacts on corporate and bank balance sheets and deploying macroprudential measures to mitigate risks from rapid bank mortgage credit growth.

Directors underscored that the upcoming review of the financial oversight architecture should ensure that the CBI’s powers and resources are commensurate with its expanded responsibilities. They stressed that the forthcoming bank privatization required vigilance to preserve high-quality ownership. Directors commended the authorities for swiftly completing the actions required for Iceland to exit FATF’s grey-list and encouraged them to continue improving AML/CFT effectiveness.

Directors stressed that Iceland’s post-pandemic growth strategy should strive to further diversify and strengthen the resilience of its economy. The strategy should aim to promote safe and sustainable tourism, support innovation, enhance human capital, reduce regulatory burdens, seek to better align wages and productivity, and ensure timely achievement of Iceland’s climate goals.

Iceland: Selected Economic Indicators, 2015–21

2015

2016

2017

2018

2019

2020

2021

Prel.

Proj.

National Accounts (constant prices)

Gross domestic product

4.4

6.3

4.2

4.7

2.6

-6.6

3.7

Total domestic demand

6.1

7.7

7.6

4.4

0.2

-1.3

2.0

Private consumption

4.5

6.7

8.0

4.8

1.9

-3.3

3.0

Public consumption

-0.1

0.9

2.9

4.7

3.9

3.1

0.6

Gross fixed investment

21.5

18.0

10.6

1.2

-3.7

-6.8

4.4

Net exports (contribution to growth)

-1.1

-0.8

-2.9

0.7

2.1

-5.4

1.7

Exports of goods and services

8.9

11.0

5.1

1.7

-4.6

-30.5

16.3

Imports of goods and services

13.5

14.6

11.8

0.5

-9.3

-22.0

11.8

Output gap (percent of potential output)

-1.1

0.9

1.3

3.0

2.4

-4.5

-2.3

Selected Indicators

Gross domestic product (ISK bn.)

2,311

2,512

2,642

2,840

3,045

2,941

3,132

Gross domestic product ($ bn.)

17.5

20.8

24.7

26.2

24.8

21.7

24.2

GDP per capita ($ thousands)

53.2

62.5

73.1

75.3

69.6

59.6

65.3

Private consumption (percent of GDP)

49.7

49.3

50.1

50.3

49.9

51.4

51.5

Public consumption (percent of GDP)

23.4

23.0

23.7

24.2

24.4

27.5

26.8

Gross fixed investment (percent of GDP)

19.3

20.9

21.8

21.6

20.6

21.1

21.8

Gross national saving (percent of GDP)

25.0

29.2

26.0

25.7

27.0

22.7

22.8

Unemployment rate (percent of labor force)

4.5

3.3

3.3

3.1

3.9

6.4

6.0

Employment

3.9

4.1

1.0

1.8

0.9

-3.0

0.8

Labor productivity

1.1

4.2

2.8

1.8

1.6

-3.8

3.0

Real wages

5.9

7.2

5.6

3.7

1.8

3.4

0.7

Nominal wages

7.6

9.0

7.5

6.5

4.9

6.3

4.3

Consumer price index (average)

1.6

1.7

1.8

2.7

3.0

2.9

3.6

Consumer price index (end period)

2.0

1.9

1.9

3.7

2.0

3.6

3.0

ISK/€ (average)

146

134

121

128

141

157

ISK/$ (average)

132

121

107

108

123

135

Terms of trade (average)

6.8

2.7

1.5

-3.7

-0.7

-2.3

-3.0

Money and Credit (end period)

Base money (M0)

27.8

3.0

37.9

-1.7

-9.2

11.8

6.2

Broad money (M3)

5.6

-4.6

5.0

7.0

6.6

7.4

8.4

Bank credit to nonfinancial private sector

3.5

4.4

9.2

11.9

2.9

10.5

3.5

Central bank 7 day term deposit rate 1/

5.75

5.00

4.25

4.50

3.00

0.75

0.75

General Government Finances 2 /

Revenue

43.2

59.1

45.4

44.9

41.9

42.4

40.3

Expenditure

43.6

46.5

44.5

44.0

43.4

49.7

49.4

Overall balance

-0.4

12.5

1.0

0.9

-1.5

-7.3

-9.1

Structural primary balance

3.4

3.6

2.0

0.8

-1.4

0.3

-2.5

Cyclically-adjusted primary balance

3.8

15.0

3.3

1.6

-0.7

-2.4

-5.8

Gross debt

97.2

79.9

69.4

61.1

68.3

79.9

80.0

Net debt

78.0

65.2

57.9

48.6

55.4

63.8

67.2

Balance of Payments

Current account balance

5.6

8.1

4.2

3.8

6.4

1.0

0.7

of which: services balance

8.9

10.5

10.6

9.0

8.5

2.5

3.4

Capital and financial account (+ = outflow)

4.8

8.5

1.7

5.5

6.8

5.4

0.6

of which: direct investment, net (+ = outflow)

-4.0

-3.5

-0.7

1.7

3.1

2.5

2.3

Gross external debt

174.8

125.1

90.3

73.3

76.5

86.0

75.4

Central bank reserves ($ bn.)

5.0

7.2

6.6

6.1

6.7

6.4

5.9

Sources: CBI; Ministry of Finance; Statistics Iceland; and IMF staff projections.
1/ For 2021, rate as of end-April.
2/ In 2020, the definition of the general government was expanded to include 24 new entities, of which the largest are the IL Fund and the Student loan Fund.

 

[1] Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

[2] At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.IMF.org/external/np/sec/misc/qualifiers.htm .