Iceland: Risk Assessment

Country Rating1

Rating: A4

Business Climate Rating1

Rating: A1

Risk Assessment2

Pace of growth sustained by household consumption

As the main driver of Iceland’s growth, household consumption will remain steady in 2013, driven by lower unemployment, higher wages and stable inflation, due to a much improved labor market since early 2012 and unemployment settling at about 6% in 2012 (compared with a peak of 9.2% in September 2010). Nominal salaries rose by almost 7.5% over the same period, but are likely to slow in 2013, as inflation will remain unchanged. Investment by companies benefiting from the restructuring of their debt (down from 360% of GDP in 2008 to 183% in June 2012) will also buoy growth. Work to enlarge the Straumsvik aluminum factory, which will last until 2014, will enable production capacity to rise progressively. Hydroelectric potential has boosted the production of aluminum, a key, power-intensive export-oriented industry that accounts for 70% of Iceland’s electricity production. Prices are expected to hold up in 2013 due to the modest recovery in world consumption. The tourism industry will perform in line with the country’s renewed attractiveness thanks to the depreciation of the Icelandic krona. The second major export industry, fishing, could be restricted by the adoption of a European embargo on over-exploited fish stocks. Mackerel fishing, which accounts for 10% of seafood exports, will be affected by the new legislation. Finally, the return of inflationary pressures, triggered by rising consumption and wages, in turn pushing up house prices (towards 2008 peaks), will prompt the Central Bank to continue tightening monetary policy. The key rate has been raised six times since August 2011 (6% in November 2012) to curb inflation, which is well above the 2.5% target.

Public and external accounts will continue to improve

As the first advanced country to solicit assistance from the IMF in 2008, the agreement signed with the Fund expired in August 2011 and the program was an acknowledged success. Iceland regained access to the financial markets, borrowing $1 billion in May 2012. It was, as a result, able to make an early repayment on the loans granted by the IMF and the Nordic countries with due dates in 2013 and 2014. Thanks to capital controls, which will continue in 2013, the Icelandic krona, which depreciated dramatically in 2011, has now stabilized at approximately 80% of its value against euro. Company competitiveness has improved strongly with exports being significantly revived and demand redirected towards domestic goods, so curbing imports. The balance of goods, in surplus since 2009, is therefore expected to reach 7.1% of GDP in 2012. The comfortable foreign exchange reserves accumulated as a result will ensure the currency’s stability in 2013. Moreover, the fiscal deficit should decrease, thanks to a public spending contraction complemented by a rise in revenue. Public debt will fall having peaked at nearly 100% of GDP in 2011.

Companies still weak

Restructuration of the banking sector will be pursued. The three main banks (Glitnir, Kaupthing and Landsbanki) have been restructured and recapitalized: the first two, renamed Islandsbanki and Arion, are owned by their creditors, while the third is 80% state-owned. The credit market has resumed supplying finance to the private sector. Loan volume has been growing steadily since late 2011 and this positive trend is confirmed by the decreasing number of company bankruptcies after an unbroken rise of six years. In September 2012, bankruptcies thus fell by 12.6% over one year. With the disappearance of the weakest companies, it has been possible, since mid-2011, to clean up outstanding loans to such an extent that the default ratio is now similar to the one for individuals. Credit is thus expected to continue to help fund companies in 2013, although the number of company insolvencies is still above pre-crisis levels.

Ongoing EU accession procedure

The left-wing coalition, in power since 2009, has a majority of only one vote following internal disagreements. The more Eurosceptic opposition parties, especially the Independence Party (IP), look set to make gains at the parliamentary elections in April 2013. Meanwhile, the EU accession procedure though progressing is far from being achieved: 10 chapters have been opened (12 still to go) and 2 chapters have been closed (25 remaining) in 2012.

Strengths

  • Partial repayment of loans from IMF and Nordic countries
  • Consolidated banking sector
  • Restructured household debt
  • Abundant thermal and hydroelectric energy
  • High tourist potential
  • High levels of foreign exchange reserves
  • Ongoing EU accession procedure

Weaknesses

  • Small economy
  • Arrears resulting from collapse of three main banks
  • High external debt 
  • Concentration of production and exports (aluminium and seafood) 

1Country and Business Climate Ratings courtesy of Coface (08/2013)
2Risk Assessment and methodology courtesy of Coface (08/2013).

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