Iceland: Risk Assessment
Country Risk Rating
Business Climate Rating
- Very high standard of living
- Low inequality in the society
- Abundant renewable energy (geothermal, hydropower)
- Flexible labour market with high openness to immigrating workers
- 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 dependence on tourist inflows
- Wage growth higher than productivity growth
Light at the end of the tunnel
2019 stuck out with an economic weakness due to two special factors: one of the two big airline companies in Iceland (WOW) became insolvent in March 2019 (with around 1000 workers, 0.5% of the labour force). Additionally, in early 2019, there was a zero quota announced for fishing capelin (which represents around 15% of Icelandic total fish production and 35% of all goods exports). Both factors are reaching into this year, so that only a gradual recovery is expected in 2020. Consumption will be key and should pick up again to some extent. In the first place, following the April 2019 wage negotiation round, employees received an increase in their yearly bonus (by around EUR 22 to around EUR 672) in December 2019. In addition, minimum wage earners will profit from an increase of around 6% in April 2020, while others will get a raise in their monthly salary of between EUR 130 and 175. Second, the government will reduce the personal income tax for lowest-income individuals, after reducing social security tax rate from 6.6 down to 6.35%. Third, the central bank of Iceland cut the deposit rate five times to 3.0% in 2019 and could even go down further in 2020, which should increase the incentive to consume. Additionally, inflation is expected to come back to the central bank target (around 2.5%), so that the purchasing power will pick up. Government spending will also increase modestly in 2020 with additional investments (e.g. infrastructure and construction). Business equipment will probably show a rebound effect after the decreasing numbers in 2019. In the housing sector however, the private demand decreased after several big projects were finished in the last years and the house prices sank rapidly in 2019. Additionally the demand from tourism (e.g. Airbnb) eased after the WOW-insolvency. Net exports will be a drag on growth in 2020. First, a fast recovery of tourism (number of flights fell by 1/4 year-on-year in spring 2019) is unlikely, which accounts for 40% of export income and 10% of GDP. There is no airline that could compensate the flights of WOW ad hoc, especially as Icelandair has to deal with the grounding of the Boeing 737 MAX jets. Then, the fishing quota for capelin is unlikely to be loosened much in 2020. However, higher numbers of other pelagic species were found in 2019 and could help maritime export numbers in 2020. The exports of aluminium should remain weak and cannot support net exports, while with a higher consumption dynamic, imports should increase again in 2020.
External and fiscal surpluses are dwindling
Due to a special effect in Q1 (i.e. WOW sold its planes abroad), the trade balance surplus (4% of GDP) increased in 2019, but should come down to a muted level in 2020 as the lower services surplus linked to tourism and transport (7.6% in 2019) should barely exceed the deficit in goods, thus taking down the current account surplus. The balances of income and transfers, however, globally showed a new dynamic and, combined, even a small surplus in 2019 (after two years of deficit) which could persist in 2020. Remittances from expatriated Icelanders (0.4%) will continue to more or less balance those from foreign workers. Income from direct investments abroad should continue to outperform payments to foreign investors. With the further reduction in capital controls, new direct and portfolio investments abroad, which had fallen to a trickle, are expected to gain some strength thanks to pension funds activity. Conversely, new foreign investments will remain timid despite the release in March 2019 of last offshore króna assets. Foreign investments other than direct investments were subject to a special reserve requirement at the central bank. This requirement was lowered to 20% in November 2018 and to 0% in March 2019.
The government surplus will decrease significantly in 2020 due to the more expansive policy. On top of social measures, the focus of the government is turning to environmental measures, with more funding for charging stations, low–emission infrastructure and tax incentives for electrical cars.
Tensions on the patchwork coalition are increasing
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 political ideologies are very divergent in the coalition, which proved itself quite robust on problematic questions like the new wage deal or passing a new law, legalizing abortion in the early weeks of pregnancy. Nevertheless, tensions will increase with the slower economy and a further decrease in support in the polls for the coalition parties. Therefore, it is not sure if the Grand Coalition will keep up until the next regular election in October 2021.