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3 December 2019

CA surplus already larger than in all of 2018

Iceland’s current account surplus will probably be larger this year than in 2018, in spite of setbacks in the tourism industry and the failure of the capelin catch. The international investment position (IIP) of the economy is at its strongest ever, providing a valuable cushion for the uncertain times ahead.

CA surplus smaller in Q3 …

The current account surplus totalled ISK 63bn in Q3/2019, according to newly published figures from the Central Bank (CBI). This is ISK 11bn less than the Q3/2018 surplus, with the difference stemming mainly from reduced tourism activity. It had already been established that the balance on services trade showed a surplus of ISK 101.4bn (as opposed to ISK 123bn a year earlier), while the balance on goods trade showed a deficit of ISK 45.9bn (as opposed to ISK 47.6bn in the prior year). On the other hand, the balance on income, which largely reflects cross-border financial income and expense, showed a surplus of ISK 13.4bn during the quarter. Net secondary income was in deficit by ISK 5.9bn, broadly the same as in the same quarter of 2018, and was affected mainly by items such as financial transfers between family members and contributions to international co-operation work.

… but considerably larger than in the first nine months of the year

Although the current account surplus shrank year-on-year in Q3, the surplus in 2019 to date is still quite sizeable. For the first nine months of 2019, it measured almost ISK 121bn, more than in all of 2018, when it totalled ISK ISBN. Irregular items such as the sale of WOW Air’s aircraft in Q1 had a significant impact, but if adjustments are made for such items, the 9m/2019 surplus was ISK 102bn, well above the 2018 total of ISK 90bn. Not only is this a handsome outcome in and of itself, it is far more favourable than was widely expected in the wake of the recent shocks to the tourism sector and the capelin fishery. This is thanks to a strong contraction in imports, plus sizeable net financial income during the year.

In September, we projected that the 2019 CA surplus would total about ISK 100bn, or 3.5% of the year’s GDP. Given that the fourth quarter is not over yet, it is highly likely that the outcome for the year will be considerably more favourable than we had projected.

Net IIP positive by about ¼ of GDP

The CBI also published summarised figures on the external position of the economy as of end-September - figures that should bring good cheer as the days grow shorter. Iceland’s net international investment position (NIIP) was positive by ISK 714bn, or nearly a fourth of GDP. This is the most positive NIIP Iceland has ever recorded, whether in ISK terms or as a share of GDP, and it represents an improvement of ISK 91bn during the quarter. The press release from the CBI indicates that the main driver of the increase was foreign nationals’ investment in domestic securities in the amount of ISK 80bn. External assets totalled ISK 3,870bn at the end of September, and external liabilities ISK 3,156bn.

The composition of assets and liabilities differs markedly. For example, ISK 1,624bn worth of external assets are in the form of securities, much of that amount due to a single pension fund’s holdings in equity securities and mutual funds in the amount of ISK 1,333bn. The CBI’s international reserves, in the amount of ISK 826bn, also account for a large share of assets. On the liabilities side, foreign-owned Icelandic equities weigh heaviest, at ISK 1,339bn, and inward foreign direct investment accounts for ISK 1,239bn. It is appropriate to bear in mind that, although the vast majority of foreign entities’ securities holdings are in bonds, a minority of these securities bear Icelandic interest rates. Therefore, the interest rate differential with abroad does not weigh too heavily in the balance on primary income, as can be seen in a robust primary income surplus in recent quarters.

Strong external position provides support during uncertain times

It is quite likely that few observers at the beginning of the decade would have predicted that Iceland’s IIP would be this positive at the decade’s end. As the chart shows, Iceland’s IIP has gone from being negative by 71% of GDP at year-end 2010 to being positive by nearly 25% of GDP. In ISK terms, the NIIP has improved by ISK 1,778bn in the interim. The strong current account surplus has been bolstered by the successful resolution of the failed banks’ estates.

The situation is even more remarkable in view of the fact that the real exchange rate has been historically quite high in recent years, although it has eased slightly in the recent term. It is unprecedented in Icelandic economic history that the country should experience both an upswing and the first quarters of a setback in exports without a current account deficit and a deterioration of its IIP.

In our opinion, this change for the better reflects a change in the behaviour of households, firms, and the public sector, where all parties have handled the upswing in a more responsible manner than they have in the past. National saving has been robust in the recent term, and as a result, the economy is far better able to face the current headwinds than it was previously. This in turn means that the probability of foreign exchange market unrest, exchange rate volatility, and the inflation spike that usually follows such volatility will be much milder than before, enabling households and businesses to face leaner times in a far less uncertain environment than Icelanders have been accustomed to. These factors weigh heavily in our opinion that the headwinds at the turn of this decade will probably be much more bearable than usual for the Icelandic economy.