Prospects for tourism dim after a decent start in 2024

Some 963,000 foreign nationals have travelled through Keflavík Airport in 2024 date, which translates to a YoY increase of 1%. The year began quite well despite the seismic unrest on the Reykjanes peninsula, and tourist numbers were up nearly 9% between years in Q1. They started to sag in Q2, however, and declined by 5% YoY for the quarter as a whole. In June, too, visitor numbers were considerably lower than we had projected in our macroeconomic forecast, released in May.

The outlook for the peak season – and thus for the year as a whole in tourism – is bleaker than we assumed in May. According to recent statements made in the media by various tourism industry leaders, the month of June probably sets the tone for the summer as a whole. In May, we forecast that tourist visits would increase in number by just over 4% YoY in 2024 and that departures via Keflavík Airport would be on a par with 2018, the strongest year on record. Although it is not long since we issued that forecast, there have been growing indications that tourist numbers will not increase this year; in fact, a YoY decline looks fairly likely.

In addition, there are numerous signs that visitors are shortening their stays and that revenues per tourist are starting to contract in real terms. Over the first five months of the year, foreign nationals’ bed-nights at registered accommodations shrank by over 5%, whereas the number of visitors arriving via Keflavík Airport grew by 3.5%. In this case, however, it is important to bear in mind that unregistered accommodation accounts for some share of the market; furthermore, travel via fly-cruise – an arrangement where guests fly to Iceland, board the cruise vessel here, and live on board during their stay – is probably increasing markedly between years.

Like other financial market analysts, we have long viewed turnover with foreign payment cards as an indicator of developments in tourists’ spending while in Iceland. However, these data are affected by the fact that various domestic goods and services providers have been shifting their acquiring business from domestic to foreign acquirers in the recent term. Because of this shift, card turnover data probably paint a misleading picture of developments in tourism revenues. Under these circumstances, data such as bed-nights and turnover according to value-added tax returns in typical tourism subsectors are better suited to analysis of developments in tourism at present.

Turnover according to most recent VAT returns cover the April-May filing period. These returns show that turnover in typical tourism subsectors totalled ISK 30bn during the two-month period, an increase of nearly 7% in nominal terms. Deflating that figure with the CPI reveals, however, that turnover was virtually flat YoY in real terms, which accords well with the other aforementioned indicators of reduced momentum in the industry.

How do lower tourism revenues affect the broader economy?

Weaker-than-expected tourism revenues – whether they stem from fewer tourists, reduced revenues per head, or both – have a pronounced effect on the economic outlook for 2024. For a start, the changed outlook affects this year’s prospects for export growth, GDP growth, the current account balance, the ISK exchange rate, job numbers, and the housing market.

In an attempt to estimate these effects, we used the Icelandic Tourist Board’s recently updated forecast of tourist numbers and compared it with the assumptions from our own May forecast. The Tourist Board projects that tourist arrivals will decline by 2% year-on-year in 2024, whereas our forecast assumed an increase of more than 4%. We also considered factors such as airline ticket sales due to transit passengers, which appear brisker than previously expected, and the probable YoY increase in cruise ship passenger numbers. Offsetting this, average revenues per tourist seem to be on the decline. It is well to bear in mind that the analysis in our model was something of a speed-boiled process and was significantly simplified in comparison with our macroeconomic forecast preparation this spring. It serves primarily to give a back-of-the-envelope sketch of the scope of the impact on a range of economic variables.

Based on the above-specified assumptions, the main changes in the economic outlook for 2024 relative to our May forecast are as follows:

• Services exports will remain flat this year, as compared with our May forecast of a volume increase measuring just over 4%. The contraction in tourism will therefore offset growth in other services exports.
• As a result, the current account surplus will be halved to 0.5% from the 1.0% we projected in May.
• All else being equal, a smaller current account surplus will lead to a weaker ISK. Nevertheless, the change is not terribly large, and other forces in the FX market could easily offset it in large part, or even in full.
• Domestic demand will be weaker than it would be otherwise. The impact on private consumption and investment will probably be moderate, however.
• GDP growth will suffer. After adjusting for the fact that reduced imports will partly offset weaker growth in exports and demand, our model indicates that year-2024 GDP growth will measure 0.4%, down from our May forecast of 0.9%.  

• Demand pressures in the housing market could ease. Reduced activity in the tourism industry usually has a dual impact on the housing market. On the one hand, housing supply shifts from the short-term tourism rental market (via AirBnB, for instance) to the market for long-term rentals or outright sales. On the other hand, the decline in job numbers will ultimately curtail inward migration, thereby relieving demand pressures in the housing market. According to SI’s data, just over half of workers employed in typical tourism subsectors in 2023 were classified as immigrants, a share that has risen steadily ever since the tourism boom began in earnest. It can therefore be estimated that one of every five immigrants in the labour market work in the tourism industry.
• The overall impact on inflation is uncertain. In the short run, a weaker ISK could cause imported inflation to be higher than we forecast in May. Pulling in the opposite direction, for instance, are less wage drift in a cooler labour market and slower rises in house prices and rent. These offsetting effects would probably have the upper hand in the final analysis.
• Interest rates could turn out lower. Developments in the policy rate depend in large part, of course, on the inflation outlook. For the short term, it is not certain whether more sluggish activity in the tourism industry will lead to lower interest rates. Nevertheless, weaker demand pressures in the economy and a more favourable medium-term inflation outlook could prompt a more rapid decline in interest rates than we projected this spring.
• To encapsulate briefly: All else being equal, recent indicators of headwinds in tourism will dampen GDP growth, reduce the likelihood of an ISK appreciation, ease pressures in the labour and housing markets, and possibly call for lower interest rates in the medium term. Although some of these shifts are doubtless welcome news to many, it would be wise to think twice before celebrating them without reservation. An output gap, a hot labour market, and demand-linked inflation are luxury problems in comparison with higher unemployment, tighter household finances, and growing operational problems in Iceland’s largest export sector. The picture sketched out above assumes a modest YoY contraction in tourism. Let us hope that it doesn’t prove to be excessively optimistic when all is said and done.