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2 December 2019

GDP growth set to be flat in 2019

Households and the public sector are the main drivers of GDP growth at present, as their financial conditions are currently very favourable. Tourism has been the centre of gravity during the current business cycle but will probably play a less prominent role in the near future.

According to newly published figures from Statistics Iceland, GDP contracted by 0.1% in Q3/2019, owing entirely to a negative contribution from net trade, as domestic demand (the sum of consumption, investment, and accumulated inventories of export goods) increased by 3.2% during the quarter. Exports contracted by nearly 13% in Q3, however, largely because of the contraction in tourism. On the other hand, imports of goods and services contracted by nearly 9% in volume terms.

Aggregate figures for the first nine months of the year show, however, that in spite of the above developments, net trade has buoyed up GDP growth. During this period, domestic demand fell by 0.9%, yet because of a positive contribution from net trade, GDP growth measured 0.2% for the quarter.

As the chart shows, the GDP growth figures reflect the tug-of-war between a sizeable contraction in investment and exports, on the one hand, and slow growth in consumption and a marked contraction in imports, on the other.

Investment and consumption supplant exports as the driver of growth

It is also interesting to study developments in moving averages of various national accounts items, since quarterly figures can be highly volatile. There seems to be a shift in the trend of various items during the period 2016-2017, with private consumption rapidly taking over from exports and, later, investment as the primary catalyst of growth. In the recent past, imports have shifted from being a drag on growth to being a major factor offsetting the contraction in investment and exports. This trend reflects the fact that, as GDP growth has lost pace, demand seems to have shifted more towards domestic goods and services.

Tourism the focal point of the current business cycle

The business cycle now coming to a close has by and large been export-driven. The emergence of tourism as Iceland’s largest export sector has been a major factor in this development. As the chart indicates, growth in services exports was one of the main drivers of GDP growth from 2013 well into 2017. Offsetting this was rapid growth in goods imports, which both provided inputs for the booming tourism sector and fostered growth in investment and private consumption. By the same token, it is the contraction in services exports that has offset declining goods imports in the recent past as regards developments in external trade.

Residential investment still growing apace

In recent years, the composition of residential investment has changed markedly, alongside the slowdown occurring after the peak of the mid-2010s. In 2018, residential and public investment offset the contraction in business investment, resulting in an overall investment growth rate of 4% for the year. In 2019 to date, however, residential investment has been the only engine of growth. In the first three quarters of the year, residential investment grew 38%. The growth rate in Q3 was particularly strong, at 54% year-on-year, a three-year high.

This handsome growth rate carries little weight, however, against a more than 23% contraction in business investment and a nearly 6% contraction in public investment. Investment as a whole has therefore contracted by a full 9% year-to-date.

Households and public sector to drive growth in the near term

As is mentioned above, private consumption has increasingly proven the driver of growth as the decade has progressed. Fortunately, this growth has not been based on rising household indebtedness; instead, it has been supported by increased buying power and population growth. Although private consumption growth has eased considerably, it remains a strong driver of domestic demand growth and therefore explains to a large degree why the domestic economy has not contracted significantly despite the weakness of tourism and, more recently, investment.

Private consumption has often had a procyclical impact on the Icelandic business cycle, with households spending freely and amassing debt during upswings rather than putting money away in preparation for the next downturn. The reverse appears to have materialised this time, as households seem to have acted as a countercyclical force because many of them can apparently afford to curtail their spending even in the face of a temporary downturn in exports and investment. The same can be said of the public sector, which now stands on firmer ground financially than during many previous shocks. We expect that households and the public sector will continue to drive growth via private consumption, public consumption, and residential and infrastructure investment.

In our last macroeconomic forecast, published in late September, we projected that GDP growth would hover around zero this year and then measure 1.3% in 2020, with households and the public sector acting as the main drivers of growth. The most recent figures suggest to us that this forecast is still quite valid.