Developments in primary income have been quite interesting in the recent term. Since the mid-2010s, there has been a sustained surplus on primary income, which consists of cross-border wage payments, on the one hand, and financial income and expense, on the other. In the past several years, the primary income surplus has been due mainly to the latter of these, while net inward wage payments have shrunk.

There are three reasons for this hefty surplus on factor income:

• Owing to Iceland’s rapidly improving NIIP, external assets exceed external liabilities by a comfortable margin, as is discussed below.
• Returns on equity securities, which account for a considerably larger share of external assets than of external liabilities, generally exceed interest expense on loans and debt instruments. This has been particularly the case in the recent term, as international interest rates have been very low and the vast majority of Iceland’s foreign liabilities are denominated in foreign currency.
• There is one important exception to this: various inward foreign direct investment (FDI) projects in Iceland (including in the energy-intensive sector) have been unprofitable, and the recorded losses on those projects are deducted on the expenditures side of the balance on income in the CBI’s books.

Although a sizeable primary income surplus is good news in and of itself, and is probably of benefit to Icelanders in the long run, it is not accompanied by commensurate foreign currency flows. A good example of this is the pension funds’ equity securities holdings, which generate handsome dividend income at the moment. But that income is not repatriated to Iceland; instead, it is reinvested, directly or indirectly, in foreign financial assets. In the short term, then, it could be appropriate that the ISK exchange rate should be on the defensive despite Iceland’s relatively favourable current account balance, even if no consideration is given to how strongly movements in the financial account – i.e., cross-border purchases and sales of financial assets – can affect the foreign exchange market at any given time.

Developments in the current account balance in 2020 to date can be considered quite favourable, given the magnitude of the blow dealt to Iceland’s key exports by the COVID-19 pandemic and related public health measures. As an example of the force of that blow, in Q2 and Q3, after the Corona Crisis swept across the country, Iceland’s revenues from travel and passenger transport by air came to a combined ISK 44bn. This represents a year-on-year contraction of 85%, as the same revenues totalled ISK 288bn in Q2 and Q3/2019.

Fortunately, expenditures on imports have also contracted markedly, which is the main reason why the deficit on combined goods and services trade measures only a scant ISK 31bn despite the export shock.

For the first three quarters of 2020, the current account showed a surplus of ISK 4.5bn, owing to a primary income surplus of just over ISK 50bn, which more than offset the trade deficit. Net outflows due to secondary income – which includes monetary transfers, development contributions, and the like – came to just over ISK 15bn during the period.

The outlook for 2020 as a whole is for a slightly more favourable outcome than the ISK 30bn deficit we had forecast in September. In the years to come, we think it highly likely that the current account will return to a sustained surplus like that seen in 2012-2019.

External position keeps improving

Iceland’s NIIP has improved rapidly in the recent term, and Q3/2020 was no exception. According to CBI figures, the NIIP was positive by ISK 969bn, or 33.5% of GDP, at the end of September. It improved by ISK 142bn (5% of GDP) in Q3, mostly as a result of positive price and exchange rate movements. The net improvement from these changes came to ISK 137bn for the period. Q3 was a fairly bountiful one in foreign securities markets, with prices rising by an average of just over 7%, according to CBI figures, while domestic share prices fell by 2.4% over the same period. Net financial transactions improved the NIIP by ISK 39bn during the quarter.

The composition of Iceland’s assets and liabilities differs markedly from that in other countries. Liabilities due to loans and debt instruments exceeded assets by nearly ISK 1,286bn at the end of September. On the other hand, net holdings in equity securities and unit shares amounted to ISK 1,565bn, and other items – chief among them the CBI’s net international reserves – were positive by ISK 975bn at the end of Q3. Inward FDI exceeded outward FDI by ISK 285bn, however. As is mentioned above, the sizeable surplus on primary income stems largely from a strong net asset position and the above-described difference in the composition of assets and liabilities.

It cannot be said too often that a healthy external asset position and prudence in external trade prior to the Corona Crisis will contribute greatly to Iceland’s economic recovery once the pandemic starts to subside. A strong asset position and large international reserves have provided an important cushion against the depreciation of the ISK in recent quarters. For a small economy with the world’s smallest floating currency, such a strong external asset position is invaluable: it greatly reduces the risk of capital flight and a currency crisis and boosts worldwide confidence in Iceland, as well as delivering better living standards for Icelanders in the future. If Iceland returns to a sustained current account surplus and external assets continue to exceed external liabilities, the NIIP is quite likely to improve even further.