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Balance of payments and external position on the mend

Iceland’s current account deficit in 2022 narrowed compared to 2021 to measure 1.5% of GDP, a far better outcome than we had anticipated. A surplus on cross-border services trade and financial income offset a gaping goods account deficit. Iceland’s external position is strong and looks set to remain so in the coming term.

According to newly published figures from the Central Bank (CBI), the current account deficit measured just over ISK 20bn in Q4/2022. This is a much smaller deficit than we had envisioned, as the goods account deficit for the quarter measured ISK 86bn and the services account surplus ISK 24bn. The more favourable outcome stemmed from a surplus of ISK 49bn on net primary income, the biggest primary income surplus in the history of CBI data. Net secondary income showed a deficit of just under ISK 8bn for the quarter.

As the chart shows, financial income and expense due to foreign direct investment have played a key role in the primary income balance over the past six years or so. According to the CBI press release, the positive results in Q4 were due largely to a poorer performance by foreign-owned companies, whose operational losses are recorded as income in the balance of payments.

Presumably, this refers mainly to the aluminium smelters. Global aluminium prices have been fluctuating widely in the recent term and have correlated quite strongly with the primary income balance in the last six years. Of course, this does not mean that high aluminium prices are flat-out bad for the balance of payments and low prices are good. High aluminium prices show strongly in goods export revenues, and the value aluminium manufacture generates for the Icelandic economy can be approximated by subtracting manufacturing inputs and aluminium companies’ calculated earnings from those export revenues. Among other things, this added value has delivered strong results for domestic energy companies recently, as can be seen, for instance, in Landsvirkjun’s recently published annual accounts.

Current account deficit smaller than expected

A more favourable Q4 current account balance means that the deficit for 2022 as a whole is considerably smaller than we had projected. It came to ISK 58bn, or 1.6% of year-2022 GDP, virtually the same share of GDP as in 2021. The goods account deficit for 2022 totalled ISK 214bn, the surplus on services ISK 187bn, the primary income surplus just over ISK 6bn, and the deficit on secondary income ISK 37bn.

The outlook is for an improvement in the current account balance in the coming term. In our macroeconomic forecast from early February, we projected that this year’s current account deficit would total ISK 57bn, followed by two years of equilibrium. That forecast still appears to be fully valid, and if anything, developments in the quarters to come could turn out slightly more favourable than we anticipated in February.

External asset position firming up

The CBI also published data on Iceland’s international investment position this morning. As before, external assets net of external liabilities are sizeable, totalling ISK 910bn at the end of 2022. This equates to 24% of GDP for the year, which represents an improvement after the significant erosion early in 2022.

The weaker IIP from autumn 2021 through mid-2022 is attributable in large part to unfavourable developments in foreign share prices, although the funding of the current account deficit is also a contributor. As the chart indicates, foreign shareholdings and mutual fund holdings constitute the backbone of Iceland’s net external assets, but these are outweighed by direct foreign ownership of domestic companies plus loans and bonds held by foreign owners. Furthermore, a portion of Iceland’s net external assets are held in the CBI’s international reserves.

IIP set to remain strong

The fluctuation in net external assets is due primarily to last year’s marked decline in the price of the pension funds’ foreign assets, which consist mainly of stocks and mutual funds. The situation has turned around as foreign markets have rallied, though, and further improvement in Iceland’s IIP can probably be expected as time passes.

Moreover, a healthier current account balance will help to maintain a strong IIP, and it is invaluable for Iceland to be a net creditor vis-à-vis the rest of the world rather than being subject to the tender mercies of creditors abroad. Fortunately, there appears to be little likelihood that Iceland will sink back to anything resembling the decade prior to the financial crisis, when its external assets were always dwarfed by its external liabilities.


Jón Bjarki Bentsson

Chief economist