The current account surplus totalled ISK 61.8bn in Q3/2023, according to newly published figures from the Central Bank (CBI). This is three times the surplus from the same quarter in 2022, as well as being Iceland’s largest Q3 surplus since 2019. It had already been established that the ISK 150bn surplus on services trade would outweigh the ISK 94bn deficit on goods trade. The CBI’s balance of payments figures also include the balance on primary income, which was positive by nearly ISK 19bn, and secondary income, which showed a deficit of ISK 13bn.
Q3 current account surplus trebles year-on-year
Iceland’s third-quarter current account surplus trebled between years, and the outlook is for a surplus in 2023 as a whole, after two consecutive deficit years. The net international investment position (NIIP) improved by ISK 145bn during the quarter, and net external assets now equal nearly one-third of GDP. This improved balance indicates that the economy is readjusting after the recent expansionary period.
The primary income balance reflects cross-border income and expense payments due to wages, on the one hand, and investments (interest and dividends), on the other. After a short-lived deficit, the primary income account has been in surplus for the past four quarters, as it generally was in the late 2010s.
Balance on income affected by aluminium smelters’ performance
As the chart indicates, income and expenses due to direct investment explain much of the past few years’ fluctuation in primary income. A major element in this is the performance of Iceland’s three aluminium smelters, which are wholly foreign-owned. When the smelters generate operating losses, the losses are entered as a deduction on the expenditures side, which is exactly what happened in Q3, when this item in the balance of payments was negative by just over ISK 11bn.
The chart shows a fairly strong correlation between global aluminium prices and the balance on income in the balance of payments. Of course, this does not imply that the current account suffers if the smelters generate profits, as the domestic value added from aluminium manufacturing also shows in goods trade figures, and an increase there usually far outweighs the deduction in the income account.
For the first three quarters of 2023 combined, the current account surplus measured just over ISK 42bn, a radical change from last year’s ISK 54bn deficit for the same three-quarter period. This is a clear sign of a turning point in the Icelandic economy, with exports taking over from consumption and investment as the main driver of growth.
In our macroeconomic forecast from late September, we projected that the current account would flip to a surplus this year – actually, we have been saying so for quite some time. The figures published now fall well into line with our forecast, which may even turn out on the low side once all is said and done. For the next two years, the outlook is for a continued modest current account surplus.
Improved international investment position
The CBI also published a summary of Iceland’s NIIP as of end-September. Since mid-year, the NIIP has improved by ISK 145bn, and external assets net of external liabilities totalled ISK 1,272bn, or just over 31% of GDP. The external position has improved markedly in recent quarters, after taking a nosedive earlier in the decade. It was at its most positive, 34% of GDP, in the beginning of the 2020s, whereas until the 2010s it had always been negative by dozens of percentage points of GDP.
As the chart indicates, Iceland’s external assets and liabilities differ greatly in composition. For instance, domestic holdings of foreign equities and UCITS shares exceed foreign investors’ holdings of equivalent domestic assets by ISK 2,410bn. The lion’s share of them are held by the pension funds, which owned equities and UCITS shares totalling ISK 2,492bn at the end of September. In addition, the CBI holds a portion of these net assets in its international reserves, and the net position relating to these and other smaller asset classes totalled ISK 697bn as of end-September.
On the other hand, inward foreign direct investment exceeds outward FDI by ISK 615bn, and as of end-Q3, Iceland’s foreign borrowings exceeded its direct and indirect foreign lending by ISK 1,221bn. Fortunately, the bulk of this external debt is denominated in foreign currency and therefore bears far lower interest than it would otherwise. Nevertheless, foreign interest rates have been on the rise recently, and interest expense on these foreign loans is therefore likely to increase steadily as a share of the debt position in the coming term. Ultimately, though, investment income from Iceland’s foreign shareholdings will probably come out on top, given that the pension funds reinvest the vast majority of it as long as inflows of premiums exceed outflows of pension benefits.
Favourable shift towards a better balanced economy
On the whole, the CBI’s new figures can only be viewed as highly favourable, and they are well in sync with other indicators implying that the economy is rebalancing rapidly, as we have reported recently. We are of the opinion that the brief current account deficit episode is at an end for now. Although we have little chance of returning to the days of the fat surpluses that characterised much of the 2010s, the outlook is for a well balanced current account in coming years.
It is gratifying to see Iceland’s NIIP improving again, and it appears likelier to strengthen further rather than weakening. Positive developments in the external balance and external asset position are enormously important for a country like Iceland, a small open economy with a floating currency, which in the past has been well acquainted with the pitfalls of imbalances and a poor external asset position.
