A large and growing goods account deficit largely reflects the steady recovery of domestic demand over the course of this year. Increased consumption and investment call for more imported inputs. In addition, growth in tourism itself calls for an increase in inputs, as well as in investment goods such as transport equipment of all shapes and sizes. But it is cause for celebration that the surplus on services trade should once again outweigh the deficit on goods trade in the current account balance equation. Presumably, this pattern will continue in the coming term, provided that the recovery of tourism does not suffer a prolonged setback.

The surplus on primary income widened somewhat between quarters but was still slim relative to recent years. As the chart shows, the recent trend in primary income has been towards smaller surpluses, after a series of hefty ones in the past few years. A peek under the hood shows, though, that the news is not all bad, as the trend is due in part to the fact that foreign-owned domestic companies are not recording losses to the same degree as they did previously. Presumably, much of this is due to companies in the energy-intensive sector, whose product prices have risen steeply in recent quarters. In other respects, the primary income surplus largely reflects Iceland’s favourable external position and the fact that Icelanders’ wage income from abroad somewhat exceeds domestic companies’ wage payments to foreign workers without a legal address in Iceland.

Deficit expected for 2021, but a surplus is in the offing

For the first nine months of 2021, the current account showed a deficit of nearly ISK 48bn, which stems mainly from the sizeable deficit on goods trade, itself largely a result of the above-mentioned surge in private consumption and investment.

According to our updated macroeconomic forecast, which takes account of the expected capelin boom, the current account will show a deficit of roughly ISK 45bn for 2021 as a whole. The most recent figures suggest that the actual deficit could turn out somewhat smaller, however. But the outlook is good further ahead, as it is highly likely that the recovery of tourism and the strong capelin season will generate vastly increased export revenues. We project that the current account surplus will exceed ISK 100bn in 2022 and grow still larger in 2023. Because current account surpluses have been the rule rather than the exception in the past decade, it looks as though this year will merely be an outlier.

Historically strong external position

The improvement in Iceland’s international investment position (IIP) shows no sign of abating, even in spite of the current account deficit in H1. At the end of Q3, the net IIP was positive by ISK 1,294bn, or over 41% of GDP, the best the country has ever measured. Movements in the financing balance improved the NIIP by ISK 89bn in Q3, and price and exchange rate movements improved it by ISK 86bn, even though prices in foreign securities market fell by an average of half a percentage point between quarters.

It is interesting to examine the composition of the NIIP, as the assets and liabilities sides differ from one another. For example, foreign debt obligations – i.e., foreign-owned bonds and direct borrowings – were well in excess of comparable foreign assets. This is because the Treasury, the banking system, and the country’s largest firms obtain part of their financing in global markets, while the banking system’s foreign lending activities are limited and only a small portion of the pension funds’ foreign assets are in bonds, foreign bank deposits, and related assets. Although net external liabilities of this type total just over ISK 1,334bn, it should be borne in mind that they are largely denominated in foreign currencies and bear very low interest at present.

On the other hand, residents’ holdings in foreign equities and unit shares exceed corresponding liabilities by more than ISK 1,990bn. Much of this is due to the pension funds, which owned foreign stock and unit shares valued at the equivalent of ISK 2,189bn as of end-September, according to CBI data.

In addition, the CBI itself holds a fair chunk of Iceland’s foreign assets, with international reserves totalling ISK 939bn at the end of September. But the international reserves generate minimal financial income, as the CBI is required to invest them in low-risk instruments at short-term interest rates that, at present, are close to historical lows.

We consider Iceland’s strong NIIP a very important sign of strength for a small open economy with the world’s smallest floating currency. For example, it has quelled fears of capital flight and a post-pandemic currency crisis among residents and non-residents alike – fears that would be unfounded. It is no coincidence that the improvement in the NIIP and the sustained current account surplus have gone hand-in-hand with greater exchange rate stability and more acceptable inflation, although inflation has certainly risen in the recent term, as it has in other countries. With the expected flip back to a current account surplus in the coming term, it is quite likely that the NIIP will improve even further. Therefore, this important foundation of the domestic economy, which fosters steadily improving living standards in Iceland, looks set to keep growing stronger.