Current account still in surplus … in spite of everything

A sizeable surplus on financial income outweighed the deficit on goods and services trade in H1/2020. The current account balance is set to weaken in H2, but the longer-term outlook is good. Iceland’s IIP has never been stronger and will continue to buttress the economy, as it has in recent quarters.

According to new figures from the Central Bank (CBI), Iceland’s Q2/2020 current account surplus totalled ISK 7bn, less than half that in Q2/2019 and the smallest surplus since Q4/2018. It had already been established that the goods account deficit for the period came to ISK 9.2bn, while the surplus on services trade totalled ISK 3.7bn. The balance on combined goods and services trade was therefore negative in the amount of ISK 5.5bn, the weakest single-quarter outcome since end-2008. CBI figures for the quarter also showed a deficit on secondary income in the amount of ISK 6.8bn, although it was more than offset by the ISK 19.2bn surplus on primary income.

Robust financial income buoys up the current account

The current account surplus for H1/2020 measured ISK 24bn, thanks to a handsome primary income balance. In fact, the current account balance excluding primary income showed a deficit of ISK 3bn in Q1.  The primary income balance has been strongly positive since the middle of the 2010s. The name “primary income” is perhaps somewhat opaque, however. In essence, the primary income balance represents income received for the use of production factors; i.e., cross-border wage income and financial income. As the chart shows, the former of these has moved closer to equilibrium in recent years, after having generated strong inflows in 2010-2015. But the main factor was that financial income exceeded financial expense, and in ever greater measure as the decade drew to a close.

The sizeable income account surplus in the recent past can mostly be attributable to three things.

First of them is the rapidly improving international investment position (IIP), discussed below. External assets now exceed external liabilities by a large margin.

The second factor is returns on equity securities, which account for a considerably larger share of external assets than of external liabilities and generally exceed interest expense on loans and debt instruments.

Third, various inward foreign direct investment projects – aluminium smelters, for instance – have been unprofitable, and in CBI accounts, the losses they generate are deducted from the expenditures side of the balance on income.

A defensive game in the second half?

We think it likely that the current account balance will turn out less favourable in H2 than in H1. The peak tourist season will be shorter and less brisk than previously expected, after public health measures at the border were tightened in mid-August, and it is difficult to envision that foreign tourists will bring in substantial foreign exchange revenues for the remainder of the year. Furthermore, there are signs that the contraction in imports will not be as abrupt in H2 as it was in H1. Nevertheless, there is a decent probability that the primary income balance will continue to show a sizeable surplus in the quarters to come. In June, we forecast a current account deficit of about ISK 60bn. The figures available thus far suggest that we may have been somewhat too pessimistic, although we still think it uncertain whether external trade will be in balance for the year as a whole. A sizeable current account surplus is likely to return in the years to come, however, provided that the real exchange rate does not rise significantly once Iceland’s key export sectors have begun to recover.

Net external assets at an all-time high

According to CBI numbers, Iceland’s IIP continues to improve apace. After several decades in negative territory, the IIP – external assets net of external liabilities – is positive by ISK 838bn, or just over 28% of estimated year-2020 GDP. The IIP improved by nearly 5% of GDP in Q2, driven mainly by booming global share prices.

We have pointed out previously how important this improved external position is at times like the present, with the COVID-19 pandemic battering the economy from all sides. Iceland’s robust income account surplus generates little in the way of foreign currency inflows, partly because the pension funds, as Iceland’s largest owners of foreign securities, generally reinvest foreign financial income (directly or indirectly), while interest on foreign loans must be paid outright for the most part.

But this strong position is a key in boosting the credibility of Iceland’s tiny currency, not least because a sizeable share of the country’s net assets is held in the CBI’s international reserves. This credibility plays an important role in preventing a temporary currency shortage like the one Iceland experienced a decade ago, with the associated collapse in the exchange rate and ensuing inflation spike.

Provided that Iceland maintains a neutral or positive current account balance in coming years, there is a good probability that the IIP will improve even more over time. This will continue to boost the economy and will make economic policy conduct easier, as it has in recent quarters.


Jón Bjarki Bentsson

Chief economist