Actually, as the chart indicates, Iceland is no stranger to hefty goods account deficits. What is missing now relative to previous years is a services account surplus large enough to overtake the deficit on goods trade. To simplify, we can say that the past few years’ goods account deficits have reflected two things: rapidly growing use of inputs for the tourism industry, on the one hand, and net positive imports for domestic consumption and investment, on the other. But tourism-generated revenues have been strong enough to offset the goods account deficits, and with room to spare – that is, they were until the Corona Crisis came to town.

The surplus on primary income was weak during the quarter – in fact, the smallest in nearly three years. But this is not entirely a bad sign, as a large portion of it is probably due to reduced losses on Icelandic aluminium smelter operations. In the recent past, these losses have shown as negative investment expense from foreign direct investment, which were always destined to be a short-lived. In other respects, the primary income surplus reflects Iceland’s positive asset position, which means investment revenues exceed expenses during the period in question.

The worst H1 since the 2008 crash

It is safe to say that the H1/2021 current account balance was poorer than expected. The total deficit came to ISK 54bn, the largest since the 2008 collapse. As is mentioned above, it stems from a large goods account deficit, which in turn stems from strong import growth. What is noteworthy this time around is that, unlike last year, the surpluses on the services and income accounts are not big enough to fill the gap. In our opinion, this wide deficit also goes fairly far in explaining developments in the ISK since mid-year, when investment-related inflows started to taper off and the exchange rate to slide again after rising markedly early this year.

In May, we forecast that the current account would show a surplus of nearly ISK 30bn for 2021 as a whole. The figures for H1 suggest that this may have been overly optimistic, however. That said, we do expect the current account to firm up in H2. Tourism-generated export revenues first began to recover towards the end of Q2, and they will probably be quite sizeable in the second half of the year, although short-term uncertainty about tourism has reared its ugly head once again. Of course, revenues from intellectual property exports in the pharmaceuticals industry could provide a windfall in Q4, as they did in 2020. But as we see it, there is doubt about whether H2 will be strong enough to outweigh the fat deficit in H1. It could well be that 2021 will see Iceland’s first full-year current account deficit since 2011. We remain optimistic, however, that the current account will regain right itself in coming quarters, once tourism returns to full strength.

IIP still improving

Fortunately, the past few quarters’ deficit has not had a discernible impact on Iceland’s IIP, which has been improving over the past decade. Foreign assets net of foreign liabilities came to ISK 1,120bn, or 36.6% of estimated GDP, at the end of June. This represents an improvement of nearly ISK 80bn since April, most of it thanks to the rise in value of Icelanders’ foreign securities during the period. Foreign assets totalled ISK 4,566bn at the end of June, and external liabilities ISK 3,445bn.

As before, it is interesting to examine the composition of the IIP, as assets and liabilities are composed rather differently. Foreign obligations in the form of bonds and direct loans weigh quite a bit more heavily than assets of the same type. 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 and related assets. Although net external liabilities of this type total just over ISK 1,335bn, it should be borne in mind that they are largely denominated in foreign currencies. Interest expense on them is limited at present, as rates on major currencies are extremely low.

Furthermore, inward FDI outweighs outward FDI, presumably due in large part to foreign-owned energy-intensive industrial investments such as data centres and some parts of the high-tech sector.

On the other hand, residents’ holdings in foreign equities and unit shares exceed corresponding liabilities by more than ISK 1,840bn. Much of this is due to the pension funds, which owned foreign stock and unit shares valued at the equivalent of ISK 2,048bn as of end-June, according to CBI data.

In addition, the CBI itself holds a fair chunk of Iceland’s foreign assets, with international reserves totalling ISK 859bn at the end of June. 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 zero in most major currencies.

In our view, Iceland’s strong IIP has been a major factor in boosting the country’s economic resilience against the blow dealt by the COVID-19 pandemic. This fosters much greater confidence in the ISK than existed back in the day when export sectors were hit hard and consequently, concerns about currency or debt crises are scarce these days. Presumably, the IIP will strengthen even further when the current account surplus widens again in the coming term.