NIIP improved despite current account deficit in 2024

In 2024, Iceland’s NIIP improved by ISK 515bn, or 11% of GDP, in spite of the year’s sizeable current account deficit, which we have discussed recently. This improvement is due in large part to tailwinds in foreign securities markets. For instance, the MSCI World Index rose 12.5% in exchange rate-adjusted terms in 2024. At the same time, Iceland’s external securities holdings (i.e., portfolio investment in securities) grew by nearly 17%, presumably owing to large-scale purchases by resident investors, particularly pension funds. In this context, it is worth noting that according to CBI data, the pension funds bought foreign currency for just over ISK 84bn in 2024.

Robust foreign shareholdings a major factor

As we have discussed previously, there is a marked difference in the composition of Iceland’s external assets, on the one hand, and its external liabilities, on the other. Although net assets are sizeable, two out of four of the main asset classes comprising the NIIP are strongly negative from Iceland’s perspective.

One of these is interest-bearing debt, which exceeded [interest-bearing] assets by ISK 1,369bn at the year-end. Fortunately, though, most of external liabilities are in the form of foreign interest, and the interest burden on these liabilities is far less than it might be otherwise. [ATH: Do you mean the burden is lighter than it would be if it were domestic interest?]

The second is net inward FDI, which totalled ISK 682bn at the end of 2024, according to CBI data. For a short while, this situation was due mainly to the aluminium smelters. Recently, though, there have been large acquisitions of Icelandic companies by non-resident entities. The Kerecis and Marel deals are two recent examples. Fortunately, corresponding foreign investments by Icelanders have more or less offset this trend, and as can be seen in the chart, the net balance on this item has held broadly unchanged in the recent term.

One asset class accounts for most of Iceland’s favourable NIIP: portfolio investment. Icelanders’ net portfolio investment holdings have grown by leaps and bounds in the past decade or so, reaching ISK 3,355bn by the end of 2024. This surge is due both to investment by the pension funds and other investors and to favourable developments in share prices over the period, foreign market turbulence notwithstanding.

In addition to portfolio investment, the CBI’s international reserves themselves improve the NIIP. Because a large share of the reserves are financed domestically, that portion is not offset by external liabilities. The international reserves have long generated paltry interest income for the CBI, but rising global interest rates have provided a bit of a reprieve in this department. Of course, the interest rate differential is unfavourable for the CBI, to the extent that domestic liabilities offset the reserves.

To put it succinctly, despite the concerns sometimes voiced about inward FDI, foreign investment in Icelandic companies gives no particular cause for concern under current conditions.  The fact is that Icelanders own far more in foreign companies, even though their holdings are diversified and consist to a large degree of UCITS fund shares.

The first decade of positive net assets

As is noted above, Iceland’s NIIP is one of the most positive on record. Actually, it only a decade since Iceland first saw its external assets overtake external liabilities. Before then, liabilities dwarfed assets by dozens of percentage points of GDP.

It is hard to overstate the significance of this turnaround in the NIIP. A small open economy with a floating currency and a negative external position is exceedingly vulnerable to the vicissitudes of global markets and to economic shocks, as we saw in stark relief during the 2008 financial crisis, which forced Iceland to impose broad capital account restrictions to prevent a currency crisis.

That risk is now in the rear-view mirror, thanks to the current positive position. The positive NIIP also has a positive impact on the stability of the ISK, and indeed, as we have seen in recent years, exchange rate volatility has diminished substantially in comparison with the period beforehand. A positive NIIP is therefore a key to Iceland’s ability to run an independent currency without the vastly increased uncertainty and risk that would affect both Icelanders and the non-residents that invest in Iceland or finance the economy in some other way.