In our view, there is no doubt that an upswing in tourist arrivals in the coming term will be the main determinant of how quickly the economy recovers from the Corona Crisis. How this will develop is highly uncertain, and the outlook has changed rapidly in recent weeks. A number of factors are at play here: the path of the pandemic in Iceland and in trading partner countries, vaccine distribution and inoculation rates, appetite for travel in the countries that generate the most travellers to Iceland, harmonisation of inoculation and immunity certificates, and relaxation of border restrictions, to name but a few.
Tourist travel of pivotal importance for economic recovery
The number of tourists who visit Iceland in the coming term is extremely uncertain. We believe a scenario analysis sheds light on the importance of tourist arrivals for the post-Corona economic recovery.
There are numerous signs that tourists from other Schengen Area countries will be among the first to come back to Iceland. Many Southern European countries that are popular tourist destinations are pressuring the authorities to adopt harmonised rules within the region and to ensure that border restrictions are no more stringent than circumstances require once immunity has become more widespread and the pandemic hopefully on the decline. In this area, we also benefit from one of the four freedoms on which the EEA Agreement rests: that people shall have freedom of movement within Europe, all else being equal.
There is greater uncertainty about Iceland’s other largest markets. The UK has been fighting an uphill battle with COVID-19 recently; however, inoculation efforts are going well, and 15% of the population have received at least one shot, as compared with 3.1% in Germany and 2.4% in France. It is not known whether the British will adopt a regulatory framework like that in other European countries, although we suspect that they will end up doing so.
The US accounts for a large share of visitors to Iceland. Like the UK, the US has been on the defensive against the virus in recent weeks, but on the bright side, inoculation efforts are gaining traction, and just over 8% of Americans have now been vaccinated. There is even more uncertainty about travellers from Asia, where in many countries inoculation programmes are in the early stages and travel restrictions are stringent.
To make a long story short, we expect tourists from mainland Europe to predominate this spring and summer, with British travellers arriving later in the summer and Americans in the final months of the year. We do not expect many tourists from other markets until next year.
Three scenarios: Tourist arrivals between 400,000 and 1 million in 2021
In order to evaluate what this high level of uncertainty about the tourism environment could mean for the economy, we prepared three scenarios for our most recent macroeconomic forecast.
The scenario used as a basis for the macroeconomic forecast itself assumes that 700,000 tourists will visit Iceland, the vast majority of them in H2. We assume 1.3 million arrivals in 2022 and 1.5 million in 2023. By way of comparison, some 2 million tourists visited Iceland in 2019.
In addition to this middle-of-the-road baseline forecast, we prepared an upbeat scenario, which we think has a roughly 10% probability of materialising or being exceeded, and a downbeat scenario, which also has a 10% probability of materialising or being exceeded.
If the optimistic scenario materialises, nearly 1.0 million tourists will visit in 2021, followed by 1.5 million in 2022 and 1.8 million in 2023. If developments are in line with the pessimistic scenario, however, tourist arrivals will be only 400,000 this year, followed by 1.0 million in 2022 and 1.3 million in 2023.
The above-described tourist arrival scenarios strongly affect the short- and medium-term economic outlook, in our opinion. If the upbeat scenario is borne out, GDP growth could approach 5% this year. Unemployment would taper off quite quickly, averaging just under 8% this year instead of the 9.4% in the baseline forecast. The ISK would appreciate more quickly than it would under other circumstances, owing to the rapid increase in foreign exchange revenues, and in turn, inflation would subside quickly, to only 1.4% in 2022. Faster growth in purchasing power, increased optimism, and lower unemployment would fuel a healthy surge in domestic demand after mid-year.
If developments in tourism follow the more pessimistic path, however, GDP growth is not likely to rise much above 1%. Unemployment will top 10% for most of 2021 and taper off more slowly in the years to follow than it would otherwise. The ISK will be embattled for most of the year, as foreign exchange revenues will be – at best – similar to those in 2020. As a result, inflation will be more persistent than it would be otherwise, and domestic demand will be sluggish.
It is worth noting that even in the pessimistic scenario, we assume that the pandemic will ultimately subside and appetite for travel will gradually return. In that case, growth would shift to the following year to a much greater extent. But this would mean vastly increased numbers of business failures and financially distressed households, a protracted fiscal deficit, and the risk that a variety of social problems would become entrenched and prove difficult to uproot. It is therefore vital that the tourism sector regain its strength sooner rather than later.