Goods account deficit a factor in ISK depreciation

This autumn’s fat deficit on goods trade probably played a leading role in the weakening of the ISK during the period. Although some of that deficit is due to the tourism industry’s growing need for inputs, domestic demand is also a major factor. The deteriorating outlook for the current account in coming quarters means that the ISK may well end up weaker than we previously expected.

At present, the ISK is down 3% in trade-weighted terms since the beginning of November, after fluctuating widely during the month. The first half of November saw a fairly rapid depreciation, and the Central Bank (CBI) ended up intervening three times in the FX market, selling a total of EUR 33m in order to rebalance the interbank market and prevent spiral formation. It was the CBI’s first intervention since mid-September.

The ISK has weakened by 6% in trade-weighted terms since mid-year. This has taken many observers somewhat by surprise – ourselves included – given the surge in tourism since the spring and the accompanying jump in revenues, which, if anything, has been even stronger than we had expected.

Gaping goods account deficit this autumn

There are numerous reasons for this trend, but goods trade is undeniably one of them. Goods trade has been generating sizeable deficits ever since mid-year – larger ones than we had projected in our macroeconomic forecast from September.

Newly published figures from Statistics Iceland (SI) show that November was anything but an exception to that rule. According to SI’s preliminary numbers, the November deficit came to ISK 42bn. Only three times has the deficit on goods trade been larger than this in ISK terms, and two of those instances were September and October 2022. The combined goods account deficit for these three months is ISK 145bn, dwarfing the ISK 59bn deficit for the same three months in 2021.

Goods imports came to ISK 121bn in November, a year-on-year increase of 20%. The largest proportional increases between years were in imported fuel (up 77% in ISK terms), passenger cars (65%), and investment goods excluding transport equipment (38%). As regards motor vehicle imports, it is worth noting that according to a press release from the Bílgreinasambandið agency, new vehicle registrations were up by more than a third YoY in November, after a slight decline in October.

The surge in fuel imports is due both to higher prices and increased import volumes. Frequent international travel and increased driving within Iceland have called for more imported fuel, and the price of oil and petroleum products was generally higher this autumn than it was a year earlier. A barrel of Brent crude, for instance, cost 12% more in US dollar terms in November 2022 than in the same month of 2021, even though the USD appreciated markedly against many other currencies, including the ISK, over that period.

Increased imports of investment and consumer goods this autumn also reflect growing domestic demand and line up well with other indicators of developments in demand. According to recent figures from SI, domestic demand – mainly a reflection of consumption and investment – increased by 4.8% YoY in Q3 and by 7.3% over the first nine months of 2022. Furthermore, it looks as though Q4 will be just as strong.

Goods exports lose momentum

Goods exports have softened somewhat in recent months relative to the spring and summer. In all, goods were exported to the tune of ISK 79bn in November, an increase of 9.5% YoY in ISK terms. The main drivers here were a 14% rise in exports of industrial goods excluding aluminium, and an 11% increase in aluminium exports. Marine product export values stood virtually still between years, however, as high global market prices for many products were offset by a contraction in export volumes. It should also be noted that farmed fish is classified as an agricultural product in SI’s books, not a marine product, and that aquaculture export revenues more than doubled between years, to ISK 5.5bn.

Other factors have presumably contributed to the past few months’ ISK depreciation as well. In a newly published memorandum from the CBI to the Financial Stability Committee (FSN), it is pointed out that worsening financial conditions abroad have made it harder for Icelandic financial institutions to obtain foreign credit-based funding. Furthermore, in the CBI’s most recent issue of Monetary Bulletin, it is pointed out that the pension funds have stepped up their foreign currency purchases in tandem with the increase in their scope for foreign-denominated investment, which stems from falling prices in foreign equity markets. Moreover, the CBI noted that forward currency sales had declined and forward currency purchases increased in September.

Headwinds in the offing for the ISK

The appreciation of the ISK in the first five months of 2022 has reversed in full, and the exchange rate is now broadly where it was a year ago. Without a doubt, external trade will continue to play a leading role in exchange rate movements in the coming year. The outlook for the ISK has darkened somewhat since we issued our macroeconomic forecast in late September.

Although tourism and other services sectors will surely continue to give the economy a shot in the arm, the likelihood of a persistent current account deficit has increased, not least because of the continued gaping deficit on goods trade. As a result, the ISK has a steep hill to climb in coming quarters, as a floating currency must respond to major changes in external trade and play a role in bringing about greater stability. This will probably require a weaker ISK than we projected back in September.


Jón Bjarki Bentsson

Chief economist