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Hefty current account deficit and weaker external position in H1/2022

Iceland’s current account showed a sizeable deficit in H1/2022, as tourism only started to pick up at the end of the period and goods imports as well as Icelanders' trips abroad were very strong at the same time. The international investment position (IIP) also deteriorated markedly during the half. Even so, it remains strong, and the outlook is for the current account balance to improve in H2.

The current account balance was negative by just over ISK 39bn in Q2/2022, according to figures just released by the Central Bank (CBI). It is the second-largest deficit since the 2008 financial crisis, if the effects of the failed banks from 2009 through 2015 are excluded. The deficit was even larger in Q1, however, when it measured ISK 45bn. It had already been reported that goods trade generated a deficit of nearly ISK 40bn during the quarter, while services trade generated a surplus of ISK 33bn. Added to CBI data today are figures from the balance on primary income, which showed a deficit of just over ISK 22bn, and the balance on secondary income, with a deficit of slightly less than ISK 10bn.

Record primary income deficit reflects rising aluminium prices

The primary income deficit in Q2 was the largest yet recorded by the CBI, with the exception of the failed banks’ calculated interest expense from the time they fell until their estates were settled – most of which was never paid. To make a long story short, the primary income account reflects cross-border wage payments, investment income, and investment expense. The large deficit is due primarily to strong returns among foreign-owned companies, particularly the three aluminium smelters. Aluminium prices were very favourable to the companies in Q2, as the war in Ukraine and a manufacturing downturn in China pushed prices sharply upwards.

To put it briefly, the smelters’ operations are recognised in balance of payments accounting under goods trade; i.e., as aluminium exports net of inputs such as alumina and carbon anodes. The foreign owners’ profit or loss is then recognised in the primary income account, while the difference is the added value that remains in Iceland in the form of, for instance, wages, goods and services purchases, public levies, and (last but not least) electrical energy purchases.

As the chart indicates, there has been a strong correlation between aluminium prices and the balance on income in recent years. Aluminium prices have fallen markedly in the past few months and are now lower than they were before Russia invaded Ukraine. This trend will probably be reflected in poorer returns for the smelters – and therefore a more favourable balance on income – but naturally, revenues from aluminium exports will decline accordingly.

Better current account balance in the offing

The current account deficit for H1/2022 measured ISK 84bn, as compared with a deficit of ISK 52bn for the entire year 2021. It is worth noting, though, that concurrent with today’s publication, the CBI significantly revised the past several quarters’ balance of payments figures. Not least among the revisions was a re-estimation of the balance on income, as the deficit turned out generally smaller than previously estimated. The 2021 current account deficit was therefore 1.6% of GDP, as opposed to the previous estimate of 2.8%. It is not impossible that the above-mentioned H1/2022 figures will also be revised at some point.

The outlook is for a turnaround in the second half of this year. Tourism revenues are growing by leaps and bounds at present and are closing in on pre-pandemic numbers. As a result, the surplus on services trade will probably be sizeable in Q3 – and comfortably large in Q4 as well, given that revenues from intellectual property exports generally fall in the last quarter of the year. Marine product prices are high as well. In May, we projected that the current account would be broadly in balance for 2022 as a whole. The latest figures suggest that this forecast could turn out a bit too optimistic, but nevertheless, the outlook for upcoming quarters is for a much more favourable current account balance than has been seen in the recent past.

IIP deteriorates after foreign securities markets slide

The CBI also published data on Iceland’s IIP as of end-June alongside the balance of payments figures. External assets net of external liabilities came to ISK 863bn, or 25% of GDP. In 2022 to date, the net IIP has deteriorated by 15% of GDP, after peaking at just over 40% at the end of 2021. It remains quite strong in historical terms, though, and bears witness to the decisive turnaround in Iceland’s external balance after decades of foreign debt collection prior to the 2008 financial crisis.

As the chart shows, the weaker external asset position is due primarily to reduced net holdings in equities and UCITS shares, which in turn stem largely from plunging foreign securities market prices in H1. For example, the MSCI World share price index fell by nearly 20% during the half. Equities and related assets constitute a much larger share of external assets than of external liabilities, as loans owed to foreign creditors and domestic bonds owned by foreign bondholders weigh heavier.

Better times ahead?

Although the IIP has eroded quite a bit and the current account showed a sizeable deficit in H1, the overall situation is very good and the outlook relatively favourable. As is noted above, the current account balance is set to improve markedly in H2, and sooner or later foreign equity markets will start to firm up again.

As a result, we think the IIP is likely to strengthen rather than weaken in the coming term. A favourable IIP and an decent external balance are absolute prerequisites for an acceptable level of stability in a small open economy like Iceland, which furthermore has one of the smallest floating currencies in the world. Fortunately, this appears unlikely to change significantly for the worse, notwithstanding the unrest characterising the global markets and the world economy.


Jón Bjarki Bentsson

Chief economist