Developments in aluminium prices affect various current account components

The primary income balance has grown steadily more unfavourable in recent quarters, flipping from being positive by over ISK 39bn in Q4/2023 to being negative by ISK 10bn a year later. This item in the CBI’s accounts captures cross-border payments due to revenues and expenses from the use of so-called primary income. Primary income refers to payments for contributed labour and capital – in other words, wage payments, interest payments on loans and other debts, and dividends or recognised losses on equity.

In recent years, cross-border wage payments have been broadly in balance. Since the beginning of the 2020s, this portion of the primary income balance has fluctuated between a surplus of over ISK 2bn and a deficit of just under ISK 2bn, but in Q4/2024, outgoing wage payments hit a record-high ISK 1.7bn. On the other hand, interest income on the CBI’s international reserves has grown in tandem with rising interest rates abroad, reaching a total of just over ISK 7bn in Q4/2024. Net income from securities holdings totalled nearly ISK 4bn during the period, not least because of the pension funds’ large stock of foreign assets, the vast majority of which are invested in foreign equity securities. Furthermore, financial expense due to “other investment” in the CBI’s books came to slightly more than ISK 7bn for the same period.

In the recent past, however, the biggest fluctuation in the balance on income has been in financial income and expenses due to foreign direct investment (FDI). A major element in this is the performance of Iceland’s three aluminium smelters, which, as is well known, are wholly foreign-owned. As we have discussed previously, there is a strong correlation between aluminium price movements and the balance on income (shown in the chart above). Aluminium prices have been rising in the recent term, and the balance on income has worsened accordingly. On the other hand, revenues from aluminium exports have increased. Ultimately, then, domestic value added from aluminium processing in Iceland is far less volatile, as it mainly comprises electricity purchases, wage payments, goods and services purchases, and payments of public levies to domestic entities.

The link between electricity prices and aluminium prices has weakened, and wage payments and services purchases are presumably inelastic in the short run. According to the website of Samál, the Association of Icelandic Aluminium Producers, the smelters’ domestic expenses totalled ISK 160bn in 2023, and it is likely that year-2024 expenses were somewhat higher, owing to the impact of higher aluminium prices on electricity purchases and public levies.

Hefty current account deficit in 2024, but improvements are in the offing

Iceland’s current account deficit hit nearly ISK 117bn last year, its largest since the financial crisis struck in 2008. As a share of GDP it measured 2.5%, whereas we had assumed in our macroeconomic forecast from January that the 2024 deficit would be 1.5% of GDP. As the chart shows, however, Iceland’s deficit was generally far larger during the pre-crisis boom years 2004-2008. Adjusted for developments in GDP over the period, the difference is even greater, as the current account deficit peaked at 23% of GDP in 2006.

The improvement over the past decade and a half stems mainly from two factors:

• First of all, the emergence of tourism as Iceland’s largest export sector, coupled with growth in intellectual property companies’ services exports, has generated surpluses that were all but non-existent before the financial crisis and have been large enough to offset Iceland’s endemic goods account deficits, often with room to spare. In this context, however, it should be noted that tourism requires significant amounts of imported goods to generate services revenues, and growth in the sector is accompanied to some extent by a larger goods account deficit.
• Second, there has been a shift in the balance on income, which has flipped from being strongly negative early in the century, when Iceland was heavily leveraged, to being positive more often than not in recent years. The main reason for this is the marked improvement in Iceland’s international investment position.

We find it striking how well the ISK has held its ground in recent quarters despite the sizeable current account deficit. This underscores our opinion that as long as the current account deficit is no larger than it has proven to be, other factors often carry greater weight as regards short-term foreign currency flows to and from the country.

We are optimistic that the current account will move towards a better balance in the coming term. In January, we projected that Iceland’s current account balance would show a deficit 0.3% of GDP in 2025 and be broadly neutral in 2026. This year has begun rather haltingly in this respect, though, and according to newly published figures from Statistics Iceland (SI), the goods account balance was negative by nearly ISK 58bn in February, the largest single-month deficit in ages. But it should be borne in mind that this massive deficit comes on the heels of a much smaller one in January (ISK 5.6bn) and that goods trade figures often fluctuate widely from month to month.

On the whole, though, we expect export growth to overtake import growth, thereby promoting a more favourable current account balance in 2025 than in 2024. If the deficit proves more persistent, however, it could put steady downward pressure on the exchange rate, even though the ISK has weathered the storm until now.