How much do tourist numbers matter in the near term?

A post-pandemic upswing in tourist arrivals will be a major factor in the economic upturn in the short run. Developments in the ISK exchange rate, inflation, unemployment, and GDP growth will depend to a considerable degree on increased tourist numbers, and the effects will probably be strongest in 2022. Over time, though, tourism will probably take its place alongside fishing and energy-intensive industry as mature export sectors and pass the growth baton to other segments of the economy.

After a promising surge this summer, Q3 tourist arrivals are set to stumble, owing to the spread of the Delta variant of COVID-19 in Iceland and abroad, its cooling effect on appetite for travel, and its impact on border restrictions.

Even so, Iceland is still widely viewed as a desirable post-pandemic travel destination. Tourists’ swift response to the relaxation of border restrictions in 2020 and 2021 indicate keen interest in visiting Iceland. Foreign forecasts suggest a fairly rapid increase in personal travel worldwide in the coming term.

The recent announcement of the US decision to open its borders to vaccinated tourists on 1 November is the most recent indication of the brightening outlook for cross-border tourism, and in coming quarters, a similar relaxation of border restrictions can be expected from the home countries of most of Iceland’s tourists.

Forecasting affected by tourism-related uncertainty

Because tourism is Iceland’s largest export sector, its recovery is of pivotal importance for the economy in the next few quarters. Job creation and growth in short-term export revenues therefore depend on developments within the sector.

In our newly published macroeconomic forecast, we project that 600,000 tourists will come to Iceland this year. Some 337,000 have already visited in the first eight months of the year, and we assume that another 260,000 will travel here in the final four months. If our forecast materialises, this year’s total will be less than one-third of the 2019 figure.

For next year, we expect tourist arrivals to more than double, to just under 1.3 million, and in 2023 we expect a 15% YoY increase, to nearly 1.5 million.

Developments in tourist arrivals are subject to considerable uncertainty, however. Because of this, we prepared alternative scenarios based on assumptions that are either more pessimistic or more optimistic than those in the baseline forecast. The assumptions and the forecasts themselves can be found in the Appendix at the end of the macroeconomic forecast. Year-2021 tourist arrivals could range from 560,000 to 700,000, and in 2022 the range is from 900,000 to 1.5 million.

Different economic scenarios

Developments in tourist arrivals will greatly affect economic developments in the coming term, with the strongest impact coming in 2022. To simplify, we assume here that the revenue generated by each tourist will be broadly in line with the average of the past year or so. But head counts are not the only variable of importance. A slower increase in tourist numbers, concurrent with longer stays and more activity from each visitor, could easily deliver the same economic benefit as the head count pattern sketched out in the baseline and the two alternative scenarios. The converse applies, of course, if the increase in tourist numbers is greater among those who stay for a short time and spend very little while in the country.

The pace of growth in tourist flows has a strong impact on developments in services exports and, by extension, on the current account balance. A more rapid increase in tourist numbers brings with it stronger export growth, an earlier return to a current account surplus, and a speedier appreciation of the ISK than would otherwise occur. This, in turn, will bring inflation down sooner, which will be reflected in stronger real wage growth.

Unfavourable developments in tourism will call forth the opposite chain of events. Export growth will be more sluggish, the current account balance less favourable, the ISK weaker, and inflation more persistent.

The developments described above will be reflected in the economy in a number of ways. Rapid job growth in the labour-intensive tourism industry will lead to lower unemployment in the coming term. Private consumption growth will be stronger because of lower unemployment, faster real wage growth, and a generally more optimistic population. Business investment will probably grow still more than it would otherwise, and demand for housing will be stronger. Domestic demand will therefore be livelier, just as exports will, although imports will also grow more rapidly. According to the optimistic alternative scenario, GDP will be 1.2% higher at the end of the forecast horizon than in the baseline example.

On the other hand, if tourist numbers increase slowly, as in the pessimistic scenario, GDP will be 1.7% lower than in the baseline, as private consumption, investment, and exports will all grow more slowly. This will be offset to a degree by weaker import growth. It is worth noting that these scenarios do not assume aggressive economic policy responses. But we are convinced that the Central Bank (CBI) will weigh the changed inflation outlook against various economic scenarios, and to some degree the Government will adjust its investment plans to accord with developments further ahead.

Tourism comes of age

In short, the recovery of tourism will be a major determinant of how quickly the economy rebounds in the immediate future. Thereafter, however, other sectors will be increasingly important in terms of growth. This is particularly the case for services sectors such as the creation and exportation of intellectual property, which has been growing rapidly in recent years, albeit in the shadow of the past decade’s surge in tourism. Further ahead, then, tourism will probably take its place beside fishing and energy-intensive industry as mature key export sectors, while sectors that rely more on knowledge and inventiveness than on natural resources will take over as the drivers of export growth.


Jón Bjarki Bentsson

Chief economist