The outcome was far poorer than in Q1/2023, when the current account was in deficit by ISK 15bn. Actually, this quarter’s result represents Iceland’s largest Q1 current account deficit since 2008. This quarter’s deficit is due both to a sizeable deficit on goods trade and a slim surplus on services trade. The goods account deficit stems largely from persistently strong imports of investment inputs, while consumer goods imports have grown more slowly. Furthermore, the failure of the capelin catch early this year has some effect, although it will show more vividly in export figures later in the year.

Headwinds in the tourism sector

The slender surplus on the services account is due not least to a weaker-than-expected tourist season in 2024 to date. In Q1, tourist visits were actually up nearly 10% year-on-year, according to figures on departures from Keflavík Airport, but even so, revenues generated by tourists’ travel within Iceland shrank by 2%. The shift is probably due to a reduction in the number of bed-nights per tourist, which naturally means a shorter average length of stay. On the whole, though, the Q1/2024 surplus on items relating to travel, transport, and transit was similar to that a year ago.

On the other hand, the deficit on services trade excluding travel and transport widened between years. For instance, expenditures classified as other business services – which includes a range of expert and technical services – increased by 10% YoY. In addition, financial services expenditures trebled between years, probably owing in part to an increase in the purchase of foreign payment card acquiring services by domestic entities.

Robust factor income

In our opinion, the best news in the latest balance of payments figures is the resilience of the surplus on primary income. In simplified terms, primary income represents cross-border wage and investment income payments. As has frequently been the case in the recent past, net revenues from direct investment, at nearly ISK 15bn, was the biggest contributor, with support from ISK 7bn in revenues from the CBI’s international reserves. These are offset by a deficit of almost ISK 4bn in cross-border wage payments, plus over ISK 6bn in expenditures relating to other investments.

It is always interesting to take a look at the interplay between net revenues from direct investment and developments in aluminium prices. The three aluminium smelters operating in Iceland are all foreign-owned, and their profit or loss at any given time is reflected rather strongly in the balance on income. In turn, their operating performance is linked fairly closely to global aluminium prices.

As the charts indicate, there is a strong positive correlation between aluminium prices and the export value of aluminium, but there is also a significant negative correlation between aluminium prices and the balance on income. High aluminium prices have a positive impact on the goods account balance, as could be expected, but on the other hand, a sizeable share of the gain delivered by high prices is transferred to the smelters’ foreign owners as profit.. Remarkably, rising aluminium prices do not appear to have eroded the balance on income to any significant degree, although the surplus has certainly receded from peak levels. Because aluminium prices have continued rising in recent months, these effects could show more strongly in an improvement in goods trade and a weaker income account balance during the current quarter.

Net external asset position still improving

The CBI has also published statistics on the external position of the economy at the end of Q1/2024. Despite the current account surplus, Iceland’s net asset position has improved considerably. Foreign assets exceed foreign liabilities by ISK 1,775bn, or more than 41% of GDP, and the NIIP improved by ISK 201bn during the quarter. The better outcome was due primarily to price and exchange rate movements, which delivered an improvement of ISK 196bn during the period.

This reflects the difference in the composition of Iceland’s external assets and liabilities. Icelanders’ direct and indirect holdings in foreign equity securities are well in excess of foreign investors’ shareholdings in Iceland. As the chart indicates, Iceland’s handsome net asset position is due to these assets, plus the CBI’s international reserves. On the other hand, inward foreign direct investment (FDI) exceeds outward GDI, and interest-bearing debt is somewhat greater than corresponding external assets.

Brisk tailwinds in foreign markets, where prices rose by an average of 8.5% in Q1, according to the CBI’s press release, are quick to make a positive mark on Iceland’s external position. The lion’s share of these foreign securities are held by Icelandic pension funds, and it looks as though 2024 is starting out quite well for the funds’ asset portfolios. The same can be said of the pension funds’ domestic bond holdings, which are likely to deliver increased net assets and solid returns after lean times in the recent past. Offsetting this is a sluggish period for the Icelandic stock market, where prices fell in Q1 by an average of 3%, according to the CBI.

External trade reflects the adjustment of the economy

Our recently published macroeconomic forecast includes a review of prospects for Iceland’s external trade and external position. The forecast states that the pivot from rapid growth to a contraction is reflected in an improvement in the current account balance. After a two-year deficit in 2021-2022, the current account showed a surplus of 1% of GDP in 2023. The surpluses on the services account and the income account outweighed the deficits on goods trade and secondary income, however.

We forecast a continued moderate current account surplus each year from 2024 through 2026, with export growth overtaking import growth in coming quarters and a period of equilibrium thereafter. Terms of trade have also developed rather favourably in the recent past, and the outlook is for a slight improvement over the forecast horizon.

A rising real exchange rate could dampen prospects for external trade later in the period, however. If the ISK appreciates faster than we anticipate or if terms of trade worsen materially, the current account surplus could flip to a deficit around the mid- to late 2020s.

In our opinion, this robust asset position is enormously important for the ISK and for the economy as a whole. After deteriorating markedly early in the decade, the external position has firmed up again, partly due to price hikes in foreign markets. The outlook is for a moderate further improvement in tandem with a CA surplus and tailwinds in markets abroad.