Is Iceland’s goods account deficit weakening the ISK?

Iceland’s hefty goods account deficit in October is due partly to strong imports of investment inputs and motor vehicles, on the one hand, and relatively sluggish exports, on the other. Developments in goods trade suggest that demand growth and activity in export manufacturing have lost pace. A handsome surplus on services trade offset the goods account deficit in Q3, and the outlook is for a fairly well balanced current account this year.

In October, the balance on goods showed a deficit of ISK 50.5bn, according to recently published preliminary figures from Statistics Iceland (SI). This is the largest single-month goods account deficit since October 2022, and more than double the deficit in September. The month-on-month surge is due both to strong imports and to a contraction in exports.

As the chart shows, the MoM increase in imports stems mainly from growth in imports of investment goods, which soared to a twelve-month high. Importation of passenger cars jumped as well, growing by more than a third year-on-year at constant exchange rates. This is a somewhat larger increase than was indicated by recently published figures from Bílgreinasambandið (BGS), an umbrella organisation representing companies engaged in the sale and service of motor vehicles, which showed a 19% YoY increase in new registrations of passenger cars in October.. The difference may be due to the importation of more expensive cars this autumn than in the same period a year ago. In this context, it is worth noting that electric cars account for a growing share of total sales, doubtless because of changes in taxation that are due to take effect at the end of the year. In all, goods imports totalled ISK 122bn in October.

It is noteworthy that importation of consumer goods other than food, cars, and fuel grew nearly 5% between October 2022 and October 2023, whereas the price of imported consumer goods in the CPI increased by 3.9% over the same period. If we assume that this increase reflects changes in import prices, it appears that importation of generic consumer goods other than food and cars has grown only marginally in volume terms.

Goods exports shrank slightly MoM, totalling ISK 71bn in October. This is due mainly to a contraction of one-fifth in marine product exports, plus a 12% MoM decline in manufactured goods exports.

Contraction in both imports and exports

In our small open economy, goods trade tends strongly to move with the business cycle. As a result, it is interesting to examine developments in imports and exports when adjusting for movements in the ISK exchange rate, using a moving average to depict the underlying pattern more clearly. YoY growth in both imports and exports was very strong from spring 2021 through autumn 2022, when the pace began to slow markedly, although it remained stronger on the imports side than on the exports side.

By now, however, both imports and exports of goods are contracting between years. In the past three months, goods imports have shrunk nearly 12% by this measure, and goods exports have fallen almost 16%. In this context, it probably makes a significant difference that foreign currency prices of export products have declined – particularly to include aluminium – as have various imported input prices. Even so, this indicates a shift in the economy. Developments in imports suggest that growth in consumption and investment has subsided, while developments in exports indicate that exported goods volumes have stagnated after having grown somewhat in the past two years.

Over the first ten months of 2023, the goods account deficit totalled ISK 336bn, an increase of ISK 85bn YoY. But the goods account only tells half the story about external trade. In recent years, goods account deficits have been the rule, not the exception, and have often been outweighed by surpluses on services trade. Actually, a wider deficit on goods trade in recent quarters partly reflects input purchases and investment activity relating to growing foreign currency generation in the tourism industry and other services export sectors.

A smaller service account surplus reflects the end of the tourism high season

Figures on the past few months’ services trade are not yet available, but in the first seven months of 2023, it generated a surplus of ISK 168bn. Presumably, August and September delivered strong surpluses as well, given visitor numbers and payment card turnover figures. October probably showed a much smaller surplus, however, owing to the decline in tourist numbers after the peak season ended.

Based on available data and historical trends, we have made a rough estimate of the past few months’ developments in services trade. That estimate suggests that the services account surplus was probably in the neighbourhood of ISK 150bn in Q3, and that the balance on combined goods and services trade showed a surplus in the range of perhaps ISK 30-35bn during the quarter.

Our estimate accords quite well with developments in the ISK exchange rate in recent months. The ISK strengthened through the end of August but has lost considerable ground since the beginning of September. To be sure, developments in goods and services trade are only one of many factors that affect currency flows to and from the country at any given time. Items such as factor income and transfers, cross-border investments, and position-taking via forward contracts make a strong impact as well, sometimes far outweighing the effects of direct trade in goods and services on the exchange rate.

Even though goods trade was relatively unfavourable in October, we expect a fairly balanced current account in 2023. The current account deficit in H1 proved no larger than ISK 4bn, according to figures from the Central Bank, and it could well be that the current account will indeed show a small surplus for the year as a whole, as we forecast in late September.


Jón Bjarki Bentsson

Chief economist