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Modest current account deficit and improved external asset position in Q1

Iceland’s current account showed a smaller-than-expected deficit in Q1 and looks set to flip to a surplus in the coming term. The net international investment position (NIIP) has begun to improve again after last year’s dip, providing important support to the ISK and the economy more broadly.

The current account deficit measured ISK 10.1bn in Q1, according to newly published figures from the Central Bank (CBI). Not only is this a smaller deficit than we had anticipated, but it also provides a sturdy springboard for this year. The goods account showed a deficit of ISK nearly 46bn, and the deficit on secondary income was ISK 12bn. On the other side of the equation, the surplus on services trade came to just over ISK 21bn, and the surplus on primary income was slightly more than ISK 26bn.

The tug-of-war between the surplus on services trade and the deficit on goods trade is a time-worn tale in Iceland’s balance of payments history – indeed, it has been the dominant theme for the past decade or so. On the services side, tourism usually plays a leading role, delivering over ISK 94bn in revenues in Q1. Tourism-generated revenues will peak in Q3, and in fact, the current account has consistently shown a surplus in Q3 ever since 2010.

Primary income fluctuates due to aluminium smelters

In a noteworthy development, the primary income balance was strongly positive for the second quarter in a row. Before then, it had shown a hefty deficit, prompting many to believe primary income surpluses had become a thing of the past. Apparently they haven’t, though, and it will be intriguing to keep abreast of developments in the next few quarters.

To put it succinctly, the primary income account reflects cross-border flows stemming from wage payments and investment income. As the chart indicates, it is primarily financial income/expense due to foreign direct investment (FDI) that causes fluctuations from one period to another. A major element in this is the performance of Iceland’s aluminium smelters, which are foreign-owned.

It is interesting, then, to compare trends in aluminium prices with the balance on income over the past several years. The two seem to correlate strongly, and developments in the balance on income therefore align neatly with fluctuations in aluminium prices, including the aluminium smelters’ operating performance in the wake of Russia’s invasion of Ukraine.

In the recent past, aluminium prices have been moving back towards pre-invasion levels, and sure enough, the same pattern – albeit considerably stronger – can be seen in the income account balance. But high aluminium prices do not erode the current account balance as a whole, as Iceland’s net revenues from the aluminium smelters are to some extent linked to aluminium prices through energy sales by Icelandic energy firms. High aluminium prices increase the export value of aluminium, but the portion of this higher price that reverts to the smelters’ foreign owners instead of remaining in the domestic economy is recognised in the income account.

We expect the current account to firm up

The CBI’s figures align well with our newly published macroeconomic forecast, which assumes that the current account balance will improve after a two-year deficit. We do expect a deficit this year, in the amount of 0.7% of GDP, followed by surpluses of roughly 1.5% of GDP per year in 2024 and 2025. For the most part, the more favourable current account surplus reflects the shift from domestic demand to exports as the main driver of growth, with the surge in tourism the main catalyst of export growth.

Improved international investment position

Concurrent with the publication of balance of payments statistics, the CBI released data on Iceland’s NIIP through end-Q1/2023. The NIIP was positive by ISK 1,022bn at the end of March, or 26% of GDP. External assets totalled ISK 5,120bn and external liabilities ISK 4,098bn. The external position firmed up somewhat during the quarter and has improved by a total of ISK 208bn since the end of September 2022. But the NIIP deteriorated by ISK 463bn in the first nine months of 2022, and the previous high is therefore quite a distance away.

What explains this volatility in Iceland’s net asset position? Developments in equity securities markets are a major factor, as share prices plummeted in Iceland and abroad throughout much of 2022. As the chart indicates, Iceland’s net position varies greatly, depending on asset class. The net asset position mainly reflects sizeable net holdings in equities and UCITS funds (owned primarily by the pension funds) and the CBI’s international reserves. On the other hand, Iceland owes a hefty amount in the form of debt instruments and loans, and inward FDI somewhat exceeds outward FDI.

Just as tailwinds in the global securities markets played a part in improving Iceland’s NIIP from 2017 through 2021, the nosedive in those same markets early in 2022 eroded Iceland’s direct and indirect foreign securities holdings, and now that global stock markets are recovering, the NIIP is doing likewise.

It is of paramount importance for Iceland to have as strong an NIIP is it has in recent years, after decades with a negative external position lasting into the 2010s. Over time, net inflows of financial income should reflect this strength, and a more stable ISK relative to earlier times depends in large part on external confidence in Iceland’s ability to honour its short- and long-term obligations.

The NIIP is likely to strengthen further in the next few years, owing partly to the prospect of a more favourable current account balance. Furthermore, the difference in the composition of assets and liabilities, with shareholdings weighing considerably heavier on the assets side, will tend to boost assets over and above liabilities side as global share prices rise. In sum, Iceland’s external balance is enjoying robust good health, and the outlook is relatively bright.


Jón Bjarki Bentsson

Chief economist