In August, the balance on goods was negative by ISK 36bn, according to recently published preliminary figures from Statistics Iceland (SI). The only time this century that Iceland has recorded a larger goods account deficit in ISK terms was this past June. In June, however, the deficit reflected unusually strong aircraft imports, whereas the August deficit stems from a number of import-side factors.
Second-largest goods account deficit this century
The August deficit on goods trade, Iceland’s second-largest since the turn of the century, was driven by booming imports in connection with strong consumption and investment. Unfavourable external trade in recent months has contributed to the weakening of the ISK since mid-year.
Broad-based import growth
Goods imports totalled ISK 91bn in August, almost double the August 2020 total, even though the ISK appreciated by nearly 8% in the interim. Unlike in June, when imports of ships and aircraft totalling over ISK 23bn made a strong impact on the figures, August imports stem from a number of categories, as the chart indicates.
For instance, imports of general investment goods totalled ISK 20.6bn, a record in the 21st century to date. Furthermore, commodity imports have grown markedly in ISK terms, presumably due to increased volume, as well as to the recent surge in global market prices.
Imports of passenger cars totalled ISK 6.2bn, and according to a recent press release from Bílgreinasambandið (the Icelandic association of motor vehicle sales and service entities), new vehicle sales were up almost 45% year-on-year in August. The press release noted in particular that sales of cars to rental agencies had doubled YoY. Imports of fuel have grown substantially in recent months, with increasing air traffic and higher global oil prices. And finally, consumer goods imports have picked up, measuring 16% higher YoY in ISK terms in the month of August.
Export growth has also gained steam, although it cannot keep pace with import growth at the moment. Total goods exports came to nearly ISK 56bn in August, an increase in ISK terms of almost 27% YoY, despite the ISK appreciation. Exports of aluminium products have gained ground as well recently, as global aluminium prices are up more than 47% in the past year, driven by surging demand and disruptions in supply. Yesterday’s price, in fact, was the highest in a decade, following news of tighter regulatory controls in China, which affect output from Chinese smelters, and the coup d’état in the West African country of Guinea, a key supplier of the bauxite used for aluminium manufacture.
The picture is more mixed when it comes to marine products, as export values have declined in recent months, following a favourable spring partly due to a strong capelin season. In August, marine product exports totalled just over ISK 19bn, a decline of approximately 5% YoY in ISK terms. According to the SI press release, this drop is due to a decline in the value of frozen filets and fishmeal, offset by stronger values for fresh and frozen fish. Marine product prices came under pressure in foreign markets after the COVID-19 pandemic struck, but are beginning to rally again. Furthermore, capelin prices have risen steeply, which will come in quite handy if next year’s capelin season is favourable.
Downward impact on the ISK
In our opinion, unfavourable goods and services trade explains a fair share of the past few months’ developments in the exchange rate. Clearly, domestic demand has picked up more strongly in the recent term than many had dared hope. But it is accompanied by a jump in imports, and in fact, it consumption growth appears to be concentrated largely in imported goods and services. Domestic investment is also import-intensive these days, as to a large extent it requires big purchases of transport equipment, and naturally, these purchases are fully reflected in import figures. At the same time, there has been a setback in the recovery of tourism that began early this summer, after border restrictions were relaxed and vaccination rates rose in Iceland and abroad.
The rise of the Delta variant and the ensuing wave of infections in late July cut into demand from foreign travellers and chilled expectations of a near-term appreciation of the ISK. At the same time, foreign currency inflows from non-residents’ investments in securities slowed down, after a very strong second quarter.
These three things – the turnaround in expectations concerning services exports, the yawning goods account deficit, and limited investment-related inflows – have presumably compounded one another in causing the ISK depreciation since mid-summer. As of this writing, the euro is trading at ISK 150.6 and the USD at ISK 127.1 in the interbank market, whereas the two currencies were trading at 146.6 and 124, respectively, at the end of June. The ISK has therefore weakened by nearly 3% against the euro and just over 2% against the US dollar in Q3 to date.
It is not a given that it will firm up in the near future, either. The outlook for tourist arrivals in the next few months has deteriorated, and the goods account deficit appears unlikely to budge much, as domestic consumption is on the rise and investment looks set to be strong in the near term. Nevertheless, we are still of the opinion that once tourism regains its footing, foreign currency inflows will quickly offset outflows and the ISK will start to strengthen once again. How this situation plays out will depend in large part on two things: first, how the pandemic develops this winter, and then, how appetite for travel develops in the countries that provide most of Iceland’s foreign tourists.