Q1 shows sizeable current account deficit and somewhat weaker external position

Iceland’s current account deficit in Q1/2022 was the largest it has recorded since the financial crisis, with relatively hefty deficits on all key components. The current account looks set to flip to a surplus after mid-year, however. Iceland’s net international investment position (NIIP) deteriorated slightly during the first quarter, owing largely to falling foreign stock prices and the appreciation of the ISK.

The current account deficit measured just over ISK 50bn in Q1/2022. It is Iceland’s largest single-quarter deficit since the 2008 financial crisis, if the estates of the failed banks are taken out of the equation. In an unusual turn of events, there was a deficit on all major components of the current account, according to newly published figures from the Central Bank (CBI), and as the chart shows, this has not happened in quite some time. The size of the deficit takes us somewhat by surprise, although to be sure, both goods and services trade delivered large deficits – ISK 20bn and just over ISK 5bn, respectively – as we have discussed recently. The trade deficit is compounded by a deficit on primary income of nearly ISK 16bn, as well as a deficit of just over ISK 9bn on secondary income.

Stronger returns in energy-intensive industry exacerbate the income account deficit

The year-on-year deterioration in the current account balance is due mainly to the large primary income deficit – the second quarterly deficit in a row, after a string of virtually uninterrupted surpluses stretching back to the mid-2010s. To make a long story short, the primary income account reflects cross-border wage payments, investment income, and investment expense. According to the CBI press release, this quarter’s puffed-up deficit is due primarily to an improved performance among foreign-owned companies in Iceland, as dividends and reinvested earnings are entered as expenditures.

The companies concerned are most likely the three aluminium smelters and the silicon metal plant near Húsavík. Rising global market prices for their products have boosted their operating performance in recent quarters, but by the same token, revenue growth shows on the income side of the goods account. As the chart shows, this quarter’s sizeable deficit has taken the place of the recent primary income surplus due to foreign direct investment, whereas other components have changed less dramatically.

From deficit to surplus after mid-year

Although such a large current account deficit is certainly something of an eyesore, we see no reason to despair about Iceland’s external balance. Many of the country’s export sectors are growing by leaps and bounds at present. This is particularly the case for tourism, although revenues from fishing, aquaculture, and energy-intensive industry are also on the rise. This is offset, of course, by higher prices for imported inputs. Furthermore, we expect that growth in investment and private consumption will ease as the year progresses. Both grew rapidly in Q1, as we discussed recently, and a slower growth rate will translate to weaker growth in imports of investment and consumer goods.

In essence, the year can be divided into two parts as regards the outlook for the current account balance. Q2 will probably see a fairly large deficit, if underlying statistics can be relied upon. But in the second half of the year, we expect the deficit to give way to a surplus. In our recent macroeconomic forecast, we projected that the current account would be broadly in balance in 2022 as a whole. The big deficit in Q1 could push the outcome for this year slightly into negative territory, however. Nevertheless, we expect the coming two years to show surpluses on external trade, in line with the pattern for most of the past decade.

NIIP deteriorates slightly

The CBI also published data on Iceland’s net international investment position as of end-March alongside the balance of payments figures. Iceland’s NIIP was positive by ISK 1,076bn, or 32% of GDP, at the end of March. In another unusual development, it deteriorated somewhat between quarters, from just over 38% of GDP at the end of 2021. The main factors here were a decline of ISK 302bn in foreign asset values as a result of price and exchange rate movements, although external liabilities declined by ISK 116bn for the same reason.

Presumably, this is due in large part to foreign stock markets’ curmudgeonly behaviour in 2022 to date, a result of rising interest rates, a bleaker economic outlook, and uncertainty about prospects for the war in Ukraine. The MSCI World Index, for example, declined by more than 9% over the first three months of the year. This will affect the Icelandic pension funds’ external assets, which for the most part are invested in UCITS funds and equity securities. Moreover, the price of these assets is affected by the strengthening of the ISK, which has appreciated by a full 3% over this same three-month period. But on the liabilities side, a stronger ISK will have a corresponding effect on external liabilities denominated in foreign currency.

Pension funds’ foreign assets contract by nearly ISK 200bn

At the end of 2021, the pension funds’ foreign assets were valued at ISK 2,410bn, but by end-March they had shrunk to ISK 2,224bn, even though the pension funds probably bought some foreign assets during the quarter. Their Q1 purchases were on the slim side, however, as was reported recently on the Innherji website . As the chart shows, Iceland’s NIIP is reflected in, on the one hand, net holdings of just over ISK 2,000bn in equities and UCITS funds, and on the other hand, net assets of ISK 739bn classified as “other”. The CBI’s international reserves comprise the majority of this latter category. On the other side is foreign interest-bearing debt due to loans and bonds, totalling ISK 1,380bn in excess of assets and inward foreign direct investment, less outward foreign direct investment in the amount of ISK 312bn as of end-March.

Although the NIIP has deteriorated a bit, just as the current account balance has, the overall position is still strong and the outlook favourable. Assuming that the current account balance moves into positive territory in the coming term, the NIIP should strengthen once again, particularly if foreign securities markets turn bullish again.


Jón Bjarki Bentsson

Chief economist