Q3: Handsome current account surplus and IIP firming up

The current account showed a surplus of just over ISK 23bn in Q3, with a hefty surplus on services trade outweighing deficits on other subcomponents. The outlook is for a sizeable current account deficit in 2022 as a whole, however. Iceland’s net international investment position (NIIP) improved again during the quarter, measuring just under 24% of GDP at the end of September.

The current account surplus measured ISK 23.1bn in Q3, making it the first quarter since Q3/2021 to show a surplus. The Q3/2021 surplus came to ISK 29bn. The peak tourist season made all the difference for the current account balance in Q3, as a robust third quarter has been the overriding pattern in the past decade.

As we have discussed recently, it had already been established that goods trade generated a deficit of ISK 71bn, while services trade showed a surplus of ISK 110bn.. Figures published today by the Central Bank (CBI) show deficits on both primary income (ISK -6.5bn) and secondary income (ISK -9.9bn).

Aluminium smelters make their mark on the balance on income

The primary income account reflects cross-border wage payments, investment income, and investment expense. In recent quarters, it has been affected by the aluminium smelters’ strong operating performance, itself a result of high aluminium prices. Because the smelters are wholly owned by foreign entities, their profits are recognised as cross-border investment expenditures in the CBI’s accounts. It is certainly no bad thing for the Icelandic economy, though, if the smelters’ operations are successful, as a portion of Icelandic energy companies’ revenues are linked to aluminium prices, and when they are high, the revenues side of the goods account balance benefits.

As is mentioned above, the primary income balance was negative by ISK 6.5bn. The deficit narrowed significantly between quarters, after having weighed in at an all-time record of ISK 23bn in Q2. As the chart indicates, the major contributor here is a deficit on financial items relating to foreign direct investment (FDI), which stems for the most part from the profit on aluminium smelter operations. On the other hand, revenues from securities investments exceeded expenditures by ISK 8.5bn, and wage payments from overseas exceeded wage payments to parties abroad by just over ISK 1.2bn.

FX reserves earn extra interest income

The CBI’s international reserves delivered interest income in the amount of ISK 1.4bn. The reserves are invested primarily in deposits and debt instruments with a very short commitment period. While global interest rates were so low, the income on the reserves was negligible, but rising interest rates in most currencies will generate better returns for both the CBI’s profit and loss account and the current account balance.

Cross-border movements of secondary income were negative by about ISK 9.9bn in Q3, reflecting monetary gifts sent between countries, payments for participation in international institutions and charitable work, and other similar items. Secondary income fluctuates relatively little from one period to another and, as the chart shows, has been consistently negative in recent decades.

Hefty deficit expected for 2022 as a whole

The current account shows a deficit of nearly ISK 65bn in 2022 to date. This is three times the deficit for the same period last year but about the same as for 2021 as a whole. In September, we projected that this year’s deficit would come to approximately ISK 57bn. Since that forecast was published, goods account figures for September and October have shown a much larger deficit on goods trade than we had expected; therefore, the current account deficit for the year looks set to be somewhat larger than we forecast in September. By the same token, it could take longer than we had anticipated for the current account to move back into positive territory, although we still expect it to stabilise further ahead.

Marginal improvement in the NIIP

The CBI published a summary of Iceland’s NIIP as of end-September alongside the balance of payments figures. Foreign assets exceed foreign liabilities by ISK 863bn, or nearly 24% of GDP. Foreign assets amounted to ISK 4,875bn and foreign liabilities ISK 4,011bn at the end of September.

The NIIP improved by about ISK 60bn during the quarter, in spite of headwinds in global financial markets. Financing activities improved the external position by ISK 62bn, reflecting investment-related flows and changes in cross-border debt. Price and exchange rate movements eroded the NIIP by about ISK 7bn over the same period, however. This was due to the aforementioned headwinds in foreign markets, as foreign securities prices fell by 6.5% between quarters and prices in the domestic stock market fell by 7.1%. Furthermore, the ISK depreciated by 1.7%, leading to a corresponding increase in the local currency value of foreign-denominated assets and liabilities.

Equity securities and FX reserves weigh heavily in the external asset position

As the chart shows, Iceland’s foreign assets and foreign liabilities differ markedly in terms of composition. For example, net shareholdings totalled just over ISK 2,000bn at the end of September, reflecting not only the Icelandic pension funds’ substantial holdings in foreign shares and UCITS funds, but also the small share of Icelandic equities that are owned by foreign investors.

On the other hand, net external liabilities in the form of debt instruments and bank liabilities totalled just over ISK 1,400bn at the end of Q3. Fortunately, though, the bulk of these liabilities are denominated in foreign currencies and bear lower interest rates than ISK-denominated liabilities do. As interest rates rise abroad, however, the expense of bearing this debt is likely to increase markedly in the near future. Inward FDI exceeded outward FDI by ISK 552bn, mainly because of the aluminium smelters, as well as other foreign-owned manufacturing activities.

And last but not least, the CBI’s foreign exchange reserves show on the assets side of the bank’s NIIP accounts. The reserves came to ISK 886bn at the end of September, after holding largely stable over the quarter. In simplified terms, it can be said that Iceland’s balance sheet is broadly in balance, apart from the CBI, and that the FX reserves make the difference as regards net external assets. The CBI owes fairly substantial sums in foreign currencies, although for the most part, the reserves are financed domestically.

Avoiding the debt quagmire of previous times is of paramount importance

As is noted above, the outlook for external trade has darkened somewhat in recent months. Robust domestic demand plays a role in this, but in addition, relative prices of exports and imports – generally referred to as terms of trade – have been developed unfavourably in the recent past.

We still expect the situation to rebalance over time, and this – together with favourable developments in global markets – should foster a continued strong NIIP. But nothing is certain during times of uncertainty, and it is of vital importance to our open economy with its tiny currency that we avoid falling back into the debt accumulation trap that ensnared us in previous times.


Jón Bjarki Bentsson

Chief economist