The NIIP was positive by ISK 2,034bn at the end of March, the equivalent of just over 43% of GDP for the past four quarters. In the first three months of the year, it had worsened by ISK 77bn, or 1.6% of GDP. External assets totalled ISK 6,771bn at the end of March, while external liabilities totalled ISK 4,737bn.
Strong external position despite current account deficit
Iceland’s net external position (also called the net international investment position, or NIIP) was quite strong at the end of March, despite a slight deterioration in Q1. The decline in securities market prices and the weakening of the US dollar versus the ISK were the main causes of the erosion. A robust NIIP lends important support to the ISK and tends to reduce the risk of a steep, protracted depreciation.
In spite of a sizeable current account deficit in Q1, as we have discussed recently, financing activities improved the external position by ISK 21bn. It should be noted that the Errors and omissions item totalled ISK 81bn in the balance of payments for the quarter, indicating a large discrepancy between the current account and the financial account in the Central Bank’s (CBI) books.
Headwinds in the markets
The deterioration of the NIIP is therefore due to negative price and exchange rate movements, which eroded the position by ISK 79bn, with external assets declining by ISK 168bn and external liabilities by 89bn. Changes in the ISK exchange rate had some impact on this. It is noted in the CBI’s press release that the ISK appreciated by nearly 1.3% in trade-weighted terms. But here it should also be noted that a large share of foreign assets held by pension funds and other long-term funds are denominated in US dollars, while the trade-weighted exchange rate index probably depicts the currency composition of external liabilities more accurately. The USD depreciated by nearly 5% against the ISK during the period.
Foreign and domestic share prices softened somewhat during the quarter. On average, foreign share prices fell by just over 2% during the period, while domestic share prices dropped more than 6%.
It should be borne in mind that there is a marked difference in the composition of external assets, on the one hand, and external liabilities, on the other. For example, inward foreign direct investment (FDI) exceeds outward FDI by ISK 851bn, largely because Icelandic companies in energy-intensive industry and data centre operations are foreign-owned. Furthermore, interest-bearing debt owed to foreign entities outweighed corresponding assets by ISK 1,360bn as of end-March. The lion’s share of these liabilities bear interest at trading partner countries’ rates, not at Icelandic rates.
On the assets side, Icelandic residents’ holdings in foreign equities and unit shares exceed non-residents’ holdings in comparable Icelandic assets by a substantial margin. The pension funds’ foreign assets weigh heavily in this equation, as they held the equivalent of ISK 3,183bn in foreign equities and unit shares at the end of Q1. The CBI’s international reserves, which totalled ISK 865bn as of end-March, also show on the assets side.
Critical support for the ISK
As is noted above, Iceland’s net external assets total just over 43% of GDP at present. This represents a major turnaround relative to the period prior to the financial crisis. Until the crisis struck, the NIIP was always significantly negative, and the situation spiralled out of control during the run-up to the collapse of the banks in 2008. Favourable settlements with the old banks’ creditors during the mid-2010s and a handsome current account surplus for most of that decade were the main drivers of the improvement in Iceland’s external asset position.
This robust asset position provides vital support for the ISK, as it is highly unlikely that capital flight would cause significant instability or require the reinstatement of capital controls. As long as the current account deficit does not grow excessively large, the outlook is for the NIIP to remain strong.
