Given that the current account was in surplus by a little more than ISK 6bn at the same point in 2023, there has been a significant about-face between years. As we have discussed recently, the change is due in large part to a weaker balance on services, which in turn stems from reduced tourism revenues and an increase in services expenditures. In addition, the goods account deficit widened somewhat year-on-year. On top of this, the primary income surplus shrank markedly, and net outgoing transfers grew between years.

As usual, aluminium smelters’ operating results affect factor income

Primary income is an umbrella term capturing revenues from labour contributions and financial activity. Thus the primary income balance is simply a settlement of cross-border payments of wages, interest, and dividends on shareholdings. We have previously discussed the relationship between the aluminium smelters’ operating performance, on the one hand, and export revenues and factor income, on the other. All else being equal, higher global aluminium prices improve the operating results of Iceland’s three smelters. Because they are all foreign-owned, profits on their activities are entered on the expenditures side of the Central Bank’s (CBI) factor income accounts, and losses are entered as deductions from the expenditures side, causing an improvement in the balance. Increased export revenues are entered to the goods account balance.

As the chart indicates, these variables have correlated relatively well in recent years. Naturally, an improvement in the smelters’ operating performance does not weaken Iceland’s current account balance, as net revenues from aluminium exports should more than offset the increase in the owners’ earnings. The difference is the added value that remains in the Icelandic economy in the form of energy companies’ revenues from energy sales, labour income, services purchases, and public levies paid by the smelters to the Icelandic authorities.

Higher interest income on international reserves

The CBI’s international reserves are invested in safe short-term assets such as foreign government bills and secured deposits with foreign banks. These assets have long generated very little interest income. With rising interest rates abroad, however, the situation has improved, as can be seen in the new figures. For example, the international reserves generated ISK 7.5bn in interest income for the CBI in Q2, the largest total on record in ISK terms. On the other hand, the CBI must pay interest on the portion of the reserves financed with foreign-denominated deposits held in the bank, as well as the portion financed in ISK. At the end of June, the reserves totalled ISK 888bn, albeit offset by foreign-denominated liabilities in the amount of ISK 350bn. According to this, just over 60% of the reserves are financed in ISK and the remaining 40% in foreign currency.

Current account surplus unlikely in 2024

Iceland’s current account deficit totalled just over ISK 64bn in H1/2024. This is far larger than last year’s first-half deficit of just under ISK 9bn. All key subcomponents of the current account balance developed unfavourably during the period, chief among them the surplus on services trade (ISK 31bn smaller than in H1/2023) and the deficit on goods trade (ISK 19bn larger). Although Q3 will probably deliver a sizeable surplus due to the peak tourist season, prospects for the current account balance have dimmed somewhat since we issued our macroeconomic forecast in May. In that forecast, we projected a CA surplus of ISK 45bn (just under 1% of GDP) for 2024 as a whole. Now, however, it seems to us that the best-case scenario will be a flat current account balance. It is also worth noting that in its newly published Monetary Bulletin, the CBI forecast a current account deficit of 0.6% of GDP for the year. External trade is therefore unlikely to provide a springboard for the ISK exchange rate in 2024.

Iceland’s NIIP deteriorates slightly …

Iceland’s net external assets totalled ISK 1,705bn at mid-year, or 38.9% of estimated GDP. This represents a deterioration of ISK 47bn in Q2, largely because external assets shrank more than external liabilities, or by ISK 132bn versus ISK 92bn. On the other hand, price and exchange rate movements improved the external position by ISK 24bn during the period.

In spite of the slight setback in the NIIP, the outcome is quite strong in historical terms. During the decades prior to the 2008 financial collapse, external liabilities were always much larger than external assets, although the situation went haywire during the pre-crash expansion[SAB1] . About a decade ago, the net position righted itself, and in recent years external assets have always exceeded external liabilities by a comfortable margin.

The recent fluctuations in the net position have stemmed mainly from differences in the composition of assets and liabilities. Net holdings in equities and unit shares form the backbone of the assets side, together with the CBI’s reserves, while interest-bearing liabilities are significantly larger than assets. Furthermore, inward foreign direct investment (FDI) somewhat exceeds outward FDI. We have recently reported on developments in pension fund assets in H1/2024. In that discussion, we noted that the pension funds’ foreign assets grew by ISK 319bn during the period, owing very largely to asset purchases and higher market values, as the ISK exchange rate was broadly stable at that time.

… but the external position remains strong

Given that there is little chance of a CA surplus in 2024, external trade will hardly lead to an increase in Iceland’s net external assets this year. On the other hand, continued buoyancy in foreign markets could improve the net position further over the remainder of the year. In any event, most indicators suggest that the external balance will be acceptable in the coming term, and that the strong external position will help hold the ISK stable and reduce the risk of FX market shocks due to capital flight or temporary headwinds in external trade.