The primary income surplus in Q1 was somewhat smaller than the average in the past two years, owing to a smaller surplus on financial income from foreign direct investment (FDI). If we look under the hood, it appears that this narrower surplus stems from both sides of FDI; i.e., reduced revenues from outward investment and smaller recognised losses on inward investment. More favourable developments in the aluminium market are responsible for at least part of this. Aluminium prices have risen steeply in the recent past, which should improve the operating performance of the smelters in Iceland.

As is noted above, we consider the Q1 current account deficit a temporary blip on the screen of Iceland’s recently established string of surpluses. With rising tourist numbers, most indicators imply that the balance on services will turn strongly positive sooner rather than later. Furthermore, we expect Iceland’s vastly improved IIP and the differing composition of external assets and liabilities to continue delivering a surplus on primary income. Offsetting this will be a continued goods account deficit and a modest deficit on secondary income. To a large degree, the secondary income deficit reflects, on the one hand, Iceland’s contributions to international cooperation and development, and on the other, monetary transfers such as those between family members.

In our recently published macroeconomic forecast, we assume that the current account will show a surplus of approximately ISK 30bn (0.9% of GDP) in 2021, followed by surpluses of at least 4% of GDP in each of the next two years. The new balance of payments figures do not change our view.

Iceland's net external position remains strong

Iceland’s IIP was broadly unchanged in Q1, according to CBI data. At the end of March, foreign assets exceeded foreign liabilities by ISK 1,069bn, an improvement of ISK 9bn during the quarter. Foreign assets amounted to ISK 4,485bn at the end of the period, while foreign liabilities totalled ISK 3,415bn.

As before, it is interesting to examine the composition of the IIP and place it into the context of the favourable balance on primary income in the recent term. As the chart shows, foreign obligations in the form of bonds and direct loans weigh quite a bit more heavily than assets of the same type. This should not come as a surprise, given that the Treasury, the banking system, and the country’s largest firms obtain part of their financing in global markets, while the banking system’s foreign lending activities are limited and only a small portion of the pension funds’ foreign assets are only in bonds and related assets. Although net external liabilities of this type total nearly ISK 1,300bn, it should be borne in mind that they are largely denominated in foreign currencies. Interest expense on them is limited at present, as rates on major currencies are very low.

Furthermore, inward FDI outweighs outward FDI, presumably due in large part to foreign-owned energy-intensive industrial investments as well as data centres and some parts of the high-tech sector.

On the other hand, residents’ holdings in foreign shares and unit shares exceed corresponding liabilities by nearly ISK 1,700bn. Much of this is due to the pension funds, which owned foreign shares and unit shares valued at the equivalent of ISK 1,036bn, according to CBI data.

In addition, the CBI itself holds a fair chunk of Iceland’s foreign assets. Its international reserves totalled ISK 857bn at the end of March, and net of foreign liabilities they came to ISK 508bn. But the international reserves generate minimal financial income, as the CBI is required to invest them in low-risk instruments at short-term interest rates that, at present, are close to zero in most major currencies.

In our opinion, it is beyond doubt that Iceland’s strong external position has done much to cushion against the economic blow caused by the COVID-19 pandemic. With the resumption of a current account surplus, as we expect, the outlook is for further strengthening in coming years.