major macro economic indicators
|2016||2017||2018 (e)||2019 (f)|
|GDP growth (%)||7.4||4.0||4.1||2.8|
|Inflation (yearly average, %)||1.7||1.8||2.7||3.2|
|Budget balance (% GDP)||12.3||0.0||1.0||1.0|
|Current account balance (% GDP)||7.5||3.4||2.6||1.0|
|Public debt (% GDP)||51.7||42.0||39.0||36.0|
(e): Estimate. (f): Forecast.
- Labour market supported by positive demographics and excellent training
- Very high per capita income
- Abundant renewable energy (geothermal, hydropower)
- Strong tourism potential
- Volcanic risk
- Small and very open economy; constraint monetary policy
- Volatile activity linked to dependence on tourist inflows: erratic failures concentrated in construction, trade and accommodation
- Lack of tourist infrastructure outside the capital
- Concentration of production and exports (aluminium and seafood products)
- Wage growth higher than productivity growth
Although growth will remain strong, activity is expected to slow significantly in 2019. The slowdown will come mainly from exports (50% of GDP). Tourism revenues (40% of exports) will likely increase moderately in line with capacity saturation, high service prices, and sluggish European demand. Moreover, even if international fish prices continue to rise, the related exports are likely to be affected by falling catches and a review of quotas following Brexit. The third key component of exports, aluminium, may see both prices (impact of US tariff measures) and production stagnate, even as the price of alumina (the imported raw material) increases further. At the same time, imports will continue to be supported by brisk domestic demand, ultimately causing trade to make a largely negative contribution to growth. Household consumption is expected to continue to surge, driven again by robust wage growth. Unemployment will be limited to 3%, despite the slowdown in tourism, which employs one third of the workforce directly or indirectly. The employment rate will remain high (79%), despite the arrival of foreign workers, particularly from Poland. Over the past four years, household purchasing power has increased by 25%. It is expected to continue to rise significantly, despite the inflationary pick-up linked to the impact of krona depreciation (in the second half of 2018) on the price of imported products, as well as wage increases above productivity growth. Inflationary pressures are expected to ease during the year with moderate growth, particularly in tourism, the increase in the key interest rate from 4.5% in November 2018 to 5%-6% at the end of 2019, which will take pressure off the krona, and the sharp slowdown in housing prices. Finally, while business investment seems to have peaked, construction – both public and private in housing, hotels and roads – will remain vibrant owing to undercapacity in these sectors. In addition, private sector debt went from representing 350% of GDP in 2009 to 160% by 2016 (roughly evenly distributed between companies and households, almost entirely in krona) and has remained at that level ever since.
Small public and current account surpluses
The small government surplus is expected to continue in 2019. Excluding debt interest, the surplus could exceed 3% of GDP. However, this performance needs to be set against the high level of economic activity, with the budget balance turning out to be mildly negative when adjusted for the economic cycle and excluding interest. Increased tax revenues resulting from the favourable economic situation will continue to be put towards improving public services and reducing debt. The additional revenues will be used to finance infrastructure projects (hospitals, retirement homes, roads, ports, etc.), as well as increased social transfers for young parents and housing. The government should also continue its environmental efforts with measures to protect natural sites and increase the tax on CO2 emissions.
The current account surplus is expected to shrink further in 2019, echoing the trade surplus, which is set to decline from 3.6% to 1.8% of GDP as imports considerably outpace exports. However, the tourism-related services surplus will continue to exceed the goods deficit. The income balance shows a small deficit, with remittances from foreign workers still limited and investment income abroad equalled by that of foreign investors. Although the last remaining restrictions on capital movements were lifted in March 2017, these flows, as recorded in the financial account (FDI, portfolio), remain small. Moreover, in the first half of 2018, capital outflows outweighed inflows, reflecting pension fund investments abroad and the narrower real yield spread. Foreign investments other than direct investments are subject to a special reserve requirement whereby 20% of the investment amount must be held in a non-interest bearing account with the central bank for one year. Foreign exchange reserves are not expected to change much and represent about seven months of imports. External debt (82% of GDP as at June 2018, with 47% of the total debt owed by companies (60% under intra-group loans), 40% by the financial system and 12% by the government) will continue to decline.
A patchwork coalition with a narrow majority
Following a new round of early elections in October 2017, the political scene is even more fragmented, with eight parties in Parliament. Prime Minister Katrín Jakobsdóttir leads a patchwork coalition government composed of her own left-leaning Green Party (11 seats out of 63), the centre-right Independence Party (16 seats) and the centrist Progress Party (8 seats). Strategic ministries have been assigned to the last two parties. Despite having a small majority (35 seats out of 63), the coalition has managed, thanks to the consensus on fiscal policy, to hold out longer than the previous three governments, which survived for less than a year.
Last update : February 2019