Ekonomske analize
Iceland

Iceland

Population 0.3 million
GDP 50276 US$
A2
Country risk assessment
A1
Business Climate
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Synthesis

major macro economic indicators

  2014 2015  2016(f) 2017 (f)
GDP growth (%) 2.0 4.0 4.6 3.9
Inflation (yearly average) (%) 2.0 1.6 2.2 3.5
Budget balance (% GDP) -0.2 -0.4 0.3 0.5
Current account balance (% GDP) 3.6 4.2 3.6 3.2
Public debt (% GDP) 82.5 67.6 55.1 50.4

 

(f) Forecast

STRENGTHS

  • Cleaned-up banking system
  • Gradual fall in public debt
  • Abundant and renewable energy (geothermal, hydropower)
  • Oil and gas reserves
  • Strong tourism potential
  • High currency reserves
  • Strong household consumption

WEAKNESSES

  • Small economy
  • High foreign debt
  • Production and exports dominated by a handful of products (aluminium and seafood)
  • Russian embargo on seafood from Iceland

Risk assessment

Investment in tourism and household consumption as growth drivers 

In 2017, growth is expected to remain high, despite a slight slowdown compared with the last two years. Household consumption will probably still be a growth driver because of the rise in real wages (already registered in 2016), which would help boost household purchasing power, and low unemployment (2.9% in October 2016). Nonetheless, weaker wage rises than in 2016 and inflation development might result in lower household consumption growth. Investment is also forecast to remain high in key sectors of the economy, although it might be hampered by a rise in salary costs insofar as productivity might rise less quickly than real wages. The fast-growing tourism industry should again make a positive contribution to economic growth because of the government's eagerness to increase investment in this sector. This would in turn strengthen the construction sector, and reduce unemployment. The fisheries and aluminium industries look set to receive major investments and continue to account for a large share of the economy (20% of GDP). However, the rise in the value of the kroner versus the euro might still make exports less competitive.

Inflationary pressures might well grow with the rise in wages, which would be less and less offset by the appreciation of the Icelandic kroner (falling cost of imports). Indeed, it would favour the growth of domestic demand. In this context and in order to limit the risk of overheating, the central bank might not rule out tighter monetary policy (rise in key interest rates), which would lead to another rise in the value of the kroner.

 

Small budget surplus and liberalisation of the capital account

Iceland seems set to post a small budget surplus in 2017, as it did in 2016. Public debt will probably therefore continue to fall, but remain well up on pre-crisis levels (28.5% of GDP in 2007). The government will nonetheless probably adopt a less expansionary budget policy, to prevent the risk of the economy overheating. Consequently, the increase in tax receipts as a result of the favourable economic situation will largely be directed towards continuing to pay down the public debt.

The current account surplus is expected to fall slightly in 2016. Forecasts suggest that exports of goods will still be hindered by the kroner's continuing rise in value since 2015 and by the embargo imposed by Russia (Iceland's fifth-largest trading partner) after the country's stance during the conflict with Ukraine. However, exports of seafood products and aluminium should still be strong and continue to account for nearly 75% of total exports. Moreover, the current account surplus will probably be ensured by the fast-growing tourism sector, thus offsetting the growth in imports (driven by very strong domestic demand) and the fall in FDI.

In mid-August 2016, the finance ministry announced the gradual lifting of almost all the capital controls that had been introduced after the 2008 crisis. The equivalent of around 10% of GDP in liquid assets are held by non-resident investors and had been frozen since the crisis. The central bank therefore allowed investors to convert their assets into foreign currency. According to the finance ministry, the lifting of capital controls led to capital outflows of around €0.3bn (2% of GDP) in 2016; the corresponding figure for 2017 is predicted to be €1.2bn (8% of GDP). However, the central bank holds large reserves and the three main Icelandic banks are well capitalised, which should ensure a stable transition to liberalisation of the capital account.

 

A fragmented political scene following parliamentary elections

Prime Minister Gunnlaugsson resigned in the wake of the "Panama Papers" tax fraud revelations (but stayed on as leader of the Progressive Party), replaced by the former minister of agriculture and fisheries, Sigurdur Johannsson, in April 2016. The parliamentary elections held on 29 October 2016 saw the Independence Party emerge as the largest party, but fail to win a majority (21 out of 63 seats). The other coalition party (the Progressive Party) won just 11.5% of the votes (9 seats), depriving the former coalition of its absolute majority in parliament. In addition, the breakthrough made by the anti-establishment Pirate Party was not as large as predicted, as it finished third behind the Left-Green Party.

Internationally, the country's withdrawal of its application for EU membership in March 2015 did no damage its relations with the bloc. Moreover, the pro-European party's performance in the election (7 seats out of 63) means the debate around EU membership looks closed for now.

 

 

Last update : January 2017

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