## 1islea2025001-print-pdf — 1. Real Sector Developments (excerpts) ## Source details **Canonical URL:** [1islea2025001-print-pdf — 1. Real Sector Developments (excerpts)](https://www.imf.org/-/media/files/publications/cr/2025/english/1islea2025001-print-pdf.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2025/english/1islea2025001-print-pdf.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2025/english/1islea2025001-print-pdf.pdf.json) --- ### Context and overall assessment - Tight macroeconomic policies reduced imbalances accumulated after the pandemic. - Continued fiscal consolidation and tight monetary policy slowed domestic demand growth and lowered inflationary pressures. - Implementation of Fund policy advice has been good (Annex IV). - New government (took office in December 2024) faces challenge of returning inflation fully to target and building resilience. - Near-term appropriateness: a tight macroeconomic policy stance; as inflation dissipates, recalibration of the policy mix is warranted to ensure a soft landing while increasing fiscal buffers. - Continued efforts needed to strengthen productivity and diversify the economy. ### Real sector — growth and demand - Real GDP growth: 0.5 percent in 2024, down from 5.6 percent in 2023. - Slowdown drivers: - Weak services exports. - Disappointing fishing season. - Constraints on energy supply that curtailed aluminum production. - Private investment: increased (pickup in residential construction and expansion of data centers) with significant leakages to imports. - Consumption growth: subdued due to a rising savings rate and less immigration. - Output gap: estimated to have narrowed sharply in 2024; slack increased as evidenced by a decline in capacity utilization. ### Labor market developments - Unemployment rate: 3.7 percent at end-2024. - Labor force declined due to less immigration; a drop in employment was more than offset by labor force decline. - Recent months: unemployment increased slightly and is broadly in line with the estimated 4 percent neutral rate on a trend basis. - Nominal wage growth: 6.6 percent in 2024, easing in line with declining inflation. - Nominal wage growth note: increased in early 2025 due to base effects. - Real wage growth: modest but outpaced productivity growth in 2024 largely due to idiosyncratic factors that reduced output. - Real unit labor costs (ULCs): have risen since the pandemic. ### Inflation, monetary policy, and reserves - Inflation: declined to 3.8 percent year-on-year in May and is within the CBI’s 1.0–4.0 percent notification band. - Housing inflation: moderated but continues to be a key driver. - Five-year break-even inflation expectations: 3.4 percent as of May 2025. - Policy rate history and path: - CBI raised policy rate by 850 bps to 9.25 percent between May 2021 and August 2023. - In October 2024, the CBI started reducing the policy rate to now 7.5 percent with the most recent 25 bps cut on May 21. - Real policy rate: around 4 percent (above estimates of the short-term neutral real rate). - Shift toward CPI-indexed loans: now accounts for 55 percent of outstanding private sector debt. - Reserves and FX action: - Reserves at 117 percent of the Fund’s Reserve Adequacy (ARA) metric at end-2024. - In April 2025 the CBI commenced regular purchases of €6 million per week (about 0.7 percent of reserves at end-2024) to offset a projected decline in reserve coverage. ### Fiscal developments and MTFS - General government deficit trajectory: - 8.9 percent of GDP in 2020. - 2.3 percent of GDP in 2023. - 3.5 percent of GDP in 2024 (temporary increase). - 2024 deficit drivers: - 1.2 percent of GDP in purchases of properties in the town of Grindavík and other volcanic-activity related spending. - Rise in social benefits linked to the 2023 wage bargaining round. - Increase in the public wage bill; partial offset from taxes on goods and services (kilometer tax stage one, removal of VAT exemption on electric cars). - MTFS 2026–30 (authorities): - Projects general government deficit of 1.3 percent of GDP in 2025 (down from 3.5 percent in 2024). - Envisages turning the fiscal deficit into a surplus of 0.3 percent of GDP by 2030 and a 3.5 percentage point reduction in the debt-to-GDP ratio. - Staff projections (measures presented to Parliament): - Deficit narrows to 0.1 percent of GDP by 2030. - Public debt projected to decline to 38 percent (of GDP) primarily due to settlement of HFF securities and sale of Islandsbanki. - Footnote: settlement of HFF securities estimated to reduce general government debt by 7.1 percentage points of GDP by 2030 (agreement approved by creditors in April 2025, subject to parliamentary approval). - Consolidation measures underpinning MTFS: - About 1.8 percent of GDP in expenditure reductions. - About 1.0 percent of GDP in revenue measures. - Staff estimates ~0.4 percent of GDP in additional measures may be needed over next 5 years to meet targets. ### Fiscal policy recommendations and options - Maintain an appropriately tight fiscal stance in 2025 (assessed as a 1.0 percentage point negative fiscal impulse excluding Grindavík purchases). - Infrastructure spending: - At minimum, maintain current level of government investment within MTFS targets. - Identify opportunities for Iceland’s large pension funds to scale up financing of infrastructure (consistent with fiduciary duties) while containing fiscal risks. - Streamline permitting and licensing procedures to speed up deployment. - Options if further measures needed: - Increase preferential VAT rate coverage (halving the VRR gap could raise nearly 0.5 percentage points of GDP). - Increase housing taxation (e.g., eliminate or restrict capital gains exemption on housing; raise property tax on vacant land). - Reassess R&D tax incentives ceiling (cost of R&D tax credit rose to 16.3 percent of corporate income tax revenue in 2021). - Comprehensive review to rationalize structural primary expenditure (structural primary expenditure increased ~5 percentage points of GDP over past decade). ### External sector assessment (Annex I highlights) - Current account: turned negative to -2.5 percent of GDP in 2024 from 0.8 percent in 2023. - Deterioration drivers: lower services exports, disappointing fishing season, lower aluminum exports to the EU, surge in capital imports. - NIIP expanded to 42.5 percent of GDP in 2024 (up from 33.4 percent in 2023). - Gross assets: 141.9 percent of GDP; gross liabilities: 99.3 percent of GDP. - REER and CA assessments: CPI-based REER appreciated ~3 percent in 2024; ULC-based REER appreciated 0.5 percent in 2024; staff assessment: real exchange rate moderately overvalued (CA gap implies 3.8 percent overvaluation; EBA-lite REER model suggests 5.8 percent). - FX intervention and reserves: - CBI share in FX turnover in 2024: 4.2 percent. - Total interventions in 2024: about 0.3 percent of GDP. - Foreign exchange reserves: US$6.42 billion by end-2024 (equivalent to 19.2 percent of GDP and about 5 months of prospective goods and services imports). ### Banking, financial stability, and macroprudential stance - Credit growth: signs of recovery in 2024 after a downward trend since mid-2022; pickup driven by lending to corporates (construction, commercial real estate); household credit subdued. - Private sector debt-to-GDP: broadly stable in 2024 and well-below its historical average. - Banking system resilience: - Banks’ capital ratios remain strong though declined slightly in 2024. - Non-performing loans (NPLs) rose modestly but remain low compared to pre-pandemic averages. - Liquidity buffers decreased slightly but remain ample. - Macroprudential stance: - Broadly appropriate; overall capital requirements relatively high. - CCyB set at 2.5 percent (top end of neutral range 2.0–2.5). - Scope for easing if systemic risks recede, but any easing should wait until CRR III effects are clear (CRR III expected to take effect by mid-2025). - Borrower-based measures (BBMs): have helped contain household credit risk and should remain on hold for now. - Plans to reduce prevalence of CPI-indexed mortgage loans should be carefully timed given their cushioning effect on borrower resilience. ### Financial sector reforms and FSAP implementation (Annex V) - Progress: - Operationalized ELA framework; merged supervision divisions; increased operational risk and cybersecurity capacity. - Ongoing AML/CFT supervisory enhancements with IMF technical assistance. - Strengthened pension fund supervision practices; legislative changes still needed (green paper expected in 2025). - Remaining priorities: - Legislative changes to enhance pension fund governance and legal protection for supervisors. - Further AML/CFT supervisory enhancements and data quality improvements for pension funds. - Continue developing liquidity and resolution frameworks (repo market, ELA operationalization, resolution playbooks and testing). ### Housing market developments and policy recommendations - House price growth: moderated but residential real estate prices remain high relative to standard metrics. - Staff estimate: house price misalignment declined to around 10 percent. - Drivers of imbalances: - Demand: increasing disposable incomes, rapid population growth, rise in short-term rentals, decline in interest rates, volcanic activity factors, structural decline in residents per household. - Supply: housing supply has failed to keep pace with demand. - Affordability: remains a concern for renters and low-income households. - Policy recommendations: - Tighten control over short-term rentals. - Make state land available for new home construction and simplify building and planning regulations. - Targeted homeowner assistance programs—designed to minimize macroeconomic risks. - Housing taxation: increase capital gains taxation on secondary homes; raise tax rate on vacant lots in urban areas to incentivize development. - Harmonize and standardize taxation of rental income to reduce arbitrage and improve equity (see property tax and rental income rules). ### Outlook, scenarios, and risks - Staff baseline projections: - Growth: 1.6 percent (2025); 2.2 percent (2026); medium-term growth reaching 2.4 percent by end of projection period. - Inflation (CPI): projected to decline gradually to the CBI’s 2.5 percent target in 2026H2. - Current account: projected to gradually strengthen over the medium term. - Adverse scenario (Box 2; calibrated on WEO Scenario A, April 2025): - Annual real GDP growth could be about 0.6 percentage points weaker on average in 2025–27. - Inflation could be about 0.2 percentage points lower on average in 2025–27. - Allowing automatic stabilizers while maintaining MTFS structural effort could lead to a temporary increase in the fiscal deficit of about 0.2 percentage points of GDP on average in 2025–27. - Policy advice: staff advise against discretionary fiscal stimulus to offset the shock; decline in inflation could allow a more rapid reduction in the policy rate. - Risk assessment: - Growth risks: tilted to the downside. - Inflation risks: broadly balanced. - Notable risks: escalating global trade tensions (announced US tariff on Icelandic goods: 10 percent; effective tariff accounting for exemptions: around 7.3 percent), cyberattacks and operational infrastructure disruptions, energy curtailments from dry weather, further decline in fishing quotas, capital flow swings, second-round wage-inflation effects from premature monetary loosening. - Authorities’ views: - Broad agreement with staff on outlook and risks. - Concur with gradual fiscal consolidation and cautious monetary easing; emphasize reserve accumulation and resilience of payments infrastructure. ### Key statistics (selected exact figures from the chapter) - Real GDP growth: 0.5 percent (2024); 5.6 percent (2023). - Projected growth: 1.6 percent (2025); 2.2 percent (2026); medium-term 2.4 percent by end of projection period. - Unemployment rate: 3.7 percent (end-2024). - Nominal wage growth: 6.6 percent (2024). - Inflation: 3.8 percent (y/y in May). - Five-year break-even inflation expectations: 3.4 percent (May 2025). - Policy rate path: raised by 850 bps to 9.25 percent (May 2021–Aug 2023); reduced to 7.5 percent with 25 bps cut on May 21 (most recent). - CPI-indexed loans share of private sector debt: 55 percent. - Fiscal deficit: 8.9 percent of GDP (2020); 2.3 percent (2023); 3.5 percent (2024); projected 1.3 percent (2025) per MTFS. - Grindavík property purchases: 1.2 percent of GDP (2024). - Public debt: just below 60 percent of GDP (2024); DSA baseline public debt: 59.1 (2024) → 47.6 (2025) → 38.1 (2030). - Central bank reserves: US$6.42 billion (end-2024); reserves at 117 percent of Fund’s ARA metric (end-2024). - Current account: -2.5 percent of GDP (2024). - House price misalignment: around 10 percent (staff estimate). *Source: 1islea2025001-print-pdf — IMF staff report excerpts.* ### 1. Real Sector Developments _____________________________________________________________________ 23 ### 1. Real Sector Developments ### Context and overall assessment - Tight macroeconomic policies have reduced imbalances accumulated after the pandemic. - Continued fiscal consolidation and a tight monetary policy stance slowed domestic demand growth and lowered inflationary pressures. - Implementation of Fund policy advice has been good (Annex IV). - The new government (took office in December 2024) faces the challenge of returning inflation fully to target and building resilience. - Near-term appropriateness: a tight macroeconomic policy stance; as inflation dissipates, recalibration of the policy mix is warranted to ensure a soft landing while increasing fiscal buffers. - Continued efforts needed to strengthen productivity and diversify the economy. ### Recent economic developments — growth and demand - Real GDP growth: 0.5 percent in 2024, down from 5.6 percent in 2023. - Slowdown drivers: - Weak services exports. - Disappointing fishing season. - Constraints on energy supply that curtailed aluminum production. - Private investment increased (pickup in residential construction and expansion of data centers) with significant leakages to imports. - Consumption growth subdued due to a rising savings rate and less immigration. - Output gap estimated to have narrowed sharply in 2024; slack increased as evidenced by a decline in capacity utilization. ### Labor market developments - Unemployment rate: 3.7 percent at end-2024. - Labor force declined due to less immigration; a drop in employment was more than offset by labor force decline. - Recent months: unemployment has increased slightly and is broadly in line with the estimated 4 percent neutral rate on a trend basis. - Nominal wage growth: 6.6 percent in 2024, easing in line with declining inflation. - Nominal wage growth note: increased in early 2025 due to base effects. - Real wage growth: remains modest but outpaced productivity growth in 2024 largely due to idiosyncratic factors that reduced output. - Real unit labor costs (ULCs): have risen since the pandemic. ### Inflation and monetary policy - Inflation: declined to 3.8 percent year-on-year in May and is within the CBI’s 1.0–4.0 percent notification band. - Housing inflation: moderated but continues to be a key driver of inflation. - Five-year break-even inflation expectations: 3.4 percent as of May 2025. - Monetary policy stance: - CBI raised policy rate by 850 bps to 9.25 percent between May 2021 and August 2023. - In October 2024, the CBI started reducing the policy rate to now 7.5 percent with the most recent 25 bps cut on May 21. - Real policy rate: around 4 percent (above estimates of the short-term neutral real rate). - Interest rates on non-indexed loans and bond yields have moved broadly in line with the policy rate. - Shift toward CPI-indexed loans (debt service depends on the real interest rate) now accounts for 55 percent of outstanding private sector debt and has cushioned borrowers from high nominal rates. - Inflation expectations context: have exceeded the inflation target for much of the past two decades (see IMF Selected Issues Paper No. 24/222). ### Fiscal developments - General government deficit trajectory: - 8.9 percent of GDP in 2020. - 2.3 percent of GDP in 2023. - 3.5 percent of GDP in 2024 (temporary increase). - 2024 deficit drivers: - 1.2 percent of GDP in purchases of properties in the town of Grindavík and other volcanic-activity related spending. - Rise in social benefits linked to the 2023 wage bargaining round. - Increase in the public wage bill. - Positive impact on taxes on goods and services from stage one of the kilometer tax and removal of the VAT exemption on electric cars. - Without the Grindavík purchases, the cyclically adjusted primary deficit declined by 0.5 percentage points, implying a modest contractionary fiscal impulse. - Public debt: remained broadly stable at just below 60 percent of GDP. - Notes on Grindavík purchases: - Government and main lenders set up a Special Purpose Vehicle (SPV) to purchase properties rendered uninhabitable; government’s contribution reclassified from below-the-line to above-the-line since the 2024 Article IV. - Nearly 90 percent of displaced homeowners used proceeds to buy new houses; assessed economic activity impact from these purchases is negligible. ### External sector developments - Current account: turned negative in 2024. - Deterioration drivers: - Lower services exports. - Disappointing fishing season. - Lower aluminum exports to the EU. - Surge in capital imports that more than offset improvement in terms of trade and increases in exports of non-traditional sectors (pharmaceuticals and aquaculture). - Primary income account weakened due to greater profit repatriation by foreign companies. - REER: both CPI- and ULC-based real effective exchange rate appreciated modestly in 2024. - External position assessment: moderately weaker than level implied by fundamentals and desirable policies (Annex I). ### Banking, credit, and financial conditions - Credit growth: signs of recovery in 2024 after a downward trend since mid-2022. - Increase driven primarily by pickup in lending to corporates, including construction and commercial real estate companies. - Credit to households remained subdued; pickup in mortgages due to falling interest rates largely offset by decline in other loans. - Private sector debt-to-GDP: broadly stable in 2024 and remains well-below its historical average. - Financial stability risks noted in later policy discussions. ### Housing market developments - House price growth: moderated but residential real estate prices remain high relative to standard metrics. - Staff estimate: house price misalignment declined to around 10 percent. - Housing imbalances drivers: - Demand factors: increasing disposable incomes, rapid population growth, rise in short-term rentals targeted at tourism, recent decline in interest rates, one-off volcanic activity factors, and a structural decline in residents per household. - Supply factors: housing supply has failed to keep pace with demand. - Housing affordability: remains a concern, especially for renters and low-income households. ### Key statistics and indicators (selected figures from the chapter) - Real GDP growth: 0.5 percent (2024); 5.6 percent (2023). - Unemployment rate: 3.7 percent (end-2024). - Nominal wage growth: 6.6 percent (2024). - Inflation: 3.8 percent (y/y in May). - Five-year break-even inflation expectations: 3.4 percent (May 2025). - Policy rate path: raised by 850 bps to 9.25 percent (May 2021–Aug 2023); reduced to 7.5 percent with 25 bps cut on May 21 (most recent). - CPI-indexed loans share of outstanding private sector debt: 55 percent. - Fiscal deficit: 8.9 percent of GDP (2020); 2.3 percent (2023); 3.5 percent (2024). - Grindavík property purchases: 1.2 percent of GDP (2024). - Public debt: just below 60 percent of GDP. - Projected growth: 1.6 percent (2025); 2.2 percent (2026). - Medium-term growth projection: reaching 2.4 percent by the end of the projection period. - House price misalignment: around 10 percent. ### Outlook and risks - Short-term outlook: - Growth projected to increase to 1.6 percent in 2025 and 2.2 percent in 2026 as rising real wages and a less restrictive monetary stance boost private consumption and investment, more than offsetting a moderately contractionary fiscal impulse. - Net exports expected to drag on growth due to strong imports of capital goods and expectations of another disappointing fishing season, offsetting recovery in aluminum exports and modest increases in tourism and exports of pharmaceuticals and aquaculture. - Inflation projected to decline gradually to the CBI’s 2.5 percent inflation target in 2026H2, but remain sticky due to elevated inflation expectations and a robust labor market. - Medium-term outlook: - Continued diversification toward higher value-added export-oriented sectors expected to bolster productivity; inflows of foreign labor to support modest employment increases. - Medium-term growth expected to outpace many advanced economies, reaching 2.4 percent by end of projection period. - Current account projected to gradually strengthen. - Achieving the medium-term outlook requires sustained efforts to foster innovation and investment in infrastructure and measures to boost housing supply. - Risk assessment (Annex II): - Growth risks: tilted to the downside. - Inflation risks: broadly balanced. - External shocks and trade tensions: - Direct impact of escalating global trade tensions projected to be limited given most goods exports are destined for Europe; projection assumes pharmaceutical sector remains exempt. - If tariffs are extended to currently exempted items (e.g., pharmaceuticals) and services exports, or if Iceland faces EU retaliatory tariffs, impact could be larger. - Announced tariff on Icelandic goods exports to the US: 10 percent; effective tariff accounting for exemptions: around 7.3 percent. - Other risks: - Indirect effects from lower growth in trading partners. - Tourism declines if U.S.-related travel falls. - Inflation could increase if trade tensions trigger supply disruptions or capital outflows that weaken the exchange rate. - Capital inflows could put upward pressure on the exchange rate and weaken competitiveness. - Domestic infrastructure attacks (physical or digital, including undersea cables) could disrupt payment flows. - Continued dry weather triggering energy curtailments or further decline in fishing quotas could weaken exports. - Second-round effects from higher wage growth and premature loosening of monetary policy could de-anchor inflation expectations. - Upside risks: lower-than-expected household savings boosting consumption; faster-than-anticipated expansion in pharmaceutical, biotechnology, and aquaculture sectors. ### Authorities’ views - Broad agreement with staff on outlook and risks. - Agreed growth likely to increase over next two years as monetary policy becomes less restrictive and inflation likely to decline. - Concerned about rising global trade tensions. - Pointed to efforts to increase foreign currency reserves to help CBI mitigate disruptive capital outflows. - Noted recent efforts to improve resilience of payments infrastructure and believed CBI’s risk-based approach reduces risk of premature monetary easing. - Concurred that medium-term growth outlook is favorable. *Source: 1islea2025001-print-pdf - 1. Real Sector Developments* ### 15. Fiscal policy in 2025 is appropriately contractionary. The authorities’ 2026–30 fiscal ### Fiscal policy in 2025 is appropriately contractionary. ### Fiscal stance and 2025 projections - The authorities’ 2026–30 fiscal strategy (MTFS) projects a general government deficit of 1.3 percent of GDP this year, down from 3.5 percent in 2024. - Staff’s forecast aligns with the MTFS projection. - Part of the improvement is due to: - expiry of one-off measures related to the volcanic activity, - a decline in interest payments, - new revenue measures. - The resulting 1.0 percentage point negative fiscal impulse (excluding the 2024 purchases of houses in Grindavík) is assessed as appropriately tight given elevated inflation expectations. ### MTFS 2026–30 targets and staff projections - MTFS envisages: - turning the fiscal deficit into a surplus of 0.3 percent of GDP by 2030, - a 3.5 percentage point reduction in the debt-to-GDP ratio. - Staff projections (including only measures presented to Parliament in a legislative proposal) suggest: - the deficit will narrow to 0.1 percent of GDP by 2030, - public debt is projected to decline to 38 percent (of GDP) primarily due to: - settlement this year of the securities issued by the Housing Finance Fund (HFF), - sale of the government’s remaining shares in Islandsbanki. - Footnote details preserved in text: - In April 2025 a qualified majority of creditors approved an agreement for the early settlement of the HFF bonds. The agreement, which is subject to approval by Parliament, is expected to result in a reduction of government debt by at least 5 percentage points of GDP. - Staff estimates that the settlement of HFF securities would reduce general government debt by 7.1 percentage points of GDP by 2030. - Charted indicators (textual): General Government Budget Balance, 2023–2030 (Percent of GDP) — Staff Baseline and MTFS 2026-30 (Authorities' Targets). Note: The projections include MOFEA's updated budget deficit for 2025. ### Consolidation measures underpinning the MTFS - The MTFS includes about 1.8 percent of GDP in expenditure reductions, including: - streamlining operations, - merging of institutions, - to create space for new spending initiatives in social security, health, and transportation. - The MTFS includes about 1.0 percent of GDP in revenue measures, including: - expanding kilometer-based taxation to all vehicles, - increasing natural resource rent taxation on tourism and fisheries. - Most measures have been presented to Parliament and are included in staff’s projections. - Staff estimates that about 0.4 percent of GDP in additional measures may be needed over the next 5 years to meet the authorities’ targets. - The MTFS outlines remaining measures that would cover this gap, but additional fiscal measures could be necessary if: - the yield from planned revenue or expenditure measures falls short of expectations, - government investments are increased. ### Infrastructure spending and growth - Government intention to scale up investment in infrastructure is characterized as appropriate given: - infrastructure gaps in transport and energy, - the need to boost productivity growth. - Observations and recommendations: - Government investment as a share of GDP is broadly in line with other advanced European countries, but the MTFS projects a medium-term decline compared to recent years. - Authorities should, at a minimum, maintain the current level of government investment within the existing MTSF targets. - Identifying opportunities for Iceland’s large pension funds to scale up their financing of infrastructure (consistent with fiduciary duties) could complement efforts, while taking care to contain any increase in fiscal risks. - Partnering with multilateral investment banks or international infrastructure funds could provide expertise with private financing of infrastructure projects. - Streamlining permitting and licensing procedures (noted as more burdensome than the OECD average) would help speed up infrastructure deployment. ### Options if further measures are needed (examples) - Increasing the preferential VAT rate and/or limiting the items that benefit from it: - Halving the gap between the VAT Revenue Ratio (VRR) in Iceland and the average in other Nordic countries (e.g., by reducing the number of items subject to reduced VAT) could raise nearly 0.5 percentage points of GDP in revenue. - Increasing housing taxation: - Eliminating the capital gains exemption on housing or restricting it to primary residences, - Raising the property tax rate on vacant land — would raise revenue and could curb speculative demand and incentivize supply in the housing market. - Streamlining R&D tax incentives: - Reassess the 2020 increase in the ceiling on business R&D expenditures eligible for tax relief to slow growth in public R&D spending. - Note: The cost of the R&D tax credit increased from just over 2 percent of corporate income tax revenue in 2012–16 to 16.3 percent in 2021. - Rationalizing government spending: - Structural primary expenditure has increased by about 5 percentage points of GDP over the past decade due to expansion of the public wage bill and higher outlays on goods and services, subsidies, and social benefits. - A comprehensive review of government expenditure to identify efficiency gains is recommended. ### Fiscal rules, Fiscal Council, and transparency - Revised fiscal rules activation in 2026: - The revised rules include a net expenditure growth rule instead of the previous budget balance rule. - They preserve the 30 percent of GDP net debt ceiling, though the pace to achieve this ceiling will be more flexible. - The combination of a net expenditure rule and flexible debt target allows factoring the state of the macroeconomy into consolidation plans and reduces procyclicality. - Enhancing the Fiscal Council: - The Fiscal Council should monitor compliance and be tasked with evaluating the macroeconomic and fiscal projections underpinning the MTFS. - Plans to assign the Council monitoring of productivity developments and making reform proposals will require a significant increase in capacity and resources. - To bolster transparency and enable ongoing monitoring, fiscal data corresponding to the coverage of the fiscal rules should be published quarterly rather than annually and be independently verifiable. - Expanding the coverage of the budget and fiscal rules to encompass the entirety of the central government would facilitate monitoring and reduce incentives to shift spending and borrowing to parts of government not covered by the rules. - Note on current coverage: The budget and fiscal rules currently cover part A1 only; quarterly statistical publications include data for the combined A sectors. ### Authorities’ views on fiscal strategy - Authorities reaffirm commitment to a gradual buildup of fiscal buffers. - They believe MTFS measures are likely sufficient to bring the fiscal deficit to a surplus by 2028 but acknowledge additional measures could be necessary if planned measures fall short. - Authorities see a substantial infrastructure gap and are seeking ways to facilitate greater involvement of Icelandic pension funds. - They support increasing the capacity of the Fiscal Council and increasing coverage and frequency of budgetary data. ### Monetary policy: calibrating the pace of monetary easing - Monetary stance: - The current monetary stance is appropriately tight given still elevated inflation and inflation expectations and is close to that predicted by a standard Taylor rule. - Projected path for inflation entails reaching the 2.5 percent target in 2026H2. - This projection is assessed using a new quantitative model of the Icelandic economy and is consistent with approximately a 200 bps reduction in the policy rate over the next 4–5 quarters. - The policy trajectory maintains a tight policy stance (but progressively less so) until inflation expectations reanchor to the 2.5 percent target. - Conditional guidance: - Persistent wage increases above productivity growth or a rise in imported inflation would warrant a more gradual easing of the monetary policy stance. - Indications that inflation is likely to undershoot the target on a sustained basis would call for a more rapid reduction in the policy rate toward its neutral level. - Transition recommendation: - As uncertainty recedes, transition to a more forecast-based inflation targeting environment to increase predictability and reduce financial market volatility; careful communication will be important. - Neutral rate assessment (summary): - The short-term neutral real interest rate for Iceland is currently estimated to be around 2.7 percent. - The neutral rate is expected to decline gradually to 2.5 percent over the medium term, in line with staff’s estimate of potential growth. - Structural and policy developments could raise or lower the neutral rate depending on productivity, AI integration, population growth, infrastructure investment, trade policy uncertainty, precautionary savings, or current account appreciation effects. ### Reserves, FX intervention, and market development - Reserves and purchases: - Reserves were at 117 percent of the Fund’s Reserve Adequacy (ARA) metric at end-2024, within the 100–150 percent range considered adequate for precautionary purposes. - In April 2025 the CBI commenced regular purchases of €6 million (about 0.7 percent of reserves at end-2024) per week to offset a projected decline in reserve coverage over the next two years. - Staff agree it is prudent to maintain reserves well above the lower end of the 100–150 percent ARA range given the uncertain external environment and the shock-prone nature of the economy. - Market development recommendations: - Explore options to gradually deepen the foreign currency derivatives market when conditions allow, to encourage greater participation of foreign investors in the domestic bond market and facilitate hedging of foreign currency risk. ### Adverse scenario and policy response (Box 2) - Adverse scenario calibrated on WEO Scenario A (April 2025), includes: - global divergence, - a trade war, - an increase in global uncertainty, - tighter financial conditions. - Estimated impacts (IceQMod simulation): - Annual real GDP growth in Iceland could be about 0.6 percentage points weaker on average in 2025–27 before gradually improving. - Inflation could be about 0.2 percentage points lower than projected on average in 2025–27. - Allowing automatic stabilizers to operate while maintaining the structural effort in the MTFS could lead to a temporary increase in the fiscal deficit of about 0.2 percentage points of GDP on average in 2025–27. - Policy advice: - Staff advise against any discretionary fiscal stimulus to offset the shock, given the resilience of the domestic economy, labor market, and relatively large automatic stabilizers. - The decline in inflation could allow for a more rapid reduction in the policy rate. *International Monetary Fund — Iceland: Fiscal and Monetary Policy Assessment (excerpts)* ### 26. The authorities reiterated their commitment to steer inflation and inflation ### 1islea2025001-print-pdf - 26. The authorities reiterated their commitment to steer inflation and inflation ### Monetary policy, inflation expectations, and reserves - Authorities reiterated commitment to steer inflation and inflation expectations back to target and expressed confidence monetary policy was sufficiently tight to bring inflation back to target. - Authorities argued upside risks to inflation and resilience of domestic demand reduced urgency to ease monetary policy in the near term. - Authorities agreed with staff that: - To help anchor inflation expectations, a restrictive monetary policy could be necessary even after inflation reaches the target. - A more forecast-based inflation targeting environment would be warranted as uncertainty declines. - Authorities agreed that an adequate level of foreign reverses was important to help the CBI prevent disruptive exchange rate movements and reiterated plans to increase reserve coverage. - Staff recommendation: CBI should commence regular purchases of foreign exchange to strengthen ability to stabilize foreign exchange market; prudent to maintain reserves well above the lower end of the 100–150 percent of the Fund’s ARA range. Authorities should explore options to deepen the foreign currency derivatives market. ### Financial system resilience and supervisory developments - Overall assessment: - Banking sector remains resilient; systemic risks are contained and broadly unchanged from last year. - Banks’ capital ratios remain strong but declined slightly in 2024 as higher impairment charges, partly related to the increase in volcanic activity, reduced profitability. - Non-performing loans (NPLs) rose modestly but remain low compared to their pre-pandemic averages. - Liquidity buffers decreased slightly but remain ample. - Foreign funding vulnerabilities identified in the 2023 FSAP continue to recede as interest rate spreads have declined and banks have refinanced foreign-currency bonds on more favorable terms. - Risks in Iceland’s large pension fund sector are broadly contained: inflows into the funds are well in excess of paid-out pension benefits while pension funds’ lending practices are relatively conservative. - Financial cycle remains on an upward trend but its pace has decelerated owing mainly to the dynamics of residential real estate prices which have plateaued at a high level. - CBI’s domestic systemic risk indicator has increased slightly over the past year but remains below its long-term average. - Supervisory and operational improvements: - Progress made on operationalizing an Emergency Liquidity Assistance (ELA) framework. - Ongoing technical assistance from the Fund to enhance AML/CFT supervision of banks. - Steps to strengthen supervision of pension funds: regular on-site inspections for large pension funds and revised outsourcing guidelines. - Need for more progress on legislative changes to improve pension fund governance, internal risk controls, and risk management. - Recommendation to proceed with pension fund reform agenda outlined in the FSAP in an incremental manner. - Need to safeguard independence and effectiveness of the CBI’s supervisory activities, including through a streamlined and independent budgetary process for financial supervision and improved legal protection for supervisors. - Continue strengthening CBI’s and financial sector’s operational risk management capacity. ### Sectoral vulnerabilities: housing, corporates, and operational resilience - Residential real estate: - Potential vulnerability: an abrupt decline in residential house prices, especially if combined with higher-for-longer interest rates and an economic slowdown, could result in deterioration in asset quality. - Mitigants: low loan-to-value (LTV) ratios, strong equity position of most borrowers, increase in household savings, and positive real wage growth in recent years. - Recommendation: further efforts to develop a housing strategy (see housing subsection). - Corporates: - Arrears on banks’ corporate portfolio increased modestly in 2024 as the economy slowed but remain low overall. - Hospitality sector: NPL ratio rose by 2.8 percentage points to 7.6 percent in 2024; deterioration due to a small number of large loans rather than widespread arrears; a decline in tourist arrivals could increase risks. - Construction sector: NPLs increased by 2.5 percentage points to 3.7 percent in 2024Q4 but remain below their historical average. - Commercial real estate risks broadly contained. - Operational resilience: - Cyberattacks are an increasing threat and Iceland is vulnerable to disruptions to its cross-border payment infrastructure. - Authorities’ mitigation efforts: strengthening CBI’s ability to ensure resilience and efficiency of domestic payment system, conducting cybersecurity exercises, establishing a cybersecurity testing framework, and making provisions for backup satellite connections in case of submarine cable disruptions. ### Macroprudential stance and capital requirements - Current stance: - Macroprudential stance broadly appropriate; overall capital requirements on Icelandic banks are relatively high compared to other European countries. - Requirements include a 2.5 percent countercyclical capital buffer (CCyB) which is at the top end of the recently announced 2.0–2.5 neutral range. - While current level appropriate given still elevated housing market risks, there may be scope for easing if systemic risks recede. - Any easing should wait until impact of the Capital Requirements Regulation (CRR) III—expected to take effect by mid-2025—is clear. - Options and safeguards: - If easing warranted, could be done by reducing the Systemic Risk Buffer (SyRB). - Any easing of the CCyB should preserve availability of capital that can be released if downside risks materialize. - Borrower-based measures (BBMs) have helped contain household credit risk and should remain on hold for now. - Plans to reduce prevalence of CPI-indexed mortgage loans should be carefully timed given indexation’s beneficial impact on borrower resilience and financial stability. - CRR III note: - CRR III introduces a new standardized approach to calculating lenders’ capital requirements which will result in a reduction in capital charges on well-collateralized mortgages and operational risk. ### Implementation of FSAP recommendations and authorities’ views - Progress since 2024 Article IV: - Operationalized Emergency Liquidity Assistance (ELA) framework. - Ongoing AML/CFT supervisory enhancements with Fund technical assistance. - Strengthened pension fund supervision practices; need further legislative progress. - Authorities’ views: - Concurred financial system is resilient; saw limited risk of housing price correction and confidence that household balance sheets would prevent adverse spillovers. - Acknowledged global trade tensions pose challenges to tourism sector but believed financial institutions have sufficient buffers. - Agreed current tight macroprudential stance is broadly appropriate, with potential easing if conditions improve. - Positive on progress implementing FSAP recommendations and supported ongoing technical assistance on AML/CFT supervision. - Expected completion of green paper diagnosing pension fund challenges later this year and supported incremental reform approach. - Saw merit in resuming discussions on improving legal protection of supervisors but noted limited scope to bridge differing opinions on constitutionality of proposed funding framework changes for financial supervision. ### Structural policies: productivity, innovation, R&D, and AI - Productivity challenges and priorities: - Investments in physical and human capital and efforts to promote innovation and improve allocative efficiency are needed to sustain productivity growth. - Labor productivity level is high but productivity growth has slowed since the global financial crisis due to lower TFP growth and declining capital intensity; currently below the productivity growth frontier. - Decline in labor productivity growth attributed to labor no longer moving to high productivity sectors (financial sector shrinkage, expansion of hospitality sector) rather than within-sector productivity decline. - Share of fast-growing firms that drive economy-wide productivity gains is below EU average. - Policy focus: improve infrastructure to facilitate access to domestic and international markets; strengthen R&D incentives; work with labor market stakeholders to incentivize higher education in shortage fields; streamline professional licensing for foreign nationals. - R&D incentives and support: - Generous tax incentives make Iceland one of the most attractive OECD jurisdictions for investing in R&D despite relatively high corporate taxes. - Result: value-added of high-tech sectors increasing rapidly; fast-growing innovative firms emerging in traditional sectors. - Concern: sharp increase in public R&D spending and rising budgetary impact and efficiency of R&D tax support scheme. - Planned legislative revision for R&D incentives offers opportunity to clarify eligibility criteria and increase predictability. - Merit in reassessing the 2020 increase in ceilings on eligible business R&D expenditures as it drives rising budgetary costs. - Consideration: make business R&D expenses deductible against payroll taxes rather than corporate income taxes because payroll tax offsets may have greater impact on firms’ R&D expenditure and avoid refunds to loss-making companies. - Artificial Intelligence (AI): - Increased AI integration could bolster productivity growth; Iceland well placed due to robust digital infrastructure, high human capital, and strong legal framework. - Staff analysis: proportion of jobs well positioned to benefit from AI higher than in other advanced economies; share of jobs at risk of displacement from AI smaller than in other advanced economies but still significant. - Policy recommendation: provide opportunities for re-skilling, scale up active labor market policies to facilitate worker movement across sectors, and provide support to most vulnerable. ### Housing market policy recommendations - Need for a housing strategy to meet growing population needs. - Measures and expected effects: - Tighten control over short-term rentals to mitigate tourism industry impact on housing demand and improve affordability for renters. - Make state land available for new home construction and simplify building and planning regulations to increase housing supply. - Targeted homeowner assistance programs can complement supply measures but must be designed to minimize macroeconomic risks. - Housing taxation can help reduce imbalances: staff analyses suggest increasing capital gains taxation on secondary homes and investment properties could help curb speculative demand. - Raising tax rate on vacant lots in urban areas could incentivize supply. - Authorities’ views: - Agreed investments in physical and human capital and efforts to promote innovation are essential. - Viewed R&D legislation review as opportunity to increase efficiency and contain costs. - Saw significant scope for AI to increase productivity and believed tight labor market would help mitigate AI-related displacement. - Emphasized commitment to improve housing supply and affordability and agreed housing support programs must minimize macroeconomic risks; saw merit in exploring tax policy changes. ### Staff appraisal: outlook, fiscal policy, and monetary guidance - Outlook and growth: - For 2025, growth is expected to strengthen to 1.6 percent supported by higher real wages, continued monetary easing, and a recovery in exports. - Direct impact of escalating global trade tensions projected to be limited though Iceland will be indirectly affected by lower growth in trading partners. - Inflation projected to decline to the CBI’s 2.5 percent inflation target in the second half of 2026. - Medium-term growth prospects favorable, driven by expansion of higher value-added export-oriented sectors. - Risks to growth tilted to the downside (notably from larger-than-expected impact of rising trade tensions); risks to inflation broadly balanced. - Fiscal policy: - Authorities’ fiscal targets seen as appropriately ambitious. - Given still elevated inflation and public debt higher than most Nordic countries despite a shock-prone economy, authorities plan to turn fiscal deficits into a small surplus by 2028 while creating space for new spending initiatives. - MTFS detailing fiscal measures increases credibility of envisaged consolidation. - Increasing infrastructure spending would bolster growth prospects; at minimum, maintain current level of government investment over medium-term. - Identify opportunities for pension funds to scale up financing of infrastructure while being mindful of fiscal risks. - Scope for further savings if needed: reduce reliance on preferential VAT rates, increase housing taxation, streamline R&D support, and rationalize government spending. - Activation of revised fiscal rules in 2026 is welcome; net expenditure rule will allow factoring in state of the economy and reduce procyclicality. - Recommendation: expand role and capacity of Fiscal Council and increase coverage and frequency of budgetary data for transparency and monitoring. - Monetary policy guidance: - Staff envisages approximately a 200 bps reduction in the policy rate over the next 4–5 quarters, entailing a gradual easing of the monetary policy stance until inflation expectations are reanchored. - Risks including persistent wage increases above productivity growth may justify a more gradual easing. - Elevated uncertainty warrants greater-than-usual reliance on incoming data, and CBI should switch to a more forecast-based inflation targeting framework as uncertainty declines. *Source: IMF staff report excerpt.* ### 45. Significant progress has been made in implementing FSAP recommendations, though ### 1islea2025001-print-pdf - 45. Significant progress has been made in implementing FSAP recommendations, though ### Financial sector reforms and supervision - Significant progress has been made in implementing FSAP recommendations, though more is needed. - Remaining priorities: - Legislative changes to enhance pension fund governance. - Strengthen AML/CFT supervision of banks. - Safeguard the independence and effectiveness of the CBI’s supervisory activities. - Strengthen legal protection for supervisors. ### Structural policies and productivity - Structural policies should focus on boosting productivity and further diversifying the economy. - Policy priorities: - Improve infrastructure. - Continue to support innovation. - Strengthen incentives for pursuing higher education. - Streamline licensing requirements for foreign nationals. - Reforms to maximize the efficiency of R&D incentives. - Note on technology and labor markets: - Iceland is well placed to benefit from AI but needs to mitigate possible disruptions to the labor market. ### Housing policy - Housing policies need further adjustment. - Government plans: - Plans to increase housing supply and improve affordability are welcome. - Design considerations: - Housing assistance programs can help but need to be carefully designed to minimize risks. - Housing taxation, for example an increase in capital gains taxation on secondary homes, can help in reducing housing market imbalances. ### Article IV timing - It is proposed that the next Article IV consultation with Iceland take place on the standard 12-month cycle. ### Real sector developments (high-level observations from figures) - Consumer spending remains subdued due in part to modest real income growth and a high savings rate. - Rebound in investment spending reflects imports of IT equipment for data centers. - Aluminum exports have moderated because of slower demand from the EU and energy constraints in 2024. - Flight arrivals have declined somewhat, mainly due to less transit traffic. - Real turnover in the tourism sector increased modestly in 2024. - Inflation (ex-housing) and inflation expectations (5y BE) are within the Central Bank of Iceland’s notification band. *Source: IMF staff summary from 1islea2025001-print-pdf - 45.* ### 2.5 percent target ### 2.5 percent target ### Labor Market Developments - Working age population and labor force continued trend increase, partly due to immigration. - Activity rate: recovered from pandemic-era lows but started to decline towards the end of 2024. - Employment rate: may have reached a cyclical peak. - Average hours worked per week: declined since the onset of the pandemic. - Beveridge curve: flattened since the onset of Covid, as immigration flows are linked to the business cycle. - Real wages: remained broadly constant despite the high inflation. - Working Population and Labor Force (Number of persons, Jan 2019–Jan 2025): range shown from 250,000 to 290,000 on chart axis. - Activity Rate (Percent of estimated population, 16–74 years old, Jan 2019–Jan 2025): chart axis 76–83 percent. - Employment Rate (Percent of estimated population, 16–74 years old, Jan 2019–Jan 2025): chart axis 70–80 percent. - Weekly Hours Worked and Employment (2019Q1–2024Q3): employment persons axis 150,000–240,000; weekly hours series shown declining. - Beveridge Curve periods shown: 2019Q1–2020Q3; 2020Q4–2022Q4; 2023Q1–2022Q4 (percent axes for unemployment and vacancy rates). - Payroll per Employee per Hour and Real Wage, 2019–2025: indices for Total and Tourism (LHS) and Real wage (RHS) with Kronas CPI-deflated series (index axes 40–180). ### Fiscal Developments and Issues - Fiscal position impacted by one-off expenditures in 2024 related to volcanic activity, resulting in an increase in non-interest spending. - Revenue composition: broadly unchanged through 2024. - Increase in spending manifested primarily in higher investments (purchase of properties in Grindavík) and other spending. - Debt level: continued a modest downward trend; now at debt levels below the average of advanced economies but higher than some Nordics. - Primary Balances, 2019–2024 (Percent of GDP): chart with Primary Balance, Cyclically adjusted Primary Balance, Structural Primary Balance (excluding one-offs) in range -8 to 4 percent of GDP (axis). - General Government Revenue and Spending, 2019–2024 (Percent of GDP): Non-interest Spending and Revenue series on chart (axis 38–48 percent). - General Government Revenue composition, 2019–2024 (Percent of GDP) highlights: - Personal Income Tax, Value-added tax, Property, Other taxes on Goods and Services, Social Contributions, Other Revenue, Corporate Income Tax. - General Government Spending breakdown, 2019–2024 (Percent of GDP) highlights: - Payroll, Goods and services, Social Benefits, Interest, Investment, Subsidies, Grants, Other. - General Government Debt, 2015–2024 (Percent of GDP): Gross debt and Net debt (less currency and deposits) series (axis 0–140 percent). - Cross-country General Government Debt (Percent of GDP): Iceland (ISL) positioned relative to many advanced economies on chart. ### External Sector Developments - Current account: deteriorated in 2024 due to a weakening trade balance and primary income account. - Exports: increased exports of pharmaceutical products partly offset weakness in aluminum, fisheries, and tourism. - FDI: moderated in 2024; portfolio flows continued to grow. - FX interbank market turnover: declined slightly in 2024 as did the share of CBI interventions. - Reserves: increased in 2024 and remain adequate for precautionary purposes. - External debt: remained stable. - Current Account Balance (Percent of GDP; 4-quarter moving average) series shown for 2016Q1–2024Q3 (axis -25 to 15 percent). - Nominal Exports (FOB) and subcomponents (Percent change, 2016–2024): series for Marine products, Aluminum, Other goods, Transport, Travel, Other services, Total exports. - FX Market Turnover and Interventions (Billion ISK, and percent) 2010–2024: Total turnover, CBI transactions, CBI's net purchases, share of CBI in total turnover. - Financial Account Balance (Percent of GDP; 4-quarter moving average) shows FDI, Portfolio, Other Investment, Reserve Assets. ### Banking Sector Developments - Growth rate of banks’ balance sheets: moderated in 2024 with the ratio of assets broadly stable. - Banks’ exposure to households and non-financial corporates: remain broadly unchanged. - Nonperforming loans: increased modestly but remained low compared to pre-pandemic levels. - Bank profitability: broadly stable. - Capital ratios of the three systemically important banks: well above regulatory minima. - Capital Requirements and Adequacy (Percent) chart lists Arion banki, Íslandsbanki, Landsbankinn with Pillar I, Pillar II, Capital buffers, CAR values displayed (e.g., 8.00 8.00 8.00 and 1.80 1.80 2.50 9.70 9.90 9.90 on chart). - Liquidity buffers: remain ample; Liquidity Requirement (LCR Total, NSFR Total) plotted with LCR limit for all currencies combined. - Banking System Assets (Percent of GDP) and Asset Growth (y/y percent change) series for 2013–2024. - Exposure to Households and Non-Financial Corporations (Percent of total banking sector assets) chart 2010–Jan-25 with axis 20–80 percent. - Non-Performing Loan Ratios (Percent) Mar-18–Nov-24: Household and Non-financial corporations series (axis 0.0–5.0 percent). - Banks' Operating Income to Total Assets (Percent) series 2013–2024 with components: Interest income, Fee and commission income, Income from financial activities, Other income, Revaluation of loans and receivables. ### Housing Market Developments - Real house prices: increase moderated in 2024; CRE-prices declined moderately. - Housing prices: remain elevated across most metrics. - Housing cycle: elevated; Real estate turnover has picked up recently. - Higher interest rates: increased the debt service burden on households’ mortgage loans. - Tighter financial conditions: supported gradual normalization of post-pandemic lending to households. - Real Estate Indices (Index, 2000M3=100): Real house price index and CRE prices series over 2000–2024. - House Prices Relative to Fundamentals (Index, January 2011 = 100): relative to wage index, building cost index, rent index through Dec-24. - Real House Price: Trend and Cycle (Index, 2000M3=100) using Hodrick-Prescott filters through 2025M3. - Real Estate Turnover (Index, December 2019 = 100): three-month moving average deflated by CPI series through 2024M03. - Household Interest Payment to Disposable Income (Percent): 2000–2024 Q2 series with value markers. - Household Loans by Source (Percent of GDP) Mar-17–Dec-24: Banks, Other Financial, Pension Funds and Insurance shares shown. ### Key Macroeconomic Projections and Indicators (Table highlights) - GDP growth (constant prices, percent): 2020 -6.9; 2021 5.0; 2022 9.0; 2023 5.6; 2024 0.5; 2025 1.6; 2026 2.2; 2027 2.4; 2028 2.4; 2029 2.4; 2030 2.4. - Private consumption (percent of GDP): 2020 52.0; 2021 51.6; 2022 50.3; 2023 49.3; 2024 49.1; 2025 49.1; 2026 48.9; 2027 48.8; 2028 48.6; 2029 48.4; 2030 48.2. - Unemployment rate (percent of labor force): 2020 6.3; 2021 5.8; 2022 3.6; 2023 3.4; 2024 3.4; 2025 3.9; 2026 4.0; 2027 4.0; 2028 4.0; 2029 4.0; 2030 4.0. - Consumer price index (average): 2020 2.8; 2021 4.5; 2022 8.3; 2023 8.7; 2024 5.9; 2025 3.5; 2026 3.0; 2027 2.5; 2028 2.5; 2029 2.5; 2030 2.5. - Central bank 7 day term deposit rate (policy rate): 2020 1/0.75; 2021 2.00; 2022 6.00; 2023 9.25; 2024 8.50; 2025 7.50 (note: for 2025, policy rate as of May). - General Government: Revenue (percent of GDP) ranges 42.2 (2020) to projected 42.6 (2030); Expenditure ranges 51.1 (2020) to projected 42.7 (2030). - Overall balance (percent of GDP): 2020 -8.9; 2021 -8.5; 2022 -4.0; 2023 -2.3; 2024 -3.5; 2025 -1.3; 2026 -0.7; 2027 -0.5; 2028 -0.3; 2029 -0.2; 2030 -0.1. - Gross debt (percent of GDP): 2020 77.5; 2021 74.9; 2022 67.5; 2023 62.0; 2024 59.1; 2025 47.7; 2026 45.4; 2027 43.6; 2028 41.7; 2029 39.9; 2030 38.1. - Current account balance (percent of GDP): 2020 1.0; 2021 -2.8; 2022 -2.4; 2023 0.8; 2024 -2.5; 2025 -2.6; 2026 -0.5; 2027 0.0; 2028 0.4; 2029 0.7; 2030 1.0. - Gross external debt (percent of GDP): 2020 90.8; 2021 84.8; 2022 75.6; 2023 75.1; 2024 67.0; 2025 65.4; 2026 61.6; 2027 58.5; 2028 55.4; 2029 52.4; 2030 49.5. - Central bank reserves ($ Mn.): 2020 6,408; 2021 7,091; 2022 5,879; 2023 5,720; 2024 6,397; 2025 6,607; 2026 6,627; 2027 6,902; 2028 6,973; 2029 7,280; 2030 7,533. - GDP (ISK bn.): 2020 2,929; 2021 3,273; 2022 3,882; 2023 4,339; 2024 4,616; 2025 4,876; 2026 5,172; 2027 5,440; 2028 5,747; 2029 6,068; 2030 6,413. - GDP ($ Mn.): 2020 21,630; 2021 25,770; 2022 28,696; 2023 31,452; 2024 33,463; 2025 35,003; 2026 37,907; 2027 40,674; 2028 43,815; 2029 47,154; 2030 50,816. - GDP per capita ($ thousands): 2020 61.1; 2021 71.9; 2022 78.6; 2023 83.8; 2024 87.2; 2025 89.5; 2026 94.9; 2027 98.7; 2028 105.2; 2029 111.0; 2030 117.2. ### Banking and Monetary Aggregates (Table highlights) - Central Bank net foreign assets (Billions of kronur): 2020 563; 2021 524; 2022 527; 2023 515; 2024 548; 2025 572; 2026 559; 2027 581; 2028 575; 2029 600; 2030 617. - Broad money (M3, end period percent change): 2020 7.4; 2021 10.9; 2022 8.9; 2023 8.3; 2024 11.7; 2025 9.3; 2026 8.3; 2027 6.8; 2028 6.8; 2029 6.5; 2030 6.3. - Credit to nonfinancial private sector (end period percent change): 2020 10.5; 2021 10.5; 2022 11.3; 2023 5.2; 2024 8.1; 2025 5.6; 2026 5.6; 2027 5.6; 2028 5.6; 2029 5.6; 2030 5.7. ### Financial Soundness Indicators (Selected, 2015–2024) - Regulatory capital to risk-weighted assets (percent): 2015 27.1; 2016 28.3; 2017 25.9; 2018 23.0; 2019 23.0; 2020 24.7; 2021 24.8; 2022 23.2; 2023 24.1; 2024 23.6. - Total nonperforming loans (NPLs), facility level (percent): 2015 2.0; 2016 1.9; 2017 2.1; 2018 2.5; 2019 2.4; 2020 3.3; 2021 2.5; 2022 1.7; 2023 1.5; 2024 1.9. - Return on assets (percent): 2015 3.8; 2016 2.3; 2017 2.1; 2018 1.8; 2019 1.3; 2020 0.3; 2021 2.2; 2022 2.0; 2023 2.3; 2024 2.1. *Source: IMF staff compilation from Central Bank of Iceland; Ministry of Finance; Statistics Iceland; Haver Analytics; and IMF staff projections as presented in the provided chapter.* ### Annex I. External Sector Assessment ### Annex I. External Sector Assessment ### Overall Assessment - The external position of Iceland in 2024 was moderately weaker than the level implied by fundamentals and desirable policies. - The current account balance deteriorated to a deficit of 2.5 percent of GDP in 2024 from a surplus of 0.7 percent of GDP in 2023. - Deterioration drivers: worsening goods trade balance and a worsening primary income balance. - A positive net international investment position (NIIP) and adequate foreign exchange reserve buffers support external sustainability and mitigate potential adverse risks. ### Potential Policy Responses - The current account is expected to remain broadly unchanged in 2025 and improve gradually over the medium-term supported by moderately tight macroeconomic policies. - The CBI’s decision to commence regular purchases of foreign exchange will help improve reserve coverage and strengthen its ability to stabilize the foreign exchange market during times of stress. - Sustained efforts to foster innovation are needed to facilitate diversification toward higher value-added export-oriented sectors. - The flexible exchange rate should act as the main shock absorber. ### Foreign Assets and Liabilities: Position and Trajectory - NIIP expanded to 42.5 percent of GDP in 2024, up from 33.4 percent in 2023. - Improvement driven by portfolio investments by pension funds, contributing to a 6 percentage points increase in gross assets to 141.9 percent of GDP. - Gross liabilities stood at 99.3 percent of GDP. - Majority of gross liabilities reflect portfolio investments in debt securities (about 26.4 percent of GDP) and FDI (about 38.2 percent of GDP). - Staff assessment: NIIP is forecasted to remain at its current levels over the medium term, but valuation effect fluctuations create uncertainties and potential downside risk. Key 2024 positions (Percent of GDP) - NIIP: 42.5 - Gross Assets: 141.9 - Debt Assets: 28.5 - Gross Liab.: 99.3 - Debt Liab.: 64.6 ### Current Account - The current account (CA) deteriorated to a deficit of 2.5 percent of GDP in 2024 from a surplus of 0.8 percent of GDP in 2023. - Causes: disappointing fishing season, lower aluminum exports to the EU, surge in imports of investment goods, weakening of primary income account due to greater profit repatriation by foreign companies. - Volcanic activity estimated to have weakened the current account by reducing the increase in tourist arrivals. - CA balance projected to remain broadly unchanged in 2025. - EBA-lite adjusted CA balance stood at -1.3 percent of GDP in 2024 after accounting for an adjustor to capture the impact of volcanic activity. - EBA-lite CA regression norm: -0.2 percent of GDP, implying a staff–assessed CA gap of -1.1 percent. - Moderate positive contribution from policy gaps, mostly due to the fiscal policy gap being smaller than the world average. ### Real Exchange Rate - CPI-based REER appreciated by about 3 percent in 2024 due to high inflation in Iceland. - ULC-based REER appreciated by 0.5 percent in 2024. - Assessment: Both CA and REER approaches suggest the real exchange rate is moderately overvalued. - CA gap implies a 3.8 percent real overvaluation (applying an estimated elasticity of -0.3). - EBA-lite REER model suggests an overvaluation of 5.8 percent. ### Capital and Financial Accounts: Flows and Policy Measures - Gross capital inflows in 2024 decreased to around 4.4 percent of GDP, down from 7.4 percent of GDP in 2023. - Reduction attributable to a decrease in direct investment, which accounted for about 1.6 percent of GDP in 2024. - Gross outflows amounted to about 5.5 percent of GDP in 2024, lower than 2023 figures, with portfolio investment as the main contributor. - Net errors and omissions rose significantly in 2024 to approximately 5.7 percent of GDP. - With the Exchange Rate Act of 2021, remaining capital flow management measures introduced in 2008 were removed; no new CFMs introduced since then. - Assessment: Capital inflows remain dependent on global market conditions; vulnerabilities related to external financing are contained given positive stock position and adequate FX reserve buffers. ### FX Intervention and Reserves Level - CBI’s share in the foreign exchange market turnover in 2024: 4.2 percent (compared to 2.3 percent in 2023). - Total interventions in 2024 amounted to about 0.3 percent of GDP. - Foreign exchange reserves increased by about by $700 million, to a total of US$6.42 billion by end-2024. - Reserves equivalent to 19.2 percent of GDP and about 5 months of prospective goods and services imports. - In April 2025, the CBI commenced regular purchases of €6 million (about 0.7 percent of reserves at end-2024) per week to offset a projected decline in reserve coverage over the next two years. - Assessment: At 117 percent of the Fund’s ARA metric, the end-2024 level of reserves remains adequate for precautionary purposes. Regular purchases of foreign exchange will enhance resilience and strengthen the CBI’s ability to prevent disruptive exchange rate movements. ### Risks (Selected from Risk Assessment Matrix) - Global conjunctural risks: - Trade policy and investment shocks: Relative likelihood High; Impact Medium. - Effects: Lower demand for Icelandic exports, reduced tourism, supply chain disruptions, capital flow swings; policy response: adjust monetary policy, allow automatic stabilizers, allow exchange rate adjustment, consider FXI if needed. - Regional conflict: Relative likelihood Medium; Impact Medium. - Effects: Lower trading partner growth, tourism income reductions, supply chain disruptions, FX liquidity risk; policy response: monetary adjustment, fiscal support, FXI as appropriate. - Structural risks: - Deepening geoeconomic fragmentation: Relative likelihood High; Impact Medium. - Effects: Lower trade and potential growth, higher input costs; policy response: allow exchange rate adjustment, intervene to prevent disorderly markets, adjust monetary policy, allow automatic stabilizers. - Cyberthreats: Relative likelihood High; Impact High. - Effects: Disruption to connectivity and cross-border payments; policy response: support critical infrastructure, liquidity support to banks if needed. - Climate change: Relative likelihood Medium; Impact Medium. - Effects: Infrastructure damage, supply disruptions; policy response: targeted fiscal support, allow exchange rate adjustment and intervene to prevent disorderly conditions. - Iceland-specific risks: - Increasing labor market tightness: Relative likelihood Medium; Impact Medium. - Effect: Higher real wage growth, inflationary pressures; policy response: adjust monetary policy, accelerate structural reforms. - Premature loosening of monetary policy: Relative likelihood Medium; Impact Medium. - Effect: Increase in inflation and inflation expectations, credibility damage; policy response: tighten/adjust monetary policy as needed. - Continuation of recent dry weather: Relative likelihood Medium; Impact Medium. - Effect: Reduced hydropower, curtailed energy supply to aluminum smelters, lower exports; policy response: invest in energy expansion, diversify away from energy-intensive industries. - Further decline in fish quotas: Relative likelihood Medium; Impact Medium. - Effect: Lower fishing quotas, weaker exports; policy response: diversify the economy away from reliance on traditional fishing industry. ### Sovereign Risk and Debt Sustainability Assessment (DSA) — Summary - Overall risk of sovereign stress: Low. - Near term: Medium; Medium term: Low. - Debt is projected on a downward path in the baseline. - Improvements and factors: - Debt indicators have improved; medium-term liquidity needs are low. - Settlement of outstanding HFF liabilities and sale of Islandsbanki will substantially lower debt in 2025. - Reintroduction of fiscal rules in 2026 will help ensure medium-term debt sustainability. - Over the longer run, narrowing of the deficit projected by the authorities requires adoption of measures specified in the MTFS 2026-30. - Long-term spending pressures are mitigated by favorable demographics due to migration inflows. - Commentary: Long-term risks are low given the advanced pension system. Age-related spending on health and social security will increase in the long-term; fiscal rules and prudent long-term planning will help ensure debt sustainability. ### DSA Baseline Scenario (Selected figures; Percent of GDP unless indicated) - Public debt: - 2024: 59.1 - 2025: 47.6 - 2026: 45.4 - 2027: 43.6 - 2028: 41.7 - 2029: 39.9 - 2030: 38.1 - 2031: 36.4 - 2032: 34.9 - 2033: 33.4 - 2034: 32.0 - Change in public debt: - 2024: -2.9 - 2025: -11.5 - 2026: -2.2 - 2027: -1.9 - 2028: -1.9 - 2029: -1.8 - 2030: -1.8 - 2031: -1.6 - 2032: -1.5 - 2033: -1.5 - 2034: -1.4 - Primary deficit (percent of GDP): - 2024: 1.0 - 2025: -0.8 - 2026: -0.8 - 2027: -1.1 - 2028: -1.3 - 2029: -1.5 - 2030: -1.6 - 2031: -1.6 - 2032: -1.6 - 2033: -1.6 - 2034: -1.6 - Noninterest revenues: - 2024: 41.2 - 2025: 41.6 - 2026: 41.2 - 2027: 41.3 - 2028: 41.5 - 2029: 41.7 - 2030–2034: 41.7 (each year) - Noninterest expenditures: - 2024: 42.2 - 2025: 40.9 - 2026: 40.4 - 2027: 40.2 - 2028: 40.2 - 2029: 40.1 - 2030–2034: 40.1 (each year) - Automatic debt dynamics: -2.1 (2024); -0.1 (2025); -0.1 (2026); 0.3 (2027); 0.2 (2028); 0.3 (2029); 0.4 (2030); 0.4 (2031); 0.4 (2032); 0.4 (2033); 0.4 (2034) - Real GDP growth (percent) — Memo: - 2024: 0.5 - 2025: 1.6 - 2026: 2.2 - 2027–2034: 2.4 (2027 through 2034) - Inflation (GDP deflator; percent) — Memo: - 2024: 5.9 - 2025: 4.3 - 2026: 3.5 - 2027: 2.7 - 2028: 3.2 - 2029: 3.1 - 2030: 3.2 - 2031: 3.1 - 2032: 3.0 - 2033: 2.9 - 2034: 2.8 - Effective interest rate (percent) — Memo: - 2024: 2.8 - 2025: 5.5 - 2026: 5.2 - 2027: 5.7 - 2028: 6.0 - 2029: 6.3 - 2030: 6.7 - 2031: 6.7 - 2032: 6.6 - 2033: 6.6 - 2034: 6.6 - Commentary: Public debt is projected to gradually decline, supported by the reinstated fiscal rule from 2026. A settlement in 2025 on outstanding HFF liabilities led to an estimated 7.1 percentage points of GDP decline in the debt ratio in 2025, and the privatization of Islandsbanki contributed a 1.9 percentage points of GDP reduction in the debt ratio (both recorded under "other transactions"). *Source: IMF staff summary from Annex I. External Sector Assessment (1islea2025001-print-pdf).* ### Annex III. Figure 3. Iceland: Medium-Term Risk Assessment ### Annex III. Figure 3. Iceland: Medium-Term Risk Assessment ### Debt fanchart module (Final Fanchart, Percent of GDP) - Fanchart width: 84.91.2 (percent of GDP) - Probability of debt non-stabilizaiton (percent): 25.60.2 - Terminal debt-to-GDP institutions index: x6.70.1 - Debt fanchart index (DFI): 1.6 - Risk signal: 3/Moderate - Commentary: "The wide fan chart is impacted by the 2008 crisis and the historical shock to debt. Debt declines in 2025 due to the settlement of ourstanding HFF liabilities and the sale of Islandsbanki. The reintroduction of fiscal rules in 2026 should underpin the baseline, but does not impact the fanchart calculated on the basis of historical shocks." ### Gross Financing Needs (GFN) module (Percent of GDP) - Average baseline GFN (percent of GDP): 4.81.6 - Initial Banks' claims on the gen. govt (pct bank assets): 4.91.6 - Chg. In banks' claims in stress (pct banks' assets): 1.50.5 - GFN financeability index (GFI): 3.7 - Risk signal: 4/Low ### Medium-Term Index (Index Number) and Overall Risk - Components and values: - Debt fanchart index: 1.6 - GFN finaceability index: 3.7 - Medium-term index: (value not separately stated beyond component indices) - Risk signal: 5/ (Final assessment: label appears truncated) - Final assessment statistics: - Prob. of missed crisis, 2025-2030, if stress not predicted: 9.1 pct. - Prob. of false alarms, 2025-2030, if stress predicted: 50.0 pct. ### Percentile and peer-group context - Percentile in peer group 2/: 0 255075100 (normalized) - Note: "2/ The comparison group is advanced economies, non-commodity exporter, surveillance." ### Triggered stress tests and timeline visuals (as presented) - Triggered stress tests (stress tests not activated in gray) shown across years: 2020 2022 2024 2026 2028 2030 with percentile bands: 5-25 pct; 25-50 pct; 50-75 pct; 75-95 pct. - Financing provided by banks: Actual / Baseline / Stress scenario series shown across years. - Medium-term index series shown across 2022–2025 with risk zones: Low risk / High risk. ### Signal thresholds and notes (as presented) - "3/ The signal is low risk if the DFI is below 1.13; high risk if the DFI is above 2.08; and otherwise, it is moderate risk." - "4/ The signal is low risk if the GFI is below 7.6; high risk if the DFI is above 17.9; and otherwise, it is moderate risk." - "5/ The signal is low risk if the GFI is below 0.26; high risk if the DFI is above 0.40; and otherwise, it is moderate risk." - "1/ See Annex IV of IMF, 2022, Staff Guidance Note on the Sovereign Risk and Debt Sustainability Framework for details on index calculation." *Source: IMF staff estimates and projections.* ### Annex V. Update on the Implementation of FSAP ### Annex V. Update on the Implementation of FSAP ### Cross-Cutting - Recommendation: Increase resources at the CBI for oversight of market risk, interest rate risk in the banking book (IRRBB), financial climate risks, and operational risks (ICT risk and cybersecurity); and for the RA. - Horizon/Status: NT - Update: - The CBI merged the Banking Supervision and Insurance & Pension Divisions into a single Microprudential Supervision Division. - Two positions are dedicated to analyzing market risk and IRRBB. - Operational risk monitoring resources, including ICT and cybersecurity, have more than doubled to 6 FTEs. - Resources increased for implementing the TIBER-IS framework for cybersecurity testing among critical financial system participants. - A new cross-divisional team for financial climate risks and environmental issues added 2 FTEs. ### Regulation and Supervision: Banking and Pension Funds - Recommendation: Develop and implement a streamlined and independent budgetary process for supervision. - Horizon/Status: NT - Update: - Supervisory fees are classified as a tax; MoFEA believes direct collection by CBI would be unconstitutional. - The CBI is exploring budgetary process options to discuss with MoFEA. - Recommendation: Update legislation to: a) ensure protection of supervisors; b) broaden the definition of related-party transactions; and c) broaden CBI’s supervisory oversight over bank’s external auditors. - Horizon/Status: NT - Update: - CBI previously proposed amendments to the Central Bank Act to enhance supervisors' legal protection post-merger with the FSA; PMO has not advanced this. - Further consultations among PMO, MoFEA, and CBI planned; a letter to the ministries is in progress. - Recommendation: Remove MoFEA staff from CBI’s FMEN (independence) and implement internal delegation of powers framework (accountability). - Horizon/Status: NT - Update: - In January 2024, an external member replaced the MoFEA staff member on the CBI's FMEN. - June 2023 amendments to the Central Bank Act strengthened delegation of powers and clarified FMEN decision-making authority (administrative fines, police referrals, revocation of operating licenses, dismissal of board members). - CBI is finalizing an internal delegation framework including signature rules and delegation from the Governor to the Deputy Governor for Financial Supervision; additional procedures for delegation (e.g., foreign exchange interventions) are being developed or are in place. - Recommendation: Implement a comprehensive on-site inspection program for banks’ risk management practices across all material risk domains, incorporating an improved risk-based supervisory plan and ensure integration of climate-risks into supervisory processes. - Horizon/Status: NT - Update: - SREP evaluates risk management resources, risk appetite, and governance annually; climate risks are included and often involve on-site visits. - Microprudential Supervision Division updated on-site inspection program: - Category 1 and 2 entities: exams on a 1–5 year cycle based on risk level. - Category 3 and 4 entities: inspections as needed, risk-based. - Recommendation: Issue application regulations or supervisory guidance to banks for appropriate and proportionate implementation of EU rules (ensure compliance with Basel standards) and EBA guidelines. - Horizon/Status: MT - Update: - CBI consulted Nordic banking supervisory authorities; following consultations, no further action is foreseen. - Recommendation: Align rules on governance, internal controls, risk management with IORP II or Solvency II, and enact more stringent rules for outsourcing. - Horizon/Status: NT - Update: - CBI revised outsourcing guidelines to establish stricter rules. - MoFEA-led working group drafting a “green paper” to diagnose pension system challenges; green paper expected in 2025, followed by a white paper compiling legislative amendments. - Recommendation: Perform regular on-site inspections for large pension funds and re-establish institutionalized supervisory dialogue. - Horizon/Status: I - Update: - On-site inspections for larger pension funds (categories 1 and 2) at least every five years; categories 3 and 4 based on risk assessment. - Annual meetings established with the four largest pension funds involving Deputy Governors and senior staff. - Biannual meetings with the Icelandic Pension Fund Association to focus on supervisory priorities. - Recommendation: Define infringements and sanctions in the Pension Fund Act. - Horizon/Status: NT - Update: - MoFEA-led working group drafting a “green paper” to be published in 2025, followed by a white paper compiling legislative amendments. ### Systemic Risk Analysis - Recommendation: Develop approaches to monitor funding risks from nonbank financial institutions (including pension funds) and foreign investors. - Horizon/Status: NT - Update: - CBI improving data collection on ownership of covered bonds from commercial banks. - Deposits from nonbank institutions and foreign investors incorporated into liquidity stress tests. - Recommendation: Differentiate inflation indexed and non-indexed lending and funding instruments in the analysis of inflation impact on banks’ credit, interest rate, and market risks. - Horizon/Status: MT - Update: - Short term: PD and LGD models being updated with new sensitivity analyses to reflect indexed vs non-indexed loans. - Long term: next revision of credit risk models will estimate PD and LGD at borrower level; data requirements may delay implementation until 2027. - Recommendation: Continue conducting liquidity stress tests with various runoff and haircut rates, enhance monitoring of LCR by currencies, and address outlier banks through Pillar 2 and supervisory actions. - Horizon/Status: NT - Update: - Various scenarios for individual currencies with different runoff and haircut rates included in liquidity stress tests. - Results included in monthly reports to the Financial Stability Committee. - LCRs for all significant currencies monitored at least monthly. - Outlier banks addressed through pillar 2 (SREP/ILAAP) and other supervisory measures. - CBI has regulatory limits for euros and calculates the euro HQLA/FX net outflows, maintaining a minimum ratio of 100 percent. - Recommendation: Closely monitor the impact of higher inflation and interest rates on banks’ solvency condition and pension funds’ investment behavior, counterparty default risk, and (particularly for smaller pension funds) Pillar III cash flows. - Horizon/Status: NT - Update: - CBI monitors changes in pension funds' investments, asset composition, risk profile, arrears, and effects on Pillar III cash flows. - Recommendation: Perform data quality checks for pension funds’ supervisory reporting data, require pension funds to submit corrections and expand automated validation rules. - Horizon/Status: NT - Update: - Enhanced automated validation rules for pension funds' annual reports and asset lists, including SQL data quality checks. - Dashboard for warnings and reporting errors developed. - Data quality checks integrated into ExMon monitoring tool with alerts that can lead to automated report rejections. - Pension funds must submit corrections for significant errors. ### Cybersecurity Supervision and Oversight - Recommendation: Investigate alternative domestic retail payment solutions in the event of a significant disruption to the credit and debit card system and refine playbooks to test how cash will be distributed and used in a crisis situation. - Horizon/Status: I/NT - Update: - Efforts to introduce an account-to-account (A2A) domestic retail solution are ongoing. - CBI, PMO, and MoFEA drafted a bill granting CBI authority to issue rules for improving domestic payments; Parliament adopted the bill on June 22, 2024. - In November 2024, CBI invited proposals for a centralized domestic infrastructure for payment requests; eight parties participated. - CBI updated its crisis cash distribution playbook and formed a Payments Council working group to assess commercial responses to significant debit/credit card disruptions. - Recommendation: Produce a financial sector specific cybersecurity strategy, clearly setting out the roles and responsibilities of each party. - Horizon/Status: I - Update: - CBI working group, in collaboration with SURF, developing a crisis coordination plan for the financial sector extending BCPs and outlining roles and responsibilities. - Plan will involve Financial Stability Council, EU-SCICF, and CERT-IS (reports to Department of Civil Protection and Emergency Management of the National Police). - Plans to launch a dedicated incident center to enhance communication and mitigate risks. - MoFEA and CBI coordinating efforts to create a cybersecurity strategy for the financial sector. ### Macroprudential Policies - Recommendation: Further enhance transparency and accountability by developing a heatmap and regularly publishing reports on risk analysis. - Horizon/Status: I - Update: - Financial Stability Committee updates a non-published heat map quarterly. - CBI is reviewing the Financial Stability Report, incorporating best practices from Nordic peers. - Recommendation: Further strengthen the analytical capacity by strengthening the analysis of tail risks, spillovers, systemic risks and calibration of macroprudential tools. - Horizon/Status: NT - Update: - CBI conducts monthly and quarterly internal analyses; publishes a detailed assessment in the Financial Stability Report twice a year. - Financial Stability Committee meets quarterly, focusing on growth-at-risk and distribution of LTV and DSTI measurements to monitor tail risks. - Committee makes quarterly decisions regarding application of macroprudential tools. - Recommendation: Continue closely monitoring cyclical risks in the real estate market and corporates, and take further macroprudential measures if risks persist. - Horizon/Status: I - Update: - Financial Stability Committee monitors RRE and CRE markets quarterly and is prepared to take macroprudential actions. - CBI tracks European CRE macroprudential measures, particularly ESRB developments. - CBI is developing a model to assess cyclical risks using quality-adjusted indexes of residential real estate and rental prices, leveraging data from the Housing and Construction Authority. - Recommendation: Close data gaps related to non-financial private sectors (households, non-financial corporates). - Horizon/Status: I - Update: - CBI and MoFEA collaborating to gain access to tax reports for households and non-financial corporates to match income information with debt data from the credit registry. - Non-financial corporate tax reports to improve data on domestic entities' foreign debt. - CBI intensified data collection on CRE by purchasing data on available square meters for sale and rent, tracking CRE rental price trends, gathering CRE under construction information from Housing and Construction Authority, and monitoring quarterly and annual results of publicly listed CRE companies. ### Liquidity and Crisis Management - Recommendation: Approve the crisis management handbook and test it in a simulation exercise, widening its scope to the resolution stage. - Horizon/Status: I - Update: - Crisis management handbook titled Contingency Plan for Liquidity or Equity Shortfall at Credit Institutions approved and operationalized. - RA participated in an internal simulation exercise in 2023 and completed its first exercise with three DSIBs in spring 2024 to assess banks' ability to produce reliable data under pressure. - Fall 2024: RA will focus on a Nordic-Baltic simulation exercise addressing winding up or resolution of a failed bank. - Specific tests for the four largest banks planned for 2025, along with a multi-annual testing plan. - Risk Management Department planning an internal test in fall 2025 covering failure and resolution of banking institutions. - Recommendation: Establish a coordination body on resolution issues between the MoFEA and the CBI (RA). - Horizon/Status: I - Update: - Discussions ongoing to formalize information sharing; options include a written MoU for a formal coordination body or a sub-group under the Financial Stability Council. - MoU signing planned in 2025. - Coordination via new subgroup with biannual meetings involving Icelandic RA and MoFEA representatives. - Recommendation: Adopt a seven-day deadline for the Icelandic Depositors’ and Investors’ Guarantee Fund (TVF) ́s disbursements and grant TVF access to adequate external funding sources. - Horizon/Status: NT - Update: - Exploring potential legislative amendments; MoFEA oversees the project with preparatory work supported by CBI. - Recommendation: Develop a repo market and operationalize the ELA, including the assessment of collateral eligibility. - Horizon/Status: NT - Update: - Efforts to develop an efficient money market face challenges due to small market size and lack of liquidity; banks reluctant to commit to two-way pricing for suggested tenors (one week to three months). - CBI established an ELA working group to ensure operational effectiveness and assess collateral eligibility; collaborated with FSA and accessed POWER BI Dashboard. - Emphasis on classifying assets by transferability; financial institutions required to report obligations to CBI's Register of Obligations for ELA collateral evaluation. - Considering legislative measures (in line with Norwegian and Swedish law) to gain exclusive authority for registration, mobilization, and monitoring of loan portfolios pledged as collateral by local financial institutions. - Recommendation: Operationalize the application of all the resolution tools (not just bail-in). - Horizon/Status: NT - Update: - Resolution plans for Iceland's three D-SIBs increasingly focused on transfer strategies (non bail-in), aligning with EEA developments. - Priority to finalize bail-in playbooks; Master playbooks (including transfer strategies) expected to be completed by 2025 in accordance with EBA Guidelines 2022/01 and amended testing guidelines. - First resolution plan using a transfer tool as preferred strategy approved. - Initial tests with the bank scheduled for 2025; RA drafting a multiannual testing plan. ### AML/CFT - Recommendation: Improve collection and analysis of data; refine the risk assessment methodology; enhance AML/CFT supervision of banks; and continue to detect unlicensed virtual asset service providers. - Horizon/Status: NT - Update: - CBI refining risk assessment methodology with IMF technical assistance. - Thematic on-site inspections conducted over the last two years and ongoing; methodology enhancements underway. - Initiatives to improve detection of unlicensed virtual asset service providers expected to be completed by 2025. - Recommendation: Continue to improve banks’ access to and maintenance of adequate, accurate and up-to-date information on the beneficial ownership and control of legal persons. - Horizon/Status: NT - Update: - Business Registry using inputs from registered entities to address discrepancies in certificates and support monitoring and supervisory actions correcting the beneficial ownership registry. - Regular communication with registered companies. - A steering group including CBI and other agencies serves as a forum for coordination and improvement of AML/CFT measures. *Annex V. Update on the Implementation of FSAP* ### Annex VI. Data Issues ### Annex VI. Data Issues ### Data adequacy assessment — summary findings - Overall Data Adequacy Assessment Rating: A - Median Rating (heatmap string): AAAABAA - Data Adequacy Assessment: "The data provided to the Fund is adequate for surveillance." - Use of data and/or estimates different from official statistics in the Article IV consultation: "None." - Other data gaps: "None identified." - The data provided to the Fund has some shortcomings that somewhat hamper surveillance. (legend text included in source.) - The data provided to the Fund has serious shortcomings that significantly hamper surveillance. (legend text included in source.) ### Sectoral questionnaire and ratings (high-level) - Data Quality Characteristics: Granularity 3/ - Questionnaire Results/Assessment: "Detailed Questionnaire Results" (table referenced) - Specific sectoral string entries from the source (as presented): - National Accounts: Coverage AABAB; Frequency and Timeliness AABBA; Consistency AAA - Prices: Coverage B; Frequency and Timeliness A; Consistency (blank) - Government Finance Statistics: Coverage B; Frequency and Timeliness B; Consistency (blank) - External Sector Statistics: Coverage AB; Frequency and Timeliness C; Consistency (blank) - Monetary and Financial Statistics: Coverage (blank); Frequency and Timeliness D; Consistency (blank) - Inter-sectoral Consistency: Median Rating (presented as part of heatmap) (Note: When the questionnaire does not include a question on a specific dimension of data quality for a sector, the corresponding cell is blank.) ### Rationale for staff assessment and key data strengths and weaknesses - Rationale for staff assessment: "Data provision to the Fund is adequate for surveillance purposes." - Key strengths: - "Expenditure-based GDP data are available by component on a quarterly basis." - Iceland subscribes to the Special Data Dissemination Standard (SDDS) since June 1996 and publishes the data on its National Summary Data Page. The latest SDDS Annual Observance Report is available on the Dissemination Standards Bulletin Board (https://dsbb.imf.org/). - Data provision to the Fund: "Publication under the Data Standards Initiatives through the National Summary Data Page." - Key weaknesses and areas for improvement: - Income Accounts by sector are "not sufficiently detailed and available only on an annual basis." - "Production-based GDP or gross value added by industry are available only on an annual basis and only in nominal terms." - Statistics Iceland is "in the intial phase of developing quarterly GDP data using the production approach." - "Currently, there are no plans to compile GDP data using the income approach." - Statistics Iceland plans to "start compiling annual data using a more micro-based approach, potentially allowing for more detailed statistics." - Services Exports "are often significantly revised given collection lags." - There is scope to improve "cooperation and data sharing between Statistics Iceland and other institutions involved in data production including the CBI and the Ministry of Finance, in order to strengthen the analysis of economic developments and to ensure methodological consistency of compiled data with international standards." - The authorities could consider publishing: - "general government asset and liabilities statistics on a quarterly frequency" and - "general government expenditure and revenue statistics on a monthly frequency." - The 2023 FSAP found remaining data gaps in the monetary and financial sector data, notably in: - "the CRE sector, micro household and NFC balance sheet data, and climate risks." ### Changes since last Article IV consultation and corrective actions - Changes since the last Article IV consultation: - "The authorities have formed a high-level working group that will look at ways to strengthen the infrastructure for data collection, building on experiences in other countries, and assess the resource needs of Statistics Iceland." - "Statistics Iceland is reviewing the methodology used for seasonally adjusting national accounts data." - "Statistics Iceland has completed an internal review on the treatment of intellectual property rights in the national accounts and balance of payments statistics, raised in the 2023 Staff Report, and concluded that the specific entries of intellectual property rights should not be included in the statistics." - Corrective actions and capacity development priorities: "None beyond the issues raised above. No capacity development priorities." ### Data Standards Initiative and key dissemination timing (as presented) - Table header note: "Annex VI. Table 3. Iceland: Table of Common Indicator Required for Surveillance (As of May 14, 2025)" - Example timing strings and entries preserved from source (selection as presented): - "Mar. 2025Apr. 2025D and MD and MDD...D" - "Apr. 2025May. 2025MMMM1WNLT 7D" - "Apr. 2025May. 2025MMMM2WNLT 1W" - "Mar. 2025Apr. 2025MMMM1M1M" - "Apr. 2025May. 2025MMMM2WNLT 1W" - "Mar. 2025Apr. 2025MMMM1M1M" - "Apr. 2025May. 2025DDDD...D" - "Apr. 2025May. 2025MMMM1MNLT 2W" - "Q4, 2024Mar. 2025QQAQ2Q1Q" - "Q4, 2024Mar. 2025QQMQ1M1Q" - "Mar. 2025May. 2025MMQQ1Q1Q" - "Q4, 2024Mar. 2025QQQQ1QNLT 10W" - "Q4, 2024Mar. 2025QQMM8WNLT 5W" - "Q4, 2024Mar. 2025QQQQ1Q75D" - "Q4, 2024Mar. 2025QQQQ1QNLT 10W" - "Q4, 2024Mar. 2025QQQQ1QNLT 10W" - Frequency and timeliness legend (verbatim from source): - "Frequency and timeliness: (“D”) daily; (“W”) weekly or with a lag of no more than one week after the reference date; (“M”) monthly or with lag of no more than one month after the reference date; (“Q”) quarterly or with lag of no more than one quarter after the reference date; (“A”) annual.; ("SA") semiannual; ("I") irregular; ("NA") not available or not applicable; and ("NLT") not later than;." ### Contextual notes and methodological references - Footnotes and methodological references preserved as in source: - 1/ The overall data adequacy assessment is based on staff's assessment of the adequacy of the country’s data for conducting analysis and formulating policy advice, and takes into consideration country-specific characteristics. - 2/ The overall questionnaire assessment and the assessments for individual sectors reported in the heatmap are based on a standardized questionnaire and scoring system (see IMF Review of the Framework for Data Adequacy Assessment for Surveillance, January 2024, Appendix I). - 3/ The top cell for "Granularity" of Government Finance Statistics shows staff's assessment of the granularity of the reported government operations data, while the bottom cell shows that of public debt statistics. The top cell for "Granularity" of Monetary and Financial Statistics shows staff's assessment of the granularity of the reported Monetary and Financial Statistics data, while the bottom cell shows that of the Financial Soundness indicators. - 7/ Encouraged frequency of data and timeliness of reporting under the e-GDDS and required frequency of data and timeliness of reporting under the SDDS and SDDS Plus. Any flexibility options or transition plans used under the SDDS or SDDS Plus are not reflected. For those countries that do not participate in the IMF Data Standards Initiatives, the required frequency and timeliness under the SDDS are shown for New Zealand, and the encouraged frequency and timeliness under the e-GDDS are shown for Eritrea, Nauru, South Sudan, and Turkmenistan. - 8/ Based on the information from the Summary of Observance for SDDS and SDDS Plus participants, and the Summary of Dissemination Practices for e-GDDS participants, available from the IMF Dissemination Standards Bulletin Board (https://dsbb.imf.org/). *Source: Annex VI. Data Issues (1islea2025001-print-pdf - Annex VI. Data Issues).* ### Annex VII. Table 1. Iceland: Detailed Sectoral ### Annex VII. Table 1. Iceland: Detailed Sectoral — Decomposition of Labor Productivity Growth (Cumulative percent and percentage points contribution) ### Overall totals (Total - all NACE activities) - 2002-2008: Total 11.0; PPE 6.8; RLE 8.7; RGE -4.4 - 2009-2013: Total 1.8; PPE 4.0; RLE -1.3; RGE -1.0 - 2014-2023: Total 9.5; PPE 9.8; RLE -0.5; RGE 0.3 ### Selected sectoral decomposition (Table 1 entries shown as: Period — Total; PPE; RLE; RGE) - Crop and animal production, hunting and related service activities - 2002-2008: 0.1; 0.8; -0.6; -0.1 - 2009-2013: 0.1; 0.0; 0.1; 0.0 - 2014-2023: -0.3; 0.1; -0.4; 0.0 - Fishing and aquaculture - 2002-2008: -2.5; 0.8; -3.2; -0.1 - 2009-2013: 1.1; -0.5; 2.1; -0.4 - 2014-2023: -1.5; 2.5; -3.6; -0.3 - Manufacturing — Food products; beverages and tobacco products - 2002-2008: -2.1; 0.9; -3.0; 0.0 - 2009-2013: 1.6; 0.9; 0.7; 0.0 - 2014-2023: -1.1; 1.4; -2.4; -0.1 - Construction - 2002-2008: 1.3; -3.3; 4.9; -0.4 - 2009-2013: -3.8; -0.2; -3.8; 0.2 - 2014-2023: 4.0; 0.0; 4.0; 0.0 - Wholesale and retail trade; repair of motor vehicles and motorcycles - 2002-2008: -0.3; 0.1; -0.4; 0.0 - 2009-2013: 0.1; 0.2; -0.1; 0.1 - 2014-2023: 1.6; 2.6; -0.9; 0.0 - Information and communication - 2002-2008: -1.0; 0.9; -1.7; -0.2 - 2009-2013: 0.8; 0.4; 0.3; 0.0 - 2014-2023: 1.2; 2.1; -0.7; -0.2 - Financial and insurance activities - 2002-2008: 4.8; 9.0; -3.8; -0.4 - 2009-2013: -2.1; 0.6; -2.9; 0.2 - 2014-2023: -1.1; 2.8; -3.7; -0.2 - Real estate activities - 2002-2008: 4.4; -2.4; 9.0; -2.1 - 2009-2013: 1.0; 2.0; -0.3; -0.7 - 2014-2023: -0.5; -2.4; 2.3; -0.4 - Public administration, defence, education, human health and social work activities - 2002-2008: 3.2; -1.8; 5.1; -0.2 - 2009-2013: 0.0; -1.7; 1.7; -0.1 - 2014-2023: 2.2; 0.2; 2.0; 0.0 ### Key patterns from Table 1 - PPE (within-sector productivity growth) contributed strongly in 2002-2008 and 2014-2023 to overall productivity growth (e.g., PPE 6.8 in 2002-2008 and 9.8 in 2014-2023 for all NACE activities). - Reallocation Level Effect (RLE) was positive and large in 2002-2008 (8.7 for all NACE activities) but declined or turned negative in 2009-2013 and 2014-2023 for the aggregate. - Reallocation Growth Effect (RGE) was negative in 2002-2008 (-4.4) for the aggregate but small positive in 2014-2023 (0.3). --- ### Annex VII. Table 2. Iceland: Breakdown of Detailed Reallocation Level Effect in Prices and Labor (Cumulative percentage points) ### Aggregate RLE decomposition (Total - all NACE activities) - 2002-2008: RLE (Total) 8.7; RLPE (Price) 1.3; RLLE (Labor) 7.4 - 2009-2013: RLE (Total) -1.3; RLPE (Price) -0.3; RLLE (Labor) -1.2 - 2014-2023: RLE (Total) -0.5; RLPE (Price) -1.2; RLLE (Labor) 0.1 ### Selected sectoral RLE decomposition (shown as: Period — RLE (Total); RLPE (Price); RLLE (Labor)) - Fishing and aquaculture - 2002-2008: -3.2; -1.3; -2.0 - 2009-2013: 2.1; 1.4; 0.5 - 2014-2023: -3.6; -1.8; -2.0 - Manufacturing — Food products; beverages and tobacco products - 2002-2008: -3.0; -1.7; -1.3 - 2009-2013: 0.7; -0.2; 0.9 - 2014-2023: -2.4; -0.9; -1.5 - Construction - 2002-2008: 4.9; -0.1; 5.3 - 2009-2013: -3.8; -0.5; -3.7 - 2014-2023: 4.0; 0.8; 3.1 - Information and communication - 2002-2008: -1.7; -1.0; -0.7 - 2009-2013: 0.3; 0.2; 0.1 - 2014-2023: -0.7; -0.4; -0.3 - Financial and insurance activities - 2002-2008: -3.8; -4.9; 1.5 - 2009-2013: -2.9; -1.4; -1.5 - 2014-2023: -3.7; -1.0; -2.7 - Real estate activities - 2002-2008: 9.0; 5.0; 3.6 - 2009-2013: -0.3; -0.2; 0.0 - 2014-2023: 2.3; -0.2; 2.4 - Public administration, defence, education, human health and social work activities - 2002-2008: 5.1; 5.5; -0.5 - 2009-2013: 1.7; 0.5; 1.3 - 2014-2023: 2.0; 2.2; -0.1 ### Key patterns from Table 2 - Labor-driven reallocation (RLLE) was the dominant component of RLE in 2002-2008 for the aggregate (RLLE 7.4 vs RLPE 1.3). - Price-driven reallocation (RLPE) turned more negative in 2014-2023 at the aggregate level (RLPE -1.2). - Some sectors show strong positive RLE driven primarily by labor reallocation (e.g., Construction 2002-2008 RLLE 5.3; Real estate 2002-2008 RLPE 5.0 and RLLE 3.6). *Source: Eurostat, IMF staff calculations.* ### 4. Property taxes are governed by the Act on Municipal Revenue Sources. The main ### 1islea2025001-print-pdf - 4. Property taxes are governed by the Act on Municipal Revenue Sources. The main ### Property tax framework and key rates - The Act on Municipal Revenue Sources governs property taxes. - Statutory rates: - Up to 0.5 percent of the property's value applies to: apartments and residential houses, including land rights; hereditary lands in rural areas; landed properties; outbuildings and structures on farms related to agriculture; all benefits and summer cottages; as well as land rights. - 1.32 percent is applied to all other real estate, such as industrial, office, and commercial buildings; fish farming facilities; medical institutions; schools; dormitories; kindergartens; gymnasiums; and libraries. - Municipalities may increase the above rates by up to 25 percent, yielding maximum rates of: - 0.625 percent and 1.65 percent, respectively. - Municipal practice: - Municipalities routinely levy lower tax rates. Example: the property tax on residential property in Reykjavik is 0.18 percent of the value of the property. - Commercial property tax in Reykjavik is 1.6 percent of the value of the property. - Exemptions under the law include churches and places of worship of the Icelandic National Church and other religious associations, museum buildings (provided they are not operated for profit), and the residences of foreign states. ### Analysis: revenue and reform options - Current revenue profile: - Property taxation in Iceland generates significant revenue, well above the EU average; this primarily reflects the relatively high tax rate applied to commercial properties. - Reform options and anticipated effects: - A revenue-neutral policy that lowers the rate on commercial properties while increasing the rate on residential properties could be beneficial. - A potentially more effective policy is to increase the property tax rate on vacant lots in urban areas: - A higher tax on idle plots raises the financial cost of holding undeveloped land. - Incentivizes owners to develop the land or sell to developers, lowering land costs, increasing housing supply, and contributing to a reduction in housing prices. ### Stamp duty (property transfer taxes) - Transaction charges on transfer of property: - Purchaser pays a registration fee of 2,700 ISK ($19.37). - Stamp duty rates: - 0.8 percent of the property's value if the buyer is an individual. - 1.6 percent if the buyer is a legal entity. - Exemptions and reductions: - First-time residential property buyers: stamp duty reduced to 0.4 percent. - Forced sales by a mortgagee: stamp duty is 0.4 percent for individuals and 0.8 percent for legal entities. - Economic effects: - Stamp duties (and transaction taxes generally) are payable upon sale, which discourages property owners from selling and leads to market distortions. - Distortive effects intensify as stamp duty rates increase. - In Iceland, the relatively low rate and presence of exemptions and reductions mean stamp duties may have a limited impact on the market. ### Rental income taxation: rules, exemptions, and issues - General rule: - Rental income earned by individuals from leasing any type of property, including residential real estate, is generally considered income from business activities. - After deducting eligible operational expenses, this income is subject to the same progressive income tax rates as wages and salaries. - Two important exemptions for individuals: 1. Long-term residential rentals covered by the Rent Act: - If no more than two distinct residential units are leased and the properties are covered by the Rent Act, the income is not classified as business income. - A flat tax rate of 22 percent applies, but 50 percent of the income is exempt, resulting in an effective tax rate of 11 percent. 2. Short-term rentals of the taxpayer’s primary residence and, at most, one additional personally used property (home accommodation, e.g., Airbnb or Vrbo): - To qualify, the rental period must not exceed 30 consecutive days or 90 days per calendar year, and total rental income must remain below ISK 2 million. - A flat tax rate of 22 percent applies to the gross income, with no deductions allowed. - If gross income from short-term rentals remains below ISK 2 million, the activity is exempt from VAT. - Corporate treatment: - Rental income earned by corporations is included in taxable corporate income and subject to the standard corporate income tax rate of 20 percent. In addition, dividends distributed from after-tax profits are subject to dividend taxation. ### Challenges, distortions, and recommended policy - Identified problems: - Tax administration challenges: indications that taxpayers may underreport or conceal rental income with relative ease. - Tax arbitrage opportunities: - The significantly lower effective tax rate applied to long-term rentals under the Rent Act creates opportunities for tax arbitrage (e.g., ostensibly renting properties long-term while informally engaging in short-term rentals). - Equity and neutrality concerns: - The current framework disadvantages professional rental operations, subjecting them to higher tax rates and more stringent regulatory requirements compared with favored long-term rentals under the Rent Act. - Recommendation: - Harmonize and standardize the taxation of rental income across property types and ownership arrangements to enhance neutrality, equity, and efficiency in the taxation of real estate income. - Note that the taxation of short-term rentals on a gross basis effectively aligns its treatment with that of rental income earned by businesses; the primary challenge appears to be tax administration rather than policy design. _Italic: Source — 1islea2025001-print-pdf (excerpt provided)_ ### 11.7 percent of GDP. This issuance serves to settle both the Treasury’s previous borrowings from the HFF ### 11.7 percent of GDP. This issuance serves to settle both the Treasury’s previous borrowings from the HFF ### Monetary Policy - In May 2021, the Central Bank’s Monetary Policy Committee (MPC) started unwinding the monetary support to offset the large contraction following the global pandemic. - The policy rate reached 9.25 percent in August 2023 in an effort to contain the sharp increase in inflation following the post-pandemic recovery and the inflationary impact of Russia’s war against Ukraine. - Inflation gradually eased from its 10.2 percent peak in February 2023 to 3.8 percent in May this year. - The policy rate has therefore gradually been lowered to its current level of 7.5 percent. - Monetary policy remains tight, reflecting the broad-based nature of inflation: - Underlying inflation remains close to 4 percent. - Medium-term inflation expectations have been stuck above 3 percent for a significant period. - MPC assessment and guidance: - The MPC views a real policy rate of roughly 4 percent as a sufficiently tight monetary stance to ensure that inflation will return to target within an acceptable time frame. - Any further easing would depend on inflation moving markedly closer to the Bank’s inflation target; premature loosening could reignite inflationary pressures and undermine re-anchoring of inflation expectations. - Authorities’ stance: agree that a tight monetary policy stance is needed to ensure inflation returns to target and that risks to the inflation outlook are broadly balanced. ### Financial sector - Icelandic financial system characteristics: - Relies largely on bank-intermediation and a large and nearly fully funded pension fund system. - Systemically important banks have maintained strong capital and liquidity ratios. - Macroprudential and borrower protection measures: - Borrower-based measures (BBMs) have been used actively by the Central Bank in the current cycle and have played an important role in safeguarding household balance sheets. - Housing market has shown clear signs of cooling: slower house price growth, reduced turnover, and declining new mortgage lending. - Capital buffers and regulatory developments: - The Financial Stability Committee determined a positive neutral rate for the counter-cyclical capital buffer. - Authorities emphasize strong and partially releasable capital buffers to safeguard financial stability amid heightened global uncertainty. - The impact of CRR III on capital levels will be assessed over the coming months and may lead to a reassessment of current buffer requirements. - Foreign exchange reserves and market access: - In April, the Central Bank initiated a program of regular foreign currency purchases in the interbank foreign exchange market to increase foreign exchange reserves. - At the end of 2024 reserves amounted to 118 percent of the IMF’s reserve adequacy metric (RAM). - Recent volatility in international financial markets has had limited impact on Icelandic financial markets; access to international capital markets has been ample at favorable terms for Government and banks. - The Icelandic króna has remained broadly stable and the economy has not experienced capital outflows seen in previous risk-off episodes. - Operational risk and infrastructure resilience: - Operational risk remains a central challenge for market participants and infrastructure. - Authorities emphasize ensuring secure and effective financial infrastructure and emergency plans to address operational shocks. - The Central Bank is catalyzing projects to increase resilience in the payment system in line with the FSAP recommendations. - Implementation of FSAP recommendations and supervisory changes: - Determined effort to implement the 2023 FSAP recommendations to enhance financial sector resilience. - Steps taken include reorganization of supervision departments of the Central Bank, enhanced internal governance, and increased resources for monitoring market risk and operational risk including ICT and cybersecurity. - Monitoring of LCR by currencies was enhanced by adding various scenarios for individual currencies to liquidity stress tests. - Changes to the Central Bank Act widened the CBI’s role in macroprudential policy and financial supervision through a merger with the Financial Supervision Authority, making the Central Bank the sole institution responsible for price stability, financial stability and financial supervision and regulation—an arrangement that has supported consistent policy decisions, transparency, shared decision-making, and accountability. ### Structural policies - Authorities’ priorities and ongoing initiatives: - Sustained investments in physical and human capital, promotion of innovation, and improved allocative efficiency are essential for sustaining Iceland’s medium-term growth prospects. - Fund recommendations align with initiatives already underway, such as an ongoing review of legislation governing R&D incentives to improve efficiency and contain costs. - Government is in final stages of preparing a new comprehensive Policy on Science, Technological Development, and Innovation covering the period through 2035; the policy is scheduled to be launched and submitted to Parliament in June 2025. - Labour market, productivity and transitions: - Boosting productivity, value creation, and regional balance is a key policy priority, to be achieved by focusing on a healthy labor market, creation of high-quality jobs, ensuring social protection, and preparing workers for the green and digital transitions. - Authorities recognize significant potential of AI to contribute to productivity growth and share staff’s view that Iceland’s tight labor market may help mitigate job displacement risks from AI adoption. - Authorities remain committed to policies grounded in principles of just and inclusive labor market transitions. - Housing policy and tax reform considerations: - Authorities agree housing support programs need careful design to minimize risks to the economy. - Authorities see merit in exploring tax policy reforms aimed at reducing housing market distortions and incentivizing new supply. ### To conclude - Authorities value the Fund’s role in surveillance of the economy and financial sector and staff’s engagement. - Authorities will carefully consider staff’s recommendations. *https://www.imf.org/-/media/files/publications/cr/2025/english/1islea2025001-print-pdf.pdf* --- _Source: https://www.imf.org/-/media/files/publications/cr/2025/english/1islea2025001-print-pdf.pdf_