## 1islea2026001

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---

### Outlook and Risks
- Growth projections:
  - Gross domestic product: 2.1 percent in 2027 (series: 5.2; 8.9; 5.0; -1.3; 1.3; 1.8; 2.1; 2.4; 2.4; 2.4; 2.4 for 2021–31).
  - Total domestic demand: 2.1 percent in 2027 (series: 7.9; 8.0; 2.5; 1.4; 3.9; 0.4; 2.1; 2.4; 2.5; 2.5; 2.5).
  - Net exports (contribution to growth): -0.1 in 2027 (series: -2.8; 0.6; 2.5; -2.6; -2.7; 1.4; -0.1; -0.1; -0.2; -0.2; -0.3).
- Inflation and labor:
  - Inflation (CPI average): 5.2 percent in 2026; 3.2 percent in 2027; declining toward target in early-2028.
  - Consumer price index (average) series: 4.5; 8.3; 8.7; 5.9; 4.1; 5.2; 3.2; 2.5; 2.5; 2.5; 2.5 (2021–31).
  - Unemployment rate: 4.2 percent in 2027 (series: 5.8; 3.6; 3.4; 3.4; 4.3; 4.3; 4.2; 4.0; 4.0; 4.0; 4.0).
- Key risks:
  - Escalation of geopolitical tensions.
  - Stronger‑than‑expected wage growth.
  - Disruptions to key export sectors.
  - Downside tilt to growth; upside tilt to inflation.
- Scenario:
  - Severe scenario (April 2026 WEO Severe Scenario calibration) differences versus baseline highlight downside growth and upside inflation risks (detailed comparisons for 2026–27 presented in source).

### Fiscal Policy and Public Finances
- Fiscal stance and targets:
  - Fiscal stance: appropriately contractionary in 2026 and beyond to lower inflation and build buffers.
  - Medium-term fiscal targets place public debt on a firm downward trajectory and are described as appropriately ambitious.
- Fiscal aggregates (percent of GDP):
  - Revenue: 43.2 percent in 2026; 43.6 percent in 2027; series 40.7; 42.3; 43.1; 42.9; 42.6; 43.2; 43.6; 43.7; 43.8; 43.8; 43.8.
  - Expenditure: 44.7 percent in 2026; 44.2 percent in 2027; series 48.7; 46.2; 45.2; 47.1; 45.0; 44.7; 44.2; 44.1; 44.0; 43.9; 43.8.
  - Overall balance: -1.4 percent of GDP in 2026; -0.6 in 2027; series -8.0; -3.8; -2.1; -4.2; -2.4; -1.4; -0.6; -0.4; -0.2; -0.1; 0.0.
  - Gross debt: 54.7 percent in 2026; 53.2 percent in 2027; series 73.6; 66.4; 61.5; 60.4; 56.1; 54.7; 53.2; 52.3; 50.7; 49.3; 48.2.
- Implementation and risks:
  - Consolidation described as appropriately ambitious; full implementation required for credibility.
  - State-owned infrastructure company could mobilize financing but requires strong safeguards, transparent monitoring/recording of contingent liabilities and off-balance-sheet exposures.
  - Information gaps on expenditure measures: further detail needed for credibility.
- Revenue and spending options if additional consolidation needed:
  - Raise the preferential VAT rate and/or narrow its coverage.
  - Increase housing-related taxation (restrict capital gains exemption; raise property tax rate on vacant land).
  - Streamline tax expenditures and R&D support.
  - Rationalize public spending and restrain the public sector wage bill.
- Text Table 1 — Revenue and Expenditure Measures, 2026 (Percent of GDP) — selected figures:
  - Sum total revenue 0.05; of which primary revenue 0.45.
  - Sum total expenditure -0.65; of which primary expenditures -0.15.
  - Individual measures include: Kilometer Fee: all motor vehicles 0.70; Excise duty on vehicles 0.14; Carbon tax raised by 15% 0.06; Fuel excise on diesel repealed -0.31; Other revenue, including interest revenue -0.40; Interest payments on public debt -0.50 (expenditure items shown verbatim).

### Monetary Policy, Inflation Anchoring, and Reserves
- Monetary stance and policy guidance:
  - Monetary policy stance remains appropriately restrictive; further tightening may be needed in the near term if inflationary pressures persist or intensify.
  - Policy should remain restrictive until inflation and inflation expectations are firmly anchored at target.
  - Recommendation to strengthen communication, including using alternative scenarios, and transition gradually toward a more forecast-based inflation targeting framework as uncertainty recedes.
- Policy rate:
  - Central bank 7 day term deposit rate: 7.75 for 2026 (series: 2.00; 6.00; 9.25; 8.50; 7.25; 7.75; ...).
  - CBI raised the policy rate in March and May (by 25 bps each) to 7.75 percent; these increases follow a cumulative 200 bps easing since October 2024.
  - Real policy rate around 3.9 percent—above the estimated 2.7 percent neutral real rate.
- Inflation and expectations:
  - Inflation (CPI average): 5.2 percent in 2026; 3.2 percent in 2027; projected to reach 2.5 percent target in early-2028.
  - Five-year break-even inflation expectations: 4 percent in June (elevated).
- Reserves:
  - Reserves are adequate for precautionary purposes; further strengthening toward the upper end of the Fund’s ARA range recommended.
  - Central bank reserves ($ Mn.): 7,916 in 2026; 8,248 in 2027; series 7,091; 5,879; 5,720; 6,387; 7,643; 7,916; 8,248; 8,565; 8,978; 9,308; 9,642.
  - FX purchases totaling €473 million in 2025 raised reserves to around 123 percent of the Fund’s ARA metric at year-end; a €138 million FX purchase program announced on May 8 will further strengthen reserves.

### Financial Sector and Macroprudential Policy
- Systemic position and banking sector health:
  - Systemic risks are contained; macroprudential stance broadly appropriate.
  - Banks are well-capitalized, profitable, and liquid, with strong asset quality.
  - Non-performing loans around 1.6 percent; aggregate liquidity coverage ratio above 200 percent.
- Vulnerabilities:
  - Corporate sector vulnerabilities in construction and tourism-related activities require vigilance.
  - Construction and tourism-related sectors account for 38 percent of all corporate lending.
  - Stage two loans in construction rose to 11 percent at end-February from six percent in 2025.
- Macroprudential measures and housing finance:
  - Borrower-based measures (BBMs) should remain broadly unchanged for now given the slowing housing market.
  - Efforts to reduce reliance on CPI-indexed mortgages may strengthen monetary transmission but should be carefully timed and sequenced.
  - Government plans to reduce reliance on index‑linked mortgages, including minimum repayment requirements from 2027.
- Financial sector reform priorities:
  - Build on FSAP recommendations; strengthen pension fund governance; safeguard independence of financial supervision; strengthen operational resilience including cyber and payments-related risks.
- FSAP implementation highlights (Annex V):
  - CBI increased operational risk monitoring FTEs; supervisory and on-site inspection frameworks updated; payments infrastructure work and cybersecurity strategy advanced; crisis management handbook operationalized; work ongoing on repo market and ELA operationalization.

### Structural Policies and Competitiveness
- Medium-term prospects:
  - Medium-term growth supported by diversification into aquaculture, biotech, renewable energy, and digital infrastructure.
  - Growth projections: 1.8 percent in 2026; 2.1 percent in 2027; medium-term growth reaching 2.4 percent by end of projection period.
- Recommended reforms:
  - Reduce regulatory barriers; streamline licensing and permitting.
  - Address skills shortages via education reform, vocational training, reskilling, and improved immigrant integration.
  - Reform wage-setting arrangements to align wage growth with productivity and the inflation target.
  - Close infrastructure gaps and improve efficiency of R&D support while strengthening the innovation ecosystem.
  - Successful implementation of the Growth Plan to 2035 requires strong cross-ministerial coordination, prioritization, monitoring, and reporting.
- Infrastructure and energy:
  - Cumulative infrastructure gap including maintenance estimated around 14 percent of GDP in 2025.
  - Planned generation capacity increases insufficient for projected demand; parts of transmission grid operating at full capacity.
  - Recommendation to fast-track green generation projects and streamline approvals to strengthen energy security and enable sectors like aquaculture and data centers.
- Education and skills:
  - PISA scores declined 40 points between 2006 and 2022; addressing this is key to long-term productivity (OECD research cited).

### EU Accession and Euro Adoption Considerations
- Overview and schedule:
  - Referendum on whether to resume EU accession negotiations scheduled for August 29, 2026.
- Costs and benefits:
  - Potential benefits: deeper trade and financial integration; elimination of exchange-rate risk vis-à-vis the euro area; potential support for investment and productivity; euro adoption could help anchor inflation expectations and provide access to euro-area financial architecture (Banking Union).
  - Potential costs: loss of independent monetary policy and exchange-rate flexibility; greater reliance on fiscal policy for stabilization; increased exposure to euro-area-wide tail risks.
- Preconditions and policy priorities if process moves forward:
  - Maintain low inflation, sound public finances, an exchange rate aligned with fundamentals, advance structural reforms to increase productivity, and align wages with productivity.
  - Strengthen fiscal framework and Fiscal Council capacity; publish timely independently-verifiable quarterly fiscal data; expand budget and fiscal-rule coverage to entire central government.

### Key Selected Indicators (exact figures highlighted)
- GDP (ISK bn.): 5,351 in 2026; 5,645 in 2027 (series 3,332; 3,947; 4,373; 4,578; 4,956; 5,351; 5,645; 5,937; 6,259; 6,590; 6,937).
- GDP ($ Mn.): 43,664 in 2026; 46,316 in 2027 (series 26,235; 29,176; 31,702; 33,187; 38,583; 43,664; 46,316; 48,777; 51,189; 53,619; 56,153).
- GDP per capita ($ thousands): 109.7 in 2026; 114.0 in 2027 (series 73.2; 80.0; 84.5; 86.5; 99.1; 109.7; 114.0; 117.6; 121.0; 124.2; 127.5).
- Gross national saving (percent of GDP): 23.3 in 2026; 24.0 in 2027 (series 20.2; 22.5; 24.2; 23.0; 23.0; 23.3; 24.0; 24.5; 25.0; 25.5; 25.8).
- Current account balance (percent of GDP): -1.3 in 2026; -0.8 in 2027 (series -2.6; -1.7; -1.2; -3.2; -3.6; -1.3; -0.8; -0.5; -0.1; 0.1; 0.2).
- Exports of goods and services growth: 4.0 percent in 2027 (series 12.4; 26.1; 3.9; -2.2; 1.0; 0.5; 4.0; 3.5; 3.2; 3.1; 3.1).
- Imports of goods and services growth: 3.8 percent in 2027 (series 20.3; 22.6; -1.9; 4.2; 7.2; -2.4; 3.8; 3.5; 3.4; 3.4; 3.4).

### External Sector Assessment (Annex I) — selected findings
- 2025 external position: moderately weaker than implied by fundamentals and desirable policies.
- Current account: deteriorated to -3.6 percent of GDP in 2025 from -3.2 percent in 2024; EBA-lite adjusted CA balance 0.5 percent of GDP in 2025 after accounting for transitory factors.
- NIIP: 44.2 percent of GDP in 2025; gross assets 141.7 percent of GDP; gross liabilities 97.6 percent of GDP.
- REER: CPI- and ULC-based REER appreciated modestly in 2025; models suggest minor overvaluation of the ISK.
- FX intervention and reserves: CBI regular FX purchases in 2025; reserves equivalent to 19.8 percent of GDP and about 5 months of prospective goods and services imports; reserve adequacy at 123.2 percent of the Fund’s ARA metric in 2025.

### Public Debt Structure and Debt Projections (Annex III)
- Public debt: actual 2025: 56.1 percent of GDP.
- Projected public debt path (percent of GDP): 2026: 54.6; 2027: 52.9; 2028: 51.6; 2029: 50.0; 2030: 48.6; 2031: 47.5; 2032: 46.2; 2033: 44.9; 2034: 43.6; 2035: 42.1.
- Residual maturity: 7. years.
- Gross financing needs (percent of GDP): 2025: 10.3; 2026: 6.1; 2027: 3.4; 2028: 6.6; 2029: 4.4; 2030: 7.0; 2031: 5.4.
- Memo: Real GDP growth (percent): 2026: 1.8; 2027: 2.1; inflation (GDP deflator; percent): 2026: 6.1; 2027: 3.3; effective interest rate (percent): 2026: 6.8; 2027: 5.3.

### Data and Statistical Issues (Annex VI)
- Data Adequacy Assessment Rating: A.
- Sector assessments: National Accounts A; Prices A; Government Finance Statistics B; External Sector Statistics A; Monetary and Financial Statistics B; Intersectoral Consistency A; Median Rating A.
- Identified gaps and recommendations:
  - Improve timeliness and frequency of government finance statistics; consider quarterly general government asset/liability publication and monthly revenue/expenditure data.
  - Improve cooperation and data sharing between Statistics Iceland, CBI, and MoFEA.
  - Statistics Iceland developing quarterly GDP production approach; income accounts by sector not sufficiently detailed and annual only.

### Policy priorities (summary)
- Monetary policy: remain data-dependent, nimble, and focused on returning inflation to target; tighten decisively if upside risks materialize; ease cautiously when sustained disinflation is evident; strengthen communication and transition toward forecast-based inflation targeting as uncertainty recedes.
- Fiscal policy: fully implement MTFS medium-term targets; keep temporary VAT reductions time-bound; prioritize automatic stabilizers in adverse shocks; target support to vulnerable households if energy shock persists while offsetting discretionary support that would compromise budget targets.
- Financial stability: maintain macroprudential stance; monitor housing and alternative financing arrangements; strengthen pension governance and operational resilience.
- Structural reforms: reduce regulatory barriers; address skills shortages and education under Education Policy 2030; reform wage-setting to align with productivity; accelerate energy and infrastructure projects; improve R&D support efficiency; implement Growth Plan to 2035 with strong coordination and monitoring.
- EU/euro considerations: weigh credibility gains against loss of policy autonomy; if proceeding, ensure low inflation, sustainable public finances, exchange rate parity consistent with fundamentals, and advance productivity and wage reforms.

*Source: IMF staff report — Iceland: Selected Economic Indicators and staff projections (2021–31).*

### 2.1 percent in 2027, supported by a rebound in net trade and easing financial conditions.

### 2.1 percent in 2027, supported by a rebound in net trade and easing financial conditions.

### Outlook and Risks
- Growth projections:
  - Gross domestic product: 2.1 percent in 2027 (series: 5.2; 8.9; 5.0; -1.3; 1.3; 1.8; 2.1; 2.4; 2.4; 2.4; 2.4 for 2021–31).
  - Total domestic demand: 2.1 percent in 2027 (series: 7.9; 8.0; 2.5; 1.4; 3.9; 0.4; 2.1; 2.4; 2.5; 2.5; 2.5).
  - Net exports (contribution to growth): -0.1 in 2027 (series: -2.8; 0.6; 2.5; -2.6; -2.7; 1.4; -0.1; -0.1; -0.2; -0.2; -0.3).
- Inflation and labor:
  - Inflation (CPI average): 5.2 percent in 2026; 3.2 percent in 2027; declining toward target in early-2028.
  - Consumer price index (average) series: 4.5; 8.3; 8.7; 5.9; 4.1; 5.2; 3.2; 2.5; 2.5; 2.5; 2.5 (2021–31).
  - Unemployment rate: 4.2 percent in 2027 (series: 5.8; 3.6; 3.4; 3.4; 4.3; 4.3; 4.2; 4.0; 4.0; 4.0; 4.0).
- Key risks:
  - Escalation of geopolitical tensions.
  - Stronger‑than‑expected wage growth.
  - Disruptions to key export sectors.
  - Downside tilt to growth; upside tilt to inflation.

### Fiscal Policy and Public Finances
- Fiscal stance:
  - The fiscal stance is appropriately contractionary in 2026 and beyond to lower inflation and build buffers.
  - Medium-term fiscal targets place public debt on a firm downward trajectory and are described as appropriately ambitious.
- Fiscal aggregates (percent of GDP):
  - Revenue: 43.2 percent in 2026; 43.6 percent in 2027; series 40.7; 42.3; 43.1; 42.9; 42.6; 43.2; 43.6; 43.7; 43.8; 43.8; 43.8.
  - Expenditure: 44.7 percent in 2026; 44.2 percent in 2027; series 48.7; 46.2; 45.2; 47.1; 45.0; 44.7; 44.2; 44.1; 44.0; 43.9; 43.8.
  - Overall balance: -1.4 percent of GDP in 2026; -0.6 in 2027; series -8.0; -3.8; -2.1; -4.2; -2.4; -1.4; -0.6; -0.4; -0.2; -0.1; 0.0.
  - Gross debt: 54.7 percent in 2026; 53.2 percent in 2027; series 73.6; 66.4; 61.5; 60.4; 56.1; 54.7; 53.2; 52.3; 50.7; 49.3; 48.2.
- Policy recommendations and options:
  - Keep the temporary reduction in the VAT rate on fuel time-bound and phase it out as planned.
  - Fully implement medium-term targets and maintain sustained discipline and credible medium-term planning.
  - Raise revenues and reduce spending if needed via options such as raising the preferential VAT rate and/or narrowing its coverage, increasing housing-related taxation, streamlining R&D support, rationalizing public spending, improving spending efficiency, and public sector wage restraint.
  - Establishing a state-owned infrastructure company could mobilize financing but must include strong safeguards to contain fiscal risks and transparent monitoring/recording of contingent liabilities and off-balance-sheet exposures.
  - Strengthen the fiscal framework: implement the amended fiscal rule, meaningfully increase the Fiscal Council’s capacity and resources, regularly publish timely and independently-verifiable quarterly fiscal data consistent with the fiscal-rule perimeter, and expand budget and fiscal-rule coverage to the entirety of the central government.

### Monetary Policy, Inflation Anchoring, and Reserves
- Monetary stance:
  - The monetary policy stance remains appropriately restrictive; further tightening may be needed in the near term if inflationary pressures persist or intensify.
  - Policy should remain restrictive until inflation and inflation expectations are firmly anchored at target.
  - Central bank 7 day term deposit rate: 7.75 for 2026 (series: 2.00; 6.00; 9.25; 8.50; 7.25; 7.75; ...).
- Communication and framework:
  - Strengthen communication, including using alternative scenarios, to enhance transparency and anchor expectations.
  - As uncertainty recedes, transition gradually toward a more forecast-based inflation targeting framework to improve predictability and reduce volatility.
- Reserves:
  - Reserves are adequate for precautionary purposes.
  - Further strengthening of foreign exchange reserves toward the upper end of the Fund’s ARA range would enhance resilience.
  - Central bank reserves ($ Mn.): 7,916 in 2026; 8,248 in 2027; series 7,091; 5,879; 5,720; 6,387; 7,643; 7,916; 8,248; 8,565; 8,978; 9,308; 9,642.

### Financial Sector and Macroprudential Policy
- Systemic position:
  - Systemic risks are contained; the macroprudential stance is broadly appropriate.
  - Banks are well-capitalized, profitable, and liquid, with strong asset quality.
- Vulnerabilities and measures:
  - Vulnerabilities in parts of the corporate sector—particularly construction and tourism-related activities—require vigilance.
  - Borrower-based measures should remain broadly unchanged for now given the slowing housing market.
  - Efforts to reduce reliance on CPI-indexed mortgages may strengthen monetary transmission over time but should be carefully timed and sequenced given their role in borrower resilience and financial stability.
- Financial sector reform priorities:
  - Build on progress implementing FSAP recommendations.
  - Strengthen pension fund governance and safeguard the independence of financial supervision.
  - Strengthen operational resilience, including against cyber and payments-related risks.

### Structural Policies and Competitiveness
- Medium-term prospects and priorities:
  - Medium-term growth prospects are supported by continued diversification toward new export-oriented sectors.
  - Structural reforms should focus on raising productivity and further diversification.
- Recommended reforms:
  - Reduce regulatory barriers; streamline licensing and permitting.
  - Address skills shortages through education reform, vocational training, and improved reskilling.
  - Reform wage-setting arrangements to align wage growth with productivity and the inflation target.
  - Close infrastructure gaps and improve the efficiency of R&D support while strengthening the broader innovation ecosystem.
  - Successful implementation of the Growth Plan to 2035 requires strong cross-ministerial coordination, prioritization, monitoring, and reporting.
- EU accession and euro adoption considerations:
  - EU accession and euro adoption are political choices that trade deeper integration and potential credibility gains against reduced macroeconomic policy autonomy.
  - If the process moves forward, maintaining low inflation, sound public finances, an exchange rate aligned with fundamentals, advancing structural reforms to increase productivity, and aligning wages with productivity will be critical.

### Key Selected Indicators (exact figures highlighted)
- GDP (ISK bn.): 5,351 in 2026; 5,645 in 2027 (series 3,332; 3,947; 4,373; 4,578; 4,956; 5,351; 5,645; 5,937; 6,259; 6,590; 6,937).
- GDP ($ Mn.): 43,664 in 2026; 46,316 in 2027 (series 26,235; 29,176; 31,702; 33,187; 38,583; 43,664; 46,316; 48,777; 51,189; 53,619; 56,153).
- GDP per capita ($ thousands): 109.7 in 2026; 114.0 in 2027 (series 73.2; 80.0; 84.5; 86.5; 99.1; 109.7; 114.0; 117.6; 121.0; 124.2; 127.5).
- Gross national saving (percent of GDP): 23.3 in 2026; 24.0 in 2027 (series 20.2; 22.5; 24.2; 23.0; 23.0; 23.3; 24.0; 24.5; 25.0; 25.5; 25.8).
- Current account balance (percent of GDP): -1.3 in 2026; -0.8 in 2027 (series -2.6; -1.7; -1.2; -3.2; -3.6; -1.3; -0.8; -0.5; -0.1; 0.1; 0.2).
- Exports of goods and services growth: 4.0 percent in 2027 (series 12.4; 26.1; 3.9; -2.2; 1.0; 0.5; 4.0; 3.5; 3.2; 3.1; 3.1).
- Imports of goods and services growth: 3.8 percent in 2027 (series 20.3; 22.6; -1.9; 4.2; 7.2; -2.4; 3.8; 3.5; 3.4; 3.4; 3.4).

*Source: IMF staff report — Iceland: Selected Economic Indicators and staff projections (2021–31).*

### 4.      Inflation has increased and is well above the Central Bank of Iceland’s (CBI’s)

### 4.      Inflation has increased and is well above the Central Bank of Iceland’s (CBI’s)

### Inflation and inflation expectations
- Inflation is above the CBI’s 2.5 percent target.
- Inflation declined to 4.1 percent in 2025 but increased in January following tax hikes on fuel and vehicles and has remained elevated at 5.2 percent in June mainly due to transport costs.
- Underlying inflationary pressures reflect rapid wage growth and persistent housing cost pressures.
- Five-year break-even inflation expectations eased somewhat in 2025 but have risen again and remain elevated at 4 percent in June, reflecting a history of above-target inflation.

### Labor market and wages
- Unemployment rate (3m/3m) rose to 5.4 percent at end-2025—above the estimated 4.1 percent neutral rate—and increased further to 5.8 percent in April.
- The labor force contracted despite continued population growth, indicating labor market slack.
- Nominal wage growth accelerated to 7.9 percent in 2025 despite lower inflation, partly due to timing of public sector wage settlements.
- Real wage growth jumped to 3.7 percent, outpacing productivity growth; wage pressures have eased somewhat since then but remain elevated.

### Monetary policy stance and actions
- The CBI raised the policy rate in March and May (by 25 bps each) to 7.75 percent, citing persistently high inflation, elevated inflation expectations, and higher commodity prices.
- These increases follow a cumulative 200 bps easing since October 2024.
- The monetary stance remains tight, with a real policy rate of around 3.9 percent—above the estimated 2.7 percent neutral real rate.
- CPI‑indexed loans account for 54 percent of outstanding household debt, cushioning the impact of high nominal rates on borrowers.
- Recommendations and guidance:
  - Further tightening may be needed near term to contain inflationary pressures, given persistently high inflation expectations and limited scope to look through shocks from the Middle East war.
  - When shocks fade, a carefully calibrated easing could be considered; under the baseline inflation is projected to start declining from 2027Q1 and reach the 2.5 percent target in early-2028.
  - Erring on the tighter side is warranted until inflation and inflation expectations are firmly anchored; materialization of upside risks would warrant keeping the policy rate higher for longer.
  - Monetary policy should remain nimble, data-dependent, and supported by clear and forceful communication, using scenarios to explain policy paths.
  - Gradual transition toward a more forecast-based inflation-targeting approach is advised as uncertainty recedes.

### Fiscal and external positions
- Preliminary data suggest the general government deficit declined to 2.4 percent of GDP in 2025 from 4.2 percent in 2024, largely due to expiry of one-off volcanic-activity measures and new revenue measures; the 2025 outcome remains subject to significant uncertainty and may be revised further.
- Public debt declined to 56.1 percent of GDP from 76.1 percent in 2020.
- The current account deficit widened to 3.6 percent of GDP in 2025, reflecting a surge in imports of computer equipment and vehicles and subdued exports; partly offset by improved terms of trade and a stronger primary income balance.
- Both CPI- and ULC-based real effective exchange rates appreciated modestly in 2025 and have risen by 50 and 100 percent, respectively, since 2010.
- FX reserve developments and recommendations:
  - FX purchases totaling €473 million in 2025 raised reserves to around 123 percent of the Fund’s Reserve Adequacy (ARA) metric at year-end.
  - A €138 million FX purchase program announced on May 8 will further strengthen reserves.
  - Increasing reserves toward the upper end of the 100-150 percent ARA range would strengthen resilience; deepening the foreign exchange market and broadening foreign holdings of ISK government bonds would support participation and hedging.

### Credit, financial conditions, and housing
- Credit growth has weakened amid tight financial conditions: household credit contracted and corporate credit growth remained subdued.
- A Supreme Court ruling in October 2025 on the legality of interest rate terms on variable-rate mortgages prompted many lenders to withdraw such mortgages, tightening conditions; these were largely reversed after the CBI eased borrower-based measures (BBMs) and lowered the policy rate, but mortgage product range remains more limited and interest rates on new indexed mortgages are higher.
- BBM easing included raising the loan-to-value limit for first-time buyers from 85 to 90 percent and increasing the share of mortgage loans that may exceed the debt-service-to-income (DSTI) limit from 5 to 10 percent.
- Housing market:
  - Nominal house prices rose modestly in 2025, but real growth slowed and turned negative in late 2025 and into early 2026 due to high interest rates, slower immigration, and rising inventories.
  - House prices are now better aligned with standard valuation metrics and appear broadly in line with fundamentals.
  - In December 2025 the CBI expanded BBMs in response to joint-ownership schemes between construction-company-backed funds and homebuyers, assessing these as riskier than conventional mortgages; use of such structures has remained limited.
  - Housing affordability remains a concern due to still-elevated house prices and high financing costs.

### Outlook and risks
- Baseline projections:
  - Growth projected to strengthen to 1.8 percent in 2026, led by a rebound in net exports as imports normalize, marine exports recover, and data center exports increase.
  - Geopolitical tensions are projected to subtract about 0.5 percentage points from growth over two years under the baseline.
  - Domestic demand is expected to remain weak in 2026; growth projected to rise to 2.1 percent in 2027 as lower inflation and a less restrictive monetary stance boost domestic demand.
  - Despite a negative output gap, inflation is projected to remain elevated in 2026, averaging around 5.2 percent, before reaching the 2.5 percent target in early-2028.
  - Medium-term growth under the baseline is expected to reach 2.4 percent by the end of the projection period, supported by diversification into aquaculture, biotech, renewable energy, and digital infrastructure.
- Severe scenario (April 2026 WEO Severe Scenario calibration) projected impacts:
  - 2026: GDP growth 0.9 (Severe) vs 1.9 (Baseline), difference -1.0; CPI inflation 6.0 vs 5.0, difference 1.0; General government fiscal balance -1.4 vs -1.1, difference -0.3; Current account balance -1.3 vs -0.7, difference -0.6.
  - 2027: GDP growth 1.2 (Severe) vs 2.1 (Baseline), difference -0.9; CPI inflation 5.1 vs 3.1, difference 2.0; General government fiscal balance -0.8 vs -0.5, difference -0.3; Current account balance -0.8 vs -0.1, difference -0.7.
- Risks:
  - Growth risks are tilted to the downside (principal downside: escalation of geopolitical tensions with larger commodity price increases, supply-chain disruption, and weaker external demand).
  - Inflation risks are tilted to the upside (principal domestic risk: stronger-than-expected wage pressures).
  - Other external downside risks include an AI-related equity market correction, rising global fiscal risks, and cyberattacks disrupting cross-border financial flows.
  - Upside opportunities include stronger-than-expected expansion in aquaculture and data centers with faster energy-capacity expansion.

### Policy priorities and structural reforms
- Calibrate policy mix to mitigate spillovers from the Middle East war, bring inflation to target, rebuild fiscal buffers, and safeguard financial stability.
- Monetary policy:
  - Remain data-dependent, nimble, and focused on returning inflation to target; use scenarios to communicate policy paths.
  - Tighten decisively if upside risks to inflation materialize; ease cautiously when sustained disinflation is evident.
- Fiscal policy:
  - Rely primarily on automatic stabilizers in adverse shocks; if needed, deploy limited, well-targeted, and temporary measures to protect low-income households while preserving price signals.
- Financial stability:
  - Monitor mortgage product market developments and systemic risks from alternative financing arrangements; maintain borrower-based measures as appropriate.
- Structural reforms to support disinflation and medium-term growth:
  - Reforms to collective wage-setting arrangements to align wage growth with productivity, including public-sector wage-setting.
  - Measures to lower market concentration and markups that contribute to persistently high service‑sector inflation.
  - Broader product market reforms to boost competition, foster innovation, and address skills shortages and mismatches to support diversification into higher value-added export sectors.

*Source: IMF staff analysis (extracted from chapter 4 of the provided IMF document).*

### 20.      The authorities reiterated their commitment to maintaining a restrictive monetary

### The authorities reiterated their commitment to maintaining a restrictive monetary policy stance until there is clear evidence that inflation and inflation expectations return durably to target

### Monetary Policy
- Authorities committed to maintaining a restrictive monetary policy stance until inflation and inflation expectations return durably to target.
- They will monitor indicators of inflation, inflation expectations and wage developments in assessing policy and are prepared to tighten policy further if needed, even if this could further curtail economic activity.
- Agreed with staff that policy should remain data dependent and that caution is warranted in calibrating any eventual easing given persistent upside risks to inflation.
- Current levels of reserves judged adequate to manage disruptive exchange rate movements; ongoing FX purchase program will keep reserve buffers adequate.
- Supportive of deepening the foreign exchange derivatives market but emphasized importance of proceeding cautiously.

### Fiscal Policy: 2026 and Medium Term
- 2026 stance: Fiscal policy in 2026 described as appropriately contractionary to reduce inflation and rebuild fiscal buffers.
- MTFS projection: general government deficit of 0.9 percent of GDP in 2026 (MTFS), broadly in line with staff forecast.
- Staff bottom-up assessment (given 2025 uncertainty) suggests:
  - Consolidation effort of 0.6 percent of GDP.
  - Resulting modest negative fiscal impulse of around 0.2 percent of GDP in 2026.
- Temporary VAT measure: temporary reduction in VAT rate on fuels from 24 to 11 percent; cost around 0.1 percent of GDP and legislated to be phased out by end-August.
- Recommendation: If energy shock lasts longer, target support to the vulnerable; offset discretionary support measures that would compromise adopted 2026 and 2027 budget targets because automatic stabilizers are already large.

- MTFS medium-term targets and rationale:
  - Balanced budget for general government in 2027.
  - Surplus of 0.8 percent of GDP by 2031.
  - Rationale: current debt 56.1 percent of GDP at end-2025 exceeds most other Nordic countries; targets aim to gradually decline debt and strengthen fiscal buffers.

- Staff projections (legislated measures only):
  - Budget will return to balance by 2031 and public debt will decline to 48 percent of GDP.
  - Include about 1.5 percent of GDP in annual net borrowing (mainly on-lending to Housing Fund and Student Educational Fund and other items).
  - Below-the-line operations will account for about 10 percent of GDP of projected debt by 2031.
  - Spending pressures beyond 2031: rising healthcare costs projected to increase spending by 1.4 percent of GDP by 2037; climate-related expenditures potentially significant but uncertain.
  - Conclusion: Debt projected to continue declining under staff’s baseline but prudent fiscal stance and full implementation of consolidation targets essential.

### Text Table 1 — Revenue and Expenditure Measures, 2026 (Percent of GDP)
- Revenue
  - Kilometer Fee: all motor vehicles 0.70
  - Excise duty on vehicles (lower on electric/higher on fossil) 0.14
  - Fisheries Levy decrease resulting from carbon tax increase 0.10
  - Carbon tax raised by 15% 0.06
  - PIT bracket sharing repealed 0.05
  - Kilometer Fee: heavy vehicles -0.04
  - VAT decrease: side effect from fuel excises repealed -0.05
  - Kilometer Fee: electric and plug-in hybrids -0.07
  - Fuel excises on petrol repealed -0.23
  - Fuel excise on diesel repealed -0.31
  - Other revenue, including interest revenue -0.40
  - Sum total revenue 0.05
  - of which primary revenue 0.45
- Expenditure
  - Mergers, streamlining, and review of operations. -0.15
  - Interest payments on public debt -0.50
  - Review of budgetary allocations . -0.05
  - System change and reorgainsation of services -0.04
  - Postponement or cancellation of projects -0.02
  - Technologisation and digitalisation -0.01
  - Sum total expenditure -0.65
  - of which primary expenditures -0.15
- Note: Minor revenue measures excluded from the list but included in the sum of total revenue.

### Fiscal Policy — Implementation, Risks, and Options
- Implementation: Fiscal consolidation over the medium term described as appropriately ambitious and should be fully implemented; greater reliance on expenditure restraint is welcome.
- Information gaps: Further details on nature of expenditure measures will be important for credibility.
- Risks from infrastructure scaling: State-owned infrastructure company established, financed through user fees and market borrowing, able to enter PPPs; scaling up infrastructure welcomed but fiscal risks (guarantees, off-balance-sheet liabilities) should be contained, transparently recorded, and regularly reported.
- Permitting/licensing: Streamlining needed; currently more onerous than OECD average.

- If additional measures needed, authorities could consider:
  - Revenue-raising measures:
    - Closing around half of the gap in the VAT revenue ratio (e.g., raising preferential VAT rate and/or narrowing eligible goods/services) could generate close to 0.5 percent of GDP in additional revenues.
    - Increase housing taxation (restrict capital gains exemption on housing; raise property tax rate on vacant land).
    - Streamline tax expenditures, reassess 2020 increase in ceiling on business R&D expenditures eligible for tax relief.
  - Rationalizing government spending:
    - Improve education outcomes for given spending level, reduce high spending on recreational services, contain growth in public sector wage bill.
  - More gradual reduction in net debt:
    - If revenue and spending reforms insufficient to scale up infrastructure, consider more gradual convergence toward debt target with clear communication reinforcing commitment to fiscal rules.

- Fiscal framework and data:
  - Amended fiscal rule should help contain spending over medium term; existing legislation provides sound basis to reassess current 2 percent expenditure-growth limit.
  - Strengthen Fiscal Council capacity and resources.
  - Regular publication of timely and independently-verifiable quarterly fiscal data consistent with fiscal rule perimeter; completion of Statistics Iceland's accrual-based quarterly accounts under IPSAS recommended.
  - Expand budget and fiscal rules coverage to entire central government (A1-A3) to increase transparency and reduce incentives to shift spending/borrowing.

### Authorities’ Views on Fiscal Policy
- Authorities committed to fiscal consolidation in line with MTFS 2027-31 targets.
- Confident 2026 deficit broadly in line with 2026 budget target.
- Emphasis on restraining public wage bill growth as key consolidation component.
- Opted for simple visible temporary VAT cut on fuels; acknowledge infrastructure spending gaps to be mitigated within projection period.
- Working on greater institutional coordination to strengthen public finance statistics compilation; supportive of strengthening Fiscal Council.

### Financial Sector Policies
- Banking sector resilience:
  - Capital ratios increased in 2025, partly due to reduction in effective risk weights under CRR III.
  - Profitability strengthened—driven mainly by higher net interest income amid balance-sheet expansion and wider interest-rate differential.
  - Asset quality: non-performing loans around 1.6 percent.
  - Liquidity buffers ample: aggregate liquidity coverage ratio above 200 percent.
  - Pension funds resilient, supported by continued net inflows and positive real asset returns.
  - CBI’s cyclical systemic risk indicator remains below historical average and broadly stable.
  - Financial cycle appears to have peaked due to easing of housing and credit cycles.

- Credit risk and sectoral vulnerabilities:
  - Mortgage portfolios sound, but abrupt residential house price declines plus higher unemployment could weaken asset quality; mitigants include moderate loan-to-value ratios, strong borrower equity, accumulated household savings.
  - Corporate lending: construction and tourism-related sectors account for 38 percent of all corporate lending.
    - Construction: stage two loans rose to 11 percent at end-February from six percent in 2025; mitigated by higher risk weights under CRR III and relatively strong equity ratio around 36 percent.
    - Tourism-related sectors: equity ratio of 24 percent, lower than Nordic peers, increasing sensitivity to downturn in tourist arrivals.
  - Authorities strengthening cyber resilience via testing, contingency planning, and payment system safeguards.

- Macroprudential stance:
  - Capital requirements relatively high for Icelandic banks; include a 2.5 percent countercyclical capital buffer (CCyB) and a two percent systemic risk buffer (SyRB).
  - CCyB at upper end of 2.0–2.5 positive neutral range.
  - Lending surveys show moderation in credit driven by weaker demand rather than supply.
  - Borrower‑based measures (BBMs): recent easing helped offset tightening after the Supreme Court ruling on variable-rate mortgages; with housing-market risks receding, BBMs should remain on hold to avoid reinforcing housing slowdown while serving as structural backstop.

- Housing finance reforms:
  - Government plans to reduce reliance on index‑linked mortgages, including minimum repayment requirements from 2027.
  - Caution: indexation has had beneficial impact on borrower and financial stability resilience; reforms warrant careful assessment.

- Supervisory and pension fund governance:
  - Strengthen pension fund governance, internal controls, and risk management incrementally.
  - Explore options to introduce more streamlined and independent budgetary process for financial supervision and stronger legal protection for supervisors.

### Authorities’ Views on Financial Sector
- Authorities concurred that the financial system is resilient, aided by sound supervision and tight macroprudential stance.
- Key risks seen in housing market and cyber events.
- Confident financial institutions have sufficient buffers to handle deterioration in asset quality.
- Supportive of continued progress on FSAP recommendations and ongoing FATF assessment (expected to be published in 2027).

### Structural Policies to Lift Potential Growth
- Growth challenge: Past decade’s GDP growth driven largely by tourism and foreign-labor inflows; sustaining medium-term growth requires stronger productivity growth, diversification into higher-value-added sectors, and reforms to support business dynamism, innovation, labor supply, skills, and infrastructure.

- Priority reform areas and recommendations:
  - Business regulation reforms:
    - High barriers to entry in parts of services sector; business regulation more restrictive than OECD average.
    - FDI regulations among most stringent in OECD—restrictions in fisheries, electricity, air transport.
    - Priorities: streamline licensing and permitting, reduce restrictive FDI regulation, digitize government services, simplify insolvency regime for SMEs.
  - Innovation:
    - Total R&D spending about 2.5 percent of GDP in 2024; target to raise to 3.5 percent of GDP by 2035.
    - Innovation outputs weaker than expected for R&D level; recommendations include enhancing efficiency of R&D support, better monitoring/reporting of R&D impact, streamline grant applications, expand research-industry linkages, develop venture capital and startup ecosystem.
  - Labor market reforms:
    - High unionization and centralized bargaining; average wage growth has markedly outpaced productivity growth over last decade.
    - Importance of wage settlements—including public sector—being consistent with anticipated productivity growth and inflation target.
    - Consider including public-sector unions in coordinated bargaining rounds and better synchronize negotiation rounds; strengthen state mediator’s authority to trigger binding votes.
  - Skills shortages and education:
    - PISA scores declined markedly over two decades and now well below OECD average.
    - Stepping up education reform under Education Policy 2030 and improving STEM training; expand vocational training and reskilling; integrate immigrants better; strengthen digital skills and AI-related training.
  - Infrastructure investment:
    - Public investment above European average but lags Nordic peers; cumulative infrastructure gap including maintenance estimated around 14 percent of GDP in 2025.
    - Energy sector: planned generation capacity increases insufficient for projected demand; parts of transmission grid operating at full capacity.
    - Fast-track green generation projects and streamline approvals to strengthen energy security and enable sectors like aquaculture and data centers.
    - Timely implementation of National Transportation Plan recommended.
    - State-owned infrastructure company could accelerate delivery but fiscal risks must be managed carefully.

*Source: IMF staff analysis as presented in the provided chapter excerpt.*

### 35.      EU accession and euro adoption are ultimately political choices that involve balancing

### EU accession and euro adoption are ultimately political choices that involve balancing deeper integration and credibility gains against reduced macroeconomic policy autonomy

### Overview
- Iceland is scheduled to hold a referendum on August 29, 2026 on whether to resume EU accession negotiations.
- Joining the EU (and, ultimately, the euro area) would deepen trade and financial integration, eliminate exchange-rate risk vis-à-vis the euro area, and could support investment and productivity.
- Iceland's membership in the European Economic Area (EEA) means it already applies a large share of the EU acquis communautaire, including single-market rules on the four freedoms, competition, state aid, and horizontal policies such as energy and environment.
- Main outstanding accession areas: the Common Agricultural Policy and the Common Fisheries Policy, where accession could require Iceland to adjust control over fisheries quota management.
- EU membership would bring Iceland inside the customs union, shielding it from EU trade defense measures such as the 2025 ferro-alloy safeguard tariff-rate quotas that were applied to EEA members.

### Authorities’ views
- Authorities broadly shared staff's structural reform priorities and highlighted the recently published Growth Plan to 2035 as the central vehicle for advancing them.
- Growth Plan key priorities: strengthening energy supply and infrastructure, simplifying regulation and licensing, and supporting innovation and export-driven industries.
- An associated Action Plan 2026–27 provides concrete implementation targets.
- Authorities emphasized a shift from diagnosing structural constraints to ensuring effective delivery of reforms.
- Authorities welcomed staff’s holistic assessment of the multiple elements/dimensions related to potential EU accession and euro adoption.

### Staff appraisal — macroeconomic developments and projections
- Economic activity moderated in recent years while inflationary pressures remained elevated.
- Growth has slowed since mid-2023 amid appropriately tight macroeconomic policies and idiosyncratic shocks.
- The current account deficit widened in 2025, due to imports for data centers and other idiosyncratic factors.
- The external position is assessed to be moderately weaker than implied by fundamentals and desirable policies.
- Staff projects:
  - Growth of 1.8 percent in 2026.
  - Growth of 2.1 percent in 2027.
  - Inflation of 5.2 percent in 2026.
  - Inflation of 3.2 percent in 2027.
  - Inflation is projected to decline toward target in early-2028.
- Key risks:
  - Escalation of geopolitical tensions.
  - Stronger‑than‑expected wage growth.
  - Disruptions to key export sectors.
- Medium-term growth prospects are supported by continued diversification toward new export-oriented sectors.
- Policy priorities: lower inflation sustainably to target, anchor inflation expectations, increase resilience to shocks by further building fiscal buffers, and advance structural reforms.

### Fiscal policy assessment and recommendations
- The fiscal stance is appropriately contractionary and the medium-term fiscal targets are appropriately ambitious and should be fully implemented.
- The temporary reduction in the VAT rate on fuel should remain time-bound and be phased out as planned.
- Medium-term targets place public debt on a firm downward trajectory.
- Longer-term spending pressures from healthcare and infrastructure underscore the importance of sustained discipline and credible medium-term planning, and transparent monitoring of credit risk related to below-the-line on-lending.
- Scope exists to raise revenues and reduce spending if needed to meet the MTFS targets, mitigate long-term spending pressures, or scale up infrastructure investment. Options include:
  - Raising the preferential VAT rate and/or narrowing its coverage.
  - Increasing housing-related taxation.
  - Streamlining R&D support.
  - Further rationalizing public spending, including through spending efficiency and public sector wage restraint.
- Plans to establish a state-owned infrastructure company could help mobilize financing but should have strong safeguards to contain fiscal risks, including careful monitoring and transparent recording of contingent liabilities and off-balance-sheet exposures.
- Strengthening the fiscal framework would boost credibility of the consolidation effort:
  - The amended fiscal rule should help contain spending over the medium term and reduce procyclicality.
  - Strengthening the Fiscal Council is welcome, but a meaningful increase in its capacity and resources will be needed.
  - Regular publication of timely and independently-verifiable quarterly fiscal data consistent with the fiscal-rule perimeter is recommended.
  - Expanding the coverage of the budget and the fiscal rules to encompass the entirety of the central government would improve transparency.

### Monetary policy, reserves, and communication
- The monetary policy stance remains appropriately restrictive, but vigilance is warranted alongside clear and forceful communication.
- Further tightening may be needed in the near term if inflationary pressures persist or intensify.
- Policy should remain restrictive until inflation and inflation expectations are firmly anchored at target.
- Strengthening communication, including using alternative scenarios, would help enhance transparency and anchor expectations.
- As uncertainty recedes, a gradual transition toward a more forecast-based inflation targeting framework would improve predictability and reduce volatility.
- Reserves are adequate for precautionary purposes.
- Further strengthening of foreign exchange reserves toward the upper end of the Fund’s ARA range would enhance resilience to external shocks.
- Efforts to deepen the foreign exchange market would support broader market participation and improve hedging opportunities.

### Financial sector stability and reforms
- Systemic risks in the financial sector are contained and the current macroprudential stance is broadly appropriate.
- Banks remain well-capitalized, profitable, and liquid, with strong asset quality.
- Vulnerabilities exist in parts of the corporate sector—notably construction and tourism-related activities—which require vigilance.
- Borrower-based measures should remain broadly unchanged for now, especially given the slowing housing market.
- Efforts to reduce reliance on CPI-indexed mortgages may strengthen monetary transmission over time, but should be carefully timed and sequenced given their role in supporting borrower resilience and financial stability.
- Financial sector reform priorities include:
  - Strengthening pension fund governance.
  - Safeguarding the independence of financial supervision.
  - Strengthening operational resilience, including against cyber and payments-related risks.
- Financial sector reforms should build on significant progress achieved in implementing FSAP recommendations.

### Structural reform priorities
- Focus on raising productivity and further diversification.
- Priorities:
  - Reducing regulatory barriers and streamlining licensing and permitting processes.
  - Addressing skills shortages through education reform, vocational training, and improved reskilling.
  - Reforming wage-setting arrangements to better align wage growth with productivity and the inflation target.
  - Closing infrastructure gaps.
  - Improving the efficiency of R&D support while strengthening the broader innovation ecosystem.
- The authorities’ Growth Plan to 2035 aligns with these priorities; successful implementation requires strong cross-ministerial coordination, prioritization, monitoring and reporting.
- OECD research suggests the 40 points decline in Iceland’s average PISA score between 2006 and 2022 could reduce long-term productivity by over 5 percent.

### EU accession and euro adoption considerations
- EU accession and euro adoption are political choices balancing deeper integration and potential credibility gains against reduced macroeconomic policy autonomy.
- Potential benefits of EU membership and euro adoption:
  - Deeper trade and financial integration.
  - Elimination of exchange-rate risk vis-à-vis the euro area.
  - Potential support for investment and productivity.
  - Euro adoption could help anchor inflation expectations, facilitate gradual convergence of market interest rates toward euro-area peers, and provide access to euro-area financial architecture, including the Banking Union.
- Potential costs and risks:
  - Loss of independent monetary policy and exchange-rate flexibility—tools that have helped absorb large and sometimes asymmetric shocks over the last decade and a half.
  - Increased reliance on fiscal policy for stabilization and greater demands on a strong countercyclical fiscal framework.
  - Increased exposure to euro-area-wide tail risks through shared backstops and crisis mechanisms.
- Given high labor market flexibility, the focus under euro adoption should be on:
  - Aligning wage growth with productivity gains.
  - Advancing productivity-enhancing structural reforms to preserve external competitiveness in the absence of exchange-rate adjustment.
- Critical preconditions if the process moves forward:
  - Adopting the euro from a position of low inflation.
  - Sustainable public finances.
  - A parity consistent with fundamentals to avoid locking in an overvalued real exchange rate that would undermine competitiveness and force adjustment through internal devaluation.

*INTERNATIONAL MONETARY FUND — ICELAND*

### 48.      It is proposed that the next Article IV consultation with Iceland take place on the

### It is proposed that the next Article IV consultation with Iceland take place on the standard 12-month cycle.

### Real sector developments
- Consumer spending growth picked up in 2025 despite slowing real income growth as the savings rate declined.
- Investment goods imports fell sharply following a data center surge; investment goods imports and general business investment show large negative swings in 2024–2025.
- Real GDP growth (annual) by year: 2021: 5.2; 2022: 8.9; 2023: 5.0; 2024: -1.3; 2025: 1.3; 2026: 1.8; 2027: 2.1; 2028: 2.4; 2029: 2.4; 2030: 2.4; 2031: 2.4.
- Real GDP (index, 2015=100) has outpaced GDP per capita over the last decade.
- Real turnover in tourism in 2025 remains around 20 percent above 2019 levels.
- Indicators point to increasing slack: capacity utilization has drifted lower and the output gap is negative.
- CPI inflation has remained above the 2.5 percent target even as the output gap is negative.
- Output gap (percent of potential output) by year: 2021: -3.8; 2022: 1.6; 2023: 3.6; 2024: 0.3; 2025: -0.1; 2026: -0.3; 2027: -0.3; 2028: -0.1; 2029: 0.0; 2030: 0.0; 2031: 0.0.

### Labor market developments
- Estimated population (16–74 years old) and labor force increased through Feb 2026; labor force growth has slowed despite continued population growth.
- Activity rate (percent of estimated population, 16–74 years old) trend shows a decline: recent values around low 80s to high 70s.
- The employment rate fell to its lowest level since October 2022.
- Growth in total hours worked was driven primarily by higher employment.
- Beveridge curve has flattened since Covid as immigration flows are linked to the business cycle.
- Wages: real wages strengthened in 2025 with nominal wage growth outpacing declining inflation.
- Unemployment rate (percent of labor force) projections: 2021: 5.8; 2022: 3.6; 2023: 3.4; 2024: 3.4; 2025: 4.3; 2026: 4.3; 2027: 4.2; 2028: 4.0; 2029: 4.0; 2030: 4.0; 2031: 4.0.

### Fiscal developments and issues
- The fiscal position has been gradually improving since the pandemic, supported by robust revenues and a decline in non-interest spending since the pandemic.
- Revenue composition broadly stable through 2025; an increase in payrolls was offset by a decline in interest and other spending following Grindavík purchases in 2024.
- Settlement of the IL Fund (previously HFF) reduced government debt by around 5 percent of GDP in 2025.
- General government headline figures (percent of GDP):
  - Total revenue: 2021: 40.7; 2022: 42.3; 2023: 43.1; 2024: 42.9; 2025: 42.6; 2026: 43.2; 2027: 43.3; 2028: 43.1; 2029: 43.2; 2030: 43.2; 2031: 43.2.
  - Total expenditure: 2021: 48.7; 2022: 46.2; 2023: 45.2; 2024: 47.1; 2025: 45.0; 2026: 44.6; 2027: 43.9; 2028: 43.5; 2029: 43.3; 2030: 43.2; 2031: 43.1.
  - Overall balance: 2021: -8.0; 2022: -3.8; 2023: -2.1; 2024: -4.2; 2025: -2.4; 2026: -1.5; 2027: -0.6; 2028: -0.4; 2029: -0.2; 2030: -0.1; 2031: 0.0.
  - Cyclically-adjusted primary balance: 2021: -3.7; 2022: -1.3; 2023: -0.8; 2024: -1.2; 2025: 0.5; 2026: 1.5; 2027: 1.7; 2028: 1.9; 2029: 2.0; 2030: 2.2; 2031: 2.3.
- Gross debt (percent of GDP): 2021: 73.6; 2022: 66.4; 2023: 61.5; 2024: 60.4; 2025: 56.1; 2026: 54.6; 2027: 52.9; 2028: 51.6; 2029: 50.0; 2030: 48.6; 2031: 47.5.
- Net debt (percent of GDP): 2021: 58.8; 2022: 55.3; 2023: 52.1; 2024: 50.4; 2025: 45.8; 2026: 45.1; 2027: 43.8; 2028: 43.0; 2029: 41.8; 2030: 40.8; 2031: 40.1.

### External sector developments
- The current account deterioration in 2024 and 2025 was driven by imported capital goods and idiosyncratic shocks.
- Export growth in 2025 was subdued.
- Improvement in the financial account was driven by increasing FDI inflows.
- FX interbank market turnover increased in 2025 with CBI’s temporary FX purchase program; reserves increased in 2025 and moved toward the mid-point of the ARA metric.
- Current account balance (percent of GDP): 2021: -2.6; 2022: -1.7; 2023: -1.2; 2024: -3.2; 2025: -3.6; 2026: -1.3; 2027: -0.8; 2028: -0.5; 2029: -0.1; 2030: 0.1; 2031: 0.2.
- Financial account (4-quarter moving average, percent of GDP) shows a swing toward net inflows driven by FDI in 2025.
- Central bank reserves ($ Mn.): 2021: 7,091; 2022: 5,879; 2023: 5,720; 2024: 6,387; 2025: 7,643; 2026: 7,916; 2027: 8,248; 2028: 8,565; 2029: 8,978; 2030: 9,308; 2031: 9,642.
- Reserve adequacy (percent of reserve adequacy metric): 2021: 139.3; 2022: 117.8; 2023: 111.9; 2024: 119.4; 2025: 123.2; 2026: 123.3; 2027: 122.1; 2028: 124.8; 2029: 124.6; 2030: 124.7; 2031: 124.2.

### Banking sector developments
- Banking system assets are growing broadly in line with GDP.
- Banks’ relative exposure to households is gradually declining in line with household deleveraging.
- Non-performing loans remained broadly stable at a low level.
- Bank profitability is sound, aided by robust net interest income; net interest margin and return metrics show improvement in recent years.
- Liquidity buffers remain ample; liquidity requirement metrics (LCR, NSFR) show compliance with limits.
- Key banking indicators (percent):
  - Regulatory capital to risk-weighted assets (IMF staff estimates for some years): 2016: 25.1; 2017: 23.2; 2018: 24.2; 2019: 24.9; 2020: 25.4; 2021: 23.7; 2022: 24.3; 2023: 23.5; 2024: 23.9; 2025: 23.9.
  - Total nonperforming loans (facility level): 2015: 2.0; 2016: 2.7; 2017: 2.2; 2018: 2.6; 2019: 2.9; 2020: 2.1; 2021: 1.5; 2022: 1.6; 2023: 1.8; 2024: 1.6; 2025: 1.6.

### Housing market developments
- Real house price growth slowed through 2025; commercial real estate prices declined.
- The share of properties selling for below the asking price has risen.
- House prices are broadly in line with fundamentals (real house price index trend and cycle analysis using HP filters).
- Real estate turnover has moderated (Real Estate Turnover index, December 2019 = 100, shows decline through 2025).
- Higher interest rates have increased the debt service burden on households’ mortgage loans.
- Tighter financial conditions have triggered a decline in household indebtedness.
- Household interest payment to disposable income (percent): 2016–2025 series rises notably in 2022–2023 and moderates thereafter.
- Household loans by source (percent of GDP) show growing role of banks, pension funds and insurance, and other financial institutions in household credit.

### Structural developments
- Iceland lags peers in strictness of business regulations, innovation and digitalization, and services trade relative to global frontier metrics; closeness-to-frontier indicators show lower scores in these areas.
- FDI regulatory restrictiveness (2024 score) places Iceland above the OECD average and most advanced economies on restrictiveness metrics.
- Firm entry and exit rates compare relatively favorably to peers, though improvement scope remains.
- Iceland’s PISA scores have fallen sharply over the last decade; relative PISA (Mathematics, Science, Reading) scores are below OECD averages in recent years.
- Gross public fixed investment (percent of GDP) shows Iceland lagging Nordic peers: 2018–2025 trend indicates lower public investment share; 2025–2050 energy forecasts show baseline and high demand scenarios where energy demand is set to outpace supply without expanded supply/entry into the energy sector.
- Energy demand and supply projections (TWh) present Baseline demand and High demand paths through 2050 indicating need for expanded energy supply (Hydro, Geothermal, Wind).

### Key projections and macro aggregates (selected)
- GDP (ISK bn.): 2021: 3,332; 2022: 3,947; 2023: 4,373; 2024: 4,578; 2025: 4,956; 2026: 5,351; 2027: 5,645; 2028: 5,937; 2029: 6,259; 2030: 6,590; 2031: 6,937.
- GDP ($ Mn.): 2021: 26,235; 2022: 29,176; 2023: 31,702; 2024: 33,187; 2025: 38,583; 2026: 43,664; 2027: 46,316; 2028: 48,777; 2029: 51,189; 2030: 53,619; 2031: 56,153.
- GDP per capita ($ thousands): 2021: 73.2; 2022: 80.0; 2023: 84.5; 2024: 86.5; 2025: 99.1; 2026: 109.7; 2027: 114.0; 2028: 117.6; 2029: 121.0; 2030: 124.2; 2031: 127.5.
- Consumer price index (average): 2021: 4.5; 2022: 8.3; 2023: 8.7; 2024: 5.9; 2025: 4.1; 2026: 5.2; 2027: 3.2; 2028: 2.5; 2029: 2.5; 2030: 2.5; 2031: 2.5.
- Central bank 7 day term deposit rate (policy rate row): 2021/2.00; 2022: 6.00; 2023: 9.25; 2024: 8.50; 2025: 7.25; 2026: 7.75. (For 2026, policy rate as of the May MPC meeting.)
- Current account balance (USD mn and percent of GDP) and trade components show a widening current account deficit in 2024–2025 driven by goods imports and capital goods.

*Source: IMF staff compilation and projections contained in the cited IMF chapter.*

### Annex I. External Sector Assessment

### Annex I. External Sector Assessment

### Overall Assessment
- The external position of Iceland in 2025 was moderately weaker than the level implied by fundamentals and desirable policies.
- The current account balance deteriorated to a deficit of 3.6 percent of GDP in 2025 from 3.2 percent in 2024.
- The current account was significantly impacted by transitory shocks that adversely affected the trade balance that more than offset a strengthening of the primary income balance and an improvement in the terms of trade.
- A positive net international investment position and adequate foreign exchange reserve buffers support external sustainability and mitigate potential adverse risks, including from higher energy prices.

### Potential Policy Responses
- The current account is expected to improve significantly in 2026 as the impact of transitory shocks in 2025 fades and gradually strengthen over the medium term supported by moderately tight macroeconomic policies.
- Sustained efforts to foster innovation are needed to facilitate the diversification of the economy toward higher value-added export-oriented sectors.
- The flexible exchange rate should act as the main shock absorber, supported by structural measures to enhance price and wage flexibility.

### Foreign Assets and Liabilities: Position and Trajectory
Background
- The net international investment position (NIIP) declined to 44.2 percent of GDP in 2025, from 48.7 percent in 2024, though it has improved significantly over the past decade.
- The decline largely reflected a reduction in direct investment assets, which accounted for a 6.2 percentage points reduction in gross assets to 141.7 percent of GDP.
- Gross liabilities stood at 97.6 percent of GDP, reflecting only modest compositional changes, and are well diversified across FDI (37.4 percent of GDP), portfolio debt liabilities (31.1 percent of GDP), and other investments (24.9 percent of GDP).

Assessment
- The NIIP is forecasted to remain at its current levels over the medium term, consistent with a recovery in the current account balance.
- Fluctuations in valuation effects create uncertainties around the projections and pose a potential downside risk.

Key statistics (2025, Percent of GDP)
- NIIP: 44.2
- Gross Assets: 141.7
- Debt Assets: 23.2
- Gross Liab.: 97.6
- Debt Liab.: 68.5

### Current Account
Background
- The current account deficit widened to 3.6 percent of GDP in 2025, reflecting a series of transitory shocks including a disappointing fishing season, weak aluminum export growth, and a surge in imports of computer equipment.
- These pressures were partly offset by an improvement in the terms of trade—driven by higher marine and aluminum prices—and a strengthening of the primary income balance due to lower dividends and retained earnings outflows.

Assessment and Model Estimates for 2025 (in percent of GDP)
- The EBA-lite adjusted CA balance stood at 0.5 percent of GDP in 2025 after accounting for adjustors to capture the transitory effect of higher imports for data centers (3.1 percent of GDP), the disappointing fishing season (0.7 percent of GDP) and disruptions to aluminum production (0.3 percent of GDP).
- The EBA-lite CA regression estimates a norm of 2.1 percent of GDP, implying a staff–assessed CA gap of -1.6 percent.
- There is a moderate positive contribution from policy gaps, primarily due to the difference between the fiscal deficit in 2025 and the fiscal balance required to stabilize debt over the medium-term.

CA/REER model summary (in percent of GDP)
- CA-Actual: -3.6
- Cyclical contributions (from model): 0.0
- Additional temporary/statistical factors: -4.1  (Notes: includes adjustment to account for the temporary impact of shock to the import of capital goods for data centers (3.1 percent of GDP), loss of capelin catch (0.7 percent of GDP) and reduction in aluminum production due to a temporary shot-down of 2/3 production at a very large aluminum smelter (0.3 percent of GDP))
- Adjusted CA: 0.5
- CA Norm (from model): 2.1
- Adjusted CA Norm: 2.1
- CA Gap: -1.6
- o/w Relative policy gap: 1.8
- Elasticity: -0.3
- REER Gap (in percent): 5.3 (CA model), 9.8 (REER model)

Notes
- Based on the EBA-lite 3.0 methodology.
- Cyclically adjusted, including multilateral consistency adjustments.

### Real Exchange Rate
Background
- Both the CPI- and ULC-based real effective exchange rate (REER) appreciated modestly in 2025, driven primarily by high inflation and wage growth in Iceland.
- The REER has appreciated significantly over the last decade, reflecting the emergence of tourism as a key export sector.
- While the appreciating REER has thus far not been associated with a deterioration in Iceland’s external position, competitiveness pressures could emerge as growth in the tourism sector moderates and future growth increasingly depends on the development of higher value-added export sectors.

Assessment
- Both the CA-based model and the REER model suggest minor overvaluation of the ISK.

### Capital and Financial Accounts: Flows and Policy Measures
Background
- Net capital outflows from the capital and financial account increased to 2.4 percent of GDP in 2025, from near balance in 2024.
- This was driven primarily by a sizeable capital account inflow stemming from a large one-off transaction—the sale of intellectual property by an Icelandic biotechnology company to a foreign entity.
- Meanwhile, inward FDI moderated and net borrowing needs were satisfied by debt portfolio investments.
- The large discrepancy between the financial account and the current account balance in 2024, leading to net errors and omissions, declined significantly to -0.4 percent of GDP.
- With the Exchange Rate Act of 2021, the remaining capital flow management measures (CFM) introduced in 2008 were removed, and no new CFMs have been introduced since then.

Assessment
- Capital inflows to Iceland remain dependent on global market conditions.
- Vulnerabilities related to external financing are contained, given the positive stock position and adequate foreign exchange reserve buffers.

### FX Intervention and Reserves Level
Background
- Under the free-floating exchange rate regime, the CBI uses interventions mainly to counter disorderly market conditions.
- The CBI commenced regular purchases of foreign exchange in April 2025 and continued doing so until year end to offset a projected decline in reserve coverage.
- As a result, the CBI’s share of the foreign exchange interbank turnover in 2025 was unusually high at 20.5 percent.
- The level of foreign exchange reserves is equivalent to 19.8 percent of GDP and about 5 months of prospective goods and services imports.

Assessment
- At 123.2 percent of the Fund’s ARA metric, helped by the CBI’s purchase program and €750 million Eurobond issuance in 2025, the level of reserves remains broadly adequate for precautionary purposes, but should gradually be increased towards the upper half of the adequacy range of 100-150 percent, given the exposure of Iceland’s economy to external shocks.

*Source: IMF staff compilation from Annex I. External Sector Assessment.*

### Annex III. Figure 2. Iceland: Public Debt Structure Indicators

### Annex III. Figure 2. Iceland: Public Debt Structure Indicators

### Public debt composition and market structure (visual indicators and commentary)
- Debt by Currency (Percent of GDP): public debt is largely in domestic currency with a significant share linked to CPI.
- Public Debt by Holder (Percent of GDP): Iceland has a large institutional investor base, including pension funds.
- Public Debt by Governing Law, 2025 (percent): domestic law, foreign law ex. multilateral, and multilateral are distinguished in the figure (perimeter shown is general government).
- Debt by Instruments (Percent of GDP): marketable debt and nonmarketable debt are depicted (perimeter shown is general government).
- Public Debt by Maturity (Percent of GDP): maturity profile shown with categories ≤ 1 year, 1-5 years, > 5 years; residual maturity: 7. years.
- Commentary:
  - "Public debt is largely in domestic currency with a significant share linked to CPI."
  - "Iceland has a large institutional investor base, including pension funds."
  - "The government lengthened the average maturity in 2025."

### Baseline scenario—key public debt and fiscal projections (Percent of GDP unless indicated otherwise)
- Actual public debt at 2025: 56.1
- Projected public debt (by year):
  - 2026: 54.6
  - 2027: 52.9
  - 2028: 51.6
  - 2029: 50.0
  - 2030: 48.6
  - 2031: 47.5
  - 2032: 46.2
  - 2033: 44.9
  - 2034: 43.6
  - 2035: 42.1
- Change in public debt (yearly):
  - 2026: -4.3
  - 2027: -1.5
  - 2028: -1.8
  - 2029: -1.3
  - 2030: -1.6
  - 2031: -1.4
  - 2032: -1.0
  - 2033: -1.3
  - 2034: -1.3
  - 2035: -1.3
- Contribution of identified flows:
  - 2026: -10.6
  - 2027: -1.5
  - 2028: -1.7
  - 2029: -1.3
  - 2030: -1.6
  - 2031: -1.4
  - 2032: -1.0
  - 2033: -1.3
  - 2034: -1.3
  - 2035: -1.4
- Primary deficit (percent of GDP):
  - Actual 2025: -0.5
  - 2026: -1.2
  - 2027: -1.5
  - 2028: -1.8
  - 2029: -2.1
  - 2030: -2.2
  - 2031: -2.2
  - 2032: -2.2
  - 2033: -2.2
  - 2034: -2.2
  - 2035: -2.2
- Noninterest revenues:
  - 2025: 41.2
  - 2026: 41.8
  - 2027: 42.1
  - 2028: 42.5
  - 2029: 42.6
  - 2030: 42.6
  - 2031: 42.6
  - 2032: 42.6
  - 2033: 42.6
  - 2034: 42.6
  - 2035: 42.6
- Noninterest expenditures:
  - 2025: 40.7
  - 2026: 40.5
  - 2027: 40.6
  - 2028: 40.6
  - 2029: 40.5
  - 2030: 40.4
  - 2031: 40.4
  - 2032: 40.4
  - 2033: 40.4
  - 2034: 40.4
  - 2035: 40.4
- Automatic debt dynamics:
  - 2026: -3.2
  - 2027: -0.3
  - 2028: 0.0
  - 2029: 0.3
  - 2030: 0.2
  - 2031: 0.5
  - 2032: 0.6
  - 2033: 0.7
  - 2034: 0.7
  - 2035: 0.7
- Real interest rate and relative inflation:
  - 2025: -1.6
  - 2026: 0.7
  - 2027: 1.1
  - 2028: 1.5
  - 2029: 1.4
  - 2030: 1.7
  - 2031: 1.8
  - 2032: 1.9
  - 2033: 1.8
  - 2034: 1.8
  - 2035: 1.7
- Real interest rate:
  - 2025: -2.0
  - 2026: 0.4
  - 2027: 1.0
  - 2028: 1.4
  - 2029: 1.4
  - 2030: 1.6
  - 2031: 1.7
  - 2032: 1.8
  - 2033: 1.8
  - 2034: 1.8
  - 2035: 1.7
- Relative inflation:
  - 2025: 0.3
  - 2026: 0.3
  - 2027: 0.1
  - 2028: 0.1
  - 2029: 0.1
  - 2030: 0.1
  - 2031: 0.0
  - 2032: 0.0
  - 2033: 0.0
  - 2034: 0.0
  - 2035: 0.0
- Real growth rate:
  - 2025: -0.8
  - 2026: -1.0
  - 2027: -1.1
  - 2028: -1.2
  - 2029: -1.2
  - 2030: -1.2
  - 2031: -1.1
  - 2032: -1.1
  - 2033: -1.1
  - 2034: -1.1
  - 2035: -1.0
- Other identified flows:
  - 2025: -6.8
  - 2026: 0.0
  - 2027: -0.2
  - 2028: 0.3
  - 2029: 0.3
  - 2030: 0.4
  - 2031: 0.6
  - 2032: 0.2
  - 2033: 0.2
  - 2034: 0.2
  - 2035: 0.1
- Contingent liabilities: 0.0 for all years 2025–2035
- (minus) Interest Revenues:
  - 2025: -1.3
  - 2026: -1.4
  - 2027: -1.5
  - 2028: -1.2
  - 2029: -1.2
  - 2030: -1.2
  - 2031: -1.0
  - 2032: -0.8
  - 2033: -0.7
  - 2034: -0.6
  - 2035: -0.5
- Other transactions:
  - 2025: -5.5
  - 2026: 1.5
  - 2027: 1.4
  - 2028: 1.5
  - 2029: 1.5
  - 2030: 1.5
  - 2031: 1.6
  - 2032: 1.1
  - 2033: 0.9
  - 2034: 0.8
  - 2035: 0.7
- Contribution of residual:
  - 2025: 6.2
  - 2026–2035: 0.0 (each year)
- Gross financing needs:
  - 2025: 10.3
  - 2026: 6.1
  - 2027: 3.4
  - 2028: 6.6
  - 2029: 4.4
  - 2030: 7.0
  - 2031: 5.4
  - 2032: 3.0
  - 2033: 3.6
  - 2034: 2.8
  - 2035: 4.4
- Of which: debt service:
  - 2025: 12.1
  - 2026: 8.8
  - 2027: 6.5
  - 2028: 9.6
  - 2029: 7.7
  - 2030: 10.4
  - 2031: 8.6
  - 2032: 6.1
  - 2033: 6.6
  - 2034: 5.7
  - 2035: 7.2
- Local currency financing:
  - 2025: 5.8
  - 2026: 2.5
  - 2027: 3.3
  - 2028: 5.5
  - 2029: 3.5
  - 2030: 3.8
  - 2031: 5.6
  - 2032: 3.7
  - 2033: 3.2
  - 2034: 3.5
  - 2035: 4.6
- Foreign currency financing:
  - 2025: 0.0
  - 2026: 0.8
  - 2027: 1.0
  - 2028: 1.9
  - 2029: 0.1
  - 2030: 1.8
  - 2031: 0.6
  - 2032: 0.6
  - 2033: 1.6
  - 2034: 0.2
  - 2035: 0.4
- Memo indicators:
  - Real GDP growth (percent):
    - 2025: 1.3
    - 2026: 1.8
    - 2027: 2.1
    - 2028: 2.4
    - 2029: 2.4
    - 2030: 2.4
    - 2031: 2.4
    - 2032: 2.4
    - 2033: 2.4
    - 2034: 2.4
    - 2035: 2.4
  - Inflation (GDP deflator; percent):
    - 2025: 6.9
    - 2026: 6.1
    - 2027: 3.3
    - 2028: 2.7
    - 2029: 2.9
    - 2030: 2.8
    - 2031: 2.7
    - 2032: 2.6
    - 2033: 2.5
    - 2034: 2.4
    - 2035: 2.3
  - Nominal GDP growth (percent):
    - 2025: 8.2
    - 2026: 8.0
    - 2027: 5.5
    - 2028: 5.2
    - 2029: 5.4
    - 2030: 5.3
    - 2031: 5.2
    - 2032: 5.1
    - 2033: 5.0
    - 2034: 4.9
    - 2035: 4.8
  - Effective interest rate (percent):
    - 2025: 3.3
    - 2026: 6.8
    - 2027: 5.3
    - 2028: 5.6
    - 2029: 5.7
    - 2030: 6.2
    - 2031: 5.6
    - 2032: 6.6
    - 2033: 6.6
    - 2034: 6.5
    - 2035: 6.4

- Extended projection commentary (verbatim excerpts of key findings):
  - "Public debt is projected to gradually decline with fiscal consolidation and growth more than offset impact from real interest rates, supported by the reinstated fiscal rule from 2026."
  - "A settlement was reached in 2025 between the government and 18 pensions funds on outstanding liabilities in HFF."
  - "Public debt at end-2025 was significantly higher than projected in the 2025 Article IV consultation, mainly due to a smaller-than-anticipated impact of the settlement of securities issued by the Housing Finance Fund (HFF) of around 5 percent of GDP on general government debt."
  - "In addition the privatization of Islandsbanki reduced public debt below-the-line in 2025 (both recorded under 'other transactions')."
  - "There is statistical uncertainty on the 2025 outcome."
  - "Below-the-line issuance, especially in the form of government on-lending, but also other activities currently captured in other identified flows, are adding on average 1.5 percet of GDP annually to debt. These on-lending activities should be carefully monitored."

### Medium-term risk assessment (Annex III. Figure 3)
- Debt fanchart module:
  - Fanchart width (percent of GDP): 83.0
  - Contrib 1/: 1.2
  - Probability of debt non-stabilizaiton (percent): 17.3
  - Contrib 1/: 0.1
  - Terminal debt-to-GDP x: 8.3
  - Contrib 1/: 0.2
  - Debt fanchart index (DFI): 1.5
  - Risk signal: Moderate
- Gross Financing Needs (Percent of GDP):
  - Average baseline GFN (percent of GDP): 5.5
  - Contrib 1/: 1.9
  - Initial Banks' claims on the gen. govt (pct bank assets): 4.9
  - Contrib 1/: 1.6
  - Chg. In banks' claims in stress (pct banks' assets): 1.3
  - Contrib 1/: 0.4
  - GFN financeability index (GFI): 3.9
  - Risk signal: Low
- Medium-Term Index (Index Number):
  - Debt fanchart index: 1.5 (Value)
  - GFN financeability index: 3.9 (Value)
  - Medium-term index: 0.2 (Value shown as Low)
  - Risk signal: 5/ Final assessment: Moderate (medium-term index indicated as Low in parts)
- Final assessment metrics:
  - "Prob. of missed crisis, 2026-2031, if stress not predicted: 9.1 pct."
  - "Prob. of false alarms, 2026-2031, if stress predicted: 52.3 pct."
- Commentary (verbatim excerpts):
  - "The fan chart is impacted by the 2008 crisis and the historical shock to debt. Debt drops 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."
- "Source: IMF staff estimates and projections."

### Realism of baseline assumptions (Annex III. Figure 4)
- Key qualitative assessment (verbatim excerpts):
  - "The realism assessment reveal potential optimism bias on the primary deficit and stock-flow adjustments at the t+5 horizon."
  - "The reduction in the primary deficit is suported by credible measures in the MTFS 2027-31 and the reintroduction of the amended fiscal rule from 2026."
  - "Historical stock-flow adjustments are impacted by HFF liabilities since 2019. A settlement agreement was reached in 2025 on outstanding liabilities and the government taking over the assets in HFF."
  - "The average issuance over the last 5 years is impacted by the pandemic period, with deficits close to the 2008 crisis, as well as the settlement of the IL Fund (HFF)."
- Color-code/percentile indications: assessment shows potential optimism bias particularly at t+5 for primary deficit and stock-flow adjustments; comparator group: "Advanced Economies, Non-Commodity Exporter, Surveillance."

### Triggered modules and long-term risks (Annex III. Figure 5)
- Triggered modules listed: Pensions; Health; Long-Term Risk Assessment: Large Amortization.
- Large amortization module findings (verbatim excerpt):
  - "The large amotization module indicates overall low funding/roll-over risks in the long-term, on staff's baseline assumptions."
  - "The risk indication is somewhat higher, but managable, using an assumption of the debt-stabilizing primary balance in the projections."
- Projection variants shown:
  - "Baseline with t+5"
  - "Baseline with t+5 and DSPB"
  - "Historical 10-year average"
- Long-run projection horizon displayed through 2054 in figures.

### Demographics and health long-term implications (Annex III. Figure 6)
- Commentary (verbatim excerpts):
  - "Demographic projections for Iceland suggest a lower trajectory of debt consolidation in some scenarios."
  - "Favorable demographics due to migration inflow is a mitigating factor."
  - "In particular Extra Cost Growth on health products and services can have an impact on the longer-term debt profile."
- Scenarios depicted:
  - Baseline: Custom
  - Health (Demographics)
  - Health (Demographics + ECG)
- Indicators shown: GFN-to-GDP Ratio and Total Public Debt-to-GDP Ratio through 2054.

*Source: IMF staff estimates and projections (Annex III. Figure 2 and related figures and tables contained in the provided content).*

### 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: NT
  - Status: 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. The CBI increased resources for implementing the TIBER-IS framework. 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: NT
  - Status: Supervisory fees are classified as a tax; MoFEA considers direct CBI collection of supervisory fees would be unconstitutional. CBI established a working group to examine options and 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: NT
  - Status: CBI proposed amendments previously; PMO has not advanced them. CBI submitted updated proposals to the PMO in late 2025. Further consultations among PMO, MoFEA, and CBI are planned; may require a broader approach beyond financial supervisors.
- Recommendation: Remove MoFEA staff from CBI’s FMEN (independence) and implement internal delegation of powers framework (accountability).
  - Horizon: NT
  - Status: In January 2024 an external member replaced the MoFEA staff member on FMEN. June 2023 amendments to the Central Bank Act strengthened delegation of powers and clarified FMEN decision-making authority, including administrative fines, police referrals, revocation of operating licenses, and dismissal of board members. CBI finalized an internal delegation framework with signature rules and delegation from Governor to Deputy Governor for Financial Supervision; additional procedures for other departments implemented.
- Recommendation: Implement a comprehensive on-site inspection program for banks’ risk management practices across all material risk domains, integrate climate-risks into supervisory processes.
  - Horizon: NT
  - Status: SREP evaluates risk management resources, risk appetite, and governance; climate risks included in SREP and often involve on-site visits. On-site inspection program updated: exams for category 1 and 2 entities on a 1–5 year cycle based on risk level; category 3 and 4 on-site inspections performed as needed.
- 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: MT
  - Status: CBI consulted Nordic banking supervisors to close gap between EU rules and Basel standards; following consultation, no further action foreseen.
- Recommendation: Align rules on governance, internal controls, risk management with IORP II or Solvency II, and enact more stringent rules for outsourcing.
  - Horizon: NT
  - Status: CBI revised outsourcing guidelines to establish stricter rules. MoFEA-led working group drafting a “green paper” on pension system challenges expected to be published in 2026, 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: I
  - Status: On-site inspections for larger pension funds (categories 1 and 2) at least every five years; smaller funds based on risk assessment. Annual meetings established with the four largest pension funds including Deputy Governors and senior staff; biannual meetings with the Icelandic Pension Fund Association.
- Recommendation: Define infringements and sanctions in the Pension Fund Act.
  - Horizon: NT
  - Status: MoFEA-led working group drafting a “green paper” to be published in 2026, 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: NT
  - Status: CBI improving data collection on ownership of all ISK bonds from commercial banks and incorporating deposits from nonbank institutions and foreign investors into liquidity stress tests.
- Recommendation: Differentiate inflation indexed and non-indexed lending and funding instruments in analysis of inflation impact on banks’ credit, interest rate, and market risks.
  - Horizon: MT
  - Status: Default risk models updated at aggregate level to better reflect indexed vs non-indexed loans. Next revision will be borrower level, improving differentiation; data collection underway; implementation expected in 2027. Borrower level models of loss given default that account for inflation indexation rolled out for households and will be rolled out for corporate sectors.
- 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: NT
  - Status: CBI incorporated scenarios for individual currencies with different runoff and haircut rates into liquidity stress tests; results included in monthly Financial Stability Committee reports. LCRs for all significant currencies monitored at least monthly. Outlier banks addressed through Pillar 2 (SREP/ILAAP) and supervisory measures. Regulatory limits for euros exist; euro HQLA/FX net outflows minimum ratio of 100 percent maintained.
- 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: NT
  - Status: CBI closely monitors pension funds' investment changes, asset composition, risk profile, and arrears; current monitoring focuses on effects of interest rate and inflation developments on investment behavior and 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: NT
  - Status: CBI enhanced automated validation rules for annual reports and asset lists, including SQL data quality checks and a dashboard for warnings and reporting errors. 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: I/NT
  - Status: 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 domestic payments; Parliament adopted it on June 22, 2024. In November 2024, CBI invited proposals for centralized domestic infrastructure for payment requests, with eight parties participating. CBI preparing a public procurement for a domestic retail payment solution based on request to pay infrastructure. A Payments Council working group assesses commercial responses to major card system disruptions. CBI re-established a platform focused on operational security in financial market infrastructures to assess risks, recommend mitigating actions, and organize exercises.
- Recommendation: Produce a financial sector specific cybersecurity strategy, clearly setting out the roles and responsibilities of each party.
  - Horizon: I
  - Status: The Central Bank of Iceland prepared a cybersecurity strategy, discussed with stakeholders, refined based on feedback, and published in March.

### Macroprudential Policies
- Recommendation: Further enhance transparency and accountability by developing a heatmap and regularly publishing reports on risk analysis.
  - Horizon: I
  - Status: Financial Stability Committee updates a non-published qualitative heat map quarterly. Financial Stability Report under review to incorporate best practices from Nordic countries.
- Recommendation: Further strengthen analytical capacity by strengthening the analysis of tail risks, spillovers, systemic risks and calibration of macroprudential tools.
  - Horizon: NT
  - Status: CBI conducts monthly and quarterly internal analyses and publishes a detailed Financial Stability Report twice a year. Financial Stability Committee meets quarterly and focuses on growth-at-risk and distributions of LTV and DSTI ratios to monitor tail risks; decisions on macroprudential tools made quarterly.
- Recommendation: Continue closely monitoring cyclical risks in the real estate market and corporates, and take further macroprudential measures if risks persist.
  - Horizon: I
  - Status: Committee monitors RRE and CRE markets quarterly and is prepared to act. A special issue on Borrower-Based Measures (BBMs) was published on 3 December 2025 covering legal framework, Iceland experience, comparisons, and research. CBI developing a model to assess cyclical risks using quality-adjusted indexes of residential real estate and rental prices; first paper published in 2025 (Working Paper no. 99: A Hedonic Housing Model for Macroprudential Policy). Further research planned.
- Recommendation: Close data gaps related to non-financial private sectors (households, non-financial corporates).
  - Horizon: I
  - Status: CBI gained access to tax reports from non-financial corporates to improve data on domestic entities' foreign debt. Intensified data collection on CRE market: purchasing data on available square meters for sale and rent, tracking CRE rental price trends, gathering CRE under construction from Housing and Construction Authority, monitoring publicly listed CRE companies' quarterly and annual results. New index for CRE prices developed at the Central Bank (see Box 3 in Financial Stability 2026/1). CBI in contact with Statistics Iceland to gain access to household tax return database. CBI started gathering data from collection agencies on household and NFC arrears on general claims.

### 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: I
  - Status: Crisis management handbook titled Contingency Plan for Liquidity or Equity Shortfall at Credit Institutions approved and operationalized. RA conducts regular tests according to a predefined schedule and EBA guidelines.
- Recommendation: Establish a coordination body on resolution issues between the MoFEA and the CBI (RA).
  - Horizon: I
  - Status: 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.
- 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: NT
  - Status: Work underway to explore legislative amendments; MoFEA oversees project with CBI support. Details to be provided later in 2026; legislative bill possibly introduced to parliament.
- Recommendation: Develop a repo market and operationalize the ELA, including the assessment of collateral eligibility.
  - Horizon: NT
  - Status: Efforts to develop an efficient money market face challenges due to small market size and lack of liquidity; banks hesitant to commit to two-way pricing for tenors from one week to three months. CBI maintains an ELA working group analyzing practical and legal perspectives and assessing collateral eligibility. CBI assesses overall ELA collateral eligibility of Icelandic financial counterparties using reported main assets and Loan Registry data; efforts underway to utilize this Register for evaluating potential ELA collateral. Considering legislative measures to gain exclusive authority for registration, mobilization, and monitoring of loan portfolios pledged as collateral.
- Recommendation: Operationalize the application of all the resolution tools (not just bail-in).
  - Horizon: NT
  - Status: Resolution plans for Iceland's three D-SIBs increasingly focus on transfer strategies (non bail-in), aligning with EEA developments. Current priority is finalizing bail-in playbooks; Master playbooks (including transfer strategies) expected to be completed by 2026 per EBA Guidelines 2022/01 and amended testing guidelines. RA focusing on operationalizing transfer strategies; first resolution plan using a transfer tool as preferred strategy approved. Further tests with banks scheduled for 2026 and 2027 per 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: NT
  - Status: CBI continuously reviews and develops its methodology for risk assessments of individual obliged entities and sectoral risk assessment. With IMF technical assistance, CBI presented its methodology and received advice. CBI cooperates with Nordic and Baltic countries on methodologies. Anticipates harmonization through regulatory technical standard (RTS) from EU legal developments; RTS expected to be implemented domestically and significantly impact data collection and calculations. CBI working on a future vision for overall risk assessment framework; methodology reviewed annually with relatively minor changes, including increased data collection related to international sanctions and asset freezing. CBI conducts regular checks at least annually to detect activity operating without registration or authorization, including VASPs. Risk-based inspections of banks have been enhanced and will continue per the risk assessment framework.
- Recommendation: Continue to improve bank’s access to and maintenance of adequate, accurate and up-to-date information on the beneficial ownership and control of legal persons.
  - Horizon: NT
  - Status: Business Registry using inputs from registered entities to address discrepancies in Business Registry certificates; data supports monitoring and supervisory actions to correct the beneficial ownership registry. A steering group including CBI and other agencies coordinates and improves AML/CFT measures.

*Annex V. Update on the Implementation of FSAP — IMF document content unit 1islea2026001*

### Annex VI. Data Issues

### Annex VI. Data Issues

### Data Adequacy Assessment (Table 1)
- Data Adequacy Assessment Rating: A
- Questionnaire Results: A
- Assessment by sector (heatmap / median rating): National Accounts A; Prices A; Government Finance Statistics B; External Sector Statistics A; Monetary and Financial Statistics B; Intersectoral Consistency A; Median Rating A
- Detailed Questionnaire Results — Data Quality Characteristics (sector-level ratings as presented):
  - Coverage: A A B A B
  - Granularity (top cell: granularity of government operations; bottom cell: public debt statistics): B (top) … A A B (bottom) — (as presented in the source table)
  - Granularity for Monetary and Financial Statistics (top cell: reported Monetary and Financial Statistics; bottom cell: Financial Soundness indicators): A … B (as presented in the source table)
  - Consistency: B A … A … (as presented in the source table)
  - Frequency and Timeliness: A A B B A
- Rating definitions (verbatim):
  - A The data provided to the Fund are adequate for surveillance.
  - B The data provided to the Fund have some shortcomings but are broadly adequate for surveillance.
  - C The data provided to the Fund have some shortcomings that somewhat hamper surveillance.
  - D The data provided to the Fund have serious shortcomings that significantly hamper surveillance.

### Rationale for staff assessment and identified data strengths and gaps
- Overall judgment: "Data provision to the Fund is adequate for surveillance purposes."
- National accounts:
  - Expenditure-based GDP data are available by component on a quarterly basis.
  - Income Accounts by sector: not sufficiently detailed and available only on an annual basis.
  - Production-based GDP or gross value added by industry: available only on an annual basis and only in nominal terms.
  - Statistics Iceland: in the initial 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.
- Government finance:
  - Recent uncertainty surrounding the 2025 general government deficit underscores the importance of timely information sharing and institutional coordination.
  - Recommendation: 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.
- External sector:
  - Data on Services Exports are often significantly revised given collection lags.
- Inter-institutional cooperation:
  - "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."
- Monetary and financial statistics:
  - 2023 FSAP found remaining data gaps notably in the CRE sector, micro household and NFC balance sheet data, and climate risks.

### Changes since the last Article IV consultation
- Authorities have formed a high-level working group to strengthen the infrastructure for data collection, building on experiences in other countries, and to assess the resource needs of Statistics Iceland.
- Statistics Iceland is reviewing the methodology used for seasonally adjusting national accounts data.
- The decision to lower the data adequacy assessment for Government Finance Statistics from A to B relates to large uncertainty created by the 2025 fiscal outcome.
- Statistics Iceland has begun addressing these issues by reviewing its data needs and sources and establishing a formal coordination process with the Financial Management Authority and the Ministry of Finance and Economic Affairs.

### Corrective actions and capacity development priorities
- "None beyond the issues raised above. No capacity development priorities."

### Data Standards Initiatives (Table 2)
- 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/)." (as stated in the source)

### Table of Common Indicators Required for Surveillance (Table 3) — selected dated observations and metadata (as of June 23, 2026)
- Exchange Rates: Date of Latest Observation 2026-06-22; Date Received 2026-06-22; Frequency: D; Frequency of Reporting: D; Expected Frequency: D; Announced Frequency: D; Expected Timeliness: ...; Announced Timeliness: D
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of Latest Observation 2026-05; Date Received 2026-06; Frequency: M; Frequency of Reporting: M; Expected Frequency: M; Announced Frequency: M; Expected Timeliness: 1M (1W encouraged); Announced Timeliness: NLT 21D
- Reserve/Base Money: Date of Latest Observation 2026-04; Date Received 2026-05; Frequency: M; Frequency of Reporting: M; Expected Frequency: M (W encouraged); Announced Frequency: M; Expected Timeliness: 2W (1W encouraged); Announced Timeliness: NLT 1W
- Broad Money: Date of Latest Observation 2026-04; Date Received 2026-05; Frequency: M; Frequency of Reporting: M; Expected Frequency: M; Announced Frequency: M; Expected Timeliness: 1M; Announced Timeliness: 1M
- Central Bank Balance Sheet: Date of Latest Observation 2026-05; Date Received 2026-06; Frequency: M; Frequency of Reporting: M; Expected Frequency: M (W encouraged); Announced Frequency: M; Expected Timeliness: 2W (1W encouraged); Announced Timeliness: NLT 1W
- Consolidated Balance Sheet of the Banking System: Date of Latest Observation 2026-05; Date Received 2026-06; Frequency: M; Frequency of Reporting: M; Expected Frequency: M; Announced Frequency: M; Expected Timeliness: 1M; Announced Timeliness: 1M
- Total assets of other depository corporations: Date of Latest Observation 2026-04; Date Received 2026-06; Frequency: M; Frequency of Reporting: M; Expected Frequency: M; Announced Frequency: M; Expected Timeliness: 1M; Announced Timeliness: 1M
- Total credit from other depository corporations: Date of Latest Observation 2026-04; Date Received 2026-06; Frequency: M; Frequency of Reporting: M; Expected Frequency: M; Announced Frequency: M; Expected Timeliness: 1M; Announced Timeliness: 1M
- Interest Rates: Date of Latest Observation 2026-06-22; Date Received 2026-06-22; Frequency: D; Frequency of Reporting: D; Expected Frequency: D; Announced Frequency: D; Expected Timeliness: ...; Announced Timeliness: D
- Consumer Price Index: Date of Latest Observation 2026-05; Date Received 2026-05; Frequency: M; Frequency of Reporting: M; Expected Frequency: M; Announced Frequency: M; Expected Timeliness: 1M; Announced Timeliness: NLT 2W
- Revenue, Expenditure, Balance and Composition of Financing — General Government: Date of Latest Observation 2026-03; Date Received 2026-06; Frequency: Q; Frequency of Reporting: Q; Expected Frequency: A; Announced Frequency: Q; Expected Timeliness: 2Q; Announced Timeliness: 1Q
- Revenue, Expenditure, Balance and Composition of Financing — Central Government: Date of Latest Observation 2026-03; Date Received 2026-06; Frequency: Q; Frequency of Reporting: Q; Expected Frequency: M; Announced Frequency: Q; Expected Timeliness: 1M; Announced Timeliness: 1Q
- Stocks of Central Government and Central Government-Guaranteed Debt: Date of Latest Observation 2026-05; Date Received 2026-06; Frequency: M; Frequency of Reporting: M; Expected Frequency: Q; Announced Frequency: Q; Expected Timeliness: 1Q; Announced Timeliness: 1Q
- Total stock of General Government Debt: Date of Latest Observation 2026-03; Date Received 2026-06; Frequency: A; Frequency of Reporting: A
- External Current Account Balance: Date of Latest Observation 2026-03; Date Received 2026-06; Frequency: Q; Frequency of Reporting: Q; Expected Frequency: Q; Announced Frequency: Q; Expected Timeliness: NLT 10W; Announced Timeliness: NLT 10W
- Exports and Imports of Goods and Services: Date of Latest Observation 2026-03; Date Received 2026-06; Frequency: Q; Frequency of Reporting: Q; Expected Frequency: M; Announced Frequency: M; Expected Timeliness: 8W (4-6W encouraged); Announced Timeliness: NLT 5W
- GDP/GNP: Date of Latest Observation 2026-03; Date Received 2026-06; Frequency: Q; Frequency of Reporting: Q; Expected Frequency: Q; Announced Frequency: Q; Expected Timeliness: 1Q; Announced Timeliness: 75D
- Gross External Debt: Date of Latest Observation 2026-03; Date Received 2026-06; Frequency: Q; Frequency of Reporting: Q; Expected Frequency: Q; Announced Frequency: Q; Expected Timeliness: 1Q; Announced Timeliness: NLT 10W
- International Investment Position: Date of Latest Observation 2026-03; Date Received 2026-06; Frequency: Q; Frequency of Reporting: Q; Expected Frequency: Q; Announced Frequency: Q; Expected Timeliness: 1Q; Announced Timeliness: NLT 10W

- Notes and definitions (verbatim from source):
  - 1 Any reserve assets that are pledged or otherwise encumbered should be specified separately. Also, data should comprise short-term liabilities linked to a foreign currency but settled by other means as well as the notional values of financial derivatives to pay and to receive foreign currency, including those linked to a foreign currency but settled by other means.
  - 2 Other depository corporations include all deposit-taking corporations (except for the central bank) and money market funds.
  - 3 Both market-based and officially determined, including discount rates, money market rates, rates on treasury bills, notes and bonds.
  - 4 Foreign, domestic bank, and domestic non-bank financing.
  - 5 The general government consists of the central government (budgetary funds, extra-budgetary funds, and social security funds) and state and local governments. The total stock of general government debt is required for SDDS Plus countries and encouraged for SDDS and e-GDDS countries.
  - 6 Including currency and maturity composition.
  - 7 Frequency and timeliness codes: (“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”) semi-annual; (“I”) irregular; (“NA”) not available or not applicable; and (“NLT”) not later than.
  - 8 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.
  - 9 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, IMF staff report (tables and text as presented in the source PDF).*

### 3.      Joining the EU implies a commitment to join the Economic and Monetary Union,

### 3.      Joining the EU implies a commitment to join the Economic and Monetary Union,

### B. Economic and Financial Trade-Offs — overview
- Joining the EU implies eventual adoption of the euro once Maastricht convergence criteria are met; in practice timing is flexible because members can delay ERM II entry.
- Euro adoption would lead to euro area membership, entry into the Banking Union, and participation in broader EU financial structures such as the Capital Markets Union (CMU) and the Savings and Investment Union (SIU).
- Assessing an appropriate exchange rate arrangement requires evaluating: initial macroeconomic conditions, structural characteristics, and exposure to economic shocks.
- Initial conditions discussed include inflation, fiscal position, reserve adequacy, and financial vulnerabilities; structural characteristics include size, openness, trade integration, cycle synchronization, and labor market flexibility.

### Initial conditions — key findings
- Iceland has had higher and more volatile inflation than the euro area; under a float the ISK can depreciate to limit real overvaluation.
- Euro adoption could strengthen monetary credibility by importing the ECB’s track record and provide a more robust nominal anchor for inflation expectations over time, potentially facilitating downward convergence of market interest rates toward euro-area levels.
- Trade-offs: euro adoption would remove independent monetary policy and the exchange-rate instrument, exposing Iceland to a common interest rate that may not match domestic cyclical conditions.
- Sustaining low inflation under the euro would depend critically on complementary domestic reforms, notably productivity-aligned wage setting and likely reforms reducing prevalence of index-linked lending.
- FX reserves: around 20 percent of GDP (over 120 percent of the IMF adequacy metric), sufficient under a float; reserve needs would fall once in the euro.
- Current external position supports either regime and would ease transition to a tighter peg or the euro.
- Balance-sheet mismatches: limited economy-wide FX mismatches; banks’ foreign liabilities largely fund exporters with FX income and regulation limits open FX positions.
- Pension system: large occupational pension system with substantial foreign currency assets—euro adoption would reduce trading costs and exchange rate risks for a large part of these assets.
- Fiscal position: consolidation aimed at restoring overall balance by 2027 and keeping debt on a declining, sustainable path; a history of pro-cyclical fiscal policy is a vulnerability.
- The recently amended fiscal stability rule with its net expenditure rule and debt anchor are broadly in line with revised EU fiscal rules and support feasibility of euro adoption.

### Structure and flexibility of the economy — key findings
- Small economy status: Iceland is a small open economy; very small economies often adopt hard pegs or foreign currencies to import credibility. The trade-off is between lower premia via a large currency area versus retaining exchange-rate adjustment for asymmetric shocks.
- Openness and trade integration:
  - Trade is about 100 percent of GDP.
  - The EU is Iceland’s main partner with roughly 55 percent+ of goods exports (and over half of imports) sent to the euro area.
  - High openness and deep EU trade links strengthen the case for a tighter euro link, reducing transaction costs and króna–euro exchange-rate uncertainty.
- Exposure to other currencies: euro adoption would remove króna–euro risk but not exposure to the US dollar due to global pricing of key exports (e.g., seafood and aluminum) and significant pensions sector foreign assets.
- Labor market flexibility:
  - Iceland’s flexicurity model, relatively adaptable hiring/firing, and labor mobility support internal adjustment required under a currency union.
  - Alignment of wage growth with productivity is critical post-euro adoption.
- Capital account and monetary-policy trilemma:
  - Iceland has largely free capital flows; capital controls lifted in 2017 and remaining restrictions lifted by 2021.
  - A fixed rate would eliminate independent monetary policy; current float preserves monetary autonomy and lets the exchange rate absorb capital-flow shocks.
  - Euro adoption would remove intra-EU currency risk and may attract investment, but Iceland would forgo national interest-rate policy and face tighter constraints on unilateral crisis measures.
- Financial markets depth:
  - Shallow ISK capital markets raise the cost of a small currency area by amplifying currency-risk premia.
  - Euro adoption would deepen financing access via European capital markets but shift key levers to EU institutions.

### Shocks and economic resilience — key findings
- Economic and credit cycles:
  - The broad economic cycle is fairly well in sync with the euro area, though there have been periods of divergence (e.g., 2012-2015 and 2022-2024).
  - The credit cycle has historically had a much larger amplitude than the euro area, partly due to the pre-2008 credit boom and subsequent balance-sheet repair.
- Idiosyncratic shocks:
  - Iceland is exposed to large idiosyncratic shocks through volatile terms of trade and tourism demand.
  - Output and external earnings hinge on fisheries, aluminum, and tourism; Iceland’s terms-of-trade shocks are larger and less correlated with euro-area terms-of-trade shocks.
  - Under a floating króna, depreciation after adverse terms-of-trade shocks cushions the economy; under the euro, adjustment would require wages/prices, labor reallocation, and fiscal support.
- Capital-flow shocks:
  - Capital-flow shocks mattered historically (notably around the 2000s boom-bust and banking crisis); today flows are more moderate under stronger regulation and oversight.
  - A flexible exchange rate helps absorb shifts in global risk sentiment; a fixed rate could be vulnerable if reserves are tested.
  - Adopting the euro would remove króna volatility and currency-crisis risk and could strengthen backstops via the Eurosystem, but would not eliminate capital cycles and may amplify credit booms if currency risk premia fall.
- Summary trade-off: cycles are broadly in sync with the euro area, but significant country-specific shocks underline the value of a flexible exchange rate as a shock absorber; euro adoption would require reliance on fiscal, labor, macroprudential policies and European backstops.

### European institutional membership — pros and cons
- Banking Union (SSM and SRM):
  - Euro area membership brings automatic participation in the Single Supervisory Mechanism (SSM) and Single Resolution Mechanism (SRM).
  - Benefits: rigorous harmonized supervision, earlier detection of risks, access to ECB liquidity facilities, EU-wide resolution arrangements, potentially lower banks’ funding costs.
  - Costs: reduced national discretion over supervision and crisis management, contributions to shared funds, exposure to cross-border risk sharing.
- Capital Markets Union (CMU) and Savings & Investment Union (SIU):
  - Aim to deepen and integrate Europe’s capital markets, reduce cross-border investment barriers, and broaden financing beyond bank credit.
  - Benefits: access to a larger funding pool for firms and infrastructure, more diversified investment opportunities for savers (including pension funds), and over time lower costs of capital as country- and currency-risk premia decline.
  - Caveats: CMU/SIU remain incomplete, benefits may take time, regulatory and legal reforms could impose adjustment costs, and deeper integration increases exposure to pan-European credit and asset-price cycles—heightening the importance of macroprudential and fiscal tools.
- Broader EU frameworks:
  - EU/euro membership embeds Iceland in frameworks such as the European Stability Mechanism and euro-area economic coordination and fiscal rules.
  - Benefits: stronger investor confidence, lower perceived country risk, potential for more resilient market access in stress, and voting rights where rules are set (beyond EEA implementation).
  - Costs: reduced ability to opt out of majority decisions, sensitive policy areas (notably the Common Fisheries Policy), and need to align any “stricter-than-EU” safeguards with EU law.

*https://www.imf.org/-/media/files/publications/cr/2026/english/1islea2026001.pdf*

### 26.      Euro or not, key reforms are essential. If Iceland choses to move toward euro adoption,

### Euro or not, key reforms are essential.

### Summary overview
- If Iceland chooses to move toward euro adoption, reforms that strengthen internal adjustment and policy credibility would become more binding because the exchange rate and independent monetary policy would no longer cushion shocks (para. 26).
- Many recommended reforms are prudent even if Iceland retains the króna, but they become even more important under a fixed exchange-rate regime (para. 26).

### Wage setting and labor flexibility
- Key finding: Euro membership increases the premium on productivity-linked wage growth and rapid “internal” adjustment following asymmetric shocks because the exchange rate can no longer adjust (para. 27).
- Policy recommendations:
  - Strengthen wage bargaining frameworks to anchor pay outcomes to productivity and the low-inflation environment (consistent with ECB’s price stability objective) (para. 27).
  - Allow collective agreements to be revisited when large shocks hit (para. 27).
  - Preserve flexicurity, labor mobility, and openness to foreign workers to help reallocate labor across sectors and reduce output costs of adjustment (para. 27).

### Prevalence of indexation
- Finding: Many contracts in Iceland are linked to the inflation rate, including rents, utilities, public procurement, many benefits, collective wage agreements with specific inflation trigger clauses, and mortgages (para. 28).
- Implication: High indexation could create greater inflation persistence and potentially dampen monetary policy transmission (para. 28).
- Recommendation: Review and possibly reform the degree of indexation, especially in case of euro adoption (para. 28).

### Fiscal governance and buffers
- Key finding: In a currency union, fiscal policy must do more stabilization work, making credible rules and buffers essential (para. 29).
- Recommendations:
  - Continue to implement the planned fiscal-rule framework (para. 29).
  - Materially strengthen the Fiscal Council’s mandate, resources, and access to timely data (para. 29).
  - Pursue medium-term consolidation to rebuild fiscal space in good times while allowing room for public investment (para. 29).
- Consistency: These recommendations align with the IMF’s 2024 and 2025 Article IV advice (para. 29).

### Financial sector and prudential policies
- Findings and priorities (para. 30):
  - Preserve strong supervision and high resilience through a potential transition to ERM II/euro.
  - Keep macroprudential policy tight enough to contain housing/credit risks, especially during a transition towards the euro.
  - Maintain ample FX reserves during the transition period.
- Institutional recommendations:
  - Safeguard supervisory independence.
  - Strengthen pension-fund governance and risk management.
  - Advance AML/CFT.
  - Improve operational resilience (cyber, payments).
  - Enhance crisis tools, including ELA and resolution readiness (para. 30).

### Legal and institutional readiness
- Requirements and actions (para. 31):
  - Align laws and institutions, including a mandate consistent with euro-area price stability.
  - Prepare the operational/legal framework for participation in the Eurosystem.
  - Assess any constitutional implications of giving up legal tender early to avoid delays.
- Complementary reforms: Raise productivity and diversification—through initiatives such as the Productivity Commission, reforms that raise competition and ease regulation, and investments in skills and innovation (including in energy-based and tech sectors)—to reduce costs of losing the exchange-rate tool and strengthen resilience under either regime (para. 31).

### Final assessment and sequencing
- Iceland has already made strides in areas key for potential euro adoption: fiscal prudence, labor flexibility, financial oversight, and macroprudential policy (para. 32).
- Risk: Entering the euro with weak fiscal discipline or rigid markets can lead to significant costs later (para. 32).
- Recommendation: Front-load reforms; many are “no-regret” moves that will strengthen the economy even if the króna is retained (para. 32).

### Selected related institutional and statistical facts from the informational annex
- Document date: July 10, 2026 (Contents) (Annex header).
- Membership Status: Joined December 27, 1945 (FUND RELATIONS) (Annex).
- Quota: 321.80 (SDR Million; Percent of Quota 100.00) (Annex).
- Fund holdings of currency: 252.00 (SDR Million; Percent of Quota 78.31) (Annex).
- Reserve tranche position: 69.80 (SDR Million; Percent of Quota 21.69) (Annex).
- Net cumulative SDR allocation: 420.62 (SDR Million; Percent of Allocation 100.00) (Annex).
- Holdings: 430.73 (SDR Million; Percent of Allocation 102.41) (Annex).
- Latest financial arrangements (selected): Stand-By approval dates include Nov. 19, 2008; Mar. 22, 1962; Feb. 16, 1961 with Amount Approved 1,400.00; 1.63; 1.63 (SDR Million) and Amount Drawn 1,400.00; 0.00; 0.00 respectively (Annex table).
- Projected Payments to the Fund (2026–2030): Principal, Charges/Interest, Total all reported as 0.00 (SDR million) (Annex).
- Exchange rate arrangements: de jure free floating; de facto floating. CBI publishes daily FX intervention data with a lag. Iceland has accepted obligations under Article VIII, Sections 2, 3, and 4 (Annex).
- Last Article IV Consultation: Discussions for the 2025 Article IV Consultation were held during April 7–11 (virtually) and April 28–May 6, 2025; staff report considered by the Executive Board on June 16, 2025 (Annex).
- FSAP: Financial System Stability Assessment discussed by the Board on June 23, 2023 (Annex).
- Selected Technical Assistance topics and dates (Annex): Capital account liberalization (March 2010), Reserves building and liquidity management (June 2010), Public debt management (July 2010), Fiscal framework issues (August 2010), and multiple other entries through March 2015 and beyond, including LEG AML/CFT Risk-Based Supervision 2025–27 (Annex).

*Prepared by the European Department (in consultation with other departments) — ICELAND: STAFF REPORT FOR THE 2026 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX (July 10, 2026).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2026/english/1islea2026001.pdf_