Iceland: Staff Concluding Statement of the 2018 Article IV Mission

IMF News, September 25, 2018

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The gradual slowdown of Iceland’s economy from the unsustainable pace of previous years is welcome.
The strengthening of the króna in 2014–16 has, with a lag, dampened tourism growth and cooled domestic demand.
An increasing supply of new homes has slowed house price appreciation.
Credit growth is accelerating, but from a low level.
The króna has been broadly stable since mid-2017.
Inflation has been near the official target for five years.
IMF staff expects growth to slow gently, eventually settling at a more sustainable rate of about 2½ percent.

Strong oil prices and mounting air transport competition are challenging the airline business.
Escalating world trade tensions threaten to hurt export prices for aluminum and other items.
Uncertainty around Brexit negotiations raises the risk of weaker export demand from one of Iceland’s biggest markets and could further complicate North Atlantic fishing cooperation.
The coming wage rounds could once again deliver excessive remuneration, hurting Iceland’s competitiveness.

Household, corporate, and public balance sheets have strengthened dramatically in recent years.
Given the economy’s small size, openness, and exposure to shocks, preserve buffers: low public debt, strong bank capital and liquidity, and adequate official reserves.
Pursue policies to lift growth potential, enhance competitiveness, and modulate risk taking.

IMF staff supports Iceland’s new fiscal targets but calls for greater clarity in the underlying fiscal plans.
The plans are likely to deliver a broadly neutral fiscal stance going forward, appropriate given the growth trajectory.
Plans are consistent with further debt reduction, creating space for countercyclical policies if risks crystallized.
Staff supports emphasis on infrastructure, health, and education, but calls for careful prioritization and execution.
Recommendations:
- Spell out saving measures.
- Reduce reliance on unpredictable dividend flows.
- Consider tax reforms carefully to support budget planning and stay within the spending envelope, ensuring observance of the overall surplus targets.

Monetary policy should remain focused on price stability as its primary objective.
The inflation target should adequately capture households’ spending patterns, including their spending on housing.
Interest rate increases would be warranted if inflationary pressures mounted—for instance, spurred by excessive wage growth—or in a scenario of large capital outflows.
Foreign exchange interventions should be limited to countering disorderly market conditions, with a strong emphasis on maintaining adequate reserves.

IMF staff supports the authorities’ plans to renew the legal basis for the special reserve requirement on selected debt inflows.
Such capital flow management measures can be useful in certain circumstances provided they do not substitute for warranted macroeconomic adjustment.
Staff notes that narrowing interest rate differentials between Iceland and the major currency zones provide further grounds for rolling back the special reserve requirement on selected inflows at this time.

Iceland is working to further strengthen financial sector oversight.
Overarching goal: a structure that is independent, well resourced, and vested with all necessary rulemaking and enforcement powers, avoiding unnecessary overlaps or potential gaps.
The tenth anniversary of the financial crisis should be seized as a time to move from debate to decisive action.
IMF staff sees merit in unifying all financial sector oversight, lender-of-last-resort, and resolution duties at the central bank:
- Would harness synergies, eliminate unwanted overlaps, better integrate micro- and macroprudential policies.
- Would reflect the systemic importance of Iceland’s pension funds and enhance preparedness for future challenges.
- Pursuing what would essentially be a merger of the regulatory agency into the central bank would also minimize transition issues.

IMF staff strongly supports efforts to improve Iceland’s wage bargaining system and anchor it on productivity growth and competitiveness.
Purchasing power has increased by a remarkable 25 percent over the last four years—and even more if viewed in foreign currency terms.
Wage agreements should be in line with productivity gains to avoid further growth in unit labor costs.

Strengthening economic and environmental sustainability is a priority.
In tourism, the growth slowdown adds urgency to adopting a holistic strategy and taking concrete actions:
- Improve tourism services at popular sights.
- Improve accessibility of destinations farther afield from Reykjavík.
In fisheries, careful management of marine resources remains central:
- Include further efforts to secure durable fishing agreements with other North Atlantic fishing nations for several migratory species.

The IMF team thanks the Icelandic authorities and others with whom it met during this visit for their hospitality, engagement, and candor.

Iceland: Staff Concluding Statement of the 2018 Article IV Mission, September 25, 2018.