Iceland: Staff Concluding Statement of the 2019 Article IV Mission
IMF News, November 11, 2019
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- Published: November 11, 2019
Economic developments and outlook
- After six years of robust growth, economic growth has weakened substantially.
- Key shocks:
- One of Iceland’s largest airlines has ceased to exist, reflecting high operating costs and intense global competition.
- The global grounding of the Boeing 737 Max has caused a significant loss of tourist arrivals.
- The decline in tourism has triggered a drop in domestic demand and increased unemployment.
- Policy-adjusted outlook:
- A moderate recovery is expected to start next year.
- IMF staff projects growth to recover to about 2 percent over the medium term.
- The recent monetary policy easing is expected to help support domestic demand.
- Budgeted public spending will contribute to growth in 2020 and the medium term.
- A partial recovery in tourism is projected to drive near-term growth.
- Social outcomes:
- Delivering one of the lowest gender wage gaps and employment gaps for disadvantaged groups and one of the highest labor shares in income among peer countries.
- The introduction of a link between the growth of wages and GDP per capita is a promising way to align pay with productivity developments.
Policy response and policy space
- Fiscal and monetary policy actions taken:
- The government has eased fiscal policy, providing a stimulus in 2019 and lowering targeted near- and medium-term general government balances.
- The Central Bank of Iceland (CBI) has reduced policy interest rates by 150 basis points since March 2019.
- The April collective wage agreement—completed with active government involvement—has moderated average wage growth for the next three years.
- Assessment of policy stance and space:
- Policy space—rebuilt in the decade following the crisis—is available, and further easing would be warranted if risks materialize.
- With output close to potential, there is no urgency for further policy easing unless economic conditions deteriorate significantly.
- Confidence in the monetary policy framework is solid. The CPI has worked well as a monetary policy target.
- The CBI’s foreign exchange arrangement has preserved exchange rate flexibility and maintained adequate international reserve buffers.
- Fiscal policy guidance:
- The authorities’ fiscal plan is appropriate in view of the weakening of the economy and is projected to lower public debt to its low precrisis level over the medium term.
- Refining the implementation of the fiscal framework could make discretionary fiscal actions more effective in smoothing upturns and downturns.
- Completing the planned government spending reviews could reveal options to reorient spending to areas with high growth contribution, complementing the recently announced growth- and progressivity-enhancing tax reform.
- Active management of the public sector balance sheet should continue to consolidate gains, including by lowering public debt service costs further.
- Monetary policy guidance:
- Further relaxation is not needed unless economic conditions deteriorate significantly, and inflation expectations fall well below target.
- Macroprudential guidance:
- Given still elevated real estate prices and favorable financing conditions, macroprudential policies in train are helping to preserve buffers for managing financial stability risks.
- Looking forward, the macroprudential policy toolkit could be expanded to include loan-to-value limits for commercial real estate loans and income-based measures to contain potential risks in the loan portfolio over the medium term.
Financial sector oversight and AML/CFT
- Ongoing reforms:
- Ongoing merger of the CBI and the financial supervisory authority (FME) is an important institutional reform intended to achieve greater efficiency, operational independence, and powers in financial oversight.
- The committees on financial supervision, financial stability, and monetary policies should provide for an integrated approach to policymaking, enhancing synergies between oversight, lender-of-last-resort, and resolution functions, while strengthening policy accountability.
- Full integration in practice will take time; the framework should be implemented as swiftly as possible and the new internal organization should bolster technical capacity and resource adequacy for supervisory work.
- A planned review of the framework in 2021 would be an opportunity to strengthen its effectiveness if necessary.
- AML/CFT urgency:
- Iceland’s recent designation (grey-listing) by the Financial Action Task Force (FATF) as a jurisdiction with strategic deficiencies in anti-money laundering and combating the financing of terrorism (AML/CFT) increases the urgency to ensure effective implementation of the AML/CFT framework.
- Since 2018, the authorities have taken important steps to strengthen the AML/CFT framework and enhance its overall effectiveness, including legislative and other reforms to improve domestic coordination and cooperation and increase resources allocated to combating money laundering and terrorism financing.
- Despite the recent grey-listing, Iceland has not experienced significant pressures in financial markets or payments so far, but continued vigilance is required.
- The authorities and banks preemptively secured open channels of communication with domestic and foreign counterparties to provide updates on AML/CFT progress and avert possible adverse effects of the grey-listing.
- Broader public awareness of the potential impact of the grey-listing for companies and households is needed.
- Recommendation:
- Swift actions are needed to complete all recommendations of the FATF and mitigate reputational risks to Iceland.
Structural reform priorities
- Key areas for reforms to support long-term growth:
- Build stronger human capital through well-targeted education reforms, focusing on teacher training and professional development and helping immigrant children integrate and reach their potential.
- Further strengthen transparency of unlisted companies with large impact on the Icelandic economy to help protect the integrity and reputation of Iceland’s business environment.
- Carry out well articulated public policy strategies to preserve the marine and tourism endowments of the country and support the sustainability of Iceland’s traditional economic activities.
- Rationale:
- The economy needs greater employment in high-skilled jobs and a boost in productivity growth.
- As a small economy, Iceland’s dependence on a few sectors and companies makes it vulnerable to shocks, with risks harder to monitor where corporate transparency is insufficient.
- Iceland’s natural resources need to be preserved to support traditional sectors.
Risks and contingency scenarios
- Main external risks to the outlook:
- Negative spillovers from global risks, including the UK’s still uncertain Brexit, rising protectionism and retreat from multilateralism, weaker-than-expected global and European growth, and further worsening in tourism activity (for instance if capacity constraints due to the grounding of Boeing 737 Max remain in place longer), could tilt the economy into a recession.
- Domestic vulnerabilities:
- Elevated real estate prices and favorable financing conditions imply potential financial stability risks.
- Corporate transparency deficiencies in systemically important unlisted companies increase downside risks.
- Policy contingency:
- Policy space built through prudent macroeconomic management permits further discretionary fiscal and monetary action should risks materialize.
Iceland: Staff Concluding Statement of the 2019 Article IV Mission (November 11, 2019).