IMF Executive Board Concludes 2024 Article IV Consultation with Iceland
IMF News, July 15, 2024
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- Published: July 15, 2024
Overview
- The Executive Board concluded the Article IV consultation with Iceland and endorsed the staff appraisal without a meeting on a lapse-of-time basis.
- The appraisal highlights an impressive recovery from shocks, with tight monetary and fiscal policies having slowed domestic demand growth, strengthened the current account, and begun to lower inflationary pressures.
- Ongoing volcanic activity on the Reykjanes peninsula has disrupted lives and livelihoods, but broader economic implications are expected to be limited.
Economic outlook and projections
- Real GDP grew by 4.1 percent in 2023 but slowed considerably through the year and into 2024.
- Growth projections:
- 2024: 1.2 percent
- 2025: 2.4 percent
- Inflation developments:
- Declined to 6.2 percent in May 2024 from a peak of 10.2 percent in February 2023.
- Projected to decline to 5.1 percent by end-2024 and 2.6 by end-2025.
- Projected to reach the 2.5 percent inflation target in first half of 2026.
- Current account: projected to gradually strengthen, including from an increasing contribution from pharmaceutical exports.
- Medium-term growth prospects are favorable, driven by an expansion of innovation-based sectors and migrant labor inflows. Risks to the outlook are broadly balanced.
Executive Board assessment — macroeconomic policy
- A coordinated tightening of macroeconomic policies has narrowed domestic and external imbalances built up during the post-pandemic period.
- Appropriately tight macroeconomic policies are expected to dampen near-term growth; monetary policy is expected to ease gradually as inflation falls.
- The CBI should lower the policy rate as inflation declines and ease toward the estimated neutral real rate once headline inflation and inflation expectations fall inside the 1–4 percent notification band and there is clear evidence that inflation will return to target.
Fiscal policy and fiscal rules
- The authorities’ fiscal targets are broadly appropriate, though additional measures are required to achieve the planned medium-term consolidation.
- The envisaged medium-term fiscal consolidation is consistent with a gradual increase in fiscal space but will require additional measures over the next five years, which could include:
- Reducing the number of items subject to reduced VAT rates.
- Streamlining tax expenditures and incentives.
- Increasing the taxation of realized capital gains on second homes and investment properties.
- Further spending measures.
- Public debt is on a downward path and resilient to shocks.
- Reactivation of the fiscal rules in 2026 is an opportunity to revisit their design to ensure fiscal sustainability and macroeconomic stability:
- Consider replacing the current overall balance rule with a limit on government spending to reduce procyclicality.
- Increase the resources of the Fiscal Council and strengthen its mandate to support the credibility of the fiscal rules.
Exchange rate policy and reserves
- An application of the IMF’s Integrated Policy Framework suggests benefits of foreign exchange interventions during times of stress due to Iceland’s shallow foreign exchange markets.
- Foreign exchange intervention can reduce the burden on monetary policy and help cushion shocks.
- The CBI should seek opportunities to increase reserves and explore options to deepen the foreign currency derivatives market consistent with market stability.
Financial sector and macroprudential policy
- Systemic risks in the financial sector have declined slightly from last year and are broadly contained.
- Financial institutions remain resilient; housing price imbalances have receded.
- The currently tight macroprudential stance is appropriate, but clarifying the neutral level of the countercyclical capital buffer would improve transparency.
- Supervisory priorities: monitor the impact of the slowing economy and still-high interest rates; improve operational risk management; monitor banks’ implementation of the strengthened NPL framework.
- Maintaining momentum in FSAP implementation requires robust interagency coordination; further progress needed on safeguarding CBI supervisory independence and improving governance and risk management of pension funds.
- Continue efforts to mitigate money laundering/terrorism financing risks.
Structural policies
- Focus areas:
- Gradually reducing state involvement in collective wage bargaining to preserve the integrity of the budgetary process.
- Accelerating the green transition; consider raising carbon taxes in sectors with relatively low levels of taxes on emissions.
- Further diversifying the economy and maximizing the economic benefits of R&D incentives.
- The recently concluded collective wage bargaining agreement is an important step forward in labor relations.
Key statistics and selected indicators (extracts)
- GDP growth (percentage change):
- 2019: 1.9
- 2020: -6.9
- 2021: 5.1
- 2022: 8.9
- 2023: 4.1
- 2024 (Proj.): 1.2
- 2025 (Proj.): 2.4
- 2026 (Proj.): 2.2
- Inflation:
- Consumer price index (end period): 9.6 (2019), 7.8 (2020), 2.6 (2021)
- Consumer price index (average): 4.5 (2019), 8.7 (2020), 3.3 (2021)
- Output gap (percent of potential output):
- 2019: -3.7
- 2020: 0.2
- 2021: -0.3
- 2022: -0.2
- 2023: -0.1
- 2024 (Proj.): 0.0
- Selected monetary and credit indicators:
- Central bank 7 day term deposit rate: 3.00 (2019), 0.75 (2020), 2.00 (2021), 6.00 (2022), 9.25 (2023)
- For 2024, rate as of end-April. (footnote retained)
- Public finances (percent of GDP):
- Revenue: 42.0 (2019), 42.2 (2020), 41.1 (2021), 42.5 (2022), 43.1 (2023), 42.3 (2024), 41.6 (2025)
- Expenditure: 43.6 (2019), 51.1 (2020), 49.5 (2021), 46.5 (2022), 45.1 (2023), 45.0 (2024), 43.3 (2025)
- Overall balance: -1.6 (2019), -8.9 (2020), -8.5 (2021), -4.0 (2022), -2.0 (2023), -1.9 (2024), -1.1 (2025)
- Gross debt: 66.5 (2019), 77.5 (2020), 74.8 (2021), 67.4 (2022), 64.8 (2023), 59.6 (2024), 54.4 (2025), 51.7 (2026), 48.9 (2027), 46.2 (2028), 43.8 (2029)
- Balance of payments and external indicators:
- Gross external debt: 78.3 (2019), 90.2 (2020), 84.4 (2021), 74.7 (2022), 71.6 (2023), 65.9 (2024), 61.2 (2025), 56.9 (2026), 52.9 (2027), 45.7 (2028)
- Central bank reserves ($ Mn.): 6,736 (2019), 6,408 (2020), 7,091 (2021), 5,879 (2022), 5,720 (2023), 5,584 (2024), 5,351 (2025), 5,385 (2026), 5,500 (2027), 5,648 (2028), 5,653 (2029)
International Monetary Fund — Executive Board conclusion of the 2024 Article IV consultation with Iceland.