IMF Executive Board Concludes 2023 Article IV Consultation with Iceland
IMF News, June 23, 2023
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- Published: June 23, 2023
Economic performance and outlook
- Real GDP grew by 6.4 percent in 2022, the fastest since 2007, driven by a strong rebound in tourism, domestic demand, and higher incomes from an improvement in the terms of trade.
- The economy is operating well above potential, contributing to inflation significantly above target and external imbalances.
- Growth projections:
- 3.2 percent in 2023
- 1.9 percent in 2024
- Medium-term trajectory: exports are expected to be the main growth driver while continued policy tightening brings domestic demand to sustainable levels.
- Inflation and current account:
- Inflation forecast to decline modestly to around 7 percent by end-2023 and to approach target by end-2025.
- Current account projected to gradually strengthen on lower import prices and tighter policies, reverting to a surplus over the medium term.
- Risks:
- Significant downside risks: more persistent inflation, tensions around upcoming wage negotiations, and tighter global financial conditions.
- Potential upside risks: breakthroughs in the pharmaceutical industry and other non-traditional industries, and commercialization of climate mitigation technologies.
Monetary and fiscal policy
- Monetary policy actions:
- The Central Bank of Iceland raised the policy rate by 800 basis points between April 2021 and May 2023.
- Staff and Directors stressed the need for a tight monetary policy stance until there is clear evidence that inflation will return to the 2.5 percent target and expectations are re-anchored; achieving this may require raising the policy rate further and keeping the real policy rate well above the neutral rate as long as needed.
- Fiscal stance:
- Fiscal policy was contractionary in 2022 but not sufficient to sufficiently slow domestic demand; the underlying fiscal stance deteriorated.
- Directors welcomed the reduction in the 2023 fiscal deficit envisaged in the draft medium-term fiscal strategy (MTFS) and noted faster consolidation in later years would help rebuild buffers.
- Authorities intend to reinstate fiscal rules in 2025, one year earlier than originally envisaged.
Financial sector resilience and FSAP findings
- General assessment:
- Iceland’s financial system exited the pandemic resilient and highly capitalized, with high bank profitability and liquidity positions exceeding regulatory minima.
- The Financial System Stability Assessment (FSAP) finds the system resilient to severe but plausible macro-financial shocks, while noting remaining vulnerabilities.
- Key vulnerabilities and funding risks:
- High exposure to mortgages and commercial real estate could create pressure if downside risks materialize.
- Foreign funding from unsecured debt securities and nonresident deposits accounts for about a quarter of total funding and is mainly used to finance foreign currency denominated corporate loans.
- Banks may need to roll over maturing foreign-currency bonds at higher spreads given global financial tightening.
- Pension funds are important bank funders (holdings of shares, direct deposits, or covered bonds); a redirection of pension fund investments abroad could create bank funding pressures.
- Supervisory and regulatory recommendations:
- Further strengthen financial resilience by ensuring regulatory agencies have adequate powers, resources, and independence.
- Enhance financial regulation and supervision framework for pension funds.
- Provide further supervisory guidance to banks in operational risks, market risk, and interest rate risk in the banking book.
- Strengthen financial crisis management, safety nets, and bank resolution frameworks.
- Consider sector-specific macroprudential tools and activate them if vulnerabilities in the commercial real estate sector persist or intensify.
- Continue strengthening the AML/CFT supervision framework.
Structural and sectoral policy recommendations
- Reduce regulatory burden and increase competition to further diversify the economy.
- Pursue reforms to improve sustainability and productivity in traditional export sectors, including tourism.
- Use upcoming wage negotiations as an opportunity to better align wages with productivity growth.
- Climate policy:
- Commended Iceland’s ambitious climate goals and pioneering green technologies.
- With emission cuts falling short of targets, update of the Climate Action Plan is an opportunity to adopt policies to accelerate the transition to a low-carbon economy, including raising the level of carbon taxes.
Executive Board assessment
- Directors agreed with the thrust of the staff appraisal: Iceland showed remarkable resilience to multiple shocks since 2019, with 2022 growth the fastest since 2007.
- Directors noted the economy is overheating, contributing to inflation significantly above target and external imbalances.
- Directors broadly supported the key policy recommendations of the 2023 FSAP and encouraged continued progress on financial sector reforms and resilience.
Selected key statistics (as reported)
- Output and growth:
- Real GDP growth: 4.2 (2017), 4.9 (2018), 1.8 (2019), -7.2 (2020), 4.3 (2021), 6.4 (2022), 3.2 (2023, proj.), 1.9 (2024, proj.), 2.1 (2025, proj.), 2.2 (2026, proj.)
- Total domestic demand growth: 7.6 (2017), 4.5 (2018), 0.5 (2019), -1.1 (2020), 6.3 (2021), 1.2 (2022), 0.9 (2023, proj.)
- Exports of goods and services growth: 0.4 (2017), -5.5 (2018), -31.1 (2019), 14.7 (2020), 20.6 (2021), 5.8 (2022)
- Imports of goods and services growth: 11.8 (2017), -0.9 (2018), -9.1 (2019), -20.6 (2020), 19.9 (2021), 19.7 (2022)
- Output gap (percent of potential output): 3.5 (2017), -5.2 (2018), -2.5 (2019), 0.6 (2020), 0.3 (2021), 0.1 (2022), 0.0 (2023, prel.)
- Levels and shares:
- Gross domestic product (ISK bn.): 2,642 (2017), 2,844 (2018), 3,024 (2019), 2,919 (2020), 3,245 (2021), 3,766 (2022), 4,117 (2023, proj.), 4,353 (2024, proj.), 4,603 (2025, proj.), 4,843 (2026, proj.), 5,103 (2027, proj.), 5,384 (2028, proj.)
- Gross domestic product ($ bn.): 24.7 (2017), 26.3 (2018), 21.6 (2019), 25.6 (2020), 27.8 (2021), 29.1 (2022), 31.4 (2023, proj.), 33.9 (2024, proj.), 36.4 (2025, proj.), 39.1 (2026, proj.), 42.0 (2027, proj.), 44.9 (2028, proj.)
- GDP per capita ($ thousands): 73.1 (2017), 75.4 (2018), 69.1 (2019), 59.2 (2020), 69.3 (2021), 74.0 (2022), 75.2 (2023, proj.), 81.6 (2024, proj.), 87.1 (2025, proj.), 92.4 (2026, proj.), 98.3 (2027, proj.), 104.5 (2028, proj.)
- Private consumption (percent of GDP): 50.1 (2017), 50.3 (2018), 50.2 (2019), 52.0 (2020), 52.2 (2021), 52.8 (2022), 52.7 (2023, proj.), 52.3 (2024, proj.), 51.6 (2025, proj.), 50.9 (2026, proj.)
- Public consumption (percent of GDP): 23.7 (2017), 24.1 (2018), 24.6 (2019), 28.1 (2020), 27.6 (2021), 25.9 (2022), 24.3 (2023, proj.), 24.4 (2024, proj.), 24.8 (2025, proj.), 25.1 (2026, proj.), 25.4 (2027, proj.)
- Gross fixed investment (percent of GDP): 21.8 (2017), 20.9 (2018), 21.3 (2019), 22.2 (2020), 22.4 (2021), 22.9 (2022), 23.0 (2023, proj.), 22.6 (2024, proj.), 22.5 (2025, proj.)
- Gross national saving (percent of GDP): 26.0 (2017), 26.4 (2018), 27.2 (2019), 22.3 (2020), 20.0 (2021), 21.1 (2022), 21.5 (2023, proj.), 21.7 (2024, proj.), 22.8 (2025, proj.), 23.3 (2026, proj.)
- Unemployment rate (percent of labor force): 3.3 (2017), 3.1 (2018), 6.0 (2019), 3.8 (2020), 3.7 (2021), 4.0 (2022)
- Prices, wages, and rates:
- Real wages: -1.9 (year not explicitly labeled in table)
- Nominal wages: 7.2 (year not explicitly labeled), 9.1; 6.5; 8.3; 9.3; 5.2 (table lists multiple entries)
- Consumer price index (average): 2.7 (2017), 2.8 (2018), 8.7 (2019), 4.6 (2020), 2.5 (2021)
- Consumer price index (end period): 9.6 (2019), 7.4 (2020)
- Central bank 7-day term deposit rate (for 2023, rate as of end-May): 4.25 (2017), 4.50 (2018), 3.00 (2019), 0.75 (2020), 2.00 (2021), 6.00 (2022), 8.75 (2023, rate as of end-May)
- Public finances:
- Revenue (percent of GDP): 45.4 (2017), 44.8 (2018), 42.1 (2019), 42.2 (2020), 41.4 (2021), 41.8 (2022), 42.8 (2023, proj.), 42.4 (2024, proj.), 41.3 (2025, proj.)
- Expenditure (percent of GDP): 44.4 (2017), 43.8 (2018), 43.6 (2019), 51.2 (2020), 49.8 (2021), 46.1 (2022), 45.5 (2023, proj.), 45.7 (2024, proj.), 45.0 (2025, proj.), 43.3 (2026, proj.)
- Overall balance: -1.5 (2017), -9.0 (2018), -8.4 (2019), -4.3 (2020), -2.7 (2021)
- Structural primary balance: -2.0 (2017), -3.1 (2018), -1.4 (2019), -1.8 (2020), -1.2 (2021), 0.2 (2022)
- Gross debt: 71.7 (2017), 63.2 (2018), 66.6 (2019), 77.8 (2020), 75.6 (2021), 68.7 (2022), 65.1 (2023, proj.), 61.2 (2024, proj.), 60.0 (2025, proj.), 58.2 (2026, proj.), 56.5 (2027, proj.), 55.2 (2028, proj.)
- Net debt: 60.3 (2017), 50.7 (2018), 54.4 (2019), 61.1 (2020), 60.4 (2021), 57.1 (2022), 51.1 (2023, proj.), 50.5 (2024, proj.), 49.1 (2025, proj.), 47.9 (2026, proj.), 47.0 (2027, proj.)
- Balance of payments and external:
- Current account balance: -2.4 (year not explicitly labeled), -0.7 (another entry)
- Services balance (of which): 7.3 (year not explicitly labeled), 7.5 (another entry)
- Capital and financial account (+ = outflow): 6.1 (year not explicitly labeled)
- Direct investment, net (+ = outflow): -1.0 (year not explicitly labeled)
- Gross external debt: 90.3 (year not explicitly labeled), 73.3, 78.4, 90.4, 82.8, 64.1, 59.6 (series)
- Central bank reserves ($ bn): 6.7, 7.1, 5.9 (series)
IMF Communications Department. Press Release No. 23/220. June 23, 2023.