Abstract
IMF Country Report No. 22/193
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IMF Country Report No. 22/193
ICELAND
2022 ARTICLE IV CONSULTATION—PRESS RELEASE; AND STAFF REPORT
June 2022
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. In the context of the 2022 Article IV consultation with Iceland, the following documents have been released and are included in this package:
A Press Release.
The Staff Report prepared by a staff team of the IMF for the Executive Board’s consideration on a lapse-of-time basis following discussions that ended on May 11, 2022, with the officials of Iceland on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on June 3, 2022.
An Informational Annex prepared by the IMF staff.
The IMF’s transparency policy allows for the deletion of market-sensitive information and premature disclosure of the authorities’ policy intentions in published staff reports and other documents.
Copies of this report are available to the public from
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International Monetary Fund
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© 2022 International Monetary Fund
Press Release
IMF Executive Board Concludes 2022 Article IV Consultation with Iceland
FOR IMMEDIATE RELEASE
Washington, DC – June 27, 2022: On June 15, 2022, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Iceland and endorsed the staff appraisal without a meeting on a lapse-of-time basis.
Iceland has weathered recent shocks to the economy relatively well. Well-designed policy measures and a solid health system eased the impact of the pandemic, allowing real GDP and employment to recover strongly. Robust domestic demand and favorable terms of trade boosted output growth to 4.3 percent in 2021, despite slower recovery in tourism. With net general government debt of 60 percent of GDP, international reserves of 29 percent of GDP, and a sound banking system, the Icelandic economy remains well positioned to handle potential negative shocks, including from the global impact of the war in Ukraine.
Growth is expected to remain moderate in 2022 and the medium term. In 2022, GDP growth is projected at 3.6 percent while average inflation is projected to reach 7.4 percent. Over the medium term, export-oriented industries are expected to be the main source of growth, while private consumption growth is expected to moderate with the tightening of monetary and fiscal policies. By 2027, real GDP is expected to reach a level about 2 percent below its pre-COVID trend. Inflation is projected to gradually fall back to target by 2025, steered by the ongoing monetary policy tightening. The current account is projected to revert to a surplus as tourism continues to recover. Risks to the recovery arise from the war in Ukraine, the pandemic, and a potential impasse in the negotiations for a new collective bargaining agreement that could result in labor market tensions and economic dislocation. On the upside, tourism and new innovative industries could help the economy recover faster.
Executive Board Assessment2
Iceland’s economic outlook is positive but subject to substantial risks. Careful policy coordination is required to entrench the recovery, contain rising housing risks, rebuild fiscal buffers while supporting the most vulnerable, and stem external imbalances, as the external position is assessed as weaker than fundamentals and desirable policies.
The authorities’ planned fiscal consolidation is appropriate as it would help bring inflation back to target and rebuild fiscal buffers. These are crucial given Iceland’s exposure to large shocks. Measures to achieve the consolidation could include streamlining VAT expenditures, public consumption, and the transfer system. The authorities should save any potential windfall fiscal revenues and reactivate the fiscal rules on time.
The monetary tightening is welcome, and the CBI should continue withdrawing monetary policy stimulus. Steering inflation and inflation expectations back to target will require further policy rate hikes and strengthening liquidity management to improve monetary policy transmission. Vigilance and data driven policy rate decisions are required, considering the evolution of inflation and inflation expectations, prospects for economic recovery, wage and house price developments, capital flows, and imported inflation.
The banking system has weathered the pandemic well, but rising systemic risks call for additional action. Surging house prices require further tightening of macroprudential measures. Reducing administrative burdens in the construction sector, redesigning regressive home ownership incentives, and providing more targeted rental assistance should address housing affordability. The merger between the central bank and the financial regulator has supported financial stability. However, there is a need to further review the CBI’s committees, budgetary independence, and microprudential powers and capacities, including to oversee pension funds’ governance and risk management practices.
Ensuring the quality of bank ownership should remain a key government objective and supervisory responsibility of the CBI. Participation and ownership criteria for investors in state owned banks should mitigate potential reputational and stability risks for the state and the financial system. The CBI should review future divestiture plans to ensure that fitness and probity of potential investors is adequately considered, and other potential prudential issues are adequately addressed.
Further efforts are needed to diversify the economy and to achieve Iceland’s climate goals. The focus should be on reducing burdens on start-ups, easing business regulations, promoting R&D investment, easing access to finance for small firms, and furthering education reforms. Ensuring inclusiveness and aligning wage and productivity growth should be key features in the upcoming collective bargaining agreement. Carbon pricing should be broadened and increased, and tax incentives for electric vehicles should be revenue neutral. Expanding the use of renewable energy would require infrastructure investments, and technological improvements may need R&D support.
Iceland: Selected Economic Indicators, 2016–22
For 2022, rate as of end-April.
In 2020, the definition of the general government was expanded to include 24 new entities, of which the largest are the IL Fund and the Student loan Fund.
Iceland: Selected Economic Indicators, 2016–22
| 2016 | 2017 | 2018 | 2019 | 2020 | 2021 Prel. | 2022 Proj. | |
|---|---|---|---|---|---|---|---|
| National Accounts (Constant Prices) | |||||||
| Gross domestic product | 6.3 | 4.2 | 4.9 | 2.4 | -7.1 | 4.3 | 3.6 |
| Total domestic demand | 7.7 | 7.6 | 4.8 | 0.9 | -1.7 | 7.3 | 2.5 |
| Private consumption | 6.7 | 8.0 | 4.8 | 1.9 | -2.9 | 7.6 | 2.8 |
| Public consumption | 0.9 | 2.9 | 4.7 | 3.9 | 4.2 | 1.8 | 1.0 |
| Gross fixed investment | 18.0 | 10.6 | 3.1 | -2.4 | -9.5 | 13.6 | 3.6 |
| Net exports (contribution to growth) | -0.8 | -2.9 | 0.5 | 1.7 | -5.4 | -3.0 | 0.6 |
| Exports of goods and services | 11.0 | 5.1 | 1.7 | -4.7 | -30.2 | 12.3 | 17.9 |
| Imports of goods and services | 14.6 | 11.8 | 0.9 | -8.5 | -21.6 | 20.3 | 15.2 |
| Output gap (percent of potential output) | 0.8 | 1.2 | 3.3 | 4.0 | -2.8 | -0.7 | 1.0 |
| Selected Indicators | |||||||
| Gross domestic product (ISK bn.) | 2,512 | 2,642 | 2,844 | 3,043 | 2,928 | 3,233 | 3,640 |
| Gross domestic product ($ bn.) | 20.8 | 24.7 | 26.3 | 24.8 | 21.6 | 25.5 | 28.0 |
| GDP per capita ($ thousands) | 62.5 | 73.1 | 75.4 | 69.5 | 59.4 | 69.0 | 74.8 |
| Private consumption (percent of GDP) | 49.3 | 50.1 | 50.3 | 49.9 | 51.6 | 51.7 | 50.7 |
| Public consumption (percent of GDP) | 23.0 | 23.7 | 24.1 | 24.5 | 27.8 | 27.4 | 25.3 |
| Gross fixed investment (percent of GDP) | 20.9 | 21.8 | 22.0 | 21.3 | 21.2 | 22.9 | 22.6 |
| Gross national saving (percent of GDP) | 29.2 | 26.0 | 25.8 | 26.9 | 22.2 | 20.2 | 23.0 |
| Unemployment rate (percent of labor force) | 3.3 | 3.3 | 3.1 | 3.9 | 6.4 | 6.0 | 4.7 |
| Employment | 4.1 | 1.0 | 1.8 | 0.9 | -3.0 | 3.6 | 1.9 |
| Labor productivity | 2.8 | 3.8 | 2.7 | 1.5 | -4.2 | 0.7 | 1.7 |
| Real wages | 6.8 | 7.4 | 3.7 | 1.8 | 3.4 | 3.7 | 1.8 |
| Nominal wages | 8.6 | 9.3 | 6.5 | 4.9 | 6.3 | 8.3 | 9.3 |
| Consumer price index (average) | 1.7 | 1.8 | 2.7 | 3.0 | 2.9 | 4.5 | 7.4 |
| Consumer price index (end period) | 1.9 | 1.9 | 3.7 | 2.0 | 3.6 | 5.1 | 8.0 |
| ISK/€ (average) | 134 | 121 | 128 | 141 | 157 | 148 | … |
| ISK/$ (average) | 121 | 107 | 108 | 123 | 135 | 127 | … |
| Terms of trade (average) | 2.7 | 1.5 | -3.7 | -0.8 | -1.2 | 3.7 | 6.2 |
| Money and Credit (End Period) | |||||||
| Base money (M0) | 3.0 | 37.9 | -1.7 | -9.2 | 11.8 | 9.0 | 13.2 |
| Broad money (M3) | -4.6 | 5.0 | 7.0 | 6.6 | 7.4 | 10.9 | 14.6 |
| Bank credit to nonfinancial private sector | 4.4 | 9.2 | 11.9 | 2.9 | 10.5 | 10.3 | 12.6 |
| Central bank 7-day term deposit rate 1/ | 5.00 | 4.25 | 4.50 | 3.00 | 0.75 | 2.00 | 3.75 |
| 3.0 | 37.9 | -1.7 | -9.2 | 11.8 | 9.0 | 13.2 | |
| General Government Finances 2/ | |||||||
| Revenue | 59.0 | 45.4 | 44.8 | 41.9 | 42.1 | 40.4 | 42.0 |
| Expenditure | 46.4 | 44.4 | 43.8 | 43.4 | 50.7 | 49.3 | 46.8 |
| Overall balance | 12.5 | 1.0 | 0.9 | -1.5 | -8.7 | -8.9 | -4.8 |
| Structural primary balance | 3.7 | 2.0 | 0.7 | -2.2 | -1.8 | -2.7 | -3.2 |
| Cyclically adjusted primary balance | 15.0 | 3.3 | 1.4 | -1.5 | -4.8 | -6.2 | -2.2 |
| Gross debt | 82.4 | 71.6 | 63.1 | 66.2 | 77.4 | 75.0 | 68.3 |
| Net debt | 67.6 | 60.2 | 50.7 | 54.1 | 60.8 | 59.9 | 55.2 |
| Balance of Payments | |||||||
| Current account balance | 8.1 | 4.2 | 3.5 | 5.8 | 1.0 | -2.8 | 0.3 |
| of which: services balance | 10.5 | 10.6 | 9.0 | 8.6 | 2.4 | 2.9 | 3.0 |
| Capital and financial account (+ = outflow) | 8.5 | 1.1 | 5.7 | 5.4 | 5.5 | 1.4 | 0.1 |
| of which: direct investment, net (+ = outflow) | -3.5 | -0.7 | 1.7 | 2.8 | 2.5 | -0.6 | -2.1 |
| Gross external debt | 125.1 | 90.3 | 73.3 | 77.9 | 89.9 | 82.9 | 80.5 |
| Central bank reserves ($ bn.) | 7.2 | 6.6 | 6.1 | 6.7 | 6.4 | 7.1 | 6.9 |
For 2022, rate as of end-April.
In 2020, the definition of the general government was expanded to include 24 new entities, of which the largest are the IL Fund and the Student loan Fund.
Iceland: Selected Economic Indicators, 2016–22
| 2016 | 2017 | 2018 | 2019 | 2020 | 2021 Prel. | 2022 Proj. | |
|---|---|---|---|---|---|---|---|
| National Accounts (Constant Prices) | |||||||
| Gross domestic product | 6.3 | 4.2 | 4.9 | 2.4 | -7.1 | 4.3 | 3.6 |
| Total domestic demand | 7.7 | 7.6 | 4.8 | 0.9 | -1.7 | 7.3 | 2.5 |
| Private consumption | 6.7 | 8.0 | 4.8 | 1.9 | -2.9 | 7.6 | 2.8 |
| Public consumption | 0.9 | 2.9 | 4.7 | 3.9 | 4.2 | 1.8 | 1.0 |
| Gross fixed investment | 18.0 | 10.6 | 3.1 | -2.4 | -9.5 | 13.6 | 3.6 |
| Net exports (contribution to growth) | -0.8 | -2.9 | 0.5 | 1.7 | -5.4 | -3.0 | 0.6 |
| Exports of goods and services | 11.0 | 5.1 | 1.7 | -4.7 | -30.2 | 12.3 | 17.9 |
| Imports of goods and services | 14.6 | 11.8 | 0.9 | -8.5 | -21.6 | 20.3 | 15.2 |
| Output gap (percent of potential output) | 0.8 | 1.2 | 3.3 | 4.0 | -2.8 | -0.7 | 1.0 |
| Selected Indicators | |||||||
| Gross domestic product (ISK bn.) | 2,512 | 2,642 | 2,844 | 3,043 | 2,928 | 3,233 | 3,640 |
| Gross domestic product ($ bn.) | 20.8 | 24.7 | 26.3 | 24.8 | 21.6 | 25.5 | 28.0 |
| GDP per capita ($ thousands) | 62.5 | 73.1 | 75.4 | 69.5 | 59.4 | 69.0 | 74.8 |
| Private consumption (percent of GDP) | 49.3 | 50.1 | 50.3 | 49.9 | 51.6 | 51.7 | 50.7 |
| Public consumption (percent of GDP) | 23.0 | 23.7 | 24.1 | 24.5 | 27.8 | 27.4 | 25.3 |
| Gross fixed investment (percent of GDP) | 20.9 | 21.8 | 22.0 | 21.3 | 21.2 | 22.9 | 22.6 |
| Gross national saving (percent of GDP) | 29.2 | 26.0 | 25.8 | 26.9 | 22.2 | 20.2 | 23.0 |
| Unemployment rate (percent of labor force) | 3.3 | 3.3 | 3.1 | 3.9 | 6.4 | 6.0 | 4.7 |
| Employment | 4.1 | 1.0 | 1.8 | 0.9 | -3.0 | 3.6 | 1.9 |
| Labor productivity | 2.8 | 3.8 | 2.7 | 1.5 | -4.2 | 0.7 | 1.7 |
| Real wages | 6.8 | 7.4 | 3.7 | 1.8 | 3.4 | 3.7 | 1.8 |
| Nominal wages | 8.6 | 9.3 | 6.5 | 4.9 | 6.3 | 8.3 | 9.3 |
| Consumer price index (average) | 1.7 | 1.8 | 2.7 | 3.0 | 2.9 | 4.5 | 7.4 |
| Consumer price index (end period) | 1.9 | 1.9 | 3.7 | 2.0 | 3.6 | 5.1 | 8.0 |
| ISK/€ (average) | 134 | 121 | 128 | 141 | 157 | 148 | … |
| ISK/$ (average) | 121 | 107 | 108 | 123 | 135 | 127 | … |
| Terms of trade (average) | 2.7 | 1.5 | -3.7 | -0.8 | -1.2 | 3.7 | 6.2 |
| Money and Credit (End Period) | |||||||
| Base money (M0) | 3.0 | 37.9 | -1.7 | -9.2 | 11.8 | 9.0 | 13.2 |
| Broad money (M3) | -4.6 | 5.0 | 7.0 | 6.6 | 7.4 | 10.9 | 14.6 |
| Bank credit to nonfinancial private sector | 4.4 | 9.2 | 11.9 | 2.9 | 10.5 | 10.3 | 12.6 |
| Central bank 7-day term deposit rate 1/ | 5.00 | 4.25 | 4.50 | 3.00 | 0.75 | 2.00 | 3.75 |
| 3.0 | 37.9 | -1.7 | -9.2 | 11.8 | 9.0 | 13.2 | |
| General Government Finances 2/ | |||||||
| Revenue | 59.0 | 45.4 | 44.8 | 41.9 | 42.1 | 40.4 | 42.0 |
| Expenditure | 46.4 | 44.4 | 43.8 | 43.4 | 50.7 | 49.3 | 46.8 |
| Overall balance | 12.5 | 1.0 | 0.9 | -1.5 | -8.7 | -8.9 | -4.8 |
| Structural primary balance | 3.7 | 2.0 | 0.7 | -2.2 | -1.8 | -2.7 | -3.2 |
| Cyclically adjusted primary balance | 15.0 | 3.3 | 1.4 | -1.5 | -4.8 | -6.2 | -2.2 |
| Gross debt | 82.4 | 71.6 | 63.1 | 66.2 | 77.4 | 75.0 | 68.3 |
| Net debt | 67.6 | 60.2 | 50.7 | 54.1 | 60.8 | 59.9 | 55.2 |
| Balance of Payments | |||||||
| Current account balance | 8.1 | 4.2 | 3.5 | 5.8 | 1.0 | -2.8 | 0.3 |
| of which: services balance | 10.5 | 10.6 | 9.0 | 8.6 | 2.4 | 2.9 | 3.0 |
| Capital and financial account (+ = outflow) | 8.5 | 1.1 | 5.7 | 5.4 | 5.5 | 1.4 | 0.1 |
| of which: direct investment, net (+ = outflow) | -3.5 | -0.7 | 1.7 | 2.8 | 2.5 | -0.6 | -2.1 |
| Gross external debt | 125.1 | 90.3 | 73.3 | 77.9 | 89.9 | 82.9 | 80.5 |
| Central bank reserves ($ bn.) | 7.2 | 6.6 | 6.1 | 6.7 | 6.4 | 7.1 | 6.9 |
For 2022, rate as of end-April.
In 2020, the definition of the general government was expanded to include 24 new entities, of which the largest are the IL Fund and the Student loan Fund.
Title page
ICELAND
STAFF REPORT FOR THE 2022 ARTICLE IV CONSULTATION
June 3, 2022
KEY ISSUES
Iceland’s economy has weathered multiple shocks since 2019 relatively well. The economic outlook is positive but suggests long-term scarring. The risks are tilted to the downside and are associated with the global impact of a potential escalation in the war in Ukraine, the pandemic, economic disruptions, and tighter global financial conditions. On the upside, tourism and new innovative industries could help the economy recover faster.
Careful policy coordination is required to entrench the recovery, stem risks and rebuild buffers to pre-pandemic levels. Policies should mitigate the flaring-up in inflation, external imbalances, and house prices. Structural reforms should facilitate economic diversification and make the economy more resilient to shocks.
Fiscal policy. The planned fiscal consolidation aims to restore fiscal buffers and reactivate the existing fiscal rules. Contingency margins are appropriately planned and should be used in a targeted manner if downside risks materialize, while potential windfall revenues should be saved. The fiscal framework has served Iceland well, and its integrity should be preserved.
Monetary policy. The tightening cycle in monetary policy should steer inflation expectations back toward the target. It needs go along with tighter systemic liquidity management. The policy rate will also help address housing price pressures, which feed directly into inflation.
Housing policies. Further macroprudential tightening through binding and effective debt service-to-income caps is needed to contain growing housing risks. Housing affordability should also be a priority and should be addressed with structural measures increasing housing supply and better targeted fiscal incentives to low-income households.
Macro-structural policies. Diversification efforts should focus on easing regulatory burdens on start-ups and spurring innovation by leveraging Iceland’s human capital and advanced digital infrastructure. The new collective wage agreement can also foster diversification and resilience through better alignment of wage and productivity growth. Achieving Iceland’s climate goals requires well-balanced fiscal incentives and environmental trade-offs in expanding renewable energy capacities.
Approved By
Laura Papi (EUR) and Guillaume Chabert (SPR)
The mission took place in Reykjavik during April 28–May 11, 2022. The team comprised Iva Petrova (head), Mahir Binici, Jorge Iván Canales Kriljenko, and Nujin Suphaphiphat (all EUR). The mission met with Prime Minister Katrín Jakobsdóttir, CBI Governor Ásgeir Jónsson, Minister of Finance Bjarni Benediktsson, and other representatives of the public and private sector. Guðrún Ögmundsdóttir (OED) joined the discussions. Kelly Gao, Indra Mahadewa, and Rachelle Vega (EUR) supported the mission.
Contents
CONTEXT
THE ECONOMIC AFTERMATH OF THE PANDEMIC
OUTLOOK AND RISKS
A. Moderate Growth with Significant Inflationary Pressures
B. Elevated Uncertainty from Diverse Sources of Risk
MACROECONOMIC POLICIES: MANEUVERING A SAFE TAKEOFF IN STORMY WEATHER
A. Restoring Fiscal Buffers while Retaining Targeted Support
B. Guiding Inflation Expectations Back to Target
C. Preserving Financial Stability
D. Fostering Economic Diversification and Innovation
STAFF APPRAISAL
FIGURES
1. Key Macroeconomic Developments
2. COVID-19 Developments
3. Tourism Developments
4. Labor Developments
5. Fiscal Developments and Issues
6. Inflation and Monetary Developments
7. External Sector Developments
8. Banking Sector Developments
9. Housing Market Developments
TABLES
1. Selected Economic Indicators, 2016–27
2. Money and Banking, 2016–27
3. Financial Soundness Indicators, 2018Q1–2021Q4
4. General Government Operations, 2016–27
5. General Government Financial Balance Sheet, 2016–27
6. Balance of Payments, 2016–27
7. International Investment Position, 2011–21
ANNEXES
I. External Sector Assessment
II. Iceland’s Pension Funds’ Assets
III. Risk Assessment Matrix
IV. Public Sector Debt Sustainability Analysis
V. External Debt Sustainability Analysis
VI. Islandsbanki’s Privatization
VII. The Role of Collective Bargaining in Fostering Macroeconomic Resilience
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.IMF.org/external/np/sec/misc/qualifiers.htm.
