Washington, DC: On June 4, 2021, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Iceland.

Iceland entered the COVID-19 crisis from a position of strength and stands favorably in its handling of the pandemic. Net and gross public debt has fallen by more than 50 percentage points of GDP since the global financial crisis, private and external debt has fallen by 200% of GDP, and international reserves have reached around 30% of GDP. Bank balance sheets are strong, with significant capital and liquidity buffers. The available policy space has enabled a rapid and substantial policy response to the pandemic, with fiscal, monetary and macroprudential measures mitigating the impact on households and businesses. The COVID-19 cases were contained quickly and vaccinations progressed as planned, with more than 60% of the population over 16 having received at least one dose.

Nevertheless, the impact of the pandemic on the economy has been significant. The collapse in global tourist flows has affected Iceland’s growth engine, which relies heavily on contact-intensive sectors. Real GDP declined 6.6%, unemployment rose sharply, the current account surplus declined, and inflation exceeded the reporting range in 2020. A modest recovery is expected to take hold in 2021, GDP expected to reach its 2019 level the following year. Scars from a slow expected recovery in tourism are expected to keep GDP 3% below its pre-COVID trend in 2026. Risks to the outlook are significant, mainly due to uncertainty over the development of the market. pandemic at national and international level and global outlook. revival of tourism.

Board assessment [2]

The executive directors praised Iceland for handling the severe impacts of the COVID-19 pandemic, thanks to the strong policy framework and cautiously accumulated buffers. Looking ahead, Directors underscored the difficult medium-term economic outlook and encouraged sound macroeconomic policies and structural reforms to enhance sustainable growth, financial stability and economic diversification.

Directors agreed that the budget support budgeted for this year would help support domestic demand, ease scars and provide insurance against downside risks. Directors also believed that Iceland’s medium-term fiscal policy plans would balance the continued need for support to the economy well with fiscal sustainability considerations. They noted that these plans appropriately refocus fiscal policy from vital support towards active labor market policies and investments in physical and human capital. Maintaining the greatest fiscal transparency will be crucial to preserve confidence in the fiscal framework.

Directors stressed that data-driven monetary policy rate decisions would remain essential to support confidence and mitigate inflation risks given the high degree of uncertainty. With the external position aligned with desirable fundamentals and policies, directors advised the CBI to continue reducing its presence in the forex market as the effects of the pandemic wear off. They also called for the completion of the ongoing reform of foreign exchange legislation in order to consolidate the liberalization of the exchange system and to clarify the conditions for possible recourse to measures to manage capital flows.

Directors stressed that emerging business vulnerabilities and real estate market risks should be addressed in order to keep the financial system strong. They recommended close monitoring of the impacts of the pandemic on corporate and bank balance sheets and the deployment of macroprudential measures to mitigate risks associated with rapid growth in bank mortgage credit.

Directors stressed that the upcoming review of the financial oversight architecture should ensure that the powers and resources of the CBI are commensurate with its expanded responsibilities. They stressed that the upcoming privatization of banks requires vigilance to preserve high quality property. Directors commended the authorities for quickly completing the actions required to move Iceland off the FATF gray list and encouraged them to continue improving the effectiveness of AML / CFT.

Directors stressed that Iceland’s post-pandemic growth strategy should strive to further diversify and build the resilience of its economy. The strategy should aim to promote safe and sustainable tourism, support innovation, strengthen human capital, reduce regulatory burdens, seek to better align wages and productivity, and ensure that targets are met on time. climatic conditions of Iceland.