The Icelandic economy performed better than expected at the beginning of the pandemic

 The Icelandic economy performed better than expected at the beginning of the pandemic with strong political support. The outlook remains challenging, however. This year a modest recovery is planned, but uncertainty remains large. The prospective recovery in the tourism and economic sector depends on epidemic control and progress in global and domestic vaccine distribution. مواضيع نقاش

Economic policies should continue to promote recovery and mitigate risks that emerge.

The planned stimulus for this year will help address the economy's still slackening, reduce scarcity and create trust in the event of downside risks. Medium-term policies should facilitate resource transfer to more productive sectors and the reconstruction of fiscal buffers.

With inflation higher than the target group and inflation expectations anchored, the CBI now needs to remain vigilant. Intervention on foreign exchange should continue to taper off.

Macroprudential measures should address emerging risks to the financial sector, including risks to the immobilization market.

Structural reforms should facilitate economic diversification and limit scarring, and be incorporated into a comprehensive recovery plan to provide ground for new sectors' growth.

Iceland has been highly exposed to health, economic and financial contagion due to the COVID-19 pandemic, as a result of its dependence on tourism. Iceland stands out favorably with fast containment of the COVID-19 cases in its management of the pandemic. However, the collapse in global tourism flows has affected significantly Iceland's growth engine, which relies heavily on contact-intensive sectors. Real GDP contracted by 6.6% and by 2020 unemployment reached 6.4%.

From a position of strength, Iceland entered the crisis. Cautious policies have provided significant space for policy over the past decade. Since the global financial crisis, public net and gross debt have decreased by more than 50% of GDP, private debt has halved and international reserves have reached approximately 30% of GDP. The balance sheets of banks were strong, with large buffers of capital and liquidity.

The broad political space enabled the authorities to react decisively to the pandemic shock:

o Fiscal policy: the government provided unconditional support to the health sector for the pandemic, increasing unemployment benefits and transfers related to the dismissal, extending grants to companies, easing fiscal burdens, offering state guarantees, increasing allocations for public investment and encouraging domestic tourism. The economy is expected to continue to support a total of 9.2 per cent of GDP in pandemic-related fiscal measures in the medium term.

o monetary policy. o monetary policy. The Iceland Central Bank (CBI) has lowered policy rates by 200 basis points, reduced the reserve requirements, discontinued deposit auctions for one month and initiated a purchase program for treasury bonds. In the face of sharp declines in export income, it also intervened on the foreign exchange market to prevent disorders in the conditions of the market.

o Policy for the financial sector. The authorities reduced the banks' countercyclical capital buffer from 2% to zero, eased liquidity demands, facilitated an extension of the loan moratorium and approved simpler temporary rules for corporate financial restructuring.

Political measures were essential to rebuild trust. Financial markets stabilized rapidly, household income was largely protected, and enterprises sustained revenue loss. Although the decline in output was significant, the recession was smaller than initially feared.

The outlook is still uncertain

However, the economic outlook of Iceland remains challenging. This year will see a modest recovery with real GDP growth significantly below its pre-COVID trend. The ongoing fiscal stimulus will support domestic demand and only modestly increase exports. With border controls in Iceland and its main trading partners still in place in 2021, tourism revenues are forecast to remain diminished in the short term. Tourism is expected to gradually recover and experience significant persistent losses in output. Overall, real GDP will only return to its 2019 level by 2022 and will continue to be below its pre-COVID trend even in 2026.

The outlook risks are substantial and downside. In the short term, they stem from the pandemic path. Abundant availability of vaccines can help herd immunity reach faster, increase confidence and open a door for a more booming tourist season. However, due to new virus strain or short-term vaccine efficacy, a resurgence of the pandemic could dash hopes for recovery and reduce the policy space. Additional negative risks are linked to the potential sharp increase in global risk aversion, deglobalization and natural disasters.

The policy mix will support people and the economy in the years to come, protect macroeconomic stability and facilitate economic resource re-allocation.

The 2021 budget allows for continued fiscal support during the recovery. The fiscal stimulus will boost demand due to slack economic conditions, help to mitigate economic scarcity and provide insurance in the event of additional downside risks. It supports health expenditure adequately and protects the most vulnerable in society. Planned public investment is well placed for recovery because of its high impact on short-term economic activity and its emphasis on increasing the potential of the economy.

The Medium-Term Fiscal Plan of the authorities is a welcome anchor in the midst of still high prospects. It clarifies and maintains fiscal policy in 2022 and provides guidance on the possible medium-term fiscal route for the government to take office after the parliamentary elections in September. The medium-term fiscal plan appropriately reorganized measures to help resource allocation and economy diversification from lifeline support for households and businesses to investments in public infrastructure and human capital. It well balances the ongoing need for economic support with fiscal sustainability considerations and gradually relieves aid as the economy recovers. This plan would thus help to restore fiscal policy to Iceland's fiscal rule and to rebuild fiscal tampons. Maintaining the most transparent fiscal accounts and implementation of policies is essential to maintain confidence in the fiscal framework.