Iceland offers comparative safety in uncertain times

More than a decade on from economic crisis, Iceland is blossoming in the risk rankings

Battered by the global financial meltdown, Iceland was once an investor pariah when its banks collapsed in 2008 and capital controls were deployed.

More than a decade on from the worst economic crisis in the country’s modern history, analysts are becoming increasingly confident in Iceland as an investor location, not least given the vulnerabilities of other European countries to the war in Ukraine.

Iceland ended 2021 on a respectable note, at 20^th in Euromoney’s global risk rankings, 13 places higher on a five-year trend basis, and significantly better off than its 47^th ranking in 2010.

But that’s not all.

Preliminary data from Euromoney’s country risk survey for the first quarter of 2022 show Iceland climbing even higher up the second of Euromoney’s five risk categories, to a lofty 15^th, putting it on a par with Belgium and Slovenia:

Stronger economy

Iceland’s improvement is largely due to its rosier economic fortunes, with the pandemic easing.

“Domestically, the pandemic is relatively a much less concern, as both infections and hospitalizations have diminished rapidly during the last weeks,” says local expert Brynjar Orn Olafsson, an economist at SB Economics.

“This is both due to the fact that the population is vastly vaccinated (of those five years and older 82% is fully vaccinated), and also to the Omicron variant, which has the highest frequency with respect to tests.”

Domestically, the pandemic is relatively a much less concern

 - Brynjar Orn Olafsson

GDP rose by 4.3% last year in real terms, supported by private consumption and investment, and the unemployment rate is down to 4.5%.

A recent forecast from Statistics Iceland indicates the economy will grow by 4.6% in 2022, further underpinned by strong tourism and high aluminium prices boosting exports.

Scores for the relevant risk factors have therefore improved, and a growing economy and the withdrawal of pandemic relief will help to put the fiscal accounts back in line after large deficits on the general government finances – of up to 9% of GDP – were built up in 2020-2021.

The government also has substantial assets boosted by equity sales as part of the process of returning nationalized banks to the private sector.

Conflict risks

The invasion of Ukraine is undoubtedly a major risk to the economy, but Olafsson says that as far as direct exposure to the conflict is concerned, Iceland has fairly little trade with Ukraine, except for exports of maritime products.

He estimates the worst-case hit to be close to 1.4% of total export volume, but with relatively low probabilities, while Iceland’s geographical remoteness from the theatre of war also lessens the risks.

The country does not need to absorb large numbers of refugees fleeing across the border, and at the extreme there is little or no risk of being attacked with nuclear weapons.

Indirectly, though, Iceland could see its terms of trade worsen, both due to recent and future increases in oil import prices.

“This is mostly relevant looking at the cost of both shipping (less margin on maritime products) and aircraft fleet (dearer airfares),” says Olafsson.

“On the flip side, though, close to half of Icelandic households are investing in electric vehicles when renewing their car, and the economy is non-reliant on the external sector when it comes to electricity and heating,” he adds.

Iceland does not import natural gas and the share of renewables in its energy mix is now more than four-fifths (the highest in Europe).

Other risks

Another pressing risk is inflation, of course, which rose to 6.7% in March. This will lead to real exchange-rate appreciation and almost certainly see borrowing rates rise even further; but in that respect Iceland is not alone, with the cost-of-living crisis a global phenomenon.

Positively, Iceland is also benefiting from political stability, strong transparency and improving confidence in its institutions.

The three-party coalition comprising the Independence Party, Progressive Party and Left-Green Movement has continued for a second four-year term following the elections that were held in September 2021.

The three parties in office have proved to be resilient and are expected to remain so

 - Brynjar Orn Olafsson

There is no desire to restart negotiations to join the EU, despite creeping support in favour of it among the population. There is stronger support for being in Nato, and generally speaking quite elevated levels of support for the government.

The minister of infrastructure and leader of the PP, Sigurdur Ingi Johannsson, is under pressure after making a racist remark recently at the Farmers Association annual conference, but it seems unlikely to be enough to break up the three-way coalition.

“The three parties in office have proved to be resilient,” says Olafsson, “and are expected to remain so.”

In any case, Iceland could withstand a government collapse. Another coalition would be formed without any major implications for policymaking.

Iceland’s minimal risk ranking seems guaranteed.