Iceland: Iceland Outlook for 2013-14

The country (Iceland)

Outlook for 2013-14

• The governing coalition of the Social Democratic Alliance (SDA) and the Left-Green Movement (LGM) is divided and lacks a parliamentary majority.
• Nonetheless, the Economist Intelligence Unit expects it to stay in office until the next general election, due in April 2013.
• The Independence Party (IP) is then expected to become the largest party again, and is likely to form a coalition with the Progressive Party (PP).
• EU accession is not expected to materialise, either because a new IP-led government would oppose EU membership, or because it would be defeated in a referendum (which is currently unlikely to be held).
• As a result of the government's fiscal austerity agenda, we expect the budget deficit to shrink further, to 2% of GDP in 2013 and 1.2% in 2014, from an estimated 3.1% in 2012.
• We forecast that real GDP growth will slow to 1.7% in 2013, especially as domestic demand weakens, compared with estimated growth of 2% in 2012. Growth should then accelerate slightly in 2014, to 2.1%.
• After estimated average inflation of 5.2% in 2012, we expect inflation to moderate to 4.1% in 2013 and 3.8% in 2014 amid higher interest rates.

Review

• In October the ruling coalition lost its one-seat majority in parliament when Robert Marshall (SDA) joined a new left-leaning party, Bright Future (BF).
• An opinion poll in early November revealed the highest support for the government since the beginning of the year. However, the IP (first in the polls) and the PP were still on course to win the election in April.
• The European Parliament and the Council of Ministers approved rules that will allow the European Commission to impose a ban on imports of fish from overfished stocks into the EU, including exports from Iceland.
• In order to address elevated inflation, the Central Bank of Iceland raised its policy interest rate by 0.25 percentage points, to 6%, on November 14th.
• In November consumer price inflation rose to 4.5% year on year from 4.2% in October, amid the ongoing weakness of the krona.
• Nominal wages rose by 5.1% year on year in October, down from 5.7% in September and a peak of 12.1% in March.

The political scene

After an era during which divisions in the SDA-LGM government and mainly within the LGM seemed to have cool down, pressures came to the fore another time when 3 LGM members of parliament voted against the 2011 budget, dipping the government's majority to only. Support for the SDA has improved slightly, but the formerly dominant IP again has additional support than any other party.

Economic policy

A provisional accord was signed in December between an Icelandic negotiating team and the administrations of the UK and Netherlands on the argument over Icesave, the Internet arm of a failed bank, Landsbanki. This accord would decrease the interest costs to Iceland substantially compared with the transaction that was before rejected in a referendum. The government has finalised its proposals to alleviate household debt. The Central Bank of Iceland has reduced its effective interest rate further.

The domestic economy

GDP improved in the third quarter of 2010 against the previous quarter after quarters of continuous decline, but underlying request remains weak. Unemployment has stabilised at 7.5% but has been helped by emigration and part-time working. Inflation has fallen to 2.6% and wages have recently been rising above inflation in contrast to before in the year.

Foreign trade and payments

National accounts figures illustrate real exports of goods and services as declining while imports have increased. However, in nominal terms, exports have grown additional strappingly and the trade surplus has risen. The current account was as well in surplus in the third quarter.