Output is set to contract by almost 8% in 2020, but is projected to expand by around 3% per annum in both 2021 and 2022, thanks to rising household consumption. Goods exports are expected to rise, although foreign tourism will take longer to gain momentum. Business investment will remain weak, but housing and public investment will pick up. Given the continued impact of the pandemic, especially on international travel, until a vaccine is deployed widely, activity will still fall short of its pre-crisis level at the end of 2022. Unemployment continues to rise and will exceed 7% in mid-2021, and wage growth will slow.
The króna has depreciated since the crisis started. Inflation expectations are rising slowly despite the downturn as wages are rising and fiscal policy is strongly expansionary. The central bank should hence remain vigilant. The government should continue to provide targeted support, including helping people and capital move to new sectors and activities. Structural reforms to strengthen competition and improve relevant skills would underpin diversification of the economy.
Iceland’s slowdown underlines the need to fix structural issues
Sound macroeconomic policies and favourable external conditions have enabled Iceland’s economy to emerge stronger from a decade of post-crisis management. Yet the impact on growth from a drop in tourist arrivals and seafood exports underlines the need for reforms to open up and diversify the economy and improve its resiliency to sectoral shocks.