20/06/2023 - Iceland’s economy is currently one of the fastest growing in the OECD, driven by foreign tourism and strong domestic demand. But growth is projected to slow as tighter financial conditions and uncertainty weigh on business investment, according to a new OECD report.
The latest OECD Economic Survey of Iceland says that policy should continue to focus on bringing down inflation, strengthening productivity growth by improving the business climate and helping migrants integrate.
Inflation remains persistent. It peaked in early 2023 at around 10% but has broadened, spreading to domestic services. It is projected to decline towards the 2.5% target, provided monetary, fiscal and financial policies remain aligned, though it is still expected to exceed 3% by late 2024. Fiscal consolidation and vigilant macroprudential policy are needed to build up fiscal space and safeguard financial stability.
Looking ahead, the Survey projects that economic growth will moderate from 6.4% in 2022 to 4.4% in 2023 and 2.6% in 2024. Household consumption will slow as real wages continue to weaken and foreign tourism levels off. Housing investment will decline in 2023 as higher real interest rates bite but is expected to pick up again in 2024. The unemployment rate is expected to edge up to around 4.5%. “Iceland has rebounded strongly from the pandemic and has proven resilient in the face of the economic impact of Russia’s war of aggression against Ukraine across Europe and globally,” OECD Secretary-General Mathias Cormann said, presenting the Survey in Reykjavik with Minister of Finance and Economic Affairs Bjarni Benediktsson. “Continued monetary policy and fiscal policy tightening remain necessary to return inflation to target and properly anchor inflation expectations. Establishing a one-stop to simplify access to migrant integration services, including skills recognition and Iceland language literacy, will help to optimise the beneficial impact of the increased number of migrants on long-term growth.”
Costs related to ageing pose a risk to long-term debt sustainability. Public spending on health and long-term care is set to rise considerably, although from a lower base than in almost any other OECD country. Reforms such as lifting the retirement age and reducing tax expenditures, would slow the build-up of debt.
Labour productivity has been trending up by only around 1% yearly, and has recently slowed further. Structural reforms to improve the business climate could reinvigorate productivity growth and help with the fight against inflation. Despite progress in tourism and construction, barriers to entry for domestic and foreign companies remain high in other sectors. Easing the overreaching system of licences and permits and investing in skills that are relevant for the labour market would help. Higher and broader taxation of greenhouse gas emissions, coupled with investment in cost-effective actions, would help to efficiently achieve further emission cuts.
Iceland should also step up its efforts to better integrate migrants and their children. Effective language training for adults and efficient skills recognition are essential for helping immigrants to meet their potential, whereas the adult learning system should be adjusted to encompass their training needs. Strengthening immigrant students’ language skills is key to improving their educational outcomes, as is better preparation of teachers to accommodate diverse educational needs in classrooms. Successful integration also requires meeting the housing needs of the immigrant population, including through increasing the supply of social and affordable housing.
See an Overview of the Survey with key findings and charts (this link can be included in media articles).
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