Fitch Affirms Iceland at 'A'; Outlook Negative

Fitch Ratings has affirmed Iceland’s Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) at ‘A’ with a Negative Outlook.

The 'A' rating is driven by Iceland’s very high income per capita, strong performance on governance, human development and doing business indicators that are more consistent with that of ‘AAA’ and ‘AA’ rated countries. Very large pension fund assets and sizeable deposits underpin financing flexibility. The rating is constrained by the small size of the economy and limited export diversification.

The Negative Outlook reflects the impact of the coronavirus pandemic on the Icelandic economy and the resulting deterioration in the public finances, with the fiscal deficit having widened materially and government debt set to increase sharply from pre-pandemic levels over the next few years. As a small and highly open economy with a sizeable concentration in tourism and commodity exports, Iceland is heavily exposed to the pandemic shock.

Iceland has high flexibility to finance large fiscal deficits arising from its response to the pandemic shock over the next few years. The economy has proved more resilient to the pandemic shock relative to Fitch’s initial expectations. Preliminary data from Statistics Iceland indicate that real GDP contracted by 6.6% in 2020, a better outturn relative to the 8% contraction at Fitch’s October 2020 rating review, mainly due to stronger domestic demand. Strong household balance sheets and government support measures contributed to a rebound in private consumption in 2H20.

In Fitch’s view, parliamentary elections in 2021 could lead to a fiscal strategy with a slower debt reduction path, but Fitch believes that broad political support for rebuilding fiscal buffers and a strong track record of public debt reduction of 70pp of GDP in 2011-2019 support fiscal policy credibility over the long run.

Future developments that could result in a positive rating action are greater confidence that the government debt to GDP ratio will decline over time once the Covid-19 crisis has subsided; sustained economic recovery, for example supported by evidence that the export-oriented sectors, particularly tourism, have been resilient to the pandemic shock.

Factors that could lead to a negative rating action are evidence that the government’s economic and fiscal strategy will fail to arrest the increase in government debt/GDP ratio over time; severe and prolonged economic weakness, for example due to a delayed recovery in the export-oriented sectors, sustained correction in the real estate market and material adverse impact on the banking sector; capital outflows at a scale that precipitates macroeconomic instability or erosion of fiscal buffers.

Fitch: Rating Action Commentaty