In its most recent quarterly report, the Financial Stability Committee of the Central Bank expects GDP to contract by 8% in 2020. The report notes that while Iceland’s three commercial banks are in a strong capital and liquidity position, there is the risk that the Central Bank’s easing of policy instruments could lead to an increase in asset prices and an increase in the likelihood of systemic risk within the economy.
The financial system on “sound footing”
The Financial Stability Committee (FSC) of the Central Bank is required to assess the value of the countercyclical capital buffer (i.e. macroprudential instruments to help counter procyclicality in the financial system) on financial institutions on a quarterly basis.
In accordance with this obligation, the FSC has published its newest quarterly report, which forecasts that GDP will contract by 8% this year. The report notes that despite the effects of the COVID-19 pandemic, Iceland’s financial system is “on sound footing,” with private sector balance sheets having grown stronger in recent years, reinforced by deleveraging and higher equity ratios.
Despite positive measures taken by the Central Bank, however, the report also states that the pandemic has accelerated the contraction of the tourism industry and the reduced access to corporate loans from financial institutions, a trend that began last year.
A possible “wave of insolvencies”
The report further outlines a number of negative side effects that can be traced to the pandemic: uncertainty about Iceland’s foreign currency revenues; a possible “wave of insolvencies” among companies in the tourist sector; a drop in aluminium prices; the disruption of marine-product sales; rising unemployment; and a drop in commercial property prices (residential property prices remain relatively unchanged).
Over the past weeks and months, the Government and the Central Bank have responded to the crisis with the adoption of wide-ranging measures, including expanding access to credit and the lowering of financing costs. These measures – which could help to reinvigorate the economy – do not come without some risk, however:
“The low-interest environment resulting from pandemic response measures exacerbates the risk of a debt bubble, either in specific sectors or in the broader economy, at a time when the financial stability policy stance is more accommodative than before. This could undermine financial stability in the coming term. It is therefore essential to take appropriate action if increased risk appetite leads to excessive credit growth when the impact of the pandemic tapers off and the economy starts to recover.”
Unemployment to reach its zenith
Haukur C. Benediktsson, Director of Financial Stability at the Central Bank, and Ásgeir Jónsson, Governor of the Central Bank, introduced the report’s findings in a press conference earlier today. Summarising the findings of the report, Haukur predicted that unemployment would reach previously unknown levels in 2020. The FSC expects unemployment to peak at between 7.4-10% in 2020, with labour-intensive sectors to be hit the hardest:
“The COVID-19 pandemic and its implications have had a profound impact on Icelandic households. The most serious is the impact on the labour market, with many companies scaling down or even halting operations. As a result, large numbers of employees have either had their working hours reduced or have lost their jobs entirely. Unemployment has soared and, according to the Bank’s most recent macroeconomic forecast, is expected to approach 12% in Q3 and measure 9% for the year as a whole, as compared with 3.6% in 2019 and the post-crisis peak of 7.6% in 2010.”