International rating agency S&P Global Ratings has affirmed Iceland’s sovereign ratings at A/A-1 with a stable outlook. The rating agency expects the pandemic to cause Iceland's economy to contract by 7.8% in 2020 before partially recovering by 4% in 2021. Despite the significant hit to the tourism sector, S&P expects that Iceland’s current account balance will remain in surplus over the next few years. The rating agency believes that the authorities will be able to consolidate public balances after 2021 and note the successful track record of fiscal deleveraging over the past decade. Resilient external balances and low net external leverage provide further economic buffers.
Iceland's stable institutional framework and effective policymaking continue to support the rating. The volatile nature of the small and open economy and limited effectiveness of monetary policy, given the strong influence of external developments on domestic inflation trends, constrain the rating.
According to S&P, the agency could raise the ratings if the economy's recovery from the pandemic exceeds expectations, and leads to a diversification of the Icelandic economy and export categories, in the process reducing the volatility in Iceland's terms of trade; a scenario that could enable quicker fiscal consolidation.
On the other hand, the rating agency could lower the ratings if the pandemic causes more permanent damage to the productive capacity of Iceland's economy than expected, while pushing net general government debt to GDP to levels materially beyond expectations.