S&P Global Ratings has affirmed its 'A/A-1' long- and short-term sovereign credit ratings on Iceland. The outlook is stable.
Resilient domestic demand helped limit Iceland's economic contraction in 2020, which amounted to almost 7% in real terms; the recovery will largely depend on how well tourism rebounds, in S&P’s view. The authorities offered significant fiscal and monetary policy support; S&P expects most measures to be rolled back toward year-end 2021. Contrary to previous crises, external pressures have been manageable; the current account remained in a narrow surplus, external leverage is comparatively low, and central bank reserves ample.
The stable outlook indicates that Iceland's economy is likely to continue recovering in the second half of 2021. This should allow the authorities to gradually roll back much of the fiscal and monetary policy support that limited the economic contraction and exchange rate volatility during the pandemic. This will limit the increase in public debt over the next few years.
According to S&P, the agency could raise the ratings if the economic recovery from the pandemic exceeds its expectations and the Icelandic economy and export categories become more diverse, reducing the volatility in Iceland's terms of trade. This scenario could enable quicker fiscal consolidation, lowering the government's debt burden to close to pre-pandemic levels.
S&P could lower the ratings on Iceland if the economic recovery proved more shallow or took longer than currently expected and the tourism sector remained depressed. This could occur if the pandemic sees a resurgence or there is a prolonged shift in travel patterns. In such a scenario, S&P considers that monetary and fiscal support could become a more permanent feature of Iceland's policy mix and could erode policy space and net general government debt levels would rise materially beyond current expectations.