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Fitch Affirms Iceland at ‘A’; Outlook Stable

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

According to Fitch, Iceland’s ‘A’ rating is underpinned by its very high income per capita and governance indicators that are more consistent with those of ‘AAA’ and ‘AA’ rated sovereigns. Despite its small sized economy, the country has built sizeable buffers which help mitigate its vulnerability to external shocks and balance of payments’ risks; including ample foreign reserves, and a comfortable fiscal cash buffer. Strong credit fundamentals also include the country’s sizeable pension fund assets, sound banking sector, and strong private sector balance sheets. The rating remains constrained by a high level of public debt and the small size of the economy with its limited export diversification.

Iceland’s post-pandemic recovery strengthened in 2022. The economy expanded by 6.4%, underpinned by robust domestic demand. Tighter monetary policy and still elevated inflation, will mean a lower positive contribution from domestic demand. Although households’ disposable income will benefit from the latest wage negotiations, higher inflation and interest rates have increased their debt-servicing burdens. Subdued investment growth is also forecast. Weaker global growth is expected to weigh on net exports. Fitch estimates general government debt returned to its pre-pandemic ratio in 2022, declining to 66.5% of GDP, from 75.4% in 2021. The sovereign has a high degree of fiscal financing flexibility, underpinned by a large general government deposit buffer (Fitch estimates 11.5% of GDP end 2022) and robust liquidity in the banking system.

Iceland has an ESG Relevance Score (RS) of '5[+]' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Public Finances: A sharp and sustained decline in the government debt/GDP ratio.

Macro: Higher trend growth and evidence of economic diversification that reduces Iceland´s vulnerability to external shocks.

Factors that could, individually or collectively, lead to negative rating action/downgrade:
Public Finances: Looser fiscal policy that places the government debt/GDP ratio on an upward trajectory.

Macro: An adverse economic shock, for example due to a sharp correction in the real estate market.

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