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 the very high income per capita and strong soft metrics that are more consistent with those of ‘AAA’ and ‘AA’ rated countries. The coronavirus pandemic has resulted in a sharp deterioration in Iceland’s near-term growth and public finance outlook. The rating is constrained by the small size of the economy and limited export diversification. The negative outlook reflects rising government debt/GDP and downside risks of a prolonged and intensified pandemic leading to macroeconomic and financial spill-overs.
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 supports fiscal policy credibility over the long run.
Iceland has high flexibility to finance large fiscal deficits arising from its response to the pandemic shock over the next few years. Icelandic private pension funds managed 168% of GDP in assets, with roughly 70% invested domestically at end-2019. The government also has strong access to the international bond market, a large cash deposit buffer and is supported by robust liquidity in the banking system.
Swift, decisive public health measures have hitherto averted the need for a strict national lockdown to manage the spread of the virus, while substantial fiscal and monetary policy stimulus packages have limited the decline in consumption and maintained broad macroeconomic and financial stability through the crisis.
The main factors that could lead to a positive rating action are greater confidence in general government debt/GDP stabilising in the medium term and greater confidence that the economy will avoid a prolonged crisis.
The main factors that could lead to a negative rating action are materially higher than forecast general government debt/GDP, for example due to lack of fiscal consolidation after the initial COVID-19 related support measures, weaker growth prospects or materialisation of contingent liabilities; capital outflows at a scale that precipitates macroeconomic instability or erosion of external buffers; and severe and prolonged economic weakness.