RATING ACTION COMMENTARY

Fitch Revises Iceland's
Outlook to Stable; Affirms
at 'A'
Fri 18 Mar, 2022 - 5:06 PM ET
Related Fitch Ratings Content:
Iceland - Rating Action Report
Fitch Ratings - London - 18 Mar 2022: Fitch Ratings has revised the Outlook on
Iceland's Long-Term Foreign-Currency Issuer Default Rating (IDR) to Stable from
Negative and affirmed the IDR at 'A'.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
The revision of the Outlook reflects the following key rating drivers and theirrelative weights:

:

High

Macroeconomic Resilience: The revision of the Outlook to Stable reflects theresilience shown by the Icelandic economy to the pandemic shock and our
expectation of a sustained growth recovery, which should facilitate fiscal deficit
and debt reduction over time.
The Icelandic economy has proved more resilient to the pandemic shock relative
to our initial expectations. Following a contraction of 7.1% in 2020, real GDP grewby 4.3% in 2021 and we expect growth at a similar pace in 2022. This was slightly
better than our forecast at the previous review (4%) but weaker than the current'A' peer median. The recovery is underpinned by a rebound in tourism flows, solid
performance of the aluminium sector supported by high aluminium prices,
improvement of the labour market and sizeable fiscal policy support. Private
consumption and investment have been the main growth drivers. Net tradedetracted from growth as imports grew at a faster pace than exports particularly
in 4Q21 due to strong domestic demand.
Recovery to Continue: We expect real GDP to grow by 4.5% in 2022 and 3% in
2023 (vs current 'A' peer medians of 4.3% and 3.5%). High aluminium prices will
improve Iceland's terms of trade and the lifting of all border containment
measures in February should support the recovery in the tourism sector. Private
consumption and investment will remain the main growth drivers, supported byfurther declines in unemployment and the government's "Investment andConstruction" initiative.
Higher fuel and food prices represent a shock, but household purchasing power
and industry profit margins are likely to be less affected by higher energy costs
than the rest of Europe. The share of renewables in the energy mix, at above 80%,is the highest in Europe, and Iceland does not rely on natural gas.
MediumGradual Deficit Reduction Ahead: The general government deficit widened to
8.9% of GDP in 2021 from 8.7% in 2020, a better outturn relative to our:

expectation at the previous review (10% of GDP) but worse than the current 'A'

expectation at the previous review (10% of GDP) but worse than the current 'A'
median (7% of GDP). We expect the deficit to decline to 6.5% of GDP as therecovery in revenue growth strengthens and the majority of pandemic-related
fiscal support unwinds. For 2023 we expect a deficit of 4.8% of GDP, above theprojected 'A' median (3.3% of GDP) and the Western European median (2.1% ofGDP). The government does not intend to reinstate its own fiscal rules before
2026. In our view, this suggests that fiscal consolidation will be gradual and thatthe government will likely extend further fiscal support to the economy should therecovery be weaker than expected. This poses risks to the fiscal adjustment.
High Financing Flexibility: We expect general government debt to remain broadly
stable at around 75% of GDP in 2022-23 and to decline slowly thereafter. The
sovereign has high financing flexibility due to the extremely large pool of private
pension funds' assets (194% of GDP), 65% of which was invested domestically at
end-2020. The government also has strong access to the international bondmarket, a large cash deposit buffer and is supported by robust liquidity in thebanking system. Moreover, government assets are large at 84% of GDP. In June
2021, the Treasury sold 35% of its stake in Islandsbanki, raising ISK55 billion(1.7% of 2021 projected GDP), which was earmarked for public debt reduction.
Further sales of government equity stakes could accelerate debt reduction overthe coming years.
Iceland's 'A' rating also reflects the following key rating drivers:
Tourism Rebound to Strengthen: Foreign tourist arrivals swiftly recovered in
2021but have room to recover further in 2022. Between August and November
2021, foreign tourist arrivals were above 60% of 2019 levels and tourism receipts
peaked at above 80% of 2019 levels. The positive trend was interrupted by the
emergence of the Omicron variant. For 2021 as a whole, foreign arrivals were
35% of the 2019 level, up from 24% in 2020. With Covid-19 containment
measures and travel restrictions lifted in February 2022, we expect the recovery
in foreign tourist flows to continue. This will underpin services exports andprivate consumption growth.

:Higher Inflation for Longer: Headline consumer price inflation rose by 6.2% inHigher Inflation for Longer: Headline consumer price inflation rose by 6.2% in
February, its highest level in nearly a decade. Inflation is being driven by domestic
factors, such as rising housing costs (which are accounted for directly in thenational measure of inflation) a more rapid rebound in economic activity and wage
growth. Increasing global commodity prices are also contributing, but are not themain driver, due to the predominance of renewables in the country's energy mix.
The Central Bank of Iceland (CBI) has withdrawn its pandemic-related
accommodative policies and since May 2021 has raised the key policy rate to2.75% from 0.75%. In addition, it has also adopted a raft of macro-prudential
measures to cool the property market.
In our view, the combination of higher interest rates, macro-prudential measuresand gradual withdrawal of fiscal support should mitigate house price pressures.
Moreover, from 2023 oil and commodity prices should also start to decline. We
therefore expect inflation to average 5.3% in 2022 and decline more markedly to
3.5% in 2023.
Strong Governance and Demographics: Iceland's 'A' rating is driven by its very
high income per capita and very strong governance and human development
indicators that are more consistent with those of 'AAA' and 'AA' rated countries. A
favourable demographic composition (the share of people of working age was
65% in 2020) supports growth potential. The rating is constrained by the small
size of the economy and limited export diversification that result in vulnerability
to external shocks and capital account risks.
ESG - Governance: 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. These scores reflect the high weight that theWorld Bank Governance Indicators (WBGI) have in our proprietary Sovereign
Rating Model. Iceland has a high WBGI ranking at the 94th percentile, reflecting
its long track record of stable and peaceful political transitions, well establishedrights for participation in the political process, strong institutional capacity,
effective rule of law and a low level of corruption.

:

RATING SENSITIVITIESRATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating
action/downgrade:-Public Finances: Evidence that the government's economic and fiscal strategy
will lead to a resumption of an upward trajectory of the government debt/GDP
ratio over time.
-Macro: Renewed economic weakness or an adverse shock, for example due to aslower-than-expected recovery in tourism, a sustained correction in the realestate market and material negative impact on the banking sector.
Factors that could, individually or collectively, lead to positive rating
action/upgrade:- Public Finances: Greater confidence that the government debt to GDP ratio will
be placed on a firm downward path, for example through implementation of a
fiscal consolidation strategy or sustained GDP growth over time.
-Macro: Sustained economic recovery beyond 2022, for example supported by adiversification of the export base and without generating macroeconomic
imbalances.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Iceland a score equivalent to a rating of 'A-' on theLong-Term Foreign-Currency (LT FC) IDR scale.
In accordance with its rating criteria, Fitch's sovereign rating committee decided
not to adopt the score indicated by the SRM as the starting point for its analysis
because the SRM output is close to the threshold between 'A-' and 'A', and on thebasis of our forecasts we expect it to improve to 'A'.
Assuming an SRM output of 'A', in accordance with its rating criteria, Fitch's
sovereign rating committee did not adjust the output from the SRM to arrive at
the LTFC IDR.

:

Fitch's SRM is the agency's proprietary multiple regression rating model that

Fitch's SRM is the agency's proprietary multiple regression rating model that
employs 18 variables based on three-year centred averages, including one year of
forecasts, to produce a score equivalent to a LTFC IDR. Fitch's QO is a forwardlooking qualitative framework designed to allow for adjustment to the SRM
output to assign the final rating, reflecting factors within our criteria that are notfully quantifiable and/or not fully reflected in the SRM.
Fitch's SRM is the agency's proprietary multiple regression rating model that
employs 18 variables based on three-year centred averages, including one year of
forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forwardlooking qualitative framework designed to allow for adjustment to the SRM
output to assign the final rating, reflecting factors within our criteria that are notfully quantifiable and/or not fully reflected in the SRM.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure
issuers have a best-case rating upgrade scenario (defined as the 99th percentile ofrating transitions, measured in a positive direction) of three notches over a threeyear rating horizon; and a worst-case rating downgrade scenario (defined as the99th percentile of rating transitions, measured in a negative direction) of threenotches over three years. The complete span of best- and worst-case scenariocredit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worstcase scenario credit ratings are based on historical performance. For more
information about the methodology used to determine sector-specific best- andworst-case scenario credit ratings, visit
https://www.fitchratings.com/site/re/10111579.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY
DRIVER OF RATINGThe principal sources of information used in the analysis are described in the
Applicable Criteria.

:

ESG CONSIDERATIONS

Iceland has an ESG Relevance Score of '5[+]' for Political Stability and Rights asWorld Bank Governance Indicators have the highest weight in Fitch's SRM andare therefore highly relevant to the rating and a key rating driver with a highweight. As Iceland has a percentile rank above 50 for the respective GovernanceIndicator, this has a positive impact on the credit profile.
Iceland has an ESG Relevance Score of '5[+]' for Rule of Law, Institutional &Regulatory Quality and Control of Corruption as World Bank GovernanceIndicators have the highest weight in Fitch's SRM and are therefore highly
relevant to the rating and are a key rating driver with a high weight. As Iceland has
a percentile rank above 50 for the respective Governance Indicators, this has apositive impact on the credit profile.
Iceland has an ESG Relevance Score of '4[+]'for Human Rights and Political
Freedoms as the Voice and Accountability pillar of the World Bank GovernanceIndicators is relevant to the rating and a rating driver. As Iceland has a percentile
rank above 50 for the respective Governance Indicator, this has a positive impact
on the credit profile.
Iceland has an ESG Relevance Score of '4[+]' for Creditor Rights as willingness toservice and repay debt is relevant to the rating and is a rating driver for Iceland, as
for all sovereigns.
Except for the matters discussed above, the highest level of ESG credit relevance,
if present, is a score of '3'. This means ESG issues are credit-neutral or have only aminimal credit impact on the entity, either due to their nature or to the way inwhich they are being managed by the entity. For more information on Fitch's ESG
Relevance Scores, visit www.fitchratings.com/esg.

RATING ACTIONS:ENTITY / DEBT !

RATING !

PRIOR !

IcelandLT IDRA Rating Outlook Stable

LC LT IDR

F1+

Affirmed

A Rating Outlook Stable

F1+

Country Ceilingsenior unsecuredLTA

AffirmedA+

Affirmed

Affirmed

VIEW ADDITIONAL RATING DETAILSFITCH RATINGS ANALYSTS
Michele Napolitano
Senior Director
Primary Rating Analyst+44 20 3530 1882
michele.napolitano@fitchratings.com
Fitch Ratings Ltd
30 North Colonnade, Canary Wharf London E14 5GN
Malgorzata Glowacka:

Associate Director

F1+

A Rating
Outlook
Negative

Affirmed

LC ST IDR

Outlook
Negative

Affirmed

ST IDRA Rating

F1+

A+

A

Associate Director
Secondary Rating Analyst+49 69 768076 279
malgorzata.glowacka@fitchratings.com
Charles Seville
Senior Director
Committee Chairperson+1 212 908 0277
charles.seville@fitchratings.com
MEDIA CONTACTSPeter Fitzpatrick
London+44 20 3530 1103
peter.fitzpatrick@thefitchgroup.com
Additional information is available on www.fitchratings.com
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one ormore of the transaction parties participated in the rating process except that thefollowing issuer(s), if any, did not participate in the rating process, or provide
additional information, beyond the issuer’s available public disclosure.
APPLICABLE CRITERIACountry Ceilings Criteria (pub. 01 Jul 2020)
Sovereign Rating Criteria (pub. 26 Apr 2021) (including rating assumption
sensitivity)
Supranationals Rating Criteria (pub. 20 May 2021) (including rating assumption:

sensitivity)

APPLICABLE MODELS
Numbers in parentheses accompanying applicable model(s) contain hyperlinks tocriteria providing description of model(s).
Country Ceiling Model, v1.7.2 (1)Debt Dynamics Model, v1.3.1 (1)Macro-Prudential Indicator Model, v1.5.0 (1)Sovereign Rating Model, v3.12.2 (1)ADDITIONAL DISCLOSURES
Dodd-Frank Rating Information Disclosure Form
Solicitation Status
Endorsement Policy
ENDORSEMENT STATUS
IcelandUK Issued, EU Endorsed

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