Iceland maintains ’A+/A-1’ credit ratings with stable outlook at S&P Global

Investing.com -- S&P Global Ratings has confirmed Iceland’s ’A+/A-1’ long- and short-term foreign and local currency sovereign credit ratings, maintaining a stable outlook. This affirmation was made on March 7, 2025, following the country’s snap elections in November 2024, which led to the center-left Social Democratic Alliance forming a governing coalition with two other parties.

The new government is expected to maintain broad policy continuity, with fiscal consolidation likely to continue. Despite a slight 0.5% expansion of the real GDP in 2024, growth is projected to average 2.3% per year from 2025 to 2028. However, Iceland will have to navigate potential tariffs and other challenges arising from a volatile global geopolitical landscape.

The country’s net general government debt, net of liquid assets, is forecasted to decrease steadily to 39% of GDP by 2028, aligning with the government’s commitment to fiscal consolidation.

The stable outlook reflects the expectation of a rebound in Iceland’s growth over the next few years, while fiscal and external deficits remain contained. The outlook also assumes that neither volcanic activity nor global trade tensions will significantly impact the country’s economic, fiscal, and balance-of-payments performance. Most of Iceland’s key aluminium exports are sold to European markets, particularly the Netherlands and Germany, mitigating direct tariff-related risks.

The ratings could be raised if Iceland’s public finances strengthen significantly more than anticipated, or if increasing diversification makes the economy more resilient to external shocks while global trade tensions ease without a sustained negative economic impact. Conversely, the ratings could be lowered if Iceland’s fiscal or balance-of-payments performance is materially weaker than baseline forecasts. This could occur if disruptive volcanic activity hampers the tourism sector and growth performance, or if Iceland is significantly affected by global trade tensions or is forced to sharply increase defense-related expenditure.

After strong growth in 2022 and 2023, real GDP rose marginally in 2024 due to a slowdown in fishing and marine product exports, tourism, and the effect of high interest rates on consumer demand. However, real GDP growth is forecasted to rebound from 2025 to 2028, averaging 2.3% a year. Inflation continued to fall, to 4.6% in January and 4.2% in February 2025, after averaging 5.9% in 2024 and 8.7% in 2023, which should start supporting consumer demand.

Iceland’s ratings reflect the country’s very high GDP per capita, strong growth track record, robust institutional framework, and sound economic and fiscal policies. However, the ratings are constrained by the volatile nature of Iceland’s small, open economy, which is vulnerable to natural events, including volcanic activity, as well as adverse external developments outside of its control, such as geopolitical risks, trade and tariff tensions, and fluctuating terms-of-trade.

Iceland’s medium-term growth prospects remain strong, assuming no lasting disruption from volcanic activity or global trade and geopolitical challenges. The country’s new government is expected to pursue broad continuity of the country’s longstanding prudent economic, fiscal, and social policies, as well as environmental protection. Real GDP growth is forecasted to rebound in 2025, averaging 2.3% in 2025-2028, supported by domestic demand due to a growing population, a comprehensive union-led wage agreement, and the expansion of knowledge-based and new economic sectors such as biotechnology and sea- and land-based fish farming.

Despite these strengths, Iceland remains a small and open economy, vulnerable to shocks and global stresses outside of its control. Iceland’s export base remains concentrated in marine products, processed aluminium, and tourism. These sectors represent nearly 70% of total goods and services exports.

Institutional arrangements in Iceland are considered a rating strength, with functioning checks and balances between government bodies. The country’s swift and effective response to recent shocks, such as the pandemic and volcanic eruption, underpins the view of generally effective and stable policymaking.

Iceland’s inflation fell to 5.9% in 2024 from 8.7% in 2023, and the central bank continued its rate cutting in February 2025, reducing the key rate by another 0.5% to 8.0%. The general government deficit is expected to average 1% of GDP in 2025-2028, supporting a reduction in net general government debt to 39% of GDP by 2028. The country’s current account is forecasted to remain in a small deficit averaging 1.6% in 2025-2028, with Iceland expected to remain in a net external creditor position through 2028.

Icelandic banks’ profitability is anticipated to remain sound but edge down with moderating margins and cost inflation, including normalizing cost of risk. Nevertheless, growing lending volumes and strong fee and commission income, alongside market-leading operating efficiency, are expected to partly ease pressure on revenue. At the same time, incumbent banks’ capitalization should remain robust, with ample margins above regulatory capital requirements despite ongoing capital optimization efforts and inorganic growth.

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