Robust financial buffers help Iceland support its economy through COVID-19

Robust financial buffers help Iceland support its economy through COVID-19

Bjarni Benediktsson, Minister of Finance and Economic Affairs, explains the prudent fiscal policies that have put Iceland in a strong position for economic rebound


Iceland has received global praise for its effective handling of the coronavirus crisis. Having overcome the sanitary challenge, the focus is now on reactivating the economy. How do you assess the impact and magnitude of the COVID-19 crisis on Iceland, and what is your outlook for the second half of 2020?

By mid-March, we started to realize that our economy was going to be hit severely—especially after quarantine measures and restrictions on social gatherings were put in place with inhibiting effects on travel. Iceland is very reliant on tourism. Our tourism sector has grown in double digits for the past few years. In the latter part of March and early April, private consumption plunged, due to the spread of the virus and the containment efforts. I must say, Icelanders had a very good attitude and followed the containment guidelines diligently. We had a very effective strategy where people were highly involved: those who had had the virus were quarantined, those that had been around them were asked to isolate. We were very effective through our efforts to minimize the spread of the virus and to track everybody. We focused on early detection, containment measures and contact tracing. People were asked who they had been around, those that were at risk or had symptoms were quarantined; and then, of course, we had to implement gathering bans from the middle of March.

At the moment we only have two individual active cases of COVID-19 that we know of in Iceland. At the top of the curve, it surpassed 1,000. Another very interesting thing we have done is that we have had very widespread testing that provided important oversight of the prevalence of the disease in the population. We have already tested around 18 percent of the population, which gave us a lot of information. From an economic standpoint, we’ve had a twofold task at hand: first to deal with the fall in private consumption, then secondly, the fact that we don’t have any tourists anymore. It has been a shock for the economy. Nearly all air flights to Iceland stopped.


Back in 2008, Iceland had faced the world’s biggest financial crisis but had managed to get back to its feet quite miraculously in just a few years. The country was in fact enjoying a strong economic revival, with a focus on technology, renewable energy and tourism, when the coronavirus pandemic hit. Even if the two crises are not comparable in essence, what are the main lessons learnt from 2008 that Iceland could leverage to overcome this new historical challenge and how has the 2008 crisis helped prepare the country for this new global recession?

 After 2008, we’ve been focusing on lowering our public debt and reducing that really did help. Since the financial crisis we’ve had really strong and long growth periods, even by international standards. The amount of debt deleveraging that has taken place during this growth phase is truly exceptional. Public debt has dropped by tens of percentage points of gross domestic product (GDP). At the end of last year the public debt had been brought down to 28 percent of GDP, a quite favorable position in international comparison. And at the same time, households’ debt levels and corporate debt levels have also come down significantly. When you add to that the buffers that have been built, for example in the financial sector, I think we are in a very strong position to take on the tasks that followed in the wake of this pandemic. We have had a very strong build up of our foreign exchange reserves in recent years, they now account to about 30 percent of GDP, which gives us considerable leverage.

In addition, our banking system is very well capitalized, and so the banks are in a good position to support firms and households as needed through the pandemic.

I think the lessons learned during the financial crisis are that you need to be prepared when a crisis hits you—and it doesn’t give a clear signal before it attacks. When I was working as a lawyer in the container business, we used to see “freak waves” hit a container ship and not even due to bad weather. This crisis is more or less like a freak wave rising out of pretty good weather, causing severe damage. It was not something that you could see from a long distance but it hit us very hard suddenly. However, since the financial crisis, we have created some cushions here in Iceland, with a shrunken public debt level, sustainable houshold and corporate debt, ample currency reserve and the sound capitalization of banks. All of these cushions, along with a fully funded private pension system, come in very handy at the moment.


Your government has launched a $1.6 stimulus package to help reignite the economy and compensate for the losses resulting from the drop in economic activity. This was followed by a second recovery package worth $411 million and a third package as well. Tell us a bit about the scope of these stimulus packages: what specific sectors of the economy are being targeted and what are your expectations for the near- and mid-term impact of these measures.

When we introduced our initial measures, we had very little oversight of what was going to happen. What we did know was that there was panic. We knew that there would be a shock, especially in the tourism sector. We knew that a lot of companies would need to get extensions on public payments, taxes and so on. So our initial response was to defer due dates for taxes for a month or so, while waiting to see what would happen. We also introduced a program of government backed lending through the banking system, where we provide state guarantees toward loans that are tunneled through the financial sector. Through the packages, we updated that plan to have different types of loan options: some have 70 percent state guarantee, others have 85 percent and for small businesses they can go up to 100 percent.

We had such a big drop in private consumption that revenues of firms in certain segments of the economy almost disappeared. From an academic standpoint this is an interesting situation: this freak economic wave hits the economy, is very damaging, with a large part of the private sector taking a direct hit and subsequent repercussions for the revenues of the public sector. Up to 100 percent of revenues are lost for a while in businesses ranging from hair salons to large hotel chains, parts of the economy and jobs are threatened. But you don’t really know for how long that will remain, you don’t really know if travel bans will last for one or two months, or till the end of the year, or even longer. So we decided to take it step by step.

Initially, we announced to the firms that were in total uncertainty and had lost over 70 percent or 75 percent revenues that no matter what their losses are, the state would compensate the salary gap of employees with a reduced employment ratio, in order to avoid large-scale lay offs. The government paid directly the lost employment percentage to the employees, up to a certain ceiling, thus ensuring that the employer-employee contract was protected. All the rights under the employment contract were protected and the relevant employee was not laid off. We introduced that plan for 2.5 months. Now, we have extended that program with further restrictions: by the end of June, the employer will have to pay not 25 percent but 50 percent and then by the end of August, they will have to take over the employee contract again.

We understand that some companies won’t be able to cater for the 25 percent gap for longer than the 2.5 months’ period and, inevitably, will eventually have to lay off people, since we are looking at companies that have lost more than 75 percent of the revenue. As they have been out of revenue for such a long time, it is very unlikely that they will be able to pay wages for the three-month layoff period to the employee. A typical company that has lost all its revenue will at least have great difficulties paying all its employees for three months, during the lay off period. In such cases we agreed to support companies, even though they have laid off their employees, in an effort to keep them alive, so that they can go into standby mode. We believe this is a temporary situation and that it would be a greater loss for the economy if those companies were to go bankrupt. Employees get not only full salary but also pension rights and their right of leave paid up, while the company will potentially stay alive through this program and go into hibernation for a while. Since most of them are in the tourism sector, they can be ready when activity starts again. We believe that we are saving a lot of value for the economy by doing this.

In May, when private consumption picked up again, a lot of companies took on their employees again. Private consumption in May 2020 was higher than May last year. It dropped very severely in March and April, but bounced back up in May.

Further to that, we have also decided to increase direct government investment in 2020 in various sectors, such as road building, infrastructure building of any kind. We prioritized projects that were ready on the shelf that would increase productivity and were high in terms of manpower needs. We also put aside funds for research and development (R&D) and startups, and gave injections into the competitive funding that we have for R&D in Iceland. So those that had applied previously for 2020 and had not been accepted could potentially get funding for their programs. This is both for basic research but also for more practical or technical research, things that need funding in the R&D fields and are almost on the verge of ripening in terms of being a business idea.

So to summarize Iceland’s economic response to the crisis: we have extended support to the labor market, provided loan guarantees to viable companies, offered compensation to businesses that were required to close their doors, increased public investment and R&D funding. Last but not least, we have also decided to speed up the digitalization of government services. This is an ongoing program but given the growing need for further productivity in all sectors, private and public, we have committed to accelerate the pace and increased funding in 2020. This is an integral part of what we’re doing and something I really strongly believe in for the future. We have to come up with our three-to-five year fiscal plan on how to make ends meet in the near future, in order that we don’t just live by borrowing money. We need to balance the budget at some time in the coming years and I think that increased productivity in the government sector is very important for that case.


At the end of May, Iceland issued bonds to the amount of 500 million, which has been quite a success as the bonds were oversubscribed seven times, with demand totaling 3.4 billion. How do you explain this strong market confidence that investors still place in Iceland and how will this enhance the country’s capacity to overcome the economic implications of the current crisis?

Rating agencies have upgraded their rating of Iceland in recent years. We have pretty good ratings historically at the moment, so the buffers that have been built up in recent years have been helping. We got our best market rate in the treasury’s history last year, where we entered the market at around 0.1 percent. Rates were a little bit higher, but well below 1 percent. In comparison, back in 2008-2009, even though we had low government debt, the International Monetary Fund and the Nordic countries were lending money at around 2.5 percent on top of EURIBOR, and the market was only offering us 5.5 percent in U.S. dollars in 2011. So we are very happy that our efforts have borne fruit as the market has shown trust in the economy. I believe it is based on the increased discipline that we’ve built into our structure through the fiscal framework and fiscal rules provided by the recent organic budget law, our commitment to lowering public debt and to adhering to a prudent medium-term budget plan.

We have a good history of rebounding fairly strongly, and not just since the last crisis. I think we have a few advantages that will surely help this time around as well, such as the Icelandic currency, the Krona, which has depreciated appropriately and will increase our competitiveness, strengthening our exporting sector. This happened without any inflation pressure domestically. So the Icelandic Krona has assisted us as a shock absorber, supporting exports in the medium term as well as tourism in the longer term. Tourism was struggling a little bit before the crisis in fact. Iceland is listed sometimes as the most expensive company in Europe or in the same league as Norway and Switzerland. It had become expensive, salaries in the sector had increased, and so I think it’s good that salaries in euro terms or dollar terms have come down a little bit.


Iceland has always stood as an exception in Europefrom the way it has handled the crisis to its social model. In which other areas is Iceland setting the example in your opinion and where can the country be a role model for others?

I believe Iceland can set an example in several areas. Gender equality, for instance, is exceptional. Female work participation has for a long time been higher than anywhere else in the world. We have been updating our paternity leave rules, so that we now have a plan for a 12-month paternity leave, which is an integral part of the gender equality issue. Female participation in the workforce goes hand in hand with those rules.

With regard to environment protection, Iceland also has much to offer. We have set ourselves some sustainability goals not only in the environmental sector but also in terms of public finances and in the way we run society. We have recently introduced wellbeing measures that we adhere to when we put together our governmental budget for the medium term. These are a few areas that I think make Iceland stand out a little bit and where we can be a good example.


Talking about sustainability, one area where Iceland is trying to play a role is sustainable finance. At the European Free Trade Association-Economic and Financial Affairs Council (EFTA-ECOFIN) annual meeting in November 2019, the theme was sustainable finance. What role and place can sustainable finance play in the new economic paradigm of the post-COVID19 world? What are the types of discussions you are keen to have now with your counterparts at EFTA and ECOFIN?

I believe we have made a lot of progress in sustainable finance in recent years through the organic budget law. We need to make sure that we hold account of all liabilities and that all expenditures are accounted for in our finances. This is the only way that we can make sure that we are not claiming living standards now that our descendants will pay for in the future. That’s the kind of thinking we all need to start picking up. If we want to be responsible toward future generations, sustainability of what we are doing and rights we are claiming at the moment are crucial. And that goes for all things: not only for the funding of our welfare system and healthcare system, but also our transportation system, educational system and last but not least our pension system. In all those areas of public finances we need to make sure that all expenditures and all liabilities that follow from what we are doing at the moment are accounted for and funded. If they are not funded, we need to come up with a plan to make sure that they will be funded in the near future. That’s the only way that we can look unashamedly in the eyes of our children in the kindergarten.


As we are slowly and hopefully exiting the peak of the healthcare crisis, the time has come to reflect on the lessons learned and look at how to restart our economies and societies. What have been the key lessons learned in Iceland and, going forward, what are your priorities to propel economic growth in the country?

Over the last years, while I have been the Minister of Finance and Economic Affairs, we have had a pretty good surplus in many of our budget years. At the same time, there was a need for more expenditure here and there in society. I’ve often been asked why I was putting such a big emphasis on having a surplus when there was a perceived need for that money in many areas of our society. The truth is, in my opinion, that it is always necessary to build buffers for the bad days. People don’t really see them on the horizon, they feel that things are okay and it should be fine to spend more, but the fact of the matter is that you don’t really know when the bad years will come. So a crucial lesson to be learned now concerns the importance of building buffers for the future. That’s what we need to do now in the aftermath of this crisis. We need to make sure that we regain the jobs that have been lost, but also that we create new ones and find ways to create more value-creating jobs in our economy. We also need to keep being inventive, and make sure that we are doing enough R&D so that jobs of the future will be created in our economy. We need to maintain our competitiveness and continue to create value. At the same time, we have to make sure that we don’t overspend so that we can gradually restore the balance in our budgets, and in that way rebuild our financial buffers through the growth we generate. That’s the cycle I think we will always have to go through.

The only reason why we have not been forced to apply austerity measures in public finances at the moment, as was unavoidable after the banking crisis in 2008, is because our robust financial buffers provide us with the leverage to protect the quality of the public services we have built up in Iceland—for the time being at least. Our job at the moment is to protect the quality of the public services that we have built up. We can do that by borrowing money for some time but we will need to use that time very efficiently to create new value and new jobs. We need to put in place the right incentives to make sure that money flows to those that are in need, for them to grow again. We need to preserve our R&D and propel the right, targeted investments that are needed for our economy at this moment. If we fail to get the GDP growth and the jobs that our economy needs to support our level of public services, we will have no option but to apply austerity measures. There are therefore big stakes in front of us. These calls for the right decisions; if we make mistakes, that will be costly for the public sector.


What is your final message to our readers?

We need to make sure that we retain trust. We have to believe in the future: we should not withdraw and crawl into our little shells; on the contrary, we should open borders again. We need renewed international trade, we need trust to be reestablished, and for that to happen everybody needs to participate. As soon as the health measures show effect we will need to start thinking about the future. It’s a huge challenge. On the one hand we are dealing with a very dire economic situation, but on the other hand we have to take care of our future. For that we need international cooperation and we need trust to be rebuilt. We need international trade.

Maybe I have a very simple mindset for the future, but I’m very optimistic that we will overcome the current difficulties. That’s what we have done in the past: we’ve overcome more difficulties than what we are faced with right now, and we just need the right mentality to go through these times.