Medium-term Fiscal Strategy Plan 2024-2028: to counter inflation, safeguard living standards and support growth
The government's fiscal strategy plan for the next five years lays out its strategy to utilise fiscal policy in a targeted manner to counter inflation and overheating by increasing expenditure restraint and revenue generation and postponing public investments. At the same time, important basic services that the government has significantly reinforced in recent years are maintained, based on the strong position of the Treasury. Financial support will be provided for those groups least able to withstand the impact of rising inflation, as was done with the government's support actions during the pandemic and the previous year.
The Treasury’s fiscal position has improved significantly in recent quarters, and the fiscal outlook for this year appears likely to be better than implied by the most optimistic scenarios of previous projections. Eighteen months ago, the objective was set in the government’s Fiscal policy statement to halt the increase in debt to GDP ratio no later than by year-end 2026, however this goal now appears to be within reach as early as the end of this year.
This is explained in the new Medium-term Fiscal Strategy Plan for 2024-2028. The Treasury's primary balance is expected to be ISK 74 billion better this year than anticipated in the budget, and to show a surplus of ISK 24 billion if current estimates prove correct. A positive primary balance means that government revenues for the year are higher than expenditures excluding interest income and expenses. It would be the first positive primary balance since 2019 with this milestone being achieved a year earlier than anticipated in the last fiscal strategy. The surplus in the primary balance is important to ensuring the arresting of the rise in the debt to GDP ratio and is a major step towards returning a positive overall balance by the end of the plan period.
If the current estimates prove correct, the improvement will mean that the Treasury will dampen demand and thus reduce inflationary pressure in 2023.
Considerably lower public debt ratio
The rapid improvement in the Treasury’s primary balance and the country’s strong economic recovery have resulted in a substantially lower debt ratio for the Treasury and the public sector than previously expected. The 2021-2025 Medium-term Fiscal Strategy estimated that public sector debt would be around 55% of GDP at year-end 2022. In fact, this figure was 40% of GDP, which is quite low by international comparison.
Balance regained
The consequences of Russia's invasion of Ukraine and the rapid growth of the economy play a major role in the rise in the inflation rate in Iceland. Although still below the European average, inflation is a definite concern, and it needs to be reduced. Iceland entered the current period of inflation from a strong position in terms of purchasing power and the development of living standards. It is important for the public to preserve the major purchasing power advances of recent years so they will not diminish through long-term inflation.
The government's role in such circumstances is to reduce its impact on demand in the economy and continue to improve its fiscal performance. Doing so counteracts both inflation and the current account deficit. At the same time, the financial plan provides targeted support for those groups least able to withstand a higher cost of living.
However, the Treasury's heavy debt service and role as lender to public entities mean that some borrowing will be needed every year and the debt level will rise in nominal terms even though the primary balance has become positive. In 2024, the Treasury is expected to pay interest of some ISK 48 billion. Added to that is ISK 49 billion of imputed interest on unfunded pension obligations and inflation indexation.
The most effective way to reduce this interest burden is to concentrate on reducing inflation and lowering the debt level as much as possible. Towards the end of the plan period, the primary balance is estimated to be positive by 1.3% of GDP and Treasury debt is projected to have been reduced to 30% of GDP.
A joint project
It is very important that the positive development of the Treasury balance and debt ratios continue. In the short term, the fiscal strategy is co-ordinated with actions of the Central Bank of Iceland to bring inflation back to target as soon as possible. The government emphasises exercising expenditure restraint through prioritising expenditure items within the current expenditure framework and reducing new expenditure. Thus, the line ministries efficiency target for next year will be doubled from 1% of appropriations to 2%, with the exception of schools, where the reduction will be 0.5%. Police departments will be temporarily exempt from these requirements in 2024–2025, and prisons, healthcare, and geriatric institutions, as well as social insurance and health insurance, will be exempt for the entire plan period as before. In addition to this, a special additional efficiency target will be imposed on the ministries main offices increasing the total level of their efficiency target from 2% to 3% next year.
Further work on consolidating state institutions
Emphasis will be placed on reducing state expenditures over the medium-term by utilising opportunities in digitisation, coordinated purchasing and re-evaluating real estate needs. The focus will be on merging smaller operating units and increasing joint operations and shared utilisation of facilities. Reducing the number of square metres of state office space is estimated to save around ISK 2 billion per year by the end of the period.
A special cost-cutting rule will be applied to state contracts over five years of age, aimed at having these contracts tendered out as provided for in the Public Procurement Act, and in so doing achieve an additional savings of up to ISK 4 billion.
Increased digitisation improves efficiency in public institutions, giving them scope to economise in tandem with staff turnover. In this context, it can be pointed out that if half of the persons retiring in the next five years, excluding front-line staff, were not replaced the savings could amount to a cumulative saving of ISK 7 billion over the next five years. This will be explored further over the coming months.
Continued advances in digital services are a prerequisite for achieving these goals, as those organizations that have progressed the furthest in digitization can now expect an increase in productivity of up to 50%.
Successful results mean state support for electric vehicle imports can be reduced
Major success has been achieved in the electrification of the motor vehicle fleet and the supply of affordable cars has increased. In recent years, tax incentives have been granted for the purchase of eco-friendly cars. In the past year, this support has been reduced: firstly when the VAT concession for plug-in hybrid cars expired in May 2022 and, secondly, with a reduction in the amount of the VAT concession for fully clean energy cars at year-end 2022 from ISK 1,560,000 to ISK 1,320,000 per vehicle.
The total amount of VAT incentives on electric cars is expected to amount to ISK 10.2 billion in 2023. This amount will decrease considerably next year, but in order to continue supporting energy conversion projects, a total of ISK 7.5 billion will be provided to the Energy Fund (Orkusjóður) in 2024. This amount is expected to decrease again from 2026 onward to ISK 5 billion annually. It is emphasized that, although incentives for the purchase of electric vehicles will decrease, there will still be a financial incentive for households and companies to replace vehicles powered by fossil fuels due to lower operating costs.
In addition, the rate of VAT reimbursement for residential construction will be reduced from 60% to 35% from mid-2023, to dampen inflationary pressure.
A new and stronger economy
In recent years the Icelandic economy has undergone a positive transformation, which is continuing at a rapid pace, not least due to new and vital pillars of the country's economy.
Unprecedented investment has been directed to research and development and 2,000 new jobs have been created in hi-tech and industrial sectors in two years. Export earnings in intellectual property increased by 17% in nominal terms between 2020 and 2022, and the sector has significant growth potential. Major investments are in the pipeline in aquaculture and Icelandic fisheries is steadily advancing. Tourism has regained its previous level following the pandemic. Few societies are better placed to take advantage of the global climate and energy revolution.
30 thousand jobs since the pandemic
The vitality in Icelandic society has resulted in better living standards than in most other countries. Unemployment is at a minimum, and strong growth has resulted in the creation of nearly 30,000 jobs from the lowest point during the COVID pandemic.
Purchasing power generally has increased significantly, and the purchasing power of wages among the lowest-paid private-sector groups generally rose in 2022, despite higher inflation. Taxes have been reduced, salaries have increased significantly and social security benefits have been increased. The purchasing power of households' disposable income was ISK 200 billion higher in 2022 than in 2019 and never have more people bought their first home than in 2020 and 2021. Household defaults on loans have not been less than in 2022 since statistics on this have been gathered.
Prioritising growth
Accompanying the restraint in state operations will be prioritisation of further infrastructure improvement and value creation. As before, the focus is on taking advantage of growth in the economy and the sale of government assets to invest in a stronger society.
The biggest single project of the period is the construction of the new National University Hospital (NUH). The overall budget for the project, a total of ISK 211 billion, extends to 2030 and includes massive building construction as well as equipment and information technology. The overall plan provides for the construction of a new treatment centre and research laboratory to be completed in 2027.
Further development of NUH will be provided for in future fiscal plans for the years 2028-2030. This stage includes future arrangements for psychiatric services and the renovation of older buildings, along with other projects.
Support to improve the situation of low-income earners and protect people's livelihoods will be continued. Numerous measures have been implemented to that end in recent years, including a large reduction in income tax, increases in social security benefits, increases in housing and interest benefits as well as higher limits for reductions to benefits, almost doubling the earnings excluded from assessment for disability pensioners, and a special child benefit increase. In addition, efforts have been made to simplify and improve the child benefit system. During this Medium-term Fiscal Strategy plan period, an overall review will be made of the disability pension system, which will include greater emphasis on support earlier in the illness period than is currently the case, preventive measures in the labour market, and a review of the amounts of payment categories, with the aim of improving the situation of the least well off.
A further billion to strengthen the university level
Investment will continue in opportunities for future growth. ISK 1 billion will be provided specifically to strengthen the university level in 2024, increasing in steps to ISK 2 billion before the end of the period, together with an additional allocation to vocational training at secondary school level, of up to ISK 600 million annually at the end of the period. Support for R&D will continue, and appropriations for innovative companies will increase by ISK 1.9. billion in 2024, with previously temporary funding sources made permanent. During the period a total of ISK 3 billion will be provided for additional research by the Marine Research Institute and a total of ISK 2.2 billion for expanded regulation of aquaculture, which is a steadily expanding sector. Finally, Iceland will continue its strong support for Ukraine, with ISK 750 million devoted to defence-related projects for Ukraine next year, as was the case this year.
The Medium-term Fiscal Strategy for 2024-2028 presents a clear vision: In the short term, reducing economic overheating and inflation, while safeguarding the living standards of the most vulnerable. In the longer term, to lay the foundation for further growth in Iceland on stronger economic pillars, greater opportunities, and improved living standards.