Is a new fiscal plan on track?

A fiscal plan was approved by Alþingi yesterday. It covers the next five years and shows how the government projects that the Treasury's revenues, expenditures, balance and debt will develop over the period. According to it, the Treasury is to deliver a surplus of ISK 1.1 billion next year. The Treasury's total expenditure, however, amounts to ISK 1,683.5 billion, so the surplus amounts to only 0.065% of the Treasury's expenditure. There is therefore almost no room for error if the target of a balanced budget is to be met.

Assumptions have worsened

The assumptions of the fiscal plan are based on the Central Bank's economic forecast from February of this year. In the Central Bank's updated forecast, published earlier this month, the outlook has however worsened. It assumes higher unemployment, higher inflation and lower economic growth. These changed assumptions are not taken into account in the fiscal plan.

According to the plan's assumptions, each percentage point of unemployment costs the Treasury ISK 9-10 billion. The changed forecast for unemployment, from 4.3% to 5%, therefore in itself indicates an increase in expenditure of ISK 6-7 billion. On top of this, a bill on shortening the benefit period of unemployment insurance was amended during Alþingi's deliberations. The benefit period will be shortened from 30 months to 24 months instead of 18 months as the fiscal plan's assumptions had anticipated. That change entails additional expenditure of ISK 1.2 billion in 2027 and ISK 3.7 billion annually thereafter.

The Central Bank also assumes higher inflation than before, namely 3.6% instead of 2.7%. Higher inflation raises interest costs and price indexation on the Treasury's debt. Although it may increase the Treasury's revenues (for example through higher revenue from value added tax), it increases uncertainty in the state's finances.

The Central Bank's updated forecast finally assumes lower economic growth than before, namely 1.8% instead of 2.2%. Lower economic growth means that economic activity will be less and the Treasury's revenues lower than they would otherwise be. From the foregoing it is clear that the newly approved plan for a balanced budget in 2027 will not be met without changes.

Borrowing continues

The Treasury's balance only tells half the story, however. It measures the difference between revenues and expenditures, but does not take into account investments, lending, repayments and other financial movements. For that one must look at the net financing balance, which shows whether the state needs to take out new loans or can pay down debt.

The net financing balance is expected to be negative throughout the period of the fiscal plan. Borrowing in excess of repayments will average around ISK 88 billion per year over the period. In other words, the state will continue to need to finance itself with new loans, with the corresponding effects on interest costs over the longer term.

The accumulation of debt in recent years has meant that interest expenses have become the second-largest expenditure item of the public sector. According to the fiscal plan, the Treasury's interest expenses will total around ISK 790 billion over the period, which is equivalent to just over ISK 430 million per day over the next five years.

When such a large share of tax revenues goes to interest expenses, it reduces the scope to finance basic services, infrastructure development and other pressing tasks of the state. That is why it matters not only to deliver an operating surplus, but also to halt the continued accumulation of debt.

Efficiency savings are coming too slowly

To ensure a surplus and halt continued borrowing, efficiency measures must be undertaken. At the start of the parliamentary term the government received around 4,000 submissions with over 10,000 efficiency proposals. The Prime Minister's working group subsequently developed 57 scheduled measures that could save the state ISK 71 billion over the period 2026-2030.

Implementation has, however, proceeded slowly. In the just over a year that has passed since the plans were presented, only 5 of the 57 measures have been implemented. Now most signs point to the government, at the close of the parliamentary session, abandoning large measures proposed by the working group, despite the fact that the assumptions of the fiscal plan have worsened and the need for efficiency savings has increased.

A balanced budget or wishful thinking?

Since the Act on Public Finances was passed about a decade ago, the fiscal plan has been intended to be a guide for the public finances and to create predictability about the development of revenues, expenditures, balance and debt. Such a plan only fulfils its role, however, if the assumptions are credible and the measures on which it is based are implemented.

Neither applies now. The economic outlook has worsened since the plan was put forward, the projected surplus is vanishingly small and the net financing balance will remain negative throughout the period. At the same time, efficiency measures are proceeding slowly and most signs point to the government intending to abandon large measures proposed by its working group.

It is positive that the government sets itself a target of balance in the public finances. But targets count for little if the assumptions do not hold and the measures do not follow. If the government wishes to achieve real results in the public finances, it must build on the right assumptions and follow through on its own efficiency measures. Otherwise the target of a balanced budget is little more than wishful thinking.

Birta Karen Tryggvadóttir

economist in the Iceland Chamber of Commerce's policy division

This article was automatically translated from the Icelandic original.