Russia not yet ready to lend to Iceland

REYKJAVIK/MOSCOW Fri Oct 17, 2008 3:57pm EDT

A share trader sits behind his terminal at the Icelandic stock exchange in Reikjavik, October 14, 2008. REUTERS/Thorvaldur Orn Kristmundsson

A share trader sits behind his terminal at the Icelandic stock exchange in Reikjavik, October 14, 2008.

Credit: Reuters/Thorvaldur Orn Kristmundsson

REYKJAVIK/MOSCOW (Reuters) - Russia is not yet convinced it should make a loan to Iceland to help dig it out of a financial crisis, a Russian source said on Friday.

But as the island ran down more of its meager foreign reserves, Iceland said it hoped its biggest bank, Kaupthing, would next week be able to re-open its Luxembourg branch to pay back Belgian and Luxembourg depositors.

Two weeks after a banking collapse destroyed the value of its economy and currency, Iceland has still to decide whether to go to the International Monetary Fund (IMF) for help.

Prime Minister Geir Haarde said a decision was still expected within a week. In the meantime, talks with Russia this week on a loan have not yet led to a deal.

"At the current moment, we do not yet have enough reasons to give them credit," a senior Russian government source told Reuters. "We did not refuse. We are continuing the talks."

The island of 300,000 people is the most serious state victim of the global credit crunch. But banking problems in Ukraine and Hungary have also sent those countries scrambling to the IMF and European Central Bank amid fears they might be next.

Billions of dollars in foreign savings are locked up inside Iceland's banks, attracted by some of the highest interest rates in Europe. One such group is people from Belgium and Luxembourg.

Belgian Prime Minister Yves Leterme met Haarde, to discuss these depositors and Haarde said Iceland hoped the receiver running Kaupthing could re-open the Luxembourg branch.

"If that is the case then it looks like the problems with respect to the depositors will be solved within a relatively short period of time," Haarde told a news conference.

Leterme said he hoped a solution could be found by next Tuesday to bring the bank back into operations.

Leterme said no loan to Iceland had been discussed.

OFFERING BARS, VOLCANOES, AIRBASE?

But with banking debts several times its gross domestic product, Iceland needs money badly.

Analysts have also wondered what price Russia -- suffering its own economic problems and increasingly at odds with the West in the aftermath of the Georgia war -- might exact.

Iceland has repeatedly said it will not offer Russia use of a former U.S. airbase but one analyst said Russia might be keener on a deal if Iceland was successful in being elected to a temporary post on the U.N. Security Council.

But Iceland lost out to Turkey and Austria for the two European seats on offer on Friday, apparently in part because of its financial crisis, gaining only 87 votes from the 192 member assembly.

Facing a brutally hard landing from years of prosperity, Iceland this week slashed interest rates and raised controls to stimulate the economy and prevent capital flight.

The central bank has also been selling foreign currency to local banks -- whose domestic assets have been nationalized -- at almost half the rate at which the crown has been trading internationally. Firms are only allowed foreign exchange for essential purchases such as food and fuel.

"Effectively, you have a dual exchange rate which isn't that unusual in this sort of case," said one analyst, asking not to be named to avoid damaging commercial relationships.

"What the government is doing is giving away foreign exchange locally at much cheaper than the market rate."

Meanwhile Iceland hopes its currency collapse will attract more tourists drawn by its nightlife, spas and volcanoes. For now bars and restaurants along Reykjavik's main street are doing a roaring trade -- perhaps in part because of the crisis.

"Actually, when people get depressed they drink more," said bar manager Friesteinn Gislasson. "The crisis has not hit us so much so far."

(Writing by Peter Apps; Editing by Matthew Jones)

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