Iceland leader rejects UK, Dutch compensation bill

Tue Jan 5, 2010 1:54pm EST

* Decision casts doubt on further aid, EU bid

* UK says 'no' in referendum would make Iceland outcast

* Fitch downgrades Iceland to junk

(Adds Fitch downgrade)

By Omar Valdimarsson

REYKJAVIK, Jan 5 (Reuters) - Iceland's president rejected a bill to repay Britain and the Netherlands more than $5 billion their savers lost when Icelandic banks collapsed, forcing a referendum on the issue and threatening vital economic aid. President Olafur Grimsson's refusal to sign the unpopular Icesave bill into law on Tuesday plunged the country into a political crisis and put its hopes of joining the European Union in jeopardy.

In Brussels, an Icelandic official negotiating Iceland's EU membership bid said the government expected to hold a referendum in 4 to 8 weeks. The outcome is highly uncertain -- a recent poll showed almost 70 percent of voters oppose the bill.

Prime Minister Johanna Sigurdardottir, who has pushed hard for a deal to repay the two countries the money they used to compensate savers who lost funds in Icelandic accounts, said her government was committed to honouring Iceland's debts.

Britain warned Icelanders that if they rejected the bill, the north Atlantic island with just 320,000 people faced financial isolation.

"The Icelandic people ... would effectively be saying that Iceland does not want to be part of the international financial system," Financial Services Minister Paul Myners said.

That would mean losing access to international funding and being shunned as a business counterparty, he said.

Rating agency Fitch reacted to Grimsson's decision by downgrading Iceland's long-term foreign currency issuer default rating to "junk" status with a negative outlook. [ID:nWNA1378]

The next tranche of a 1.8 billion euro ($2.60 billion) loan from Iceland's Nordic neighbours is also likely to be delayed, a Finnish official said.

The Dutch government said it was "very disappointed" and would demand an immediate explanation.

Only once before in the republic's 65 years has a president refused to sign a bill into law, triggering a referendum.

"Now the people have the power and the responsibility in their hands," Grimsson told a news conference.

Nearly a quarter of Icelandic voters, angry at the prospect of paying debts they find onerous and unfair, had petitioned Grimsson to reject the bill.

They accuse Britain and the Netherlands of using their EU veto and IMF voting power to bully a small country's taxpayers into repaying savers who imprudently poured money into high interest Icesave accounts.

Parliament narrowly passed the Icesave bill late last month -- a revised version of an earlier law which Britain and the Netherlands had rejected as unacceptable.

"This is a big surprise ... it's very market negative," said Petter Sandgren, head of money markets at SEB. "I assume it would affect the IMF package."

The cost of insuring Icelandic debt against default was little changed, with five-year credit default swaps at 428 bps after the news, compared with 427 on Monday.

Critics of the bill say it would load Icelanders with extra debts equivalent to 40 percent of gross domestic product or $18,000 per citizen including interest payments. The government disputes the figures.

Iceland's main banks -- Kaupthing, Glitnir and Landsbanki, operator of the high-yield Icesave accounts -- all imploded as the global financial crisis left them unable to service the huge debts run up in the course of a rapid expansion overseas.

The financial meltdown caused the collapse of trade in the Icelandic currency and a recession that has left the volcanic island nation dependent on IMF-led aid.

The row with Britain and the Netherlands over Icesave held up initial IMF payments and made it difficult for Iceland to relax exchange controls put in place to shelter the currency.

"You can't hold a referendum in three days and this issue is pressing. The IMF will have to put on hold payment of any future tranches of aid until we have a 'yes' vote," Danske Bank analyst Lars Christensen said.

The second review of the IMF-led aid programme is due in the middle of January. [ID:nLDE5BK1WQ]

(Additional reporting by Simon Johnson and Nick Vinocur in Stockholm, Tarmo Virki in Helsinki, David Milliken and Sebastian Tong in London, Ben Berkowitz in Amsterdam; writing by Niklas Pollard, editing by Tim Pearce)




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