Icelanders oust government over austerity program
* Independence Party takes first place in vote
* Little public trust in parliament
* Election seen as rejection of bailout terms and EU membership
* Campaign focused on household debt relief
By Balazs Koranyi and Robert Robertson
REYKJAVIK, April 28 (Reuters) - Fatigued by years of austerity and swayed by promises of debt relief, Icelandic voters dumped the Social Democrats from power on Saturday, returning a centre-right government that ruled over its stunning financial collapse just five years ago.
Once a European financial hub, this windswept north Atlantic island of glaciers, geysers and volcanoes has been limping along for years, still crippled from a crash that brought it to its knees in just a matter of days.
"We are offering a different road, a road to growth, protecting social security, better welfare and job creation," Independence Party leader Bjarni Benediktsson, the favourite to become the next prime minister after his party took first place in the vote, told Reuters as the results were coming in.
"What we won't compromise about is cutting taxes and lifting the living standards of people," said Benediktsson, 43, a former professional soccer player.
The victory caps a remarkable comeback for Benediktsson.
Just two weeks ago he considered resigning after record low poll ratings prompted calls for him to hand over his party's leadership to his deputy.
Hailing from a wealthy family with extensive business interests, Benediktsson, an avid trout and salmon fisher, was considered out of touch and tainted by the financial collapse.
Instead of stepping aside, he fought back with a rare personal television interview, giving voters a glimpse of his human side and propping up his party's ratings.
His Independence party took 26.5 percent of the vote, giving it 19 seats in the 63-seat parliament. The Progressive Party collected 22 percent, winning 18 seats, while the ruling Social Democrats got 13.5 percent and 9 seats, according to results with over two-thirds of the vote counted.
Benediktsson's first task will be to form a coalition, although a tie-up with Sigmundur Gunnlaugsson's Progressive Party, an ally in several governments over the past three decades, is a widely expected outcome.
In a country where Nordic civility prevails, the president walks without security and members of parliament are listed in the phone book, coalitions are usually formed in just days.
"Historically two-party coalitions are the strongest and ... if you look at the (results board) the choice seems to be clear," Benediktsson said. "We'll go into coalition with whoever we can govern with."
The Independence Party has been part of every government between 1980 and 2009, presiding over the privatisation of the banks, the financial sector's liberalisation and its eventual demise.
Campaigning on a platform of tax cuts, it promised relief to households whose inflation-indexed mortgages have kept growing, despite several write-offs since the crash.
It also argued that foreign creditors of its failed banks, now locked into the country because of capital controls, will have to accept a massive write-off, perhaps as much as 75 percent, before they would be let out.
The write-off and the refinancing of other corporate debt, for example to Landsbanki and Reykjavik Energy, could let Iceland ease capital controls within 12 to 18 months, Benediktsson predicted.
Still, Gunnlaugsson was not yet ready to concede the premiership: "Sometimes the biggest party delegates the prime minister, sometimes not. We've seen all sort of governments."
The vote was also a de facto rejection of EU membership as staunchly independent-minded voters rejected the Social Democrats' argument that joining the block was the only way for long-term security.
With a population of just 320,000, Iceland became a European financial centre 10 years ago when its liberalised banks borrowed heavily on ultra cheap overseas markets and lured British and Dutch savers with high returns.
Amassing assets worth more than ten times Iceland's GDP, Landsbanki, Kaupthing and Glitnir collapsed in quick succession, dragging the entire country into a financial abyss in October 2008.
The shiny Land Rovers that some Icelanders purchased, jokingly renamed 'Game Over,' were collected and taken offshore by enterprising Europeans, property prices tumbled, unemployment soared and the currency was only saved by capital controls that locked in foreign investors indefinitely.
The Social Democrats stabilised the economy with a bailout package hailed as exemplary by the IMF, but a series of policy blunders, tax hikes, leniency toward foreign creditors and their inability to deal with soaring household debt cost them popularity.
Leaden skies and driving sleet were a fair reflection of the mood of voters who have seen promises of a quick recovery fade, while mortgage debts rise, prices soar and capital controls keep investment at a record low. Turnout of 83.3 percent was the lowest since Iceland gained independence from Denmark in 1944.
"People seem to have a very short memory," Halldor Gudmundsson, 44, said after casting his ballot on Reykjavik's outskirts. "These are the parties that got us into the mess in the first place."
Like many voters, he has little faith in the ability of politicians to make a difference.
A recent Gallup poll showed that only 15 percent trust parliament, making it the second least-trusted institution after banks.
"There's so little room to manoeuvre and they promised so much, their popularity will be gone in three months," said Egill Helgason, a political commentator for the Icelandic national broadcaster RUV.