REYKJAVIK Iceland's credit ratings could be downgraded into "junk debt" status after its voters rejected a deal to repay Britain and the Netherlands for losses from a banking crash, Standard & Poor's said on Wednesday.
In a weekend referendum, Icelandic voters spurned a deal providing a state guarantee for repaying more than $5 billion to the British and Dutch for money spent compensating savers who lost money as banking group Landsbanki collapsed in 2008.
Prime Minister Johanna Sigurdardottir, facing a parliament no-confidence vote after the referendum defeat, highlighted the risks the nation faced as a result of now having to wait and go to court to settle the matter.
"The Icelandic electorate was presented with two evils last Saturday -- to assume a responsibility they believe is not theirs, or to risk a verdict that may be heavy to carry," Prime Minister Sigurdardottir said in a statement.
Economists have said failure to resolve the issue could delay progress in loosening currency controls, deter investment and weaken an already battered credit rating.
Sigurdardottir had previously argued that Iceland should strike a deal with its creditors and put the matter to rest. But on Wednesday she changed tack, saying there was some ambiguity in what Iceland should actually be responsible for.
"The government of Iceland has always said it would honor its international obligations, but there is a great deal of uncertainty as to what these alleged 'international obligations' entail in actual fact -- opinion on and interpretation of the European directive in question is highly disputable."
S&P said it put Iceland on its list for a possible downgrade due to higher economic risks in the wake of the "no" vote.
The agency has a BBB-/A-3 foreign currency rating, meaning it is just one notch above the so-called "junk" rating category.
COSTLIER IN THE END?
The issue is now likely to be settled by a European Free Trade Association (EFTA) court, an outcome which some analysts have said could prove to be more costly for Iceland than the agreement dismissed by voters. IDnLDE73900H
"We expect that a ruling by the EFTA court could take a year or longer," S&P's credit analyst Eileen Zhang said.
"The prolonged dispute over the Icesave issue could weaken Iceland's relationship with other European countries, increase its external financing risks, and hinder Iceland's economic recovery prospects as well as delay the lifting of capital controls and its return to international capital markets."
The rejection has also raised doubts over Iceland's access to aid from the International Monetary Fund (IMF) and its Nordic neighbors, though the center-left government has said it expects the lenders to continue supporting it.
Nordic neighbors Sweden, Norway, Denmark and Finland have pledged 1.775 billion euros in total to Iceland, provided it sticks to its IMF program and honors international obligations. Half of that amount has been paid out so far.
Norway said on Wednesday it would stand by its 480 million euro ($696 million) loan agreement with Iceland. Sweden has pledged slightly more and its government said it will propose to parliament that the credit also be extended.
A Finnish finance ministry official meanwhile said the question of extending loans needed to be discussed.
Sigurdardottir, whose center-left bloc faces a vote of no-confidence later on Wednesday which it is widely expected to survive, said latest estimates were that the assets of Landsbanki would cover more than 90 percent of claims related to Icesave accounts, run by the bank.
(Additional reporting by Wojciech Moskwa and Victoria Klesty in Oslo and Johan Sennero in Stockholm; writing by Niklas Pollard; editing by Stephen Nisbet)