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UPDATE 1-IMF to look at Iceland debt in next review

(Adds details from conference call)

WASHINGTON, Oct 29 (Reuters) - An International Monetary Fund mission is expected to conduct a second review of Iceland’s loan program in December and will look at a restructuring framework for private household and corporate debt, a senior IMF official said on Thursday.

Mark Flanagan, the IMF mission chief to Iceland, said on a conference call with reporters that Iceland’s external debt was much higher than initially believed but is sustainable.

The IMF approved a $2.2. billion loan program for Iceland in late 2008 after several large banks failed, triggering a collapse in the crown currency and throwing the economy into a deep recession.

“While we do see higher debt right now, we also firmly believe that this debt is sustainable. In particular, we have tested it against a variety of macroeconomic shocks, and we believe it will remain on a robust and sustainable downward path,” he said.

“For this large level of debt, a big chunk of it is confined to a very narrow corner of the corporate sector and that lends us some assurances” that it will not translate into a problem for Iceland as a whole, he added.

Iceland’s central bank warned this week that a growing number of households could slip deeper into debt as the country’s financial crisis persist.

The IMF approved a first review of Iceland’s IMF program and the disbursement of $167.5 million on Wednesday, following delays complicated by an international dispute over what to do about foreign savers who lost money when banks, including online bank IceSave, collapsed.

Flanagan said the resolution over Landsbanki’s IceSave accounts were never a formal condition of the IMF program, but the review was held up because of disputes with creditors, including Britain and the Netherlands.

“The fund has never had a formal condition on IceSave completion. Never. Because other creditors made it a condition, we had to wait until they were satisfied that their conditions were being satisfied.”

He added: “At this point all are happy that there has been sufficient progress on the IceSave issue.”

Flanagan said Iceland’s debts should be reduced through “discreet adjustments,” including the restructuring of corporate balance sheets and the sale of assets in failed banks.

“We think most of the IceSave obligations will be covered by asset recovery and that amounts to about 40 to 50 percent of GDP (gross domestic product),” he added.

Flanagan said Iceland’s economy should start recovering next year with quarter-over-quarter growth likely to reappear either in the second or the third quarter. Still, growth for the entire 2010 may remain negative, he added.

He said growth would likely come from Iceland’s export sector and a pick-up in private-sector investment. Iceland’s currency had depreciated by some 40 percent since the start of the crisis. Flanagan said the crown currency was “well below levels at which the export sector is very competitive.”

Flanagan also noted talks were underway for the development of a new aluminum smelter in Iceland.

Reporting by Lesley Wroughton, Editing by Chizu Nomiyama and Jeffrey Benkoe