* Iceland govt eyes Feb. 20 for Icesave referendum -draft
* Parliament to reconvene on Friday, ahead of schedule
* Polls suggest public against bill
* Economics minister said IMF aid on hold pending resolution
(Adds Gallup poll, background on talks, govt statement)
By Omar Valdimarsson
REYKJAVIK, Jan 6 (Reuters) - Iceland’s government proposed on Wednesday a Feb. 20 referendum on repaying Britain and the Netherlands for huge sums lost in a failed savings bank, an issue that divides the country and threatens more economic pain.
Britain has warned Iceland it faces economic isolation if voters reject the bill authorising repayment of more than $5 billion to cover compensation already paid out by the British and Dutch governments to holders of Icesave accounts.
Parliament had approved the deeply unpopular bill, but President Olafur Grimsson stunned international markets and the government on Tuesday by refusing to sign it, citing a wave of popular anger over the measure.
The Feb. 20 date was given in a draft referendum bill, seen by Reuters, which is due to go before parliament. Legislators have been called back to start work on Friday, nearly three weeks ahead of schedule, due to the Icesave impasse.
The government confirmed in a statement it would propose a referendum for late February, but did not specify the date.
Swathes of the 320,000 population think it unfair that they should have to pay for the mistakes of private firms under the watch of foreign governments.
Polls released on Wednesday showed opposition to the bill is strong, although it has eased in recent weeks. Polling firm MMR reported 58 percent of respondents would vote against the bill, while a Gallup poll said 51 percent were opposed.
The Icesave saga threatens to hold up much-needed financial aid for Reykjavik, put the country’s European Union candidacy in jeopardy and undermine the coalition government.
The government has sought to push through an Icesave deal while acknowledging public fury, arguing Iceland must honour its debts and failure to do so would have dire repercussions.
The president’s move has made the task more daunting.
“I don’t like it, certainly,” Economics Minister Gwlfi Magnusson told Reuters in a telephone interview. “And we wish things were different, but those were the cards that were dealt and we’re trying to do our best given the situation.”
Magnusson said further aid from the International Monetary Fund and efforts to loosen capital controls were on hold until the Icesave impasse was settled.
“You could say it’s put on ice until the problem has been resolved,” Magnussen said, adding that the result could be a further contraction of the Icelandic economy this year after a fall estimated at more than 8 percent in 2009.
Ministers rushed to allay foreign creditors’ fears, holding talks with their counterparts in Britain and the Netherlands as well as at the EU level, a government spokesman said.
State media reported that Finance Minister Steingrimur Sigfusson would meet British officials in the coming days. A government official said Foreign Minister Ossur Skarpheoinsson would speak with British Foreign Secretary David Miliband.
The European Commission said on Wednesday that the way Reykjavik handles the Icesave issue could affect the assessment of its EU membership bid.
Financial markets took a dim view of developments, although international exposure to Iceland is much smaller than in the heady years that preceded its October 2008 meltdown.
The cost of insuring Icelandic debt against restructuring or default jumped on Wednesday. Five-year credit default swaps rose 38 basis points to 482 bps from Tuesday’s close, according to CDS monitor CMA DataVision.
Moody’s Investors Service said the Icesave referendum could lead to political instability which would put pressure on the country’s credit ratings.
Rival agency Fitch downgraded Iceland to “junk” status on Tuesday and Standard & Poor’s said it too may slash its ratings.
Grimsson, whose post is mostly symbolic, used his constitutional power to force a referendum. It was only the second time in the republic’s 65-year history that a president has refused to sign a bill.
Iceland applied for EU membership last year, but public opinion on joining the bloc has soured, in large part because of the Icesave issue.
Many Iceland residents believe Britain and the Netherlands are using their veto power as EU members and their IMF voting rights to bully the small North Atlantic nation.
A group called InDefence has mobilised anti-Icesave sentiment, organising a petition that called on the president to reject the bill and acting to rally the public on the issue.
“This referendum is not about whether Iceland should pay, but how much and how fair the deal is,” Johannes Skulason, a spokesman for InDefence said. “There is immense anger at the Icelandic bankers who gambled the future of Iceland’s economy, lost and then ran away.”
People in Iceland are also furious with Britain, which used anti-terrorism legislation to freeze Icelandic assets during a chaotic period in late 2008 when Iceland’s banks all collapsed.
A “no” vote would put pressure on the coalition government of Social Democrats and Left-Greens to resign. (Editing by Robin Pomeroy)