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Iceland Sees No Quick Fix to Icesave Crisis

By Omar R. Valdimarsson

(Bloomberg) — Iceland's government says it sees no immediate political solution to contain the fallout of President Olafur R. Grimsson's decision to veto a depositor bill that had sought to repair U.K. and Dutch diplomatic relations.

"The reaction of the international community has been very harsh and the decision is already causing us severe economic difficulties," Economy Minister Gylfi Magnusson said in an interview yesterday. "However, there's no immediate solution available at the moment; there's nothing that we are working towards behind the scenes."

The presidential veto threatens to stall an economic resurrection that Iceland's Social Democrat, Left Green government had toiled over for a year. Grimsson's Jan. 5 announcement prompted Fitch Ratings to downgrade Iceland to junk, while Standard & Poor's the same day said it may lower its BBB- rating more than one level to non-investment grade. The news sent credit default swaps on Iceland's debt to the highest since August last year on concern the island may be headed for default.

Iceland's $2.1 billion International Monetary Fund loan, with a further $2.5 billion pledged by Sweden, Denmark, Norway and Finland, has been shelved because of Grimsson's decision to block the depositor accord, Magnusson said. He doesn't expect a review scheduled for this month to take place, he said.

Brink of Default'

"The IMF can't move onwards with the program unless the financing is in place," Magnusson said. "The Nordics have stated and restated that they will not deliver further payments until this matter is resolved. Therefore it is obvious that the IMF can't complete its second review."

A lack of IMF-led funds "could potentially push the Icelandic government to the brink of a default," Danske Bank A/S Chief Analyst Lars Christensen said in a Jan. 5 note.

The veto also puts in peril central bank plans to ease capital controls, and will probably prevent the central bank from cutting interest rates further, Magnusson said. The benchmark seven-day collateral lending rate is 10 percent, compared with 18 percent a year ago. The central bank in November started relaxing capital controls that have been in place for more than a year and said further easing depends on economic stability.

Turnaround in Polls

"If the delay" in resolving Icesave "is only a few weeks, then the damage is only limited," Magnusson said. "However, if it will take months to resolve this issue and international loan markets are limited or closed for Iceland, it can cause us serious problems."

Delays in settling the bill will lead to a deeper economic contraction, higher unemployment, less tax revenue and a wider budget deficit, Magnusson said. Unemployment jumped to 8 percent in November and will reach 9.8 percent this year, the central bank said in November. Real disposable incomes slumped 19.2 percent last year and will fall a further 15.8 percent this year, contributing to an 8.5 percent economic decline in 2009, it said.

Prime Minister Johanna Sigurdardottir's office said yesterday the bill will be put to a referendum in late February. Polls had shown as many as 70 percent of Icelanders opposed Icesave. A Jan. 5-6 poll conducted for the newspaper Vidskiptabladid showed that 55.7 percent of Iceland's voters support Grimsson's veto. Fifty-eight percent polled said they would vote down the bill in a referendum. The Vidskiptabladid poll had a margin of error of 3.3 percentage points.

'Months to Resolve'

A Jan. 6 Capacent Gallup poll showed voter opposition to the bill may be thawing. According to that poll, 51 percent of Icelanders now disagree with Grimsson's veto, compared with 41 percent who back his decision. Fifty-three percent of voters plan to back Icesave in a referendum, the Gallup poll, published by broadcaster RUV, showed. RUV gave no margin of error.

Grimsson said in an interview with the British Broadcasting Corp. last night that he can't see why the U.K. and the Netherlands could object to the accord being put to a referendum.

"It could take months to resolve this," Fitch Senior Director Paul Rawkins said in a Bloomberg Television interview yesterday. "They've got to set up a referendum. If it doesn't pass, the whole thing starts again. We almost look as if we're back to square one."

Rawkins said Fitch's BB+ rating carries a negative outlook because "we don't know how this is going to play out. The government could fall."

Even after Grimsson's veto, "the government is committed to honoring its legal obligations and won't run away from anything," Finance Minister Steingrimur Sigfusson said in a Jan. 6 interview. "There is no indication" that the government will need to resign, he said.

To contact the reporter on this story: Omar R. Valdimarsson in Reykjavik

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