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07/01/2010 | Iceland Prepares for Referendum as President Refuses to Sign Compensation Deal with U.K., Netherlands

Global Insight Staff

Iceland's president has taken action to facilitate a national referendum on the controversial compensation deal agreed with the United Kingdom and the Netherlands, allowing Icelanders to exercise their democratic right to decide national economic policy; however, the action could have substantial repercussions for the rehabilitation of the island's decimated financial sector, and in the wider international community.

 

IHS Global Insight Perspective

 

Significance: Icelandic President Olafur Grimsson yesterday refused to sign into law the Icesave compensation deal with the United Kingdom and Netherlands, paving the way for a national referendum on the proposed bill.

Implications: The compensation deal has provoked political and public controversy for the better part of 2009, and the President's refusal to sign it is likely to complicate matters for the coalition government, which has been working doggedly to attain parliamentary approval for the bill.

Outlook: Icelanders have come out overwhelmingly against the bill in opinion polls conducted, meaning a referendum is likely to see the bill defeated. This would dent the government's efforts to rehabilitate Iceland's financial industry and potentially put into jeopardy loan arrangements with the International Monetary Fund and Nordic neighbours, as well as European Union membership aspirations.

Iceland's financial saga, which began in October 2008, appears to have once again taken a dramatic turn following President Olafur Ragnar Grimsson's refusal to sign into law a US$5-billion compensation deal agreed with the British and Dutch governments. The so-called Icesave deal would have seen the Icelandic government guaranteeing to repay US$5 billion to the U.K. and Dutch governments, which compensated Icesave's customers when the bank (an online subsidiary of the nationalised Landsbanki bank) collapsed in 2008. The scheme, which represents around 40% of Iceland's GDP, was due to be repaid over 14 years at an interest rate of 5.5%, with the interest bill being deferred for the first seven years. The President's decision to veto the bill is only the second such instance in 60 years; as a result it has taken the government and international community by surprise, with the United Kingdom insisting that the compensation deal must be approved, while the Netherlands deemed the events "unacceptable". However, the decision was not wholly unexpected, given the large public outcry over the bill, which saw one-quarter of Iceland's population signing a petition for the president to refuse to sign the bill. The president's refusal to sign the bill, which was only approved on 30 December following months of negotiations with the two foreign governments and weeks of parliamentary haggling, means that the bill will need to be presented to the nation in a referendum in order to become law. However, under present conditions, the referendum is likely to be defeated, given that recent opinion polls have indicated that 70% of the population is opposed to the compensation deal.

Mounting Resentment

The hard-line stance taken by Icelanders towards the Icesave bill is hardly unexpected, given the widespread discontent frequently voiced over the deal since negotiations on the compensation agreement started in early 2009. The reaching of the compensation deal has been a saga in itself, with the Icelandic government agreeing a deal with the United Kingdom and Netherlands in June, only to be forced to modify it in order to gain parliamentary approval for the bill in August. However, the changes inserted, which sought to link repayment to no more than 6% of the island's GDP in any given year and put a deadline of 2024 on the completion of repayments even if the full debt had not been repaid, proved to be unacceptable to the United Kingdom and Netherlands. This forced the government to go back to the negotiating table in order to get the December version of the bill, acceptable to the United Kingdom and Netherlands, approved by parliament. Throughout all of these changes, Icelanders' fury with the deal has been mounting due to a number of factors. Firstly, the Icesave deal in all its forms would force each Icelander to contribute around 12,000 euro (US$17,300) to the payback. Secondly, the electorate is angry that it is being forced to pay for the mistakes and risky behaviour of financial firms and the oversights of national regulators. Thirdly, Icelanders have still not forgiven the United Kingdom for using anti-terrorism laws to freeze Iceland's assets in late 2008, listing the Icelandic Central Bank alongside al-Qaeda as a terrorist body.

Iceland is also very bitter towards the international community, as it feels that it has been held hostage over the Icesave agreement, with the international community withholding essential loans and aid until an agreement was reached—an accusation hotly denied by the International Monetary Fund (IMF). Although the IMF has been quick to deny that any link exists between the Icesave compensation deal and its delivery of the next tranche of Iceland's loan, past experience paints a very different story. The IMF review mission was delayed for nine months from February 2009, officially over Iceland's failure to meet set conditions, but Icelanders perceived the delay to be due to the IMF waiting for resolution on the compensation dispute. Iceland was due to receive the third tranche of the loan in early 2010, meaning that the renewed delays with the Icesave deal could once again push back delivery of the next tranche of IMF funds. It could also jeopardise loan agreements reached in November 2008 with the Danish, Finnish, Norwegian, Swedish, and Polish governments, which have been linked to Iceland meeting IMF-established conditions. Furthermore, the renewed turmoil is unlikely to do much to help Iceland's credit ratings, with the agency Fitch Ratings immediately downgrading Iceland's long-term debt rating from BBB- to BB+, citing a "renewed wave of domestic political, economic, and financial uncertainty".

Outlook and Implications

The options available to the Icelandic government appear to be fairly limited after the president's veto:

  • The centre-left coalition government could present the Icesave bill to a referendum, where it would almost certainly be rejected. This would force the government to once again reopen negotiations with the United Kingdom and Netherlands in order to come up with yet another version of the despised bill. However, one bright spot would be that a convincing rejection by Icelanders could force the United Kingdom and Netherlands to soften their hard-line negotiating stances with the hope of securing a deal that would be ratified by the Icelandic government and president. The option of going to a referendum would also demonstrate to the international community that although the government is committed to securing a compensation deal, it is unable to go against the wishes of its people, who ultimately, under law, have the right to reject legislation.
  • An alternative option is that the government scraps the deal without going to referendum, instead simply going back to negotiations with the United Kingdom and Netherlands. However, this would do little to strengthen the coalition government's negotiation position, as a definitive no from the people could force the United Kingdom and Netherlands to start compromising.
  • Finally, and least likely, the government could abandon the issue of the Icesave compensation deal; however, given the strength of international pressure for the issue to be resolved and the reality that leaving the issue hanging will only damage Iceland's already decimated reputation ever further, this option is the least favourable.

In order for Iceland to even hope to rebuild its battered reputation, a compensation deal needs to be reached with the United Kingdom and Netherlands. Furthermore, stability for the financial industry is unlikely to return as long as delivery of the IMF and Nordic loans is not ensured in a coherent and timely manner, once again putting pressure on the government for resolution of the compensation dispute. However, the Icelandic government is facing a substantial challenge. On the one hand, it cannot make a deal that would push the country into bankruptcy or vitally go against the primary wants of the electorate. At the same time, rehabilitation into the international community could be made substantially more difficult without a deal, as it could threaten not only relations with international lenders but could also jeopardise the island's European Union (EU) aspirations, because the United Kingdom and Netherlands as member states would technically have the right of veto over the issue. Furthermore, under European Economic Area rules, a nation cannot join the EU if it has failed to insure its own banking deposits outside its borders. Iceland's prime minister Johanna Sigurdardottir needs to make good on the promise that Iceland is "committed to ensuring that Iceland honours its international obligations". The practical implementation of this pledge is likely to take considerable diplomatic skill and perseverance to achieve.

Global Insight (Reino Unido)

 


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