Iceland Says It Won’t Default Following Junk Rating (Update3)

y Omar R. Valdimarsson
Jan. 6 (Bloomberg) -- Iceland’s Finance Minister Steingrimur Sigfusson said his government won’t default after its debt was downgraded to junk following a presidential veto of a depositor bill that had sought to repair investor relations.
"I don’t believe there’s anything that points to" Iceland defaulting, Sigfusson said in an interview in Reykjavik yesterday. Even so, "patience toward Iceland is running out.
That is a reality we have to face."
Iceland is trying to put behind it the fallout of the banking collapse that garroted its economy 15 months ago. A settlement of the so-called Icesave depositor bill is the last milestone toward the island’s financial resurrection. Failure to pass the bill may jeopardize an international bailout agreement, Economy Minister Gylfi Magnusson said in an interview today. The veto has already triggered credit downgrades of the western nation hardest hit by the global credit crisis.
President Olafur R. Grimsson yesterday vetoed a U.K. and Dutch depositor bill after receiving a petition signed by more than 60,000 of Iceland’s 320,000 inhabitants urging him to reject the legislation. The accord, which obliges Iceland to use
$5.5 billion in borrowed funds to cover the depositor claims, will now be put to a referendum. Polls show about 70 percent of Icelanders oppose the legislation.
"The status is very difficult," Sigfusson said. "The assignment we have been tackling has been difficult enough and we are concerned about the progress and resurrection of the economy." An International Monetary Fund review scheduled for this month probably won’t take place after the veto, he said.

IMF Response

Grimsson’s decision doesn’t necessarily mean an IMF-led rescue will collapse, as long as countries that pledged to finance the emergency loans to Iceland remain committed, Mark Flanagan, the fund’s mission chief for Iceland, said in a statement late yesterday. The IMF will consult with countries providing the money for the program, he said.
The country’s $2.5 billion loan from the Nordic countries is contingent on resolving the Icesave dispute, Magnusson said in the interview.
"We could contemplate a scenario in which we could move forward without the Nordics, but I’m not sure that it would work and I don’t recommend that we take that route," he said.
Grimsson’s announcement prompted Fitch Ratings to lower Iceland’s credit grade to BB+, one level below investment grade.
The rating carries a negative outlook. Standard & Poor’s late yesterday put its BBB- rating on creditwatch negative, indicating "the likelihood of a downgrade if political uncertainty grows and external liquidity pressures persist in the wake of" the Icesave veto.

‘Renewed Uncertainties’

"This latest setback raises renewed uncertainties over the availability of bilateral and multilateral funding for Iceland’s IMF financial rescue program," Fitch senior director Paul Rawkins said in a statement yesterday.
"Moreover, it threatens to further stifle progress towards liberalizing capital controls that continue to trap significant non-resident investments in Icelandic krona and also the establishment of a credible market-determined exchange rate regime necessary to restore the economy’s access to international capital over the medium-term," Rawkins said.
Moody’s Investors Service and Standard & Poor’s both rate Iceland one level above junk. Standard & Poor’s credit analyst Kai Stukenbrock said Iceland’s rating may be lowered "by one or two notches" if the "political impasse persists or should we deem that Iceland’s access to official external financing has been affected."

Credit Default Costs

Credit default swap spreads on Icelandic debt jumped the to the highest since August, rising 35 basis points to 479 basis points, according to CMA DataVision prices. A higher CDS price reflects a higher cost of insuring against default.
"We would expect to see negative rating actions as a result of the president’s decision," Danske Bank A/S chief analyst Lars Christensen said in a note yesterday.
Since the collapse of its biggest banks in October 2008, Iceland has been struggling to reach agreements with creditors trying to recoup about $80 billion in debt. Landsbanki Islands hf, which offered the so-called Icesave accounts outside Iceland’s borders, owed $28 billion of that.
After Iceland’s banking implosion, the krona lost as much as 80 percent against the euro on the offshore market. The central bank imposed capital controls, locking in as much as 700 billion kronur ($5.6 billion) in foreign assets denominated in kronur.

Contacted IMF

The central bank had started to ease the capital restrictions in November, and said last month continued relaxation of controls depends on the stabilization of the economy.
"The IMF was contacted today and I’ve spoken to a few people, among them the finance minister of the Netherlands,"
Sigfusson said yesterday. "We will now meet with the central bank, leaders of labor and employer unions."
Iceland is relying on a $2.1 billion loan from the IMF and a $2.5 billion loan from the Nordic countries.
Even after Grimsson’s veto, "the government is committed to honoring its legal obligations and won’t run away from anything," Sigfusson said. "There is no indication" that the government will need to resign, he said.
Parliament will reconvene on Jan. 8, instead of Jan. 26 as originally planned, to discuss the fallout of Grimsson’s veto and to pass laws on national referenda, the Prime Minister’s office said yesterday.