Veto of repayment bill leaves Iceland isolated

Iceland risks international isolation after refusing to honour its pledge to repay money lost in the IceSave bankruptcy.

The Icelandic president, Olafur Ragnar Grimsson found himself caught between a rock and a hard place. Should he bow to the anger of his citizens, who were unwilling to repay 3.8 billion euros owed to the Netherlands and the UK? Or should he prevent his country from becoming economically and diplomatically isolated?

After five days of deliberation, he chose the former, and refused to sign a bill requiring the state to repay the two countries. In doing so, he cast his country into a constitutional crisis and took Iceland a step back in solving the problems created by the economic crisis that hit in October 2008.

The international fallout left little to the imagination. Other nations directly involved called Iceland’s failure to meet international commitments a crying shame. Its fellow Nordic nations, Sweden, Norway, Finland and Denmark said a 1.8 billion loan they had promised would be shelved for the time being.

Junk status for Iceland

Fitch credit rating agency lowered Iceland’s ranking from BBB to BB+, denoting junk-status. Standard & Poor is considering a similar shift. Age Bakker, a custodian with the International Monetary Fund (IMF), said that payments to Iceland, part of a 2 billion euro loan package, might be postponed due to the president’s veto.

Negotiations regarding Iceland’s entry into the EU have also come under heavy pressure. Not that the Dutch and the British can do much to stop Iceland from joining the EU, nor can other member states. Still, Dutch European parliamentarian Hans van Baalen threatened to do just that last Tuesday. The Dutch finance minister also implied similar sanctions might be forthcoming.

On its own, Iceland will not dig itself out of the hole it is in. The country, which has a mere 320,000 residents, is simply too small to overcome the recession by itself. Its financial sector has been all but devastated, its tourism industry has ground to a halt, partly due to the economic crisis, and the nation has few other sources of income apart from fishing. Iceland will need the IMF, the Nordic nations and Europe in the years to come, if it is to rebuild its economy.

It is not hard to imagine why Icelanders are loath to repay the debts incurred by IceSave. The island nation has been hit hard hit the financial crisis and is overloaded with debt. Still, Iceland would have to start repaying its debts in 2016, dependent on economic growth, under the vetoed law.

Iceland: 'we are not terrorists'

The Icelandic furore was stoked further by a measure the British took shortly after IceSave went bankrupt. To protect British account holders, the Brown administration froze all British assets owned by Landsbanki, of which IceSave is a subsidiary. The legal pretext for this move was provided by an anti-terrorism law. Nearly 85,000 Icelanders signed a petition titled “Icelanders are not terrorists”. The population feels it, too, is a victim of the crisis, not a perpetrator. They think bankers and financial regulators should pay the price for the damage they did.

This message has fallen on deaf ears in the UK and Dutch governments, who are using no uncertain terms to convey their discontent. Understandable, considering they not only stand to lose 3.8 billion euros, but also risk setting an unwanted precedent for future financial disputes. Diplomatically speaking, the idea that countries left in slightly better shape by the economic crisis should bear the burden of those not so lucky, is a hard sell indeed.

A solution to this conflict will not be found any time soon. Iceland’s government and its president are divided on the issue. Prime minister Johanna Sigurdardottir has already said president Grimsson has overstepped his legal position in refusing to sign the law, making it unlikely it will be rescinded. The only viable option left seems to be a public referendum on the matter, which would allow the 240,000 voters to have their say. Opinion polls have shown that 70 percent of the population opposes the current repayment plan, meaning it will probably be only a matter of weeks before it is voted down.

What's next?

With this new law off the table, Iceland will fall back on another law dating back to September 2009, which did receive both the parliament and the president’s approval. The Dutch and the British opposed this original legislation since it did not specify a due date by which the money needed to be repaid. Under the original law, repayments had also been made dependent on economic growth in, leaving the British and the Dutch without any guarantees they would ever be repaid in full.

The new bill, refuted by the president, was an amendment to this earlier law, forced upon Iceland by the British and the Dutch after tense negotiations.

While the Dutch minister of finance still opposes this older law, a bankrupt Iceland will do him little good. This means that measures against Iceland might prove counterproductive, if punishment is doled out too severely.