Iceland in turmoil after reneging on debt

Britain warned Iceland on Wednesday it could be blocked from joining the European Union after the tiny North Atlantic country's president voted against repaying $5.7 billion US in loans to Britain and the Netherlands.

Icelandic President Olafur Grimsson's decision Tuesday not to sign into law a bill on the loans caught many by surprise and threatens to damage Iceland's international standing as it attempts to recover from financial collapse.

International credit ratings agency Fitch slashed Iceland's credit rating to junk status, while Standard and Poor's said it may cut the country's currency ratings if political uncertainty and external liquidity pressures continue.

Grimsson said Tuesday the matter would be decided in a referendum among Iceland's voters, where opposition is so strong to the bill that many fear a "no" vote that would overturn the bill's narrow passage through parliament last month.

A draft bill on the referendum, to be put before parliament on Friday, gives Feb. 20 as the tentative date for the poll.

The legislation would have repaid the British and Dutch governments for the funds they have already paid out to their citizens who lost money when internet bank Icesave, a subsidiary of Icelandic bank Landsbanki that was available only in Britain and the Netherlands, collapsed.

The savings of Iceland's own citizens were protected from the collapse of its banking sector in October 2008 by an unlimited domestic deposit guarantee.

British Financial Services Minister Paul Myners said Iceland risks pariah status if the country's 243,000-member electorate votes "no."

"The U.K. government stepped in to ensure that all retail depositors with Icesave were fully paid out, and now we expect the Icelandic government to ensure that we are repaid that amount which Iceland owes us," Myners was quoted as saying in the Times newspaper.

Aware of consequences

Myners said Iceland was fully aware it would sacrifice any relationship with the International Monetary Fund and possible entry to the EU if it failed to repay the money.

"I don't think it's a case of us having to warn them," he said. "The Icelandic government recognized that this was the case."

Under European Economic Area rules, a country must insure its own banking deposits outside its borders before it can join the EU. Britain and the Netherlands also have the power to veto the EU's application, which was made formally last month.

Icelandic Finance Minister Steingrimur Sigfusson said late Tuesday he had spoken with Dutch Finance Minister Wouter Bos.

"He was, of course, very disappointed and shocked and told me the discussion in the Netherlands was uneasy and at times strong," Sigfusson said. "We agreed to try rather to steady the waters and try and calm things down."

Grimsson vetoed the legislation after receiving a petition signed by one-quarter of Iceland's population of 320,000.