The sun does not rise over Iceland until after 11am at the end of December and sets again before 4pm. Yet when Reykjavik's parliament, the Althingi, announced on New Year's Eve that it had approved state guarantees to cover £3.5bn of loans to compensate British and Dutch savers with the collapsed Landsbanki, it looked as if the beleaguered Atlantic island faced a bright new future.
Landsbanki was one of three Icelandic banks that boomed during the past decade, shifting the country's economic focus from fish to financial services. Deposits raised abroad, including from the UK and the Netherlands, totalled six times the island's gross domestic product, briefly putting Icelanders among the richest people in the world. But since all three had to be rescued in 2008, the economy has collapsed and the 320,000 residents face an austerity programme that makes Britain's look insignificant.
The promise to repay the UK and Dutch governments for compensating customers of Landsbanki's online Icesave accounts was key to unlocking a $10bn refinancing programme led by the International Monetary Fund. An IMF mission to Reykjavik agreed the final terms before Christmas and was ready to put its proposals to the fund's executive board this month, paving the way for the Icelandic economy to emerge from recession and start earning its way back to solvency.
However, all that was thrown into doubt when president Olafur Grimsson refused last week to approve the Icesave law, as the legislation agreed by the Althingi during that dark evening is commonly known. The presidency is usually a ceremonial role: only once before has a holder blocked legislation – when Mr Grimsson opposed a media law in 2004 – but parliament backed down then. MPs hastily debated new legislation on Friday to organise the unprecedented referendum, agreeing to a 20 February vote, even though that could mean the IMF postponing its rescue.
Mr Grimsson, president since 1996 and Iceland's minister of finance for four years until 1991, denies picking a fight with either his own parliament or with Britain or the Netherlands. The tall university professor knows England well, having followed his degree at Manchester University with a PhD there on "smaller European democracies", but on the Icesave law he believes that for this small European island, direct democracy should override parliament.
It will take only a simple majority of voters to reject the law and a large part of Iceland's population is angry at its treatment by the IMF and countries such as Britain. Gunnar Sigurdsson is an artistic director who speaks for a wide range of other workers when he says: "A majority of the Icelandic people are against further co-operation with the IMF. We seriously doubt that the co-operation between Iceland and the IMF is for the benefit of the Icelandic nation. It is becoming clear to us that the agenda of the IMF is primarily to indebt the Icelandic nation in order to protect the interests of investors."
Some think Britain was too ready to protect the deposits of 400,000 UK savers who had chosen a foreign-owned bank paying high returns and should thus bear some of the loss. Icelanders argue that they saw little gain from their banks' expansion because the deposits were re-lent overseas.
Sigurdsson's concern is that his countrymen will be mired with debt they can never repay. The Icesave compensation alone is equivalent to more than £10,000 for every islander. Britain paid out £2.4bn to savers and the Dutch paid £1.2bn but they have demanded repayment from Iceland, even if the loan is spread over 15 years with no payments until 2017 and sales of Landsbanki assets could repay half the debt.
But Icelanders are already suffering as their economy collapses. Government revenues have been static over recent years but expenditure has soared by 73 per cent, turning a budget surplus into a massive deficit. VAT receipts have collapsed by 20 per cent because Icelanders have curtailed spending, and taxes on car sales plunged by 84 per cent in the year to November. However, the cost of servicing Iceland's debt has jumped from 12bn to 59bn kronur.
The kronur's 40 per cent fall against other currencies increases the size of the banks' foreign debts. It also makes imports expensive, giving double-digit inflation in a country where mortgage costs are indexed to prices. Household and corporate debt has had to be restructured but a moratorium on mortgage repossessions ends next month.
The IMF hiked interest rates to 18 per cent before easing them to 12 per cent, but says they would have to be 40 or 50 per cent to support the kronur. IMF managing director Dominique Strauss-Kahn warns that the VAT and income tax systems must be reformed and says spending cuts must include reductions in wage bills, improved social-benefit targets, and yet lower investment and maintenance expenditure.
The devalued currency helps exports, of course, but Iceland's main export, apart from fish, is aluminium and crucial foreign plans to build new smelters – which would bring in the overseas currency necessary to repay debt – have been put on ice.
The IMF's rescue plan is already six months behind schedule because of the Icelandic government's delay in meeting conditions. The head of the fund's mission to Reykjavik, Mark Flanagan, says: "The fund has never had a formal condition on Icesave completion. Never. How Icesave affected the timing of the review was indirect and related to the broader financing for the programme. Because other creditors of Iceland made it a condition, we had to wait until they were satisfied. The dispute between Iceland, Britain and the Netherlands concerning Icesave complicated efforts by Iceland to secure additional external financing for the programme from other participating countries."
Iceland's prime minister, Johanna Sigurdardottir, says her left-leaning government remains committed to the Dutch and UK loan agreements and the guarantees, insisting they are integral to the country's economic revival. She says the Icesave law has already taken effect but admits it will become null and void if the referendum rejects it, as currently expected.
That could mean Ms Sigurdardottir, an air stewardess for 10 years, looking for a new job as well as affecting Iceland's future. "The government is committed to ensuring Iceland honours its international obligations," she maintains.
Mr Flanagan says the IMF is evaluating the situation and consulting with Iceland and other countries. "As I've said, Icesave has never been a formal condition of the IMF programme and it is not a formal condition now either. What we require at every review is that the mix of policies, macroeconomic targets and external financing be consistent. If it doesn't add up, we simply can't put it in front of our executive board. It would not be accepted.
"Would non-passage of Icesave affect financing assurances? I don't know how these things will play out," he says. "I'm not willing to speculate."
Mr Sigurdsson has no restraint however. "The IMF put the Icelandic government up against the wall to protect the interests of the UK and Holland in the Icesave dispute," says the artistic director. "It is unacceptable that an international organisation should conduct its business in such a manner and this has seriously undermined the credibility of the IMF in Iceland."
Timetable of failure: Warning signs of meltdown were ignored
By Greg Walton
IceSave lured customers with promises of impossibly high interest rates and quick returns before its collapse in 2008 which cost British and Dutch savers more than £3.4bn. The British subsidiary of Landsbanki offered customers interest rates of up to 6.7 per cent – well in excess of high street rivals – and required an initial deposit of only £1,000. Nearly 300,000 British savers had IceSave accounts frozen in October 2008 when the global slowdown crippled Iceland's overstretched banking sector. In total, British investors had £4bn saved with the online bank.
In addition to unsustainably high rates of interest, the online bank aggressively sought to increase deposits through a slick advertising campaign managed by a big City PR firm. "As I recall they received some marketing awards. They did advertise quite a lot," said Iceland's Progressive Party leader, Sigmundur Gunnlaugsson, whose InDefence group has campaigned for a referendum on the repayment of debts to the UK and the Netherlands. Mr Gunnlaugsson says: "The breakthrough was being listed on the online comparison sites where the IceSave account was often had the highest rate of interest."
The press too played a role in attracting savers to the scheme, often holding up the bank's cash ISA as the market leader. In late January 2008, The Mail on Sunday recommended IceSave's easy-access account to readers in an article entitled "Safe homes for your cash as panic spreads on markets", just months before Iceland's banking sector ran into difficulty.
Warning signs before the collapse were largely played down by commentators. The entire Icelandic banking sector was under scrutiny in the months before the demise of IceSave. Credit rating agency Moody's launched a review into the country's financial services industry at the end of January 2008 and Standard & Poor's warned of difficulties for its major banks, including Landsbanki. Despite these signs of impending meltdown, the online account was still recommended to British savers.Reuse content