Business World

Icelandic lawmakers will today start debating budget cuts needed to bridge a 20 billion kronur ($157 million) gap and ensure continued payments of a bailout, the prime minister’s adviser said.

The parliament in Reykjavik aims to approve the measures by July 1, Hrannar Bjorn Arnarsson, a political adviser to Johanna Sigurdardottir, said in an interview yesterday. The Cabinet this week agreed to generate an extra 10.4 billion kronur by raising taxes, with expenditure cuts making up the rest.

Failure would jeopardize a $155 million tranche of an International Monetary Fund loan needed to rebuild the economy. Iceland on June 6 agreed terms for a $5.44 billion loan from the U.K. and the Netherlands to settle internet Icesave accounts held in failed lender Landsbanki Islands hf. The country has yet to settle separate bank creditor claims of $80 billion.

“There’s no shortage of political will to do what’s necessary,” said Paul Rawkins, a senior director at Fitch Ratings in London. “On the contrary, the government is very keen to put the program into place. The implementation risk is therefore quite low.”

Fitch rates Iceland BBB- with a negative outlook, one notch above junk. “Public debt is rising quite fast and the cost of bank restructuring promises to exacerbate this,” Rawkins said. “We’re waiting for all these things to fall into place before we complete our review of the rating.”

Growing Debt

The cuts will be “widely spread,” Finance Minister Steingrimur Sigfusson said in an interview yesterday. “The largest single cut will be in road construction, the second largest being the welfare system. The total cuts will amount to 10 billion kronur. In total, spending cuts and tax increases will amount to more than 20 billion kronur.”

Iceland will run a 177 billion kronur budget deficit this year, equivalent to 12 no fax cash advances.6 percent of gross domestic product, the Finance Ministry said in May. Government debt will grow to 1.5 trillion kronur, or 103 percent of the economy, it said.

The country came under IMF administration at the end of last year after seeking a $2.1 billion loan from the Washington- based Fund to avert a default following the failure of its biggest banks. The economy will contract 11 percent this year, the central bank estimates, the most since the island gained full independence from Denmark in 1944.

Worst Happened

“The worst that could happen has already happened in Iceland insofar as the banking system has imploded, the currency has collapsed and the economy is headed for a steep recession,” Rawkins said.

Fitch still rates Iceland as investment grade because the country has yet to default on its sovereign debt, Rawkins said.

“Domestic debt markets continue to function, but public debt sustainability is going to become an issue,” he said.

Iceland imposed capital restrictions at the end of last year, meaning non-resident investors holding about 700 billion kronur in assets are locked into their holdings.

“The quicker they can resolve the capital controls, the better,” Rawkins said. “There will come a point when they need access to international capital markets.”

The central bank has said it targets a gradual removal of controls within two years.

“A realistic timeline for removing capital controls may be 2010,” Rawkins said. “I don’t think there’ll be any sign of the economy starting to recover until the beginning of 2010.”

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