Page last updated at 17:31 GMT, Sunday, 7 March 2010

Q&A: Iceland debt referendum

Protestors in Iceland
Many Icelanders are demanding a "reasonable" agreement.

Iceland has held a referendum on plans to repay the UK and the Netherlands debts owed from the collapse of Icesave bank.

Despite overwhelming opposition to the proposal, the country faces years of financial pain.

What was the referendum about?

Iceland's 320,000 citizens voted on whether their government should repay Britain and the Netherlands more than 3.8bn euros (£3.4bn) - equivalent to each person contributing 99 euros a month for eight years.

Britain and the Netherlands say they are due the money following Iceland's financial meltdown in 2008. But Icelanders say the terms of the repayment are too onerous and rejected the package in its current form.

The collapse of three of Iceland's biggest banks overwhelmed the country's deposit-insurance scheme.

Some 340,000 British and Dutch depositors in the Icesave online bank (owned by Landsbanki) had to be bailed out by their domestic compensation scheme.

Now these two countries want their money back from Reykjavik.

At stake is nothing less than Iceland's ability to restore its economic credibility in the eyes of the world

According to Dragana Ignjatovic, analyst at IHS Global Insight: "In order for Iceland to even hope to rebuild its battered reputation, a compensation deal needs to be reached."

Speaking to the BBC, Chancellor Alistair Darling said the UK would get its money back, if not for many years.

"It's not a matter of whether the sum should be paid. There is no question we will get the money back but what I am prepared to do is to talk to Iceland about the terms and conditions of the repayment," he told the BBC's Politics Show.

Asked about how long it would take for the UK to be repaid, Mr Darling said it would take "many, many years".

But there was never any suggestion many people would vote "Yes".

That's why the referendum became an explosive political issue.

Most Icelanders argue that they should not be penalised for their government's failure to rein in spending and for the excesses of a few banks.

As we are seeing in Greece, and elsewhere in Europe, the majority of people don't want to be penalised for the actions of a few.

Iceland's rising unemployment and high living costs means the country is taking longer to emerge from recession. The economy shrank 6.5% last year and is forecast to shrink about 2.5% this year.

There is also a lingering dislike at the way Britain has conducted itself.

London used anti-terrorist legislation to freeze the assets of Icelandic banks, sparking the worst diplomatic row between the two countries since the Cod Wars fishing dispute in the 1970s.

What does the Icelandic government say?

The magnitude of those payments are such that we would have little left for anything else"
Iceland's economics minister Gylfi Magnusson

Last December Iceland's parliament agreed - after much soul-searching - to approve a repayment package.

Under this deal the "debt" would be repaid over 14 years at an interest rate of 5.5%, with the interest bill deferred for the first seven years.

However, in January, following public outrage, President Olafur Ragnar Grimsson vetoed the deal. This set up the referendum.

There were last-minute talks in London to resolve the issue, with Britain and the Netherlands thought to have offered a reduced interest rate.

But hopes of a deal which would have forestalled the need for a referendum were dashed.

What are consequences for Iceland of a "No"?

A "No" vote might strengthen the government's hand in negotiations.

That said, it would still be a blow for Iceland's shaky Social Democrat-Left Green coalition, which had approved a deal.

Iceland's Prime Minister Johanna Sigurdartottir has staked much of her political reputation on backing an Icesave deal.

And the dispute has also overshadowed Iceland's application to join the European Union, which was submitted last July. This application is effectively on hold until the Icesave issue is resolved.

More importantly, a "No" vote could have severe consequences for Iceland's attempt to re-build its shattered economy and repay its debts.

An application for about $4.6bn in loans from the International Monetary Fund appears to have stalled.

The IMF has said that the Icesave dispute should have no impact on the loans.

But Britain and the Netherlands, along with Nordic countries, are thought to have made the loans conditional on Iceland repaying international debts.

About 1bn euros in foreign debt matures in 2011. Gylfi Magnusson, Iceland's economic affairs minister, has warned: "The magnitude of those payments are such that we could we would have little left for anything else."

Rating agency Moody's said recently that the deadlock may force it to downgrade Iceland's debt to junk, making it even harder for the country to borrow much-needed funds on the international market.

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