Iceland's parliament met on Friday to thrash out plans for a referendum on repaying more than $5 billion to Britain and the Netherlands in the wake of a banking collapse.
Reaching agreement with the two European Union countries is vital for the continued flow of aid to Iceland, still in the grip of a devastating recession after the implosion of its currency and financial system in late 2008.
But Icelandic President Olafur Grimsson unexpectedly refused to sign an amended law this week on repayment, citing a wave of popular anger over the bill.
The bill can still become law if voters approve it a referendum that the government plans to hold in late February or early March, but opinion polls suggest a majority of the 320,000 Icelanders oppose it.
If they reject it, an earlier version — passed during the summer — enters into force. But Britain and the Netherlands had rejected the earlier terms because repayments would not be guaranteed after 2024.
Spain, which holds the EU presidency, said the issue could hold up Iceland's progress toward joining the 27-nation bloc.
"Clearly if it (the bill) is not approved, it could slow down the whole calendar...it could slow the whole process of negotiations," Spanish Foreign Minister Miguel Angel Moratinos said.
Cash-strapped Iceland has lobbied other Nordic governments to keep credit flowing. Finland and Norway both said on Friday a condition for their loans to the country is that it meets its international commitments.
British and Dutch depositors in high-interest "Icesave" bank accounts lost their money when Iceland's banks collapsed in 2008 after years of aggressive expansion fueled by debt. The two countries compensated savers in full and want their money back.
But many Icelanders oppose giving an open-ended state guarantee they believe will saddle them with a crippling burden. The legislation has been derided as the "Iceslave" bill.
Einar Haraldsson, spokesman at the prime minister's office, said parliament needed to decide on the referendum date, adding: "There will be a debate on the phrasing of the question."
Britain has said Iceland faces financial isolation if voters do not approve the measure. Ratings group Fitch downgraded the country's debt to "junk" status this week and other agencies have issued credit warnings.
Paul Rawkins, a senior director at Fitch, said that if Icesave were to be resolved swiftly, the rating would look sturdier. "We have downgraded Iceland quite a lot, so I think at this point we would wait and see how this plays itself out actually," Rawkins told Reuters Insider.
Beyond debts to Britain and the Netherlands, Iceland has $2.6 billion in foreign currency obligations, much of it due in 2011.
The opposition Independents, who have fought the bill, have called for a cross-party group to reach agreement on new terms that would be more acceptable to voters, and then to renegotiate with Britain and the Netherlands.
Bjarni Benediktssson, leader of the Independents, said he favours renegotiating but he is not against a referendum. "I don't care if we reject the agreement in a referendum or if we renegotiate now. I am looking for a solution," he told Reuters.
Benediktsson said he believes the British and Dutch may now realize they have been trying to push through a deal which Iceland's people cannot accept.
Prime Minister Johanna Sigurdardottir told news website Visir.is the government was open to considering cancelling a referendum if it was clear that parliament and voters wanted that. But she suggested that was unlikely.
Her spokesman Haraldsson said the government was not actively looking at any alternative to holding the referendum, though a new initiative from Britain, the Netherlands or a third party could potentially unlock the situation.
While many Icelanders believe the bill is too hard on taxpayers, others see it as the only way to restore the country to economic normality, ensure it has access to international markets and allow it to join the EU.
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