The government in Reykjavik yesterday sent a letter to the European Free Trade Association’s Surveillance Authority, Economy Minister Arni Pall Arnason said at a press briefing in Reykjavik yesterday.

“We’re hopeful that our remarks will lead to the ESA being able to close the issue and not proceed with the matter,” Arnason said in an interview, before publishing the letter.

Iceland faces a year-long legal battle over $5.9 billion, or about half its economic output, in depositor claims from the U.K. and Netherlands after voters rejected a government accord to back payment with taxpayer funds, Finance Minister Steingrimur J. Sigfusson said last month. The risk of a protracted dispute prompted Standard & Poor’s on April 13 to put Iceland’s BBB- rating, the lowest investment grade, on credit watch negative amid “higher economic risks.”

The cost of insuring against an Icelandic default has risen 20 percent since voters rejected the depositor accord in an April 9 referendum. Credit default swaps on five-year debt rose to 258 basis points last week, from 216 on April 11.

Autumn Repayment

“In our talks with the U.K. and the Netherlands, we’ve explained the situation and the fact that Landsbanki will begin payments later this year,” Arnason said in the April 29 interview. Repayment may start “as early as the autumn,” he said.

An estimate published by the Finance Ministry on March 2 showed Landsbanki’s resolution committee expects the lender’s estate to cover 89 percent of depositor claims, once all its assets are liquidated.

A new estimate due to be published May 19 may “show an even higher rate of recovery,” Arnason said. “Should anything be outstanding once Landsbanki has completed all payments and winding-down proceedings, that’s something that we’ll discuss with the U.K. and the Netherlands.”

The bank’s estate may cover 100 percent of claims, Finance Ministry spokeswoman Rosa Bjork Brynjolfsdottir said April 10.

Landsbanki Assets

Landsbanki, which together with Kaupthing Bank hf and Glitnir Bank hf had amassed debts about 10 times the size of Iceland’s economy before the 2008 meltdown, is in talks with eight banks to handle the sale of its stake in frozen-goods chain Iceland Foods Ltd., the bank said last week.

Other assets held by the lender include stakes in jeweler Aurum Holdings, toystore Hamleys Plc and the department store House of Fraser.

Larentsinus Kristjansson, the head of Landsbanki’s resolution committee, declined to comment on a Financial Times report that the Iceland Foods transaction alone may generate as much as 2 billion pounds ($3.3 billion), in an April 26 interview.

More than 350,000 British and Dutch depositors in Icesave, as the high-yielding Landsbanki accounts were known, risked losing their savings when the bank collapsed more than two years ago. The island has since relied on a $4.6 billion International Monetary Fund-led loan to stay afloat, and put in place capital controls to prevent a krona selloff.

Bondholders

The District Court of Reykjavik ruled on April 27 that U.K. and Dutch Landsbanki deposits are priority claims that must be repaid before obligations to bondholders, freeing up more funds to honor the Icesave debt.

Landsbanki bondholders can expect 9 cents on the euro, according to prices provided by H.F. Securities. That compares with 30.50 cents on Glitnir bonds and 29 cents on Kaupthing bonds.

Iceland’s economy is still struggling to emerge from its financial meltdown. Gross domestic product contracted 1.5 percent in the fourth quarter from the third, bringing last year’s overall decline to 3.5 percent, the statistics office said March 8. Unemployment held at 8.6 percent in March, the highest rate in almost a year, the Directorate of Labor said on April 12.

The economy will expand 2.3 percent this year, 2.9 percent in 2012 and 2.7 percent in 2013, the central bank said April 20.

Economic Recovery

“As the picture of the Icelandic economic recovery becomes clearer we expect to resume our plans to issue Treasury bonds in foreign currencies,” Arnason said. “When we explain the real facts and figures and focus on the underlying strong foundations of the economy, the people in the investor community we’ve spoken to have agreed with our conclusion that the economy is on solid ground.”

The EFTA’s Surveillance Authority in May last year started infringement proceedings against Iceland under its obligation to cover all depositor claims. Those proceedings had been shelved during Iceland’s parliamentary handling of Icesave. The accord was put to a referendum after being blocked by President Olafur R. Grimsson. The government said last month it may look into curbing the president’s ability to veto laws passed in parliament.