Moody's Investor Service has downgraded Iceland's debt ratings outlook to negative from stable over concerns about the tiny island nation's external liquidity.

In an update Tuesday, the ratings agency says Iceland's economic recovery is threatened by delays in the resolution of the so-called Icesave dispute — the repayment of $5.3 billion to Britain and the Netherlands to compensate government payments to citizens with accounts in a collapsed Icelandic bank.

Iceland's government was pushed into a national referendum that rejected an agreed deal after public anger about the harsh repayment terms.

Moody's acknowledges Iceland may still achieve a better deal, but says the current uncertainty is harmful to its short-term economic and financial prospects.