Iceland: slipping again?

February 2, 2010

Just when you thought it was all over, Iceland looks like it’s in trouble again.  The cost of insuring Iceland’s debt against restructuring or default has risen this week to 720 basis points in the five-year credit default swap market, its highest since mid-2009.  That means it costs 720,000 euros a year for five years to insure 10 million euros of Icelandic debt against default.

Icelanders are to vote by March 6 on a deal to repay $5 billion lost in online Icesave bank accounts in Britain and the Netherlands. Those governments compensated savers when the bank collapsed and now want their money back from Reykjavik, but opinion polls show voters are likely to reject what are seen as the harsh terms of the agreement.

ICELAND/The uncertainty has driven debt insurance costs back up towards the levels seen just before the country’s banking system and government collapsed in Oct 2008.

The government doesn’t have to worry too much yet, as it has a $10 billion international aid pakcage, and no major debt maturing before 2011, when a 1 billion euro bond expires.

But if the IMF doesn’t like the look of the way the political mood is turning and decides to withhold funds, the country will find it hard to pay up.

“The main problem (Icesave) poses to Icelandic public finances is that the British and Dutch governments have enough political clout to block any financial aid to Iceland, be it from the IMF, Scandinavia or the EU, unless the issue has been solved,” said analysts at Icelandic bank Arion (formerly New Kaupthing) in a research note.

Iceland’s troubles once had the power to move other markets, given the amount of speculative capital tied up in its high-yielding markets. With capital controls on its currency, that is no longer the case.

But if Iceland has trouble with complying with IMF agreements, investors may fear that other countries with unstable finances — Ukraine, Latvia, Romania etc, could follow.

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