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DE RUEHRK #0217/01 2771615
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O 031615Z OCT 08
FM AMEMBASSY REYKJAVIK
TO RUEHC/SECSTATE WASHDC IMMEDIATE 3823
INFO RUCPDOC/USDOC WASHDC IMMEDIATE
RUEATRS/DEPT OF TREASURY WASHINGTON DC IMMEDIATE
RUEHZL/EUROPEAN POLITICAL COLLECTIVE

UNCLAS SECTION 01 OF 02 REYKJAVIK 000217 
 
USDOC FOR LEAH MARKOWITZ 
TREASURY FOR LAWRENCE NORTON 
STOCKHOLM FOR FCS 
 
SIPDIS 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PGOV IC
SUBJECT:  ICELANDIC GOVT TO RUN FIRST DEFICIT IN FIVE YEARS, KRONA 
CONTINUES SLIDE 
 
REFS: A) Reykjavik 213 
  B) Evans-Norton email 10/01/08 
 
¶1.  (SBU) Summary:  Counter to the hopes of the Icelandic 
government, saving Glitnir Bank has not saved the economy, as the 
krona has fallen by 15 percent over the last two days and Iceland's 
credit ratings have dropped.  In the midst of the bad news, the 
first budget deficit since 1996 was announced and banks are trying 
every means possible to shore up their holdings.  Politically, the 
government's visibility has somewhat been dwarfed by David Oddsson, 
the Chairman of the Icelandic Central Bank Board of Governors and 
former Prime Minister.  Prime Minister Haarde's annual "State of the 
Union"-equivalent address on October 2 had difficulty getting 
attention over reports that Oddsson is calling for a unity 
coalition.  While Haarde's Political Advisor dismissed these rumors, 
the government is struggling to give the impression that it is in 
control of events here.  End Summary. 
 
¶2.  (U) After the Icelandic Government's purchase of a majority 
share in the country's third-largest bank on September 29 (ref A), 
many had hoped the economic situation would stabilize and the 
krona's slide would stop.  In this atmosphere, the October 1 
presentation of the 2009 government budget bill offered little 
comfort.  For the first time since 2003, the government anticipates 
a deficit (approx. ISK 56.9 billion, or $517 million).  Earlier 
forecasts had predicted a deficit of ISK 20 billion, or $182 
million, for 2009, but estimates have changed in the last few weeks. 
 Further, the last time a budget bill was presented with a deficit 
was in 1996.  For the past three years, the state treasury has 
delivered a total surplus of ISK 283 billion, or $2.57 billion. 
Further doom and gloom comes from the fact that the budget proposal 
was completed for printing prior to last weekend's banking crisis 
and therefore does not account for the GOI's purchase of a 75 
percent stake in Glitnir Bank and the further depreciation of the 
krona.  The changed economic situation will probably be considered 
in the parliament's handling of the bill.  After the nationalization 
of Glitnir on September 29, Standard & Poor's and Fitch Ratings 
downgraded Iceland's sovereign credit ratings. 
 
¶3.  (U) After the credit rating downgrades, the Icelandic krona 
tumbled nearly 15 percent from September 29 to October 3 to ISK 
112.99 against the dollar, which is the the weakest since the 
Central Bank of Iceland quit restricting its movement in March 2001. 
 Over the last five days, the krona has come under heavy selling 
pressure, also falling 12 percent against the euro.  In addition, 
credit default swap (CDS) spreads for Icelandic banks have soared. A 
wider CDS spread means that yields on riskier debt rose sharply, 
while those of safe government bonds fell. The krona's sell-off was 
precipitated by turmoil in the overleveraged banking sector, which 
in turn is posing serious risks to Iceland's overall financial 
stability. 
 
¶4.  (U) The three major Icelandic banks are rapidly trying to shore 
up cash.  On October 1, Iceland's number two bank Landsbanki said it 
will reverse its recent expansion and sold the majority of its 
overseas corporate finance and brokerage platforms to 
Reykjavik-based Straumur-Burdaras Investment Bank for 380 million 
euros, or $525 million.  The deal strengthened Landsbanki's capital 
position and leaves it focused on commercial and corporate banking. 
Nonetheless, Fitch cut its long-term rating on Landsbanki from A to 
BBB, and Moody's put its A2 long-term rating of Landsbanki up for a 
possible downgrade.  Meanwhile, Kaupthing, Iceland's biggest bank by 
value, said in February it would sell its asset finance and 
commodity trade finance businesses in Britain.  It sold part of this 
in August.  On October 2, the spokesman of Kaupthing's Danish unit, 
FIH, Jonas Sigurgeirsson, said the bank had no plans for further 
sales.  He added that Kaupthing had been very successful in raising 
deposits, meaning it was less reliant on wholesale funding, which 
has become very difficult to find and very expensive for Icelandic 
banks in the current market climate.  "The liquidity and the 
position of Kaupthing is very strong," Sigurgeirsson said. 
Additionally, Kaupthing is still pressing ahead with its recent plan 
to acquire a major Icelandic savings bank in order to add to its 
deposit holdings. 
 
¶5.  (SBU) Adding to the government's headaches, on October 2 
newspapers reported that David Oddsson, the Chairman of the Board of 
Governors at the Central Bank of Iceland (and previously PM and 
Independence Party chair from 1991-2005), has mentioned twice in the 
last few days in meetings at the Central Bank and at the Prime 
Minister's Office that forming a unity government (including all 
parties in the parliament) should be considered in light of the 
serious economic situation in Iceland.  This has raised eyebrows, 
while pundits have pointed out that the current coalition government 
 
REYKJAVIK 00000217  002 OF 002 
 
 
enjoys a strong parliamentary majority and would be unlikely to 
yield to such a coalition.  The general public is increasingly 
calling for action, while PM Haarde and the government, in press 
statements and interviews, maintain that the economic situation will 
get better.  In a conversation with PolOff, Haarde's Politicl 
Advisor put the Oddsson rumors down to a groupwithin the IP that 
wants to sow discord and possily rid themselves of their Social 
Democratic Allance coalition partners.  This group supposedly has 
never liked the current coalition and would rather re-form an 
alliance with the Progressive Party.  Haarde's Advisor cautioned 
that this was an "extremely dangerous time" to be playing politics 
and said Haarde would be pressing ahead regardless. 
 
¶6.  (U) Haarde's annual policy address to the Althingi (parliament) 
went forth against this backdrop on the evening of October 2, and 
while offering little in the way of policy specifics was praised by 
leading daily Morgunbladid for showing optimism and determination in 
the face of the current challenges.  While the opposition parties 
unanimously criticized the PM's lack of specificity, Left-Green 
Chair Steingrimur Sigfusson was notable in his cheerleading for the 
Icelandic people to rely on their strengths and the country's 
resources (something of a departure for the often-critical 
Sigfusson).  Perhaps inspired by Oddsson's comments about a unity 
government, Sigfusson also encouraged the PM to call the leaders of 
all major elements of society together to hammer out a national 
consensus on a way forward. 
 
¶7.  (SBU) Comment:  The general public listened anxiously to 
Haarde's speech to hear what proposals the government might have. 
Though Haarde's cautious optimism may have offered a calming effect, 
he will have to work hard to overcome the image -- eagerly reported 
by the media here -- of an inactive government shell-shocked by 
recent events.  Results in securing outside guarantees or added cash 
reserves to back up the krona would do much to calm anxieties here, 
and Haarde and his team appear to know that the pressure is on.  End 
Comment. 
 
VAN VOORST