Its rejection would force Iceland’s increasingly shaky left-wing coalition to reopen negotiations with the British and Dutch governments — both of which have taken a hard negotiating stance.

Icelandic banks were aggressive investors in Northern Europe, luring depositors with high rates. But short-term financing for the highly leveraged institutions dried up when the credit crisis hit.

Iceland reached an agreement with Britain and the Netherlands last June to reimburse those governments for loans they used to repay the first 20,887 euros (about $30,000) lost in each bank account — the minimum they say Iceland is required by treaty to pay. The outlines of that deal appear to remain in force.

But the presidential rebuke is being described as a momentous decision for Iceland. It also highlights a widening rift between European governments — pressed by bond investors, ratings agencies and the International Monetary Fund to cut budgets and shrink deficits — and their recession-battered citizenry.

Late last month, the constitutional court in Latvia vetoed a move by the government there to cut pensions in line with an I.M.F.-sponsored austerity package. That development threatens the I.M.F. agreement and the country’s ties with foreign creditors.

Governments in Ireland, Greece and even Britain are also finding it difficult to satisfy both bond investors and voters. In a country that was driven to default by the speculative overseas excesses of its banks, there is doubt and suspicion over the motivations of outsiders, but also a grudging recognition that Iceland is obliged to repay Britain and the Netherlands for bailing out depositors. The two countries stepped in to help Icesave, the Internet unit of Landsbanki, which collapsed in late 2008 along with the rest of Iceland’s banking sector.

The savings of Icelandic citizens were protected by an unlimited domestic deposit guarantee.

In a statement, the British treasury said that the “government expects Iceland to live up to its obligations.”

British government officials cast doubt on what will happen next. Iceland has never held a referendum and there is scant language in its constitution explaining how one should be carried out.

Iceland’s prime minister, Johanna Sigurdardottir, told reporters in Reykjavik that Iceland would have its referendum and that “Iceland honors its international obligations.”

Any backroom dealings between Iceland and its lenders is likely to be received with even more anger by Icelanders.

Emotions remain raw over Britain’s invoking of antiterror laws in its initial response to the failure of Icelandic banks. There is also a strong feeling in Iceland that the bargain to repay the depositors of Icesave is nothing but large nations ganging up on a small one.

“The U.K. and the Dutch have been pushing too hard and they have been using the I.M.F. to pressure Iceland,” said Ogmundur Jonasson, once a health minister in the current government who resigned recently over the Icesave bill. “I am hoping now that they will respect democracy and understand that one has to listen to what the people say.”

Amendments added to the bill as it made its way through Parliament — including one that said repayments would not be made if Iceland’s gross domestic product fell below a certain level —angered officials in London and Amsterdam.

The bill passed by the Icelandic Parliament on Dec. 30 removed some of those conditions, but the president said the matter was not for politicians to decide, as “the nation is the highest judge for the validity of law.”

The government in October 2008 nationalized the country’s three biggest banks, Glitnir, Kaupthing and Landsbanki. Those banks failed owing more than $60 billion to creditors overseas.

The friction has complicated the country’s efforts to regain access to international lending to rebuild its economy, which shrank at an annual 7.2 percent rate in the third quarter.

And with further I.M.F. aid dependent on a final resolution to the Icesave matter, fears are growing that the country might tilt toward insolvency.

“By pushing so hard, the British and the Dutch might push Iceland into bankruptcy and get no money back at all,” said Jon Danielsson, an expert on the Icelandic economy at the London School of Economics. “Without the deal, the government is facing a debt burden of 140 percent of G.D.P. With the deal, it goes to 200 percent, giving Iceland one of the highest debt burdens in the world.”

Source >  NYT | jan 05