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### Viewing cable 08REYKJAVIK217, ICELANDIC GOVT TO RUN FIRST DEFICIT IN FIVE YEARS, KRONA

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
08REYKJAVIK217 | 2008-10-03 16:04 | 2011-01-13 05:05 | UNCLASSIFIED//FOR OFFICIAL USE ONLY | Embassy Reykjavik

`

    VZCZCXRO8121
    OO RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
    RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
    DE RUEHRK #0217/01 2771615
    ZNR UUUUU ZZH
    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

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