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### Viewing cable 09REYKJAVIK101, Iceland: Tough Times Ahead: Minister of Finance Paints

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
09REYKJAVIK101 | 2009-06-05 17:11 | 2011-01-13 05:37 | CONFIDENTIAL | Embassy Reykjavik

`

    VZCZCXRO1950
    PP RUEHDBU RUEHFL RUEHKW RUEHLA RUEHNP RUEHROV RUEHSR
    DE RUEHRK #0101/01 1561711
    ZNY CCCCC ZZH
    P 051711Z JUN 09
    FM AMEMBASSY REYKJAVIK
    TO RUEHC/SECSTATE WASHDC PRIORITY 4084
    INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
    RUEHZL/EUROPEAN POLITICAL COLLECTIVE
    RUEAIIA/CIA WASHDC

` `

    C O N F I D E N T I A L SECTION 01 OF 02 REYKJAVIK 000101

    SIPDIS

    E.O. 12958: DECL: 06/04/2019
    TAGS: EFIN ECON PREL IC
    SUBJECT: Iceland: Tough Times Ahead: Minister of Finance Paints
    Somber Picture

    Classified By: CDA Neil Klopfenstein for reasons 1.4 (b) and (d).

    ¶1.  (C) Summary: Iceland Minister of Finance Steingrimur J. Sigfusson
    predicted difficult times for Iceland in the year ahead at a June 3
    meeting with the CDA. Sigfusson promised significant tax hikes and
    budget cuts, with much of the pain to come in the fall. Negotiations
    with labor and capital to map out a consensual road ahead have been
    unusually calm and understanding, particularly with often contentious
    government unions. He noted that agreements on loans from the Nordic
    countries and Poland are nearly finalized, but that promised support
    from Russia is not nailed down. Sigfusson was confident that a
    mid-July review by the IMF would go well. The Minister noted the
    government's delicate balancing act regarding interest rate levels.
    He said that the "bleeding" Icelandic business sector and
    considerable public clamor to relieve the debt burden of Icelandic
    consumers argue for lowering rates. On the other hand, he is well
    aware of the IMF's concerns that quick and drastic reductions in
    rates could erode efforts to stabilize the kronur. Sigfusson confided
    that talks are underway again to resolve the Icesave accounts issue.
    He said the "UK is sending mixed messages," while talks with the
    Dutch are going better. Although not a supporter of joining the EU
    himself, Sigfusson believes the Parliament will agree to begin
    membership negotiations in the next few weeks. He believes that vote
    will be close, and that a "no" vote would bring down the current
    government.  End Summary

    ¶2.  (C) On June 3, at the Embassy's first meeting with Minister of
    Finance Steingrimur Sigfusson since Iceland's April 25th elections,
    the Minister described the government's May 28th sin tax hikes on
    alcohol, tobacco, and gasoline as "the first of many cold showers."
    He said the taxes were raised without notice because of rumors that
    such an action was imminent and because it was a necessary measure
    that the government could take in the middle of the financial year
    without Parliamentary approval.  Sigfusson said more unpopular
    announcements will come in the next week and that there will be a
    huge effort to raise revenues and cut expenditures before the start
    of the next fiscal year. These plans will be debated in the next
    Parliament, which opens in October.

    ¶3.  (C) The government is trying to build a consensus for drastic
    actions by negotiating with key social partners (business, government
    unions, and private sector unions and associations).  Sigfusson said
    these discussions have proceeded with unusual calm and understanding.
     He noted that this was particularly the case with the government
    employee unions, which have been traditionally contentious
    negotiators.  The unions are intent on saving jobs and are willing to
    forego wage increases for two years to do so. The Minister said that
    some private sector unions, particularly outside of Reykjavik, have
    been reluctant to compromise on wage increases.

    ¶4.  (C) Minister Sigfusson was upbeat about the IMF loan package.  He
    said he expected a mid-July IMF review, which he thought would go
    well.  Sigfusson shared that all was on track with the loans from the
    Nordic countries, which he suggested would be finalized soon.  He was
    delighted that the Poles were likely to provide the full $250 million
    that they had pledged last fall.  They will be given a copy of the
    Nordic paper work as a model("with the interest rate whited out").
    The Russian commitment of $500 million is less certain, but
    negotiations continue. A meeting with a high level Russian Treasury
    official is scheduled soon.  Sigfusson admitted that if the Russian
    funds fall through, Iceland will be facing a gaping hole in their
    package. If this happens, he indicated they would go knocking on
    other doors, including Canada, the United States, other European
    countries, and perhaps China.

    ¶5.  (C) The CDA raised U.S. Treasury Department concerns about the
    Iceland Central Bank's recent steep interest rate cuts.  Sigfusson
    noted that the government is feeling real political heat to lower
    rates.  He said, "The business community is bleeding." Lower rates
    are particularly important to revive the profitability of the banking
    sector, he said, which needs to reduce the gap between what they pay
    depositors and what they earn on their foreign loans.  Sigfusson is
    very aware of the capital flight risks of lower rates, but feels that
    current controls to keep capital in the country are working
    effectively.  The Minister said that he thought the risk posed by
    lower rates was worth it to preserve suffering Icelandic businesses
    (and the jobs they provide). He said that in the end that neither
    side would be happy.  (Comment:  The Central Bank announced a rate
    cut of 1 percent on Thursday, well below the 6% cut that some
    advocated). When asked about whether the government was exerting more
    control over the Central Bank, Sigfusson said that they have no real
    influence, but do exchange a lot of information.

    ¶6.  (C) Regarding the Icesave negotiations, Sigfusson confided that
    "secret" talks are underway.  He said, "We will announce the talks if
    progress is made." (Comment: A local daily carried a story on the
    talks in today's paper.) Sigfusson reiterated that the Government of
    Iceland will live up to its obligation to reimburse Icesave
    depositors for their losses, as required by EU regulations.  However,
    he said the reimbursement scheme considered by the previous

    REYKJAVIK 00000101  002 OF 002

    government last year (in which Iceland would take loans from the U.K.
    and Holland for the full amount of the deposit guarantees it owes)
    was not tenable. In its place, the government envisions a new payback
    plan: the assets of the banks would be liquidated over the next
    several years (Sigfusson said it could take up to seven years) and
    the returns from the assets would be turned over to the UK and Dutch
    governments to pay back Iceland's debt.  Sigfusson estimated that
    these assets could cover up to 75% of the Iceland government's debt
    to the U.K. and the Netherlands. The remaining debt would be paid
    back by a loan with terms to be determined after the final obligation
    is known.  The advantage of this plan, according to Sigfusson, is
    that Iceland would not be saddled with a huge loan on its books,
    which would affect the country's financial ratings.

    ¶7.  (C) Sigfusson admitted that the Netherlands is more open to this
    plan than are the British.  He said the Dutch understand that there
    were faults with the EFTA deposit insurance system and are
    sympathetic to the hard situation in Iceland.  On the other hand,
    Sigfusson stated, "The UK government is sending mixed messages, and
    have delayed a few meetings." He speculated that local British
    politics, as well as the instigation of Anti-Terrorism legislation
    and the loss of charity organization deposits, also contribute to
    British reluctance to endorse the plan.

    ¶8.  (C) Sigfusson is clearly aware that the Icesave negotiations will
    not likely be resolved before the anticipated IMF review in July.  In
    discussions with IMF representative Mark Flanagan last week, the
    Minister asked Flanagan if Iceland could proceed with the review if
    everything else was in order except an agreement with the British.
    Flanagan said Iceland had a right to ask for the review to proceed.
    Sigfusson indicated that Iceland would ask other IMF Executive
    Committee board members to prevent a UK block of the review, should
    the British seek to stop it.

    ¶9.  (C) The Minister predicts that the Parliament will approve a
    resolution to begin negotiations to join the European Union before
    its summer recess. The vote will be close, as some of the opposition
    parties are milking the decision for political gain.  He says the
    Social Democratic Alliance (SDA) Party has much riding on this vote,
    and that should it fail, the SDA/Left-Green coalition government
    would likely fall. Sigfusson, himself skeptical of EU membership,
    fears that many, especially in the SDA, see the EU as a panacea for
    all of Iceland's ills. He says, "Our priority should be fixing things
    here and now.  The benefits of EU membership are at least a decade
    away."

    ¶10.  (C) Comment:  To the surprise of some, Sigfusson is proving to
    be a serious and responsible Minister of Finance.  Although many in
    his Left-Green Party have been suspicious of the IMF loan from the
    start, the Minister has acknowledged to Emboffs on several occasions
    the importance of the IMF package and his commitment to ensure its
    success.  Sigfusson has resisted (probably while gritting his teeth)
    most temptations to outright blame the current crisis on the excesses
    of capitalism. He does not hesitate, however, to take an occasional
    swipe at the rightist opposition and remind voters that Iceland's
    present economic mess is not of his doing. We are somewhat skeptical
    of the Minister's read out on the status of the Icesave negotiations.
     The British Ambassador painted a much bleaker picture in
    conversations with Emboffs a fortnight ago, saying the Icelanders
    have not been serious about addressing the issue, and that they were
    offering up naive "hair-brained" schemes of little substance to pay
    back the British loans.

    KLOPFENSTEIN

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