Iceland: Tough Times Ahead: Minister of Finance Paints

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 �A;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