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
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

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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