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

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FM AMEMBASSY REYKJAVIK
TO RUEHC/SECSTATE WASHDC PRIORITY 4084
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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