Iceland down but not out if IMF flows delayed: central bank

Sedlabanki Deputy Governor Arnor Sighvatsson told Reuters foreign investors should remain calm if Icelanders reject the Icesave bill in Saturday's referendum, which would probably freeze the foreign aid needed to revive a collapsed economy.

There is no specific deadline at which further delays will have serious repercussions, he said in an interview.

If this would drag into 2011, we would have some refinancing issues. However, we do have sufficient reserves to honor our obligations, but it would take the reserve position of the central bank uncomfortably low if that were to drag on until late 2011.

Asked what he would tell investors if Iceland rejected the Icesave agreement in the ballot as all opinion polls suggest, Sighvatsson said: Stay calm. We will eventually get there.

This is not the end of the world. It merely implies that negotiators have run out of time to finish a deal before the referendum but it does not change the fundamentals in any way.

Iceland has never defaulted on its debt and it will never do so.

Sighvatsson said the economic impact of a no vote on Icesave depends on whether the Icelandic government can quickly reach another agreement with Britain and the Netherlands over paying back some $5 billion lost during the financial crisis.

Surveys show nearly three-quarters of Icelanders want to nullify the 2009 agreement on repayment of debts owed to the two European states, which compensated savers in their countries who had lost money in Icesave deposit accounts.

If there will be a new round of negotiations, which will give a significantly better result, then we'll recover relatively soon, he said.

If this drags on, we will be in a more difficult situation and the risk to credit ratings will be greater.

ECONOMY CLOSE TO BOTTOM

Sighvatsson said Iceland needed the IMF funds to boost forex reserves and credibility before it again tested market appetite for its debt when refinancing bonds due in late 2011.

If the Icesave problems put the IMF program on hold, it would take more time to rebuild confidence, relax capital controls and draw much-needed investment back in.

The economy is at least getting close to the bottom, Sighvatsson said from his office overlooking the long-delayed construction site of the Reykjavik opera house, a project gone bust in the crisis.

We see private consumption stabilizing. The question is what is going on with investment. That might keep on contracting for some time, especially if we see further delays in foreign direct investment because of the uncertainty associated with the Icesave dispute.

Sighvatsson said uncertainty over the continued availability of IMF funds meant that Iceland might not be able to relax capital controls needed to safeguard the crown currency.

It is a matter of confidence, which might be restored quite quickly at some point, he said.

But for now we are not in a position to do this with very negative sentiment not only toward Iceland, but (also due to) problems and a negative sentiment in the international markets, stemming from the fiscal problems of Greece and elsewhere.

He said the internally convertible crown had stabilized, helped by a trade surplus.

In my view, from a long-term perspective the crown is seriously undervalued, he said, adding that the central bank has not intervened on the onshore-only crown market since early November, after it bought crowns quite regularly during 2009.

(Editing by Andrew Roche)