The Icelandic government said on Thursday it would repay early a fifth of the billions of dollars of loans it received from the International Monetary fund and its Nordic neighbors in the wake of the collapse of its banking sector in 2008.

The early repayment of the loans is a symbolic step for the country of just 320,000 people on its road to recovery from a financial meltdown that left its economy in tatters and its name a byword for the ravages of the global financial crisis.

The government said in statement it would prepay 116 billion Icelandic crowns ($909 million) of the loans this month - 55.6 billion to the IMF and 60.5 billion to the Nordic countries - that had been slated for repayment over the next few years.

The prepayment amounts to just over 20 percent of the funding from the IMF and the Nordic countries in connection with the IMF-led standby arrangement, it said.

The decision to make the payment was made in view of the Treasury and the central bank's relatively strong foreign currency liquidity position in the near term.

Iceland's main commercial banks collapsed in the space of a week as the global financial crisis struck in late 2008, imploding under the weight of huge debts built up during an aggressive overseas expansion.

The Icelandic government was forced to seek aid from the IMF and its fellow Nordic countries to stabilize the economy and impose rigid capital controls to avert a complete collapse of the North Atlantic country's currency.

Iceland has recovered unexpectedly strongly since the meltdown though the government had to move to plug loopholes in capital controls this week to protect its still vulnerable currency.

The economy, once dominated by banks that had swelled to almost ten times the gross domestic product (GDP), expanded last year for the first time since the crash and Iceland recovered its investment-grade credit status with ratings agency Fitch in February.

The repayment to the IMF covered loans maturing in 2013 while those being repaid to the Nordic countries covered maturities coming due in 2014 and 2015, as well as a portion of 2016 maturities, the finance ministry said.

Repaying the loans, which originally totaled 3.4 billion euros at current exchange rates, would reduce the Treasury's gross debt by about 3.4 percent of GDP and external liabilities by around 6.6 percent of GDP, it added.

Today's transaction is an element in paying down short-term debt, thus reducing the expense associated with the holding of the central bank's foreign exchange reserves without increasing refinancing risk or depleting the reserves, it said. ($1=127.58 Icelandic crowns, based on Sedlabanki onshore rate)

(Reporting by Niklas Pollard, Editing by Gary Crosse)

Iceland