S&P cuts Iceland outlook to negative from stable

STOCKHOLM: Standard & Poor's cut its outlook on Iceland's credit rating to negative from stable on Friday and warned it could lower the rating if government plans to forgive household debt significantly weaken public finances.

Icelandic households remain heavily indebted following a 2008 financial crisis which saw the country's banks collapse, sending the nation into its deepest-ever economic downturn.

A new government swept to power in April on a promise to offer households fed up with several years of austerity greater debt relief.

S&P said household debt forgiveness could pose a significant risk to Iceland's finances.

"The negative outlook reflects that we could lower the ratings over the next two years if household debt forgiveness substantially worsens Iceland's fiscal ratios or weakens our assessment of the effectiveness and predictability of policymaking," S&P said in a statement.

It said the write-offs, if funded through a haircut imposed on existing creditors to the defaulted Icelandic banks, could also damage foreign investors' confidence in Iceland and delay the lifting of capital controls in the country.

"The scope, overall cost, and financing of the write-down remain unclear, but we consider the risk of bringing additional debt from the private sector onto the public sector balance sheet to be significant," it said.

The new centre-right coalition has said it hopes to secure a deal with foreign creditors on a write-off of as much as 75 percent of the debt in the estate of the failed banks.

The move by S&P will be seen as a setback for a nation which is still trying to pick up the pieces. Economic growth has returned thanks to booming tourism and a thriving fishing industry, but many Icelanders remain saddled with debt as their inflation-linked loans taken on in the run-up to the crisis spiked when the crown currency and property prices collapsed.

Capital controls have been in place since, stemming capital flight, but they are also hindering foreign investment and holding back growth.

S&P, which expects Iceland's economy to grow on average by nearly 2 percent annually in the coming years, affirmed its BBB-/A-3 long- and short-term foreign and local currency sovereign credit ratings on the country.

It said that the ratings could stabilise at the current level if the scope of debt relief was limited, the cost to the state was contained, and the mode of financing did not - in its view - deter investment into the Icelandic economy.