Iceland Forecasts Record $1.4 Billion Budget Deficit

By Helga Kristin Einarsdottir

Dec. 11 (Bloomberg) -- Iceland’s economic contraction next year will push the budget into its biggest deficit on record, a government forecast showed, forcing the country to deplete emergency loans granted last month.

Iceland will post a budget deficit of between 165 billion kronur ($1.43 billion) and 170 billion kronur, the government told reporters in Reykjavik today.

The deficit implies the country will burn through much of a $2.1 billion loan from the International Monetary Fund granted last month. The economy may shrink 10 percent next year, the IMF estimates, the island’s deepest recession since at least 1945, following the collapse of its banking industry and currency. Aside from the IMF loan, Iceland has pledges from the Nordic countries and Poland for a further $2.7 billion in loans.

“It doesn’t look good,” said Lars Christensen, chief analyst at Danske Bank A/S in Copenhagen. “It’s clear that a substantial portion of the IMF loan will be used to finance the deficit and they may well need to seek additional funding.”

The deficit corresponds to about 15 percent of the economy, based on 2007 GDP data from Statistics Iceland adjusted for the IMF’s forecast of a 10 percent contraction.

Kaupthing Bank hf, Landsbanki Islands hf and Glitnir Bank hf all collapsed in October after the lenders were unable to secure enough short-term funding to operate their business.

The government will cut spending by 45 billion kronur next year to prevent an even bigger gap, it said today.

‘Tragic Story’

“The income basis of the previous budget proposal has been greatly distorted in the wake of the collapsed banking system,” Prime Minister Geir Haarde told reporters. “Whole revenue contributions are disappearing; we need to react.”

The failure of the banks crippled the krona, forcing Iceland to limit official trade in the currency to daily central bank auctions. The krona was returned to a managed free float on Dec. 4 after the government passed a bill imposing capital restrictions lasting two years.

“It’s a deeply tragic story,” Christensen said. “One wants to be positive but the scope of the collapse has exceeded our worst-case scenario.”

The proposed spending cuts were presented to the parliament’s budget committee today.

To contact the reporter on this story: Helga Kristin Einarsdottir in Iceland at einarsdottir@bloomberg.net.