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Iceland slashes rates, seeks Russian help in crisis

Iceland moved to shore up its ravaged economy by slashing borrowing costs on Wednesday and officials pursued efforts to get help from Russia in tackling the worst financial crisis in the island's history.

The central bank cut its main interest rate to 12% from 15.5%, hours before Prime Minister Geir Haarde was due to address parliament on how the government is coping with a crisis that has brought down the banking system and made the local currency untradeable.

A team from Iceland met Russian officials in Moscow on Wednesday for a second day of talks on a possible multi-billion-euro loan.

Iceland is also due to present a plan to the International Monetary Fund (IMF) in the coming days and is widely expected to seek funds.

The global financial crisis, which has struck Iceland particularly hard, has brought the Washington-based lender sharply into focus again as vulnerable countries turn to it for help.

An IMF team is on its way to Ukraine, whose central bank said the country may draw on standby support from the fund.

Iceland's crisis, however, is somewhat unique. The north Atlantic economy of some 300,000 people is highly developed and years of rapid growth have brought it unprecedented prosperity.

Icelandic banks in recent years embarked on a campaign of unbridled expansion, building up operations overseas but taking on huge debts. When global credit markets froze, the banks found themselves unable to meet obligations.

Now, with the economy reeling, people are confused.

“You do not know what is happening, you do not feel informed. Will the IMF come and take control?” said Arni Gudmundsson, a 29-year-old man who described himself as self-employed.

He said the rate cut was a good idea. “And I think they will have to take them down further simply in order for people to survive.”

Iceland has had high interest rates for several years as the central bank has tried, unsuccessfully, to rein in inflation. A collapse of the Icelandic crown had added to inflation pressures because Iceland imports so much of its goods.

But politicians have been calling for lower rates in recent days and ordinary Icelanders could not understand what was holding the central bank back.

“Finally they did it, the idiots,” said mason Smari Kauksson, 47. With bank overdraft rates running at 25%, life has become tough for many people.

“The next phase of the banking crisis will be difficult with severe economic contraction,” Sedlabanki said in a statement released in Icelandic on its Web site. It added the crisis would mean the loss of many jobs and said it had held informal talks with employers and unions to discuss the situation.

The rate cut “will help companies that will now have to be financed by Icelandic banks. This will be a big help for them,” said Asgeir Jonsson, analyst at Kaupthing. He said inflation would be countered by the sharp fall in the housing market, which accounts for 20% of the consumer price index.

Kaupthing, the largest bank in Iceland, was taken over last week by the state along with Landsbanki and Glitnir.

“The main thing is that they have to stabilize the currency and get the payments system going again,” Jonsson said.

On Tuesday, Iceland drew on swap facilities it had set up with Nordic nations, tapping Denmark and Norway for €200 million ($273 million) each to help get its currency market working again.

Sedlabanki said it had set up a temporary trading system to allow for international currency transactions, while it wanted to continue to limit foreign currency outflows from the country.

Central Bank Governor David Oddsson has come under criticism, some from political leaders, that he had not done enough to stave off the crisis and that his communications had at times exacerbated problems.

Haarde on Tuesday gave his firm backing to Oddsson.

“I have full confidence in him,” Haarde told Reuters when asked whether Oddsson should go. “This is not the time to assess blame for what happened, this is the time to find solutions.” (Reuters)