Iceland reached tentative agreement Friday with the International Monetary Fund for a $2-billion loan over two years, an aid package that comes after the country's banking system collapsed amid the global credit crunch.
The government said the deal, which still must be approved by the IMF's board in Washington, will also give Iceland immediate access to $830 million to head off the financial threat to the entire economy.
The country's currency, the krona, has lost half its value since January and banking transactions to and from the island nation in the middle of the North Atlantic have seized up, leaving its population of 320,000 virtually stranded.
"This program will enable us to secure funding and gain access to the necessary technical expertise required to stabilize the Icelandic krona and to provide support for the development of a healthier financial system," Prime Minister Geir H. Haarde said in a statement.
"As a result, Iceland will commit to a sustainable long-term economic policy, and a plan for the recovery of the Icelandic economy," he added.
The loan is the first by the IMF to a Western nation since 1976 — the long dormant agency is talking to close to a dozen countries about financial help.
IMF managing director Dominique Strauss-Kahn said that Iceland had put together "an ambitious economic program" to restore confidence in the banking system, stabilize the krona and achieve medium-term fiscal consolidation.
Economic reforms warrant support
Strauss-Kahn said those strong policies justified the high level of access to IMF resources and deserved the support of the international community.
"The authorities' program is focused on the essential upfront measures needed to restore confidence and economic and financial stability," he said. "The overarching goal is to support Iceland's efforts to adjust to the economic crisis in a more orderly and less painful way."
Iceland said it will use the funds to reintroduce a flexible interest rate regime and revise its financial regulation, particularly insolvency laws.
Haarde said Iceland expects the IMF deal to encourage lending from other sources.
Iceland turned to the international agency after talks with Russia over a four billion euro ($6.5 billion) loan failed.
It has also been holding talks for two days with a delegation from the Norwegian government over possible financial assistance and has suggested that Japan and other Nordic nations could offer more support.
Iceland has already called on a swap facility, drawing 200 million euros ($324 million) each from the Norwegian and Danish central banks — it can take up to a total of 500 million euros ($810.3 million) from each. A similar deal with Sweden's central bank has not yet been used.
Iceland's central bank, Sedlabanki, is facing a considerable loss following the collapse of the banking system.
After the three main banks — Glitnir, Landsbanki and Kaupthing — went into insolvency, Sedlabanki created new banks to handle domestic commercial banking activities.
It said it considered transferring liabilities for securities pledged to the central bank to those new institutions, but regulators had determined that all debt instruments issued by the old banks remain with those banks to guarantee transparency.
The banks' foreign debts amount to over $60 billion, dwarfing the country's gross domestic product of $14 billion.