WASHINGTON (MNI) – The following text is a statement by Standard &
Poor’s Tuesday on the sovereign ratings of Iceland:

Rating Action

On May 17, 2011, Standard & Poor’s Ratings Services affirmed its
‘BBB-/A-3′ long- and short-term foreign-currency sovereign credit
ratings on the Republic of Iceland. At the same time, we lowered the
long-term local-currency sovereign credit rating to ‘BBB-‘ from ‘BBB’
and affirmed the ‘A-3′ short-term local-currency rating. We removed the
ratings from CreditWatch, where they were placed with negative
implications on April 13, 2011. The outlook is negative. The transfer
and convertibility assessment is unchanged at ‘BBB-‘.

Rationale

We removed the ratings on Iceland from CreditWatch because we
believe the immediate threat to Iceland’s external financing gap has
receded. We lowered the long-term local-currency rating and assigned a
negative outlook on both the foreign- and local-currency ratings because
of Iceland’s high external and fiscal debt burdens, which we believe
could grow were it not for the capital controls that limit residents’
capacity to invest overseas and nonresidents’ ability to exchange krona
holdings for foreign exchange.

Iceland relies on official funding to close its external financing
gap through the end of this year. Although the Icelandic electorate
rejected, for a second time, the government-negotiated Icesave agreement
with the U.K. and the Netherlands at a referendum on April 9,
2011–which had put Iceland’s IMF program at risk–we believe that the
IMF and Nordic countries will continue to provide funding.

The Icelandic authorities and the IMF have reached an
agreement–subject to approval by the Executive Board on completion of
the fifth review–and the Nordic governments are about to extend or have
already extended the availability of their bilateral loans in support of
Iceland’s program. This arrangement should complete Iceland’s external
financing requirements over the next few years.

The flexibility of Iceland’s prosperous economy supports our
investment-grade ratings on the sovereign. We expect the Icelandic
economy to grow again in 2011 after having contracted more than 10%
during 2009-2010. We expect positive terms of trade and more optimistic
domestic sentiment to support a moderate recovery in the near term,
while planned energy-intensive investment projects are also likely to
increase investments and exports from 2012 onwards.

In addition, we expect the restructuring of household and
corporate-sector balance sheets to accelerate during the next 12 months
as a few key court cases related to lending in foreign currency are
resolved. Uncertainty in Iceland’s legal framework has depressed the new
banks’ willingness to lend.

On the back of expected positive growth and continued fiscal
consolidation, we estimate that the government will reach a primary
surplus in 2011, enabling the general government debt burden to start to
decline in 2012. Including the IMF and Norwegian lending to the central
bank, gross general government debt peaks at 128% of GDP in our
forecast, while net debt peaks at about 82% of GDP. Our forecast
includes additional support for Ibudalanasjodur (Housing Financing Fund)
and the few remaining savings banks.

Outlook

The negative outlook reflects the likelihood of a downgrade if the
government debt burden increases further, either because the economy
stalls, the fiscal position reverses, or the capital account
liberalization fails.

The economic recovery in Iceland is fragile and could be hurt by a
number of factors, such as weaker external demand, worsening terms of
trade, loss of competitiveness (because of a return to wage growth
outstripping productivity growth), or further delays in private-sector
balance sheet restructuring. Government debt could also increase further
if significant fiscal slippage results from political instability,
higher-than-expected needs to further support the banking sector, or
substantial currency depreciation as the capital controls ease. We
likely would lower our ratings on Iceland if net government debt levels
increase significantly.

On the other hand, if the private-sector debt restructuring makes
good progress in the next 12 months, the Icelandic enterprises start to
invest again, and the reformed financial system functions more
effectively, growth should pick up and result in better fiscal outcomes
and a faster reduction in government debt. These factors likely would
improve confidence and allow a swifter lifting of capital controls. In
this case, the investment-grade ratings on Iceland would stabilize.

** Market News International Washington Bureau: 202-371-2121 **

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