Fitch Ratings has downgraded Iceland's long-term debt rating from BBB- to BB+, citing a 'renewed wave of domestic political, economic and financial uncertainty' for the country.
The downgrade came after Iceland's President Olafur Ragnar Grimsson said he would not sign an unpopular bill to compensate Britain and the Netherlands over the failure of Icesave bank. Instead the bill now goes to a referendum.
'Today's decision by Iceland's President to refer the 'Icesave' agreement to a referendum creates a renewed wave of domestic political, economic and financial uncertainty,' Fitch said.
'It also represents a significant setback to Iceland's efforts to restore normal financial relations with the rest of the world,' it added.
Britain has insisted, however, that the compensation deal must go through, with the Treasury urging Iceland to meet its 'obligations'.
Under the Icelandic constitution, if a president refuses to sign a bill voted by parliament, the issue is put to a popular referendum.
The Icesave bill, narrowly approved by the Icelandic parliament on December 31, calls for the payout of €3.8 billion to the British and Dutch governments for having compensated more than 320,000 British and Dutch savers who lost money in the collapse of the Icelandic bank.
Icesave, an online subsidiary of the Landsbanki bank that had to be rescued in October 2008 as the global credit crunch hit, had attracted British and Dutch savers due to its high interest rates.
The British and Dutch governments compensated disgruntled savers and then turned to Reykjavik for the money to be returned. The payout has stirred up resentment among many ordinary Icelanders hard hit by their country's financial meltdown in October 2008.
Some 60,000 people - about a quarter of the country's electorate - have signed a petition protesting against the bill and calling for the issue to be put to a referendum.
A poll taken in August suggested nearly 70% of Icelanders were against the Icesave deal, the compensation amounting to about €12,000 for each citizen on the small island nation.
The dispute has also delayed the disbursement of funds under of a $2.1 billion dollar IMF standby loan arranged in November 2008 following the collapse of Icelandic banks. The IMF announced on December 14 it had reached an agreement with Iceland on the release of a third tranche of the loan.
