By Omar Valdimarsson
REYKJAVIK (Reuters) - Iceland's president on Sunday triggered a referendum on an updated plan to repay $5 billion to Britain and the Netherlands for debts incurred in the financial crisis, renewing uncertainty over economic recovery.
Iceland, where the economy and financial system crashed in late 2008, owes Britain and the Netherlands money they used to bail out domestic savers who lost money in online "Icesave" accounts run by a failed Icelandic bank.
Icelandic President Olafur Grimsson said the new terms thrashed out over months of negotiation were better than the first deal, rejected by Icelanders last year.
However, he said it was fundamental "the people exercised legislative power in the Icesave dispute."
"I have, therefore, decided in accordance with Article 26 of the constitution, to refer the new bill to a referendum."
Icelandic Finance Minister Steingrimur Sigfusson said the government would not resign.
"There is no reason for that," he said. "If the agreement is defeated in the referendum, we will address that question."
A referendum will be held as soon as possible but will not take place for at least a month.
Resolving the Icesave dispute has long been seen as necessary for Iceland's plan to join the European Union and for getting the economy back on its feet.
The government wants a deal, but there is deep resentment on the island. Many Icelanders believe it is unfair that taxpayers must foot the bill for mistakes made by private banks.
The Dutch government said the time had passed for talks over Iceland's debts.
"We have passed the stage of negotiations, but it is not up to us how this situation in Iceland will advance. We are sure the Icelandic government will consider the new situation and we hope to hear from them soon," Dutch Finance Ministry spokesman Niels Redeker said.
A British Treasury spokesman said: "We have noted the decision of the Icelandic president. We look forward to clarification of the Icelandic position in the coming days."
COLLAPSE
Iceland's financial meltdown caused the crown currency to collapse and sent the economy into a tailspin. The country had to be bailed out by the International Monetary Fund and others.
Strict capital controls were slapped in place to prevent an outflow of funds, keeping Iceland cut off from international capital markets and stunting its recovery.
Things have slowly been returning to normal. Interest rates have dropped from around 18 percent to 4.25 percent currently and inflation is under control. The country has taken steps to recapitalize its banking system and the central bank has been mulling its first international debt issue since the crisis.
The economy should grow this year for the first time since 2008.
The Icesave bill was supposed to be another step toward normalization.
Should Icelanders reject the plan, however, progress on EU membership and ending capital controls -- key to restarting the flow of foreign investment -- will be more difficult.
Prime Minister Johanna Sigurdardottir said she was concerned that repayment terms could now be set by European authorities who would step in if the three parties cannot agree.
The government has said the ultimate cost for Iceland under the current Icesave bill was likely to be no more than 50 billion crowns ($425 million), with Landsbanki assets covering the rest. The EU could set tougher terms.
Grimsson's veto was the second time he has rejected an Icesave repayment bill.
In a March 2010 referendum, an overwhelming majority of the country's roughly 200,000 voters threw out an earlier payment plan, sending negotiations between the three countries back to square one and delaying economic recovery.
A total of 44 members of the 63-seat parliament backed the new repayment plan earlier this week.
(Additional reporting by Aaron Gray-Block)
(Reporting by Omar Valdimarsson, writing by Simon Johnson, editing by Diana Abdallah)
