By Sakari Suoninen and Omar Valdimarsson
REYKJAVIK (Reuters) - Crisis-struck Iceland called on the International Monetary Fund for $2 billion (1.255 billion pounds) in aid on Friday to help fix a broken banking system, restart currency trading and soften the blow from a withering economic downturn.
The Washington-based lender said its staff in Reykjavik and Icelandic authorities had reached agreement on an economic programme that would be supported by the financial assistance.
"The goal is to restore faith in the Icelandic economy and stabilise the currency and restructure the banking system," Prime Minister Geir Haarde told a news conference broadcast on national television.
The deal still needs to be approved by the IMF board and Haarde said he expected it would take about 10 days for the review to take place.
Iceland's financial system has all but collapsed and its economy is suffering badly after the country was forced to take over three of its biggest, debt-laden banks this month.
Paul Thomsen, head of an IMF mission in Iceland, said the economy could contract as much as 10 percent next year.
The north Atlantic island of just 300,000 people has become the first national victim of a global crisis that has felled some of the biggest names on Wall Street and sparked panic in financial markets.
International trade in Iceland's krona (crown) has ceased, a nasty dispute has broken out with Britain over deposits held in Icelandic accounts and the country has begun a wide search for assistance.
Ordinary Icelanders have watched in dismay as their country has gone from being a prosperous nation brimming with confidence to having to go cap in hand for funds.
Pall Bjarnason, a 62-year-old architect, drew comfort from the IMF news. "Considering the situation we're in, definitely this is going to help."
He expected a few months of suffering on the island before Iceland would start to rise up again "from the ruins."
"BILLIONS" MORE NEEDED
The prime minister said total funding needs had not been quantified exactly. "With the $2 billion from IMF, that would be a good part of it, but I think we still need several billion in addition," he said in a joint interview with Reuters and Swedish daily Dagens Industri.
But Haarde hopes that with the IMF on board, other countries will follow the lender's lead.
The Fund is to dole out $833 million once it agrees on the two-year deal, money that Iceland badly needs as it seeks to rebuild confidence in its currency and institutions.
The IMF has been accused in the past of being too dogmatic in demanding reforms. Critics charge it has sometimes increased the pain of countries already experiencing economic trauma.
Haarde said in the news conference he did not think the fund was being unreasonable. "We don't think the fund has put down any unacceptable conditions," he said.
The amount requested came partly as a surprise after media reports this week said Iceland was going to get $1 billion from the IMF as part of a $6 billion package. An official with knowledge of discussions between the IMF and Iceland had told Reuters a deal was under way with those same figures.
A statement from the IMF released soon after his comments said the stand-by arrangement involved 1.4 billion of Special Drawing Rights, which equals some $2.1 billion.
But the sum pales in comparison to the debts that Iceland's big banks have taken on over the years to fund an ambitious, but ultimately fatal, programme of expansion.
The three banks taken over by the state have more than $60 billion in foreign currency debts. Those debts became virtually impossible to repay once the Icelandic crown began its freefall.
The IMF's Thomsen said stabilising the currency was an urgent priority. He said there was "no doubt" monetary policy would have to be relatively tight for a while to prevent capital from "flying out" of the country.
(Reporting by Sakari Suoninen via Stockholm newsroom; editing by Michael Roddy)
