Iceland begins building new government

REYKJAVIK (Reuters) - Iceland's president called on the social democrats, junior partner in the outgoing coalition, to form a new government with opposition parties on Tuesday to tackle a crisis that has abruptly shattered decades of rising prosperity.

Prime Minister Geir Haarde resigned on Monday after his Independence Party's coalition with the Social Democratic Alliance (SDA) collapsed under pressure from mounting public anger and sometimes violent protests. In so doing, he won the distinction of becoming the first leader to fall as a direct result of the global economic crisis.

The SDA, with 18 of 63 parliamentary seats, is the second biggest party and has long been more eager than the Independents to seek membership of the European Union.

President Olafur Ragnar Grimsson told reporters he had asked Ingibjorg Gisladottir, foreign minister under Haarde and head of the SDA, to take the lead on forming a government.

"I have decided to ask the leaders of the Social Democratic Alliance and the Left-Green party to engage in conversation about forming a new minority government backed by the Progressive Party," he told reporters at his residence.

Gisladottir said she was working for agreement by the weekend.

Coalition talks must bridge a number of differences central to the future of a country, once relatively poor, which began to thrive in the 1950s with the establishment there of a U.S. Cold War base. In more recent years it has built a booming financial industry, which quickly collapsed with the onset of global crisis.

The Left-Greens are lukewarm on EU membership, which Gisladottir's party supports. Left-Green leader Steingrimur Sigfusson has struck a populist note and called for negotiations to be reopened with the IMF on Reykjavik's $10 billion (7.1 billion pound) aid package to modify reforms demanded.

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Grimsson said he believed a national unity government comprising all five parties in parliament, the Althing, was not practicable under the current circumstances.

"The formation of a national unity government could take a long time and I believe it's essential that a workable government come in to place as soon as possible," he said.

Gisladottir, who recently had treatment for a benign brain tumour, appeared on Monday to rule herself out from becoming prime minister, saying she planned to take a leave of absence for one or two months.

Gisladottir proposed Social Affairs Minister Johanna Sigurdardottir as a candidate for prime minister.

The announcement came after Grimsson met Gisladottir and Sigfusson of the Left-Greens. He held individual talks with both leaders late on Monday.

The global financial crisis hit the North Atlantic nation in October, ending a decade of rising prosperity by triggering a collapse in the currency and financial system.

To stay afloat last year, Iceland negotiated an International Monetary Fund package with support from several European countries. International trade in the island's currency is effectively frozen.

Sigfusson, who wants Iceland to renegotiate the terms of the loan package, said after meeting with Grimsson it was essential that a new government be formed as quickly as possible.

Iceland's leaders received a fresh reminder on Tuesday of how dire economic conditions have become for the island's 320,000 residents.

Consumer confidence this month plunged to the lowest since measurements began in 2001, falling 23 percent from the prior month and 83 percent from a year earlier, according to pollster Gallup.

(Additional reporting by Kristin Arna Bragadottir and Omar R. Valdimarsson; Editing by Ralph Boulton)