An island in the age of austerity

Until President Grimsson dropped his bombshell this week, Iceland's recovery from its disastrous descent into economic catastrophe had been going pretty well. A bill that would finalise the island nation's repayment of the £3.2bn it owes to the British and Dutch governments after the collapse of Icesave looked as if it was about to go through; for the first time in a long time, the economic signs were turning positive.

"The outlook was improving day by day," the Finance Minister, Steingrimur Sigfusson, explained yesterday, with a rueful scratch of his head. "It was becoming more and more realistic that we would see a stable situation."

The story of how that unravelled is one of intense and ham-fisted politics. It features an egotistical President sharply at odds with the will of his parliament, a furious Foreign Minister dismayed at the British response, and a serious failure of communication at the heart of the Icelandic government. But it's also a story of something simpler: a country that got sick of being told what to do.

Tuesday's political earthquake began in the office of President Olafur Ragnar Grimsson. The head of state had merely to sign the coalition's Bill to set the Icesave repayment scheme in stone. He told no one outside his immediate circle of his plans, and the finance ministry had sent him reams of economic data that it believed showed that the consequences of a veto were simply too awful to contemplate. Surely, they thought, he would sign the legislation.

Mr Sigfusson, a nay-saying Icelandic Vince Cable outside government during the boom, felt he had done all he could. "We warned him very firmly against this decision," he said. "Much of what we said would happen would already come true. I'm very disappointed that he did not better consider the data we put to him. By now he must realise he should have looked at it more closely."

In the event, the President, with a face as grim as his name, spoke to the nation of a different agenda entirely. The government had no prior notice of his intentions, and received no official notification until six minutes into the speech, which was already unfolding in a direction that spelt disaster for the ruling coalition.

In London, the reaction was swift – and stern. Gordon Brown's spokesman called the presidential veto "very disappointing", while the City minister, Lord Myners, warned that Reykjavik risked not being "regarded as a safe counter-party with whom to do business". The Icelandic Foreign Minister, Ossur Skarphedinsson, was upset by that reaction, to say the least, and particularly riled by suggestions that Iceland's prospective membership of the EU might be called into question. "They were extremely hostile," he said yesterday, before a phone conversation with David Miliband and a hastily called ministerial meeting to hammer out the mechanics of the unprecedented referendum. "To bring our EU application into this matter is extremely unfriendly and unhelpful."

The politicians are upset with the President, and the public are upset with the politicians, and no one knows quite what to do with the bankers; but on the EU dimension, at least, every Icelander seems able to agree. The consensus in Reykjavik is that a more conciliatory approach from the British and Dutch governments – as well as the EU – in the first place could have produced a Bill that met with the public's approval.

Near the former headquarters of Kaupthing, one of the three banks whose nationalisation in October 2008 heralded the crisis, Bjarni Stefansson, a shop assistant, struck a similar note to his Foreign Minister. "All this Alistair Darling wanted was to look strong. We are the ones who pay for it."

That anger at Britain, and a sense that Iceland was being pushed around simply because it was the little guy, was behind the petition signed by one fifth of the population demanding the President call a referendum.

Magnus Arni Skulason, the mild economist behind the InDefence group that initiated the Bill, was cautious yesterday in his analysis. He confessed that he had put the odds of the President vetoing the bill at 50-50 at best. In government, though, the decision was met with utter shock. "The President kept us totally in the dark," said Mr Sigfusson. "He didn't let us know what he was doing. And that made our reaction very difficult. We put out a press release within the hour, but the damage was already done."

As evening set in around half past three in Reyjkavik yesterday, animated civil servants at the finance ministry were hard at work to minimise that harm. They worked from an office with bookshelves that featured such helpful tomes as How to File for Bankruptcy under US Bankruptcy Code chapters 7 and 13.

Mr Sigfusson's anger was still palpable. He had spoken with his British counterpart, Mr Darling, but the conversation was fruitless. "At least we are on speaking terms," he said. "But I cannot say there was any advancement."

Many Icelanders now feel that whatever they do, the situation is unlikely to improve soon. The international reaction – Holland has also been highly critical – has left some nervous that getting what they wished for may not prove straightforward. "I guess I'm still pretty happy this decision was made," said Leifur Welding, a property manager, "but I don't know if Joe the Plumber should be deciding what we do. But I'm sure we can get a much better deal. If we sign this one my children will be in debt for the rest of their lives."

The flats Mr Welding runs are a signal reminder of the continued impact of the economic crisis on the capital. When the roomy, sleek-looking premises were built in the boom years, everyone joked that they were for the bankers. Then, says Mr Welding, "all these rich 25-year-old bankers started building 500 or 600 square metre mansions in the suburbs. They're 10 times the size of those apartments." Now the downtown blocks are available to tourists, with a studio starting at £25 a night.

A similar after-the-storm feel applies at Hotel 101, a swish-looking establishment with a restaurant-bar that was for the last 10 years the favourite hang-out for the wealthy entrepreneurs who once seemed to rule the city. At lunch-time yesterday, the establishment was all but empty.

As Icelanders look forward to a decade that is shaping up to be rather less glamorous, there remains a feeling that if it is only treated fairly, the country would gladly embrace a quieter life.

"Iceland was literally being taken over by oligarchs," says Andri Snaer Magnason, the author of Dreamland: a Self-Help Manual for a Frightened Nation. As he speaks, he cuts frugal-looking slices from the hefty burger sitting on his plate. "This news makes us more frustrated than angry. Now people just want to get on with their lives."