Fitch Ratings cut Iceland's long-term sovereign foreign currency credit rating one notch to BB-plus, or junk status, on Tuesday after President Olafur Grimsson forced a referendum rather than sign a bill seen as key to restoring the nation's access to foreign capital.
The outlook on the credit is negative, Fitch said in a statement.
"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 sovereign credit analyst Paul Rawkins said.
"It also represents a significant setback to Iceland's efforts to restore normal financial relations with the rest of the world," Rawkins added.
Grimsson refused to sign a bill that would repay $5 billion to Britain and the Netherlands for money lost by savers in those countries when its Icesave bank collapsed in 2008.
Both Britain and the Netherlands have already compensated savers.
The decision is also seen as a threat to economic aid as the island nation has been reliant on a $10 billion lifeline from lenders led by the International Monetary Fund.
The government said a referendum would be held as soon as possible.
The outcome is highly uncertain, with opinion polls showing almost 70 percent of voters oppose the bill.
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