Nov. 7 (Bloomberg) -- Iceland may receive a $6 billion financial aid package from a group led by the International Monetary Fund after the collapse of the island's banking system paralyzed much of its foreign exchange market.

The group also includes Scandinavian countries, the U.K., the Netherlands and Poland, which will contribute about $200 million to the group, the Polish Finance Ministry said in an e-mailed statement. Magdalena Kobos, a spokeswoman for the ministry, confirmed the authenticity of the statement by telephone.

Iceland's central bank yesterday predicted a deeper recession than previously expected and lifted its inflation forecast. The economy will shrink 8.3 percent next year, compared with a July estimate of a 2 percent contraction. Inflation will average 14.1 percent in 2009, compared with a previous estimate of 7.6 percent.

The IMF has said it will lend the Atlantic island $2.1 billion. Norway has offered 500 million euros ($635 million) and the Faroe Islands 300 million kroner ($51 million). The IMF executive board yesterday postponed until Nov. 10 a meeting to approve the loan, Prime Minister Geir Haarde told lawmakers. The IMF said on Oct. 30 the board would consider the loan on Nov. 5.

The central bank yesterday kept its benchmark interest rate at a record 18 percent, following conditions dictated by the IMF.

Currency Crisis

Iceland needs to keep rates high to stabilize the currency, even after the IMF said the economy may contract as much as 10 percent in 2009 as the failure of the island's biggest banks led to the collapse of the krona. The central bank, which now holds daily krona auctions setting the rate at about 164 per euro, has urged banks to reserve foreign exchange for purchases of food, fuel and medicine as it tries to revive the currency.

The government took control of the island's three biggest banks, Kaupthing Bank hf, Landsbanki Islands hf and Glitnir Bank hf last month after they were unable to secure short-term funding. That precipitated the collapse of the krona, with the central bank attempting a currency peg, only to abandon the measure the following day citing ``insufficient support.''

The three banks together amassed debt worth $61 billion, equivalent to about 12 times the size of the economy, according to Bloomberg data. The government has yet to provide a clear plan on how that debt will be repaid, with Glitnir and Kaupthing already having failed to make bond payments.

Ring-Fencing

According to credit analysts Eileen Zhang at Standard & Poor's, the government is ``ring-fencing'' the domestic interests and ``probably abandoning'' external liabilities, she said in an Oct. 9 interview.

Icelandic officials prepared for talks with creditors in the next few weeks aimed at restructuring the country's banks' foreign currency debt, the Wall Street Journal reported today, citing participants. Deloitte & Touche LLP has been hired to give advice to the resolution committees set up by the Icelandic Financial Services Authority, the Journal reported.

The last western nation to seek IMF support was the U.K. Britain's 1976 application for IMF aid under then Prime Minister Jim Callaghan left the Labour Party in tatters as it was forced to abandon spending pledges it had been voted into office on.

The period of economic turmoil, including a 16 percent slump in the pound against the dollar in 1976, was also pivotal in securing backing for the Conservative Party, leading to the election of Margaret Thatcher in 1979.

Moody's Investors Service had rated Iceland's government bonds Aa1 until Oct. 8 this year. The rating company now ranks the island's state debt A1. Moody's also cut its foreign currency bond rating to Aa1 from Aaa on Oct. 8.

To contact the reporter on this story: Nathaniel Espino in Warsaw nespino@bloomberg.net

Last Updated: November 7, 2008 02:01 EST