REYKJAVIK: Iceland's president has defended as "democratic" his decision to veto a compensation deal to cover the Icesave bank collapse, amid anger in Britain and the Netherlands.

President Olafur Ragnar Grimsson also said Iceland was committed to working with London and The Hague to meet its obligations over Icesave, after refusing to sign a bill on compensation for the British and Dutch governments.

Grimsson has instead referred the issue to a referendum, following public opposition to the bill, sparking a political and economic storm, with doubts growing over Iceland's recovery and EU membership bid.

"All over Europe there are countries that trust the people with the referendum," he told the BBC's Newsnight programme late Wednesday.

"What I decided to do was simply to follow an honoured European tradition of allowing the people to make the final decision."

Officials in Britain and the Netherlands have urged Reykjavik to meet its international obligations after they had had to compensate local savers who lost their money in Icesave.

On Wednesday, Standard and Poor's put Icelandic debt on CreditWatch negative, saying the veto could undermine the country's rescue package from the International Monetary Fund -- although the IMF has said there was no link.

S&P said that "as a result, we could lower our ratings on Iceland by one to two notches within a month."

Moody's Investors Service meanwhile said the president's move had "uncertain credit implications but will certainly complicate any near-term plans (for Iceland) to exit from its financial and economic crisis."

On Tuesday, Fitch credit rating agency downgraded Iceland's long-term debt rating to junk status, from BBB- to BB+, citing a "renewed wave of domestic political, economic and financial uncertainty."

The Icesave bill, narrowly approved by the Icelandic parliament on December 31, calls for 3.8 billion euros (5.4 billion dollars) to be paid to the British and Dutch governments who had to compensate more than 320,000 British and Dutch savers who lost money in the collapse of the Icelandic bank.

The payout has stirred up resentment among many ordinary Icelanders.

About 60,000 people -- or about a quarter of the electorate -- have signed a petition protesting against the bill which they fear will doom them to decades of poverty, all because of the mistakes of a handful of bankers and financial regulators that sparked their country's financial collapse in October 2008.

The Icelandic parliament is expected to reconvene on Friday to discuss whether to hold the referendum on February 20, a political advisor for Prime Minister Johanna Sigurdardottir told AFP.

Sigurdardottir has staked her political future on passage of the bill, suggesting her government could step down if it were blocked.

A poll among 877 Icelanders and published on Wednesday by the MMR polling institute indicated that 58 percent would vote 'No' to the Icesave bill in a referendum and 42 percent would support it.

Meanwhile, Britain and the European Commission warned Iceland a 'No' vote could jeopardise its bid to join the European Union.

A spokesman for the European Commission, which is preparing an opinion for the EU's 27 member states on how long Iceland might need to join the bloc, said "economic questions like the case of Icesave ... will be analysed very closely."

Baldur Thorhallsson, a political science professor at the University of Iceland and an EU specialist, told AFP he expected the Icesave debate to play a role in Iceland's membership bid.

"A decision is expected in March from the EU on whether to start the negotiations and I think the UK and Netherlands will hesitate before agreeing to the negotiations," he said.

Icelandic support for an EU application soared above 60 percent at the height of the country's financial collapse, with the bloc seen by many as a safe haven.

But by September, a Gallup poll showed that 50.3 percent of Icelanders opposed EU membership and only 32.7 percent supported it.

The EU implications however took a backseat in Iceland on Wednesday, with more attention paid to the impact the Icesave bill would have on the country's economic recovery as concerns grew that foreign investment could be hit as a result.

"The key to the recovery is that Iceland has access to (international) financial markets," Vilhjalmur Egilsson, director of the Federation of Icelandic Employers, told the daily Frettabladid.