Iceland's president said on Tuesday he would not sign into law a bill to repay more than $5 billion lost by savers in Britain and the Netherlands when the island's banks collapsed, creating fresh political turmoil for the crisis-hit country.

President Olafur Grimsson's rejection of the bill is seen putting aid from international lenders, as well as aspirations to join the European Union, in serious jeopardy.

Financial aid is vital for Iceland in the wake of its economic meltdown,

Only once in the republic's 65-year history has a president, whose post is largely symbolic, refused to sign a bill into law.

The constitution requires the issue to be put to a public vote if the president refuses to sign off on a bill.

"It has steadily become more apparent that the people must be convinced that they themselves determine the future course," Grimsson told a news conference.

"The involvement of the whole nation in the final decision is therefore the prerequisite for a successful solution, reconciliation and recovery."

After weeks of heated debate, Iceland's parliament late last month narrowly passed the bill in a move seen as a boost to the country's hopes of swift entry to the European Union and of getting its shattered economy back on track.

But the bill still required the approval of Grimsson, who was petitioned by nearly a quarter of the North Atlantic island nation's voters asking him to refuse to sign the bill and force a referendum on the fiercely debated issue.