Voters in Iceland rejected a second plan to repay debts to Britain and the Netherlands from a bank crash, partial referendum results showed Sunday, and the prime minister said economic and political chaos could follow.

The worst option was chosen. The vote has split the nation in two, Prime Minister Johanna Sigurdardottir told state television, saying it was fairly clear the no side had won.

With around 85,000 votes in the referendum counted, official figures showed 58 percent had voted against the accord compared with 42 percent in favor, the television said. Iceland has 230,000 voters but the turnout was not immediately available.

The prime minister, who had predicted a no vote would cause economic uncertainty for at least a year or two, did not say whether the government planned to resign.

We must do all we can to prevent political and economic chaos as a result of this outcome, she said.

The debt was incurred when Britain and the Netherlands compensated their nationals who lost savings in online Icesave accounts owned by Landsbanki, one of three Icelandic banks that collapsed in late 2008.

Icelandic lawmakers in February backed the repayment plan agreed with creditors in December but the president refused to sign the bill, triggering the vote. In March 2010, Iceland rejected an earlier Icesave repayment blueprint in a referendum.

COURT

Many Icelanders say taxpayers should not have to bail out irresponsible banks.

I know this will probably hurt us internationally, but it is worth taking a stand, Thorgerdun Asgeirsdottir, a 28-year-old barista said after casting a no vote at the Reykjavik city hall.

Svanhvit Ingibergs, 33, who works at a rest home, said: I had no part in causing those debts, and I don't want our children to risk having to pay them. It would be better to settle this in a court.

The dispute over repayment has soured relations between the small North Atlantic island nation and the two other countries.

It may now be solved in a European court rather than in bilateral talks -- a solution that may take several years and that some economists say would be much costlier.

It is clear that we have reached the end of the negotiation road, Finance Minister Steingrimur Sigfusson told television.

Sigurdardottir said Iceland would now defend its case before the court of the European trade body overseeing Iceland's cooperation with the EU, the EFTA Surveillance Authority (ESA).

Economic Affairs Minister Arni Arnasson told the television he would be in touch next week with ESA, which said last year, in a first stage in legal proceedings that Iceland should pay compensation to Icesave depositors.

Policymakers and economists have said solving the Icesave issue would help Iceland, whose economy fell into deep recession after its banks failed, get back into foreign credit markets to fund itself. That is a condition for it to remove controls on capital flows it imposed in 2008 to stabilize a tumbling currency.

The controls have left an estimated equivalent to a quarter of Iceland's gross domestic product in the hands of foreign investors, many of whom are expected to want to pull out when controls are lifted. Ratings agencies follow the vote closely. Moody's has said it may lower its credit rating on Iceland in case of a no.

Standard & Poor's analyst Elieen Zhang said a no vote might possibly result in a lengthy legal process and further uncertainties regarding the ultimate fiscal cost.

(Editing by Philippa Fletcher)

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