@vartec: It's not quite a SNAFU..
IIS can indeed read encrypted text if you encrypt it using standard .NET encryption mechanism that won't break any UTF8 or Unicode encoding. Microsoft is also encouraging this as a best practice.
You can see a sample on encrypting connection string from this:
"How to: Secure Connection Strings When Using Data Source Controls"
http://msdn.microsoft.com/en-us/library/dx0f3cf2.aspx