Kingdom of the Netherlands-Aruba: Concluding Statement of the 2013 Article IV Consultation Mission
April 26, 2013
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Aruba has weathered two major shocks in recent years that resulted from the global financial crisis and the shutdown of the oil refining operations. Real GDP contracted by a cumulative 15 percent during 2009-10. These shocks have substantially eroded the authorities’ fiscal policy space and public debt has climbed to 67 percent of GDP. Partly due to strong policy actions, tourism, the mainstay of Aruba’s economy has rebounded quickly, the banking sector has withstood the recession well, and unemployment has significantly decreased. Nonetheless, the overall economic recovery is progressing gradually, and output is still 12 percent below its pre-crisis level. Aruba faces the challenge of rebuilding its lost fiscal space without jeopardizing a relatively weak recovery. Fiscal deficit is projected to decline in 2013, and a daunting task remains ahead. Ensuring a steady recovery will require maintaining competitiveness through further diversification of tourism markets and keeping wage growth in line with productivity developments.
The economy faces a tepid recovery
1. The economy suffered two major shocks in the last four years. First, the global financial crisis, which hit Aruba’s tourism sector and Foreign Direct Investments (FDI) in 2009, and second, the shutdown of oil refining operations by Valero due to poor profitability. Although tourism, the mainstay of Aruban economy, rebounded quickly due to aggressive market diversification efforts, real GDP took a second dip in 2012. Unemployment has come down substantially since 2009 but remains high at 9½ percent at end-2012 partly due to the shutdown of the oil refinery.
2. Growth is projected to resume in 2013. The economy is expected to grow at little over 2 percent in 2013 on account of robust tourism and some pick-up in private consumption due to price deflation as a result of structural reduction of water and electricity tariffs. A rebound in investment is expected during 2014-16 on account of large infrastructure and urban renewal projects. However, Valero’s shutdown of refining has created harder-to-fill gaps in private investment and non-tourism exports which will hold down a more robust recovery. Real GDP is projected to reach its pre-crisis level only in 2018.
3. Short-term risks are tilted to the downside while, in the medium-term, economic prospects could be brighter. With a high dependence on tourism and oil imports, Aruba faces downside risks from renewed weaknesses in the global economy and increases in oil prices. In the medium-term, there are upside risks from resumption of oil refining by Valero, and large scale investment in the renewable energy sector.
Ambitious fiscal consolidation is needed to rebuild the lost fiscal policy space
4. Notwithstanding measures taken, Aruba’s fiscal position deteriorated sharply since 2008. Preliminary data suggests that the overall fiscal balance recorded a deficit of 8½ percent in 2012. The authorities have undertaken notable reforms in recent years to address the deteriorating pension and health related expenditure in cooperation with the partners of the Social Dialogue, including introducing a mandatory general pension. These measures, along with collection of tax arrears, were not sufficient to contain the rapid widening of the deficit, which had been a combined result of halving of the business turnover tax rate to stimulate the economy, rising public sector wage bill (partly a result of payment for arrears), and increased spending on goods and services. Public debt has reached 67 percent of GDP at end-2012, and the financing of the deficit, despite a successful bond issuance last year, has substantially eroded government deposits.
5. Appropriately, fiscal consolidation is planned to take hold this year. The 2013 budget aims to halve the deficit through higher dividend payments from state-owned enterprises, and containment of wage and other current expenditures. The mission views putting the deficit on a downward path as an urgent task and deems a reduction of the overall deficit to 6 percent of GDP in 2013 as achievable. To ensure this outcome, the mission recommends resisting possible expenditure pressures during the election year.
6. In the medium term, Aruba will need ambitious and steadfast fiscal consolidation. Without additional measures, the central government’s fiscal deficits will remain elevated in the medium term risking public debt reaching unsustainable levels. Financial deficits of the general pay-as-you-g0 pension system Algemene ouderdomsverzekering (AOV), despite recent reforms, and payment for the investment projects under the Public Private Partnerships (PPP) could further widen the deficit beginning as early as 2014. Aruba’s exposure to external shocks, a narrow economic base, the fixed exchange rate regime, and a sizable interest burden call for building up fiscal buffers and reducing debt to a prudent level. The mission recommends a consolidation of at least 8 percent of GDP to reach a small fiscal surplus and bring debt down to below 60 percent of GDP by 2018. To ensure that financial liabilities from the AOV and the PPP do not add to the fiscal pressures, it is important to implement further pension reforms and put a limit on the size of the PPP-related expenditure commitments.
7. Both expenditure and revenue measures will be needed to achieve the envisaged consolidation.The authorities’ plan to balance the budget by 2016 mostly through expenditure reduction is a move in the right direction. The authorities also plan to establish a fiscal council and adopt a fiscal rule. The mission welcomes these objectives, and recommends clearly identifying specific measures and undertaking necessary steps early on to achieve the planned expenditure reduction. Additional revenue measures are needed given the size of the consolidation. International comparison suggests that there is scope for revenue increase through higher indirect taxation. This can be done either through increasing current indirect taxes, or through implementing a value-added tax (VAT) designed to fit Aruba’s specific needs. Since the latter may warrant technical assistance and a preparation time of 1½ to 2 years, the authorities would need to start with the preparatory work for VAT soon, if they choose to go this way, in order to reap benefits in the medium-term.
Monetary policy should continue to support the recovery
8. The current accommodative monetary policy stance is appropriate, given projected deflation and economic slack. Credit growth remains in the single-digit with low demand and tight lending standards. The banking system’s excess liquidity has increased substantially since mid-2012 and may increase further if the government secures external financing through bond issuance and manages to reduce its interest burden on the existing debt stock through arrangements with the Netherlands. In case the demand picks up and credit growth turns rapid, a very low risk at this point, the authorities would need to mop up the excess liquidity by increasing the required reserves ratio.
9. The banking sector has withstood the recent recession well. Preliminary 2012 data shows that the nonperforming loan ratio has come down substantially since 2010 and stands at around 7 percent as of end-2012, with loan loss provisioning levels improving. The aggregate capital adequacy ratio stood at 19.6 percent at end-2012, well above the regulatory minimum and higher than in the pre-crisis period. Profitability indicators started to recover in recent months but remains below their pre-crisis levels.
A steady recovery needs safeguarding competitiveness
10. Despite recent shocks, Aruba seems to have maintained its external competitiveness. Reflecting the strength of the tourism sector, the non-oil current account balance has improved consistently since mid-2000 reaching a balanced position in 2012. The overall current account surplus of 4½ percent of GDP in 2012 reflects a one-off export of Valero inventory. External debt remains high at 105 percent of GDP, but the high share of long-term debt reduces rollover risks. Aruba’s foreign exchange reserves, which cover 5 months of imports and 41 percent of broad money, also seem adequate to safeguard the pegged exchange rate regime.
11. A steady recovery strongly depends on maintaining competitiveness going forward. Recent initiatives to diversify the tourism market and the reduction in utility prices have helped Aruban economy’s competitiveness. With the U.S. accounting for 60 percent of tourists, the mission sees scope for further diversification. For a pegged exchange rate economy prone to external shocks, maintaining competitiveness will also depend on containing wage growth, particularly given Aruba’s declining productivity, and increasing labor market flexibility.
12. Developing the renewable energy sector in the long run offers substantial potential but caution is needed in its financing. In the absence of oil refining and the limited growth prospects for tourism, Aruba needs a new source of growth. Given the adverse demographic trends, a capital- and technology-intensive growth pillar centered on available natural resources offers the right long-term path for economic diversification for Aruba. The mission recommends financing such projects through FDI in order to preserve Aruba’s external sustainability.
The mission team is grateful to the authorities and other counterparts for their excellent hospitality and highly cooperative and frank discussions.