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Kingdom of the Netherlands-Netherlands and the IMF

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Public Information Notice (PIN) No. 03/92
August 8, 2003
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2003 Article IV Consultation with the Kingdom of the Netherlands—Netherlands

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2003 Article IV consultation with the Kingdom of the Netherlands—Netherlands is also available.

On July, 30, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Kingdom of the Netherlands—Netherlands.1

Background

Following several years of expansion, the Dutch economy is now in its third year of weak growth. Real GDP rose only 0.2 percent in 2002, and is projected to fall by 0.2 percent this year. However, activity is expected to begin to pick up later in the year, and to grow by 1.4 percent in 2004. Domestic demand growth stalled as rapid house and equity price increases, which had been boosting demand, came to an end. Profits and international competitiveness were threatened by high wage and price inflation during the boom of the late 1990s, and corporate balance sheets came under pressure. Export growth also collapsed, reflecting mainly the worldwide economic slowdown. The labor market initially reacted only gradually to the slack pace of activity, as firms hoarded labor, but in the first half of this year the unemployment rate began to rise sharply. Softness in labor and product markets moderated wage and price inflation, which are now converging on euro-area rates.

Substantial risks to economic recovery remain. To a large extent, the Netherlands shares these risks with the rest of Europe. There are as yet no concrete signs of stronger growth, and consumer and business sentiment are weak. Adjustment of corporate balance sheets may take longer than expected, and the fiscal retrenchment needed in many countries may hinder short-term growth. For the euro area, the recent currency appreciation is an additional risk. Domestically, a key risk is the possibility of sharp falls in house prices, which rose rapidly to historically high levels during the boom period. While the continuing shortage of housing may sustain prices, substantial declines could cut domestic demand significantly.

The fiscal position has deteriorated sharply, from a surplus of 2.2 percent of GDP in 2000 (1.5 percent of GPD excluding UMTS proceeds) to a deficit of 1.6 percent of GDP in 2002. This reflected in large part the operation of the automatic stabilizers, but also involved a significant structural weakening. Measures taken in the 2003 budget and the new coalition agreement should arrest and, over the next four years, partly reverse this deterioration. A strong medium-term fiscal position of a surplus of some 1 percent of GDP has been recommended by a high-level advisory body to deal with the fiscal strains of population aging. Health-care spending has emerged as an important source of budgetary pressure in the wake of a relaxation of top-down controls in favor of a more demand-driven system.

The substantial improvements in labor-market performance in the past two decades are attributable mainly to increased flexibility and sustained wage moderation. As a result, the Netherlands has enjoyed high employment and very low unemployment rates. Policy initiatives are nonetheless needed to address remaining weak points. The authorities are committed to reform of the large disability program (the beneficiaries of which amount to 13 percent of employment) and are introducing measures to raise labor-force participation of those in the 55-65 year age bracket. A start is to be made in reducing work disincentives at low earnings levels by reining in income-linked rent subsidies. Although the Netherlands is still generally in the forefront of EU countries with regard to product-market reform, momentum appears to have flagged.

Executive Board Assessment

Executive Directors commended the authorities on a longstanding record of sound fiscal and structural policies that had delivered an extended period of strong economic growth and very low unemployment. However, since 2000 economic activity has slowed considerably owing to declining growth in the United States and the euro area and an erosion of external competitiveness, as well as to weak domestic demand which can be traced to the end of rapid house price increases, falling equity prices, and concerns by firms regarding profitability and the state of their balance sheets.

While Directors expressed concern about these developments, they also referred to the past record of reform and the tradition to seeking social consensus to keep labor costs under control. They were confident that the Dutch authorities would succeed in meeting the new challenges.

Directors looked forward to a gradual recovery late this year and into 2004. Growth is expected to be stimulated by monetary easing in the euro area and the expected recovery in the United States, and wage and price inflation are falling toward euro-area levels. However, Directors also referred to the downside risks. Concrete signs of recovery had yet to materialize, and business and household confidence remained weak. Moreover, the appreciation of the euro could hinder growth and a possible correction in house prices could further undermine consumption.

Directors noted the sharp deterioration of the fiscal position. While this, to some extent, reflected the appropriate operation of the automatic stabilizers, Directors observed that the underlying position had also deteriorated. In the absence of corrective measures, this development risked jeopardizing the long-term fiscal goal of reducing the national debt over time to help pay for pension and health-care costs associated with population aging.

Directors thus commended the new government for taking measures to strengthen the public finances over the medium term. In view of the uncertainties regarding the economic recovery, they endorsed the approach of the authorities to allow the substantial operation of the automatic stabilizers in the short run. They also welcomed the emphasis on spending control and on durable measures to strengthen the medium-term fiscal position. Directors noted that spending could prove difficult to control, especially if the recent rapid increases in health-care outlays were not reined in. They agreed that the authorities' medium-term fiscal framework, based on expenditure ceilings and using windfalls to reduce the deficit, would be a key to achieving the fiscal objectives, which include a return to structural surpluses. Some Directors recommended to apply this framework flexibly if growth should turn out to be weaker than expected.

Directors also noted that the tax base could usefully be broadened. They welcomed the planned elimination of the tax deductibility of early retirement schemes, which should also help to increase the labor-force participation of older workers. Most Directors considered that narrowing and ultimately eliminating mortgage interest deduction would both raise revenue and remove a distortion to the allocation of savings. Other Directors, however, cautioned that such measures could undermine the policy to promote broad home ownership and adversely affect house prices.

Directors agreed that the Dutch financial sector remained sound and well supervised. The cyclical slowdown had cut banking profits, but margins and capital ratios remained high and institutions were vigorously reducing costs. Occupational pension funds had suffered from the collapse in stock markets, but the supervisor responded appropriately by requiring coverage ratios to be bolstered. Directors welcomed the authorities' decision to codify and modernize pension supervision, and a few Directors observed that a strengthening of the pension system was needed to protect the solvency of "second pillar" funds. Directors also considered that the merger of the prudential insurance and pension supervisor with the prudential banking supervisor—which follows an extensive reorganization of financial market supervision completed last year—would strengthen oversight, especially of the large conglomerates that dominate the Dutch market. Directors looked forward to the results of the Financial Sector Assessment Program exercise which will be conducted next year. They suggested that the exercise should assess the new supervisory structure and the risks associated with a possible downturn in housing prices.

Directors emphasized that the key medium-term structural challenge would be to further increase employment rates. They welcomed a number of measures to stimulate employment among those over 55 years old. Measures to sharply reduce inflows of beneficiaries into the very large disability program should also promote employment, although in future high replacement rates might have to be lowered to reduce the program's attractiveness. Directors noted, however, that more needed to be done to strengthen incentives to work by reducing high effective marginal tax rates (including the effect of lost benefits) at low earnings levels.

Directors agreed that further product market reform would be the key to raising productivity in the medium term. They welcomed the continuing liberalization of the network industries, and some Directors saw scope for further efforts to improve the regulatory framework and strengthen corporate governance. Directors noted that, overall, momentum for reform seemed to have faded. To reinvigorate the process and build public support, the benefits to consumers of reform should be made as clear as possible.

Directors commended the authorities' support for multilateral trade liberalization, and praised them for their generous level of official development assistance which exceeds the United Nations target of 0.7 percent of GNP.



Kingdom of the Netherlands—Netherlands: Selected Economic Indicators


 

1999

2000

2001

2002

20031

20041


             

Real economy (change in percent)

           

GDP

4.0

3.4

1.2

0.2

-0.2

1.4

Domestic demand

4.3

2.8

1.4

-0.2

2.8

1.3

CPI (year average)2

2.0

2.3

5.1

3.9

2.6

2.0

Unemployment rate (in percent)

3.2

2.6

2.0

2.3

3.8

4.4

Gross national saving (percent of GDP)

26.6

27.6

25.2

22.6

24.2

24.0

Gross domestic investment (percent of GDP)

22.6

22.3

21.9

20.2

20.5

20.4

           

Public finance (percent of GDP)

           

General government balance

0.7

2.2

0.1

-1.6

-2.2

-2.4

Structural balance

-0.6

-0.1

-0.7

-1.9

-1.6

-1.1

Structural primary balance

3.3

3.2

2.2

0.9

0.9

1.2

General government debt

63.1

55.8

52.8

52.6

52.5

53.7

             

Money and credit

           

(end of year, percent change)

           

Domestic credit3

14.2

16.4

8.6

8.3

...

...

M34

10.1

8.7

12.5

7.1

...

...

             

Interest rates (percent)

           

Money market rate

3.0

4.4

4.3

3.3

2.6

...

Government bond yield

4.9

5.5

5.2

5.0

4.3

...

             

Balance of payments (percent of GDP) 5

           

Trade balance

4.0

4.7

5.4

6.1

5.2

5.5

Current account

3.2

1.2

2.1

2.2

3.5

3.4

Official reserves, excl. gold (US$ billion) 6

9.9

9.6

9.0

9.6

...

...

Reserve cover (months of imports of GNFS)

0.5

0.5

0.5

0.5

...

...

             

Exchange rate

           

Exchange rate regime

Member of euro area

Euros per U.S. dollar (July 31, 2003)

   

1.12

     

Nominal effective rate (1990=100)

92.1

89.0

89.6

90.3

...

...

Real effective rate (1990=100) 7

93.3

91.3

93.1

95.8

...

...

             

Sources: International Financial Statistics; Dutch authorities; and IMF staff estimates.

1IMF staff projections.

2In 2001, an indirect tax increase is estimated to have increased inflation by 1.2 percentage points.

3Credit to euro area residents.

4 Dutch contribution to euro areas M3.

5Transactions basis; does not correspond to national accounts.

6Data for 2002 are through March 2002.

7Based on relative normalized unit labor costs.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.




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