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Kingdom of the Netherlands-Netherlands and the IMF
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On September 8, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV Consultation with the Kingdom of the Netherlands—Netherlands.1
The Dutch economy is starting to recover from a period of weak performance. Following several years of rapid expansion, GDP growth averaged only 0.2 percent during 2001-03, and turned negative in the latter year for the first time in twenty years. However, growth has strengthened in recent quarters, and staff expects the economy to grow by 1.1 percent in 2004 and by 1.8 percent in 2005. Improving exports are the main driver; domestic demand is expected to take longer to recover. Meanwhile, given soft labor market conditions and economic slack generally, price and wage pressures are likely to remain subdued for the period ahead.
In the context of the nascent recovery, downside risks to the outlook for growth are a concern with those stemming from domestic sources especially pronounced. Near-term growth is unlikely to make a significant dent in still rising unemployment, so even relatively minor changes to the wage and employment outlook could prompt a reassessment of income and therefore consumption plans. High household debt accentuates income risks, including those associated with higher interest rates.
The fiscal balance deteriorated markedly. Between 2000 and 2003, the general government balance worsened by almost 5 ½ percentage points of GDP, resulting in a breach of the 3 percent Maastricht ceiling in 2003. While part of the deterioration reflected the working of automatic stabilizers, another part—amounting to roughly 2 percentage points of GDP—was structural. The policy measures announced by the authorities should bring the deficit down to just under 3 percent of GDP in 2004. Risks—which, to avoid another breach, would need to be addressed if they were to materialize—stem in particular from health care costs and the budget situation of the local governments.
On the structural front, the authorities have plans for a number of key reforms in the period ahead. The disability scheme is to be reformed by restricting access only to those fully disabled, while introducing stricter criteria and examinations, and strengthening work incentives for the partially disabled. Also, fiscal incentives for early retirement are to be fully removed, while participation in collective early retirement plans is to be made voluntary. In the area of unemployment insurance, follow-up benefits (which had added 2 ½ years to the maximum of 5 years of main benefits available) have already been phased out. The authorities plan to eliminate short-term benefits as well, and tighten the eligibility requirements for the main unemployment benefits. To reduce inactivity traps, the earned-income tax credit is being gradually increased. The Netherlands has generally been at the forefront of product market reform in Europe, although some sectors (e.g., construction and nontraded services) have remained sheltered.
Over the past year, the Netherlands took part in an IMF Financial Sector Assessment Program (FSAP). During this period, the authorities were in the process of concluding a substantial overhaul of the institutional setup for financial stability policy by moving to a new cross-sectional structure of supervision by objective (prudential and conduct of business) and revising the laws that underpin financial supervision.
Executive Board Assessment
Executive Directors noted that the Dutch economy is emerging from an extended downturn, with continued low inflationary pressures contributing to increased external competitiveness. Directors expressed concern, however, over the depth of the downturn, the significant weakening of the public finances in recent years, and the prospect of falling potential growth if slowing productivity growth were to continue at a time when the population is aging. Directors therefore commended the authorities for their efforts to restore fiscal balance and to strengthen the foundations for a broad-based growth. They emphasized the need to sustain such efforts, especially those geared to raising potential output growth through reforms to labor and product markets.
In light of the Netherlands' earlier record of sound fiscal and structural policies, which underpinned economic success, Directors were confident that the authorities would continue to pursue appropriate policies in these areas. While expressing concern about some of the recent structural increases in spending, they concurred that fiscal policy seems to be on the right path and praised the government's determination to hold the deficit in 2004 to below 3 percent of GDP.
Directors observed that, while a recovery is in train, growth is expected to be slow this year, and downside risks, from both domestic and external sources, are a concern. In particular, Directors were concerned about the rapid increases in house prices and household debt, and their potential impact on income and consumption. Against these downside risks, they viewed fiscal policy in 2004 as appropriately balanced between needed fiscal adjustment in structural terms and avoiding excessive tightening. However, in view of possible fiscal slippage, Directors supported measures to limit public spending through closer cooperation between the central and local governments and, if necessary, direct budgetary controls on health care spending.
Directors pointed to the benefits of an ambitious medium-term fiscal adjustment, recommending a structural improvement of at least half a percentage point of GDP per year through the government's term. They considered that such an adjustment would put fiscal policy on an appropriate path toward ensuring fiscal sustainability and dealing with the impact of population aging, while also bolstering confidence. Directors were in broad agreement with the authorities' emphasis on debt reduction to save on interest payments to cover aging costs, but stressed that stronger and more concrete medium-term fiscal consolidation plans are needed. In identifying measures, they encouraged the authorities to improve incentives for work, including measures in the tax-benefits system. Some Directors favored a gradual phasing out of mortgage interest deductions, though these Directors and others stressed the need to consider carefully the impact of this measure on the housing market and the financial system.
Directors commended the broad features of the fiscal framework, particularly the emphasis on medium-term expenditure ceilings, but noted the importance of strengthening certain aspects. In this context, they welcomed the decision to devote revenue windfalls solely to debt reduction, thus avoiding a procyclical bias. Directors also urged the authorities to eschew spending cyclical expenditure savings. In addition, they stressed that enhancing the transparency of the expenditure ceilings and the ability to monitor them would strengthen clarity and discipline in the system.
Directors were encouraged by the authorities' efforts to reform the labor market. They welcomed important reforms to raise labor force participation and work effort, including the envisaged abolition of fiscal incentives for early retirement and the plan for a major overhaul of the disability scheme, supported by tight enforcement of any stricter disability criteria. However, while acknowledging the difficulties in building consensus for reform, Directors cautioned that reforms should also include the unemployment insurance scheme, to avoid having workers shift from one category of inactivity to another. Directors also urged the authorities to address inactivity traps, including by adjusting the minimum wage, which would also enhance the demand for low-skilled labor. To further raise participation, Directors stressed the importance of taking into account changes in life expectancy in determining the retirement age.
Directors were encouraged by efforts to raise productivity growth, noting that while overall productivity is high, its growth has slowed considerably in recent years. They therefore welcomed the establishment of the high-level Innovation Platform, the efforts under way to significantly reduce administrative burdens and improve corporate governance, and the work of the competition agency. Nevertheless, with a view to facilitating more efficient resource allocation, Directors felt that overly stringent employment protection hindered flexibility and implicitly taxed new hiring. In addition, Directors noted that greater wage differentiation would be helpful in attracting labor to higher productivity companies and sectors and in opening a channel to realize returns from investment in human capital. Directors also urged regulators to persevere with efforts to open new avenues for competition.
Directors welcomed the analysis of the FSAP and agreed with its conclusion that the financial system is sound, resilient to potential shocks, and well supervised. They commended the pending new financial supervision legislation, which will further strengthen the supervision system and account for the cross-sectoral nature of financial institutions. To prevent procyclical effects, Directors also felt that the authorities needed to allow sufficient flexibility for making up shortfalls in pension fund coverage ratios without unduly prolonging adjustment. More generally, they encouraged the authorities to continue with their commendable efforts to strengthen securities settlement arrangements and the financial stability policy framework. Directors welcomed the implementation of strong AML/CFT measures.
Directors applauded Dutch support of trade liberalization and strongly praised the generosity of their overseas development assistance, even in the face of budgetary pressures.
IMF EXTERNAL RELATIONS DEPARTMENT