IMF Executive Board Concludes 2008 Article IV Consultation with the Kingdom of the Netherlands-Netherlands AntillesPublic Information Notice (PIN) No. 08/119
September 18, 2008
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On September 15, 2008 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Kingdom of the Netherlands-Netherlands Antilles.1
A long period of stagnation has ended in the Netherlands Antilles as investor confidence has been boosted by the prospect of large-scale debt relief and fiscal responsibility under the December 2005 constitutional agreement. Economic growth accelerated sharply in 2007 to 3.8 percent, driven by investments in infrastructure, the housing and tourism sectors, and increased private consumption. Preliminary indications are that the growth momentum is continuing in 2008. Inflation, which broadly tracks U.S. inflation due to the exchange rate anchor, and has been historically low, is set to jump sharply due to the elimination of implicit oil subsidies in place since 2006.
The current account deficit widened markedly in 2007 to 16 percent of GDP, in line with the surge in FDI flows related to large hotel projects. While exports moderated temporarily, tourism was a bright spot due to improvements in competitiveness as a result of infrastructure investments, the euro appreciation, and cost controls from immigration. Imports surged in tandem with high oil prices and domestic demand, as could be expected given high import elasticities, typical for small open economies with limited domestic agricultural and manufacturing production. The large current account deficit was more than financed by Foreign Direct Investment (FDI), increased Dutch aid, and private sector trade credits. As a result, reserve coverage improved, fully covering short-term liabilities.
The government retrenched its finances, mainly through controls on spending. Notwithstanding income tax cuts, revenues have held steady due to improvements in collections. Spending cuts focused on curtailing current primary expenditure through reductions in the civil service and spending on goods and services, and low wage increases. However, total spending has remained high because of interest payments. Public debt remains close to 80 percent of GDP ahead of debt relief. All in all, the current budget balance has been held at 2⅓ percent of GDP during 2005-07, and is expected to decline further in 2008.
The financial sector seems broadly healthy and compares favorably with the region, with financial soundness indicators showing adequate capitalization, profitability and low nonperforming loans. Banking sector assets remain concentrated in the top two banks, reflecting limited competition on the funding side due to capital controls on institutional investors (pension funds and insurance companies), and market segmentation. However, increasing competition from smaller banks has compressed lending spreads modestly. Supervision and Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) efforts have been strengthened.
Looking forward, constitutional changes—now foreseen for January 2010—present both opportunities and challenges. Implementation of the dissolution agreement has started, with a balanced budget rule and fiscal supervision already in place in Bonaire, St. Eustasius, and Saba, and about to begin in St. Maarten and Curaçao starting 2009. A big push is underway to implement necessary policy changes and reforms. The broad range of reforms proposed in the draft tripartite protocol agreed between labor, government and business representatives to improve productivity, and the social economic initiative, indicate strong support for seizing this "once-in-a-lifetime opportunity" to undertake necessary reforms.
Executive Board Assessment
Executive Directors welcomed the resurgence of economic growth in the Netherlands Antilles. They commended the authorities for their efforts to implement key reforms ahead of the legal and political dissolution of the Netherlands Antilles, now planned for January 2010. They encouraged the authorities to take the opportunity provided by the large debt relief from the Netherlands government under the dissolution agreement to set the budget and the economy on a more sustainable footing. Progress will now need to be made to resolve outstanding issues, particularly regarding the timing and modalities of debt relief, and post-dissolution institutions. Balanced economic growth can be expected to continue over the medium term, provided that investor confidence—instigated by fiscal discipline and debt relief—is maintained.
Directors considered that the exchange rate peg of the Netherlands Antilles guilder to the U.S. dollar has served the economy well, and remains appropriate. They welcomed the recent indications of a strengthening of competitiveness. They took note of the staff's assessment that the exchange rate of the currency is broadly in line with fundamentals, and that the size of the current account deficit expected over the medium term appears to be manageable.
Directors welcomed the measures envisaged to underpin the balanced budget rule, and the plans to achieve balanced current budgets from 2009 onwards. They supported plans to sustain revenues by broadening the tax base and rebalancing the tax burden. Recent steps to control healthcare costs and reform the pension system should help alleviate the strains on public finances. Directors emphasized that fiscal policy will need to take into account the costs of targeted income subsidies to mitigate the impact on the poorest households of increased prices and higher levels of indirect taxes. Additional expenditure savings will be needed, including through entitlement reforms, civil service rationalization, wage restraint, and further pension reform, to achieve budget balance while meeting key social spending needs.
Directors noted the critical importance of managing the impact of debt relief on financial sector balance sheets. They welcomed the central bank's planned policy response, namely, to seek agreement with the Netherlands government on a gradual schedule of debt relief to avoid excess liquidity; to tighten monetary policy; and to ease gradually capital controls on institutional investors.
Directors considered the financial sector to be broadly healthy, but called for vigilance in the likely more challenging and competitive environment that lies ahead. As the opportunity to invest in risk-free government securities declines and lending margins narrow, financial institutions may be impelled toward greater risk-taking in order to preserve profitability. Thus, the central bank will need to monitor bank lending standards closely.
Directors observed that, given the limited macroeconomic policy tools available, structural reforms—including supportive tax and labor market policies—will be key to preserving investor confidence and external competitiveness. The broad spectrum of reforms envisaged in the draft tripartite protocol between the government, employers, and the labor unions should help in this regard. Directors recommended that the reforms be implemented as a package, to facilitate their acceptance by all the concerned parties.