Kingdom of the Netherlands—Aruba: Staff Concluding Statement of the 2019 Article IV Mission

April 1, 2019

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. 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, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

Economic activity in Aruba is slowly recovering, and the outlook is broadly positive but risks are skewed to the downside. Facing a severe deterioration in the fiscal position in the decade since the global financial crisis, the authorities have embarked on an ambitious fiscal consolidation plan that pinned down targets for 2019 and the medium term. The authorities have made good progress on the fiscal reforms. They are encouraged to sustain reform momentum to achieve the targets they have set and to put public debt on a downward path. At the same time, priorities should include: maintaining reserve buffers and safeguarding financial stability; removing structural impediments to sustained and inclusive growth; and enabling effective policy making by bridging data gaps.

A gradual improvement in economic activity

1. Aruba’s economy is slowly recovering. Following two years of weak growth, real GDP expanded by 2.3 percent in 2017 on the back of strong public consumption and buoyant tourism growth—with cruise visitors and U.S. tourist arrivals more than offsetting the effects of falling tourism from Venezuela. Despite increasing tourism, growth is estimated to have slowed to 1.2 percent in 2018, largely because of weaker public consumption, and a pick-up in import growth. Inflation was in negative territory in 2016-17, but rose to 3.6 percent in 2018, mainly due to increases in the turnover tax rate (mid-2018) and oil prices.

2. Growth is projected at 0.7 percent in 2019, and 1.1 percent over the medium term. The fiscal consolidation plan, while essential to put debt on a downward trajectory, will lower real GDP growth in 2019. This effect will be mitigated by continued strong growth in tourism from the U.S., and the implementation of multiple large investment projects (including the airport, utilities, hospital, and hotels) during 2019-21. Over the medium term, real tourism exports are expected to grow steadily at around 1.2 percent, and together with contributions from domestic demand, growth is expected to increase to 1.1 percent. Inflation is projected to fall to 1.7 percent in 2019 as the base effect of the turnover tax rate hike disappears and oil prices decline. Given the currency peg, inflation is expected to follow that of the U.S. over the medium-term and gradually rise towards 2.2 percent.


3. Risks to the outlook are tilted to the downside. Aruba is susceptible to a possible downturn in the U.S. economy. Risks from the crisis in Venezuela have largely materialized over the last few years as bilateral trade saw disruptions and Venezuelan tourist arrivals declined sharply. Nevertheless, Aruba has managed to absorb the crisis impact by diversifying both suppliers and tourist markets. The Venezuelan refugee and immigrant influx appears to have been limited so far. A worsening crisis that leads to sizable refugee inflows would put pressure on labor markets, infrastructure, and tourism. The planned fiscal consolidation would address important medium-term downside risks but could have greater-than-expected effects on growth in the near term. On the upside, the implementation of needed structural reforms would boost potential growth. Albeit a remote possibility, a re-opening of the refinery would bring associated investments and employment gains.

Maintaining the momentum on fiscal reforms

4. Several recessions over the past decade have weighed on Aruba’s fiscal position. The effects of the global financial crisis and the end of oil refining in 2012 depressed activity and increased fiscal deficits and public debt. In 2014, the authorities undertook significant entitlement reforms to address the fiscal challenges. Nonetheless, the sustainability of public finances remained a concern. In 2018, the authorities focused on “crisis management”, increasing turnover tax rates, which helped reduce the fiscal deficit. In 2019, they began a longer-term effort to reform the tax system and contain the wage bill.

5. The team supports the authorities’ fiscal consolidation efforts. The adjustment needs to contain a mix of tax reforms and expenditure rationalization. Tax reform efforts could follow previous IMF advice and emphasize broadening the base and shifting towards indirect taxation. Expenditure reductions should minimize adverse growth effects and protect essential government services. The team emphasized the importance of sustaining the implementation of reforms to achieve the government’s medium-term fiscal targets. It encouraged the authorities to identify and execute a few, easy-to-implement measures first, while ensuring that reforms are equitable, transparent, and well-communicated to ensure their durability.

6. Additional reforms are needed to achieve the authorities’ targets. This is based on the team’s assessment of the measures which have already been implemented. The mission discussed with the authorities a set of possible options:

  • There is scope to increase revenues and efficiency through indirect taxes. The introduction of a value added tax could replace the current indirect tax system. Efforts to improve revenue administration would also yield tangible benefits.
  • The efficiency of public spending can be improved. The mission recommends that the authorities undertake a comprehensive review of the wage bill to understand its main drivers and to put in place lasting measures that address its structurally high level. 
  • The authorities need to consider further measures to ensure that the healthcare system (AZV) does not pressure the government’s budget. Given population aging, there is a particular need to contain increasing healthcare costs.

7. The envisaged fiscal consolidation, while sizable, is not likely to be a major drag on growth over the medium-term. Empirical work on Aruba and other Caribbean countries shows medium-term fiscal multipliers to be small, partly because of their highly open nature.[1] Attention should be given to ensuring that social safety nets remain effective throughout the adjustment process.

8. A robust medium-term fiscal framework would bolster policy credibility and ensure durable gains from the adjustment. Preparing a medium-term budget is a step in the right direction but the process would benefit from formalizing a medium-term fiscal framework and eventually adopting a formal fiscal rule to safeguard sustainability. Broadening the coverage of fiscal data beyond the central government would ensure a more complete assessment of the government’s impact on the economy and any attendant risks.

9. There is a need to coordinate across the government on and codify the strategies for fiscal financing and debt management. Financing should avoid crowding out private sector credit or unduly pressuring reserves. The mission emphasized the importance of an asset/liability management framework that would help clarify the desired government-debt portfolio, capture cost-risk tradeoffs, provide more predictability to the financial system, and reduce macro-financial risks.

Preserving reserve buffers and financial stability

10. The banking sector remains sound, but credit growth is modest. Banks enjoy healthy profits, have declining non-performing loans, and maintain elevated levels of capital and liquidity. While such levels mitigate financial sector risks, they could indicate anemic demand or lack of viable business projects. Discussions with the authorities and stakeholders suggest that credit outside of large-scale tourism projects is difficult to acquire. The upcoming results from the financial inclusion survey could shed more light on possible issues and policy solutions.

11. International reserves are currently adequate to safeguard the peg but should be increased over the medium-term to maintain sufficient coverage and build buffers. Sustained fiscal consolidation and the implementation of growth-enhancing structural reforms (as discussed below) would support reserve accumulation.

12. The monetary policy stance remains appropriate. The Central Bank of Aruba (CBA) recently announced an increase in the reserve requirement ratio to 12 percent of deposits (effective May 2019) from 11 percent. This was to bolster international reserves, especially given the central government’s decision to finance all of 2019’s borrowing needs domestically. The mission sees this move as prudent and does not expect any potential negative effects on activity as banks have excess liquidity. Going forward, further tightening would be warranted if incoming data or expectations point to downward pressures on international reserves.

Unlocking the potential for high and sustained growth

13. Aruba should maintain its high-end tourism brand, while striving to diversify tourism sources. The team’s empirical analysis shows that tourist arrivals have a positive effect on growth. However, it also identifies an “exhaustion” effect, pointing to potentially diminishing returns from additional tourists. Aruba should, therefore, focus on offering high quality services and physical tourism infrastructure to maximize spending per visitor. Continued efforts to diversify the tourism base to Latin American countries are encouraged.

14. The authorities are making efforts to diversify the economy. The team welcomes the promising sectors initiative. An additional focus on increasing renewable energy use and energy efficiency will bolster competitiveness and the economy’s resilience. Ongoing efforts to expand and modernize the health care system will benefit Aruba and could create opportunities for medical tourism.

15. There is a pressing need to address structural challenges. For the authorities’ diversification plans to reap dividends, Aruba will need to address several structural impediments to growth related to the business environment, governance, and labor markets:

  • Reforms to improve the business climate need to be reinvigorated. The priorities are to remove red tape and reduce the cumbersome procedures associated with starting a business and getting permits and licenses. The e-government initiative to simplify and speed up the permit granting process is a step in the right direction. 
  • Addressing potential governance vulnerabilities, including corruption, is paramount. The recent CBA-conducted survey on perceived corruption raises some concerns. In October 2018, the government established a Bureau of Integrity which will become operational during 2019. Initially, it will focus on corruption prevention, awareness, and training. Subsequently, it will become a reporting agency. The mission encourages the authorities to proceed with their plans to fight corruption by establishing an integrity chamber, a corporate governance code, and an ombudsman.    
  • Policy should protect the worker—not the job—and bolster human capital. Labor market regulations are rigid. Procedures for terminating employment contracts appear cumbersome and costly—creating disincentives for voluntary resignations and hiring, thereby impeding labor mobility and job growth. Policy should promote labor market flexibility and at the same time provide effective protection to workers—severance pay could be replaced by an unemployment insurance program. Additionally, there is a need to strengthen vocational training and better align education curricula with private sector job needs.

Closing Data gaps to Better Inform Policies

16. Bridging data gaps would make policy-making more effective. The team welcomes the good progress made in revising the national accounts. It encourages the authorities to seek IMF technical assistance, if needed. While recognizing limited capacity to make quick progress, Aruba should aim to be covered in key comparative indicators such as the World Bank’s Doing Business and Worldwide Governance Indicators, and Transparency International Corruption Perceptions Index.

The mission team is grateful to the authorities and other counterparts for their gracious hospitality and the highly cooperative and candid discussions.

[1] Specifically, the cost to real GDP over 4-5 years from higher consumption taxes or lower government consumption of 1 percent of GDP is estimated to be close to zero. On impact, though, the multipliers are estimated to be larger.

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