Mission Concluding Statement 

Kingdom of the Netherlands–The Netherlands: Staff Concluding Statement of the 2021 Article IV Mission

September 28, 2021

Washington, DC: An International Monetary Fund (IMF) mission, led by Mr. Alfredo Cuevas, met virtually with the Dutch authorities on an Article IV consultation from September 7-27. The following statement was issued at the end of the mission:

The Dutch economy has weathered the pandemic comparatively well, with a smaller recession than the Euro Area in 2020 and a strong recovery so far in 2021. This reflects both the intrinsic resilience of the economy, supported by a high degree of digitalization, and a comprehensive policy package that took advantage of abundant policy space. The policy interventions included a focused response of the health sector and programs to help affected businesses and individuals. This cushioned the economic impact of the pandemic by protecting jobs, supporting household incomes and helping firms preserve liquidity and solvency, also preventing adverse financial sector spillovers. Moreover, monetary accommodation and regulatory and supervisory easing supported financial intermediation during the pandemic while a successful vaccination effort has helped move the economy towards normalization.

As a result, unemployment has nearly returned to pre-pandemic lows, and bankruptcies have remained lower than usual, also helping the financial sector to maintain its resilience. Banks remain well capitalized, while intensifying pressures on pension funds and insurers from lower interest rates have been largely compensated by rising asset values. The formation of a new government offers the opportunity to set ambitious medium-term objectives and policies to support a greener and more sustainable economy, boost growth potential, and address key medium-term challenges.

Economic outlook

The economy is projected to rebound robustly in 2021. In 2021, growth is projected at 3.8 percent, as domestic demand continues to strengthen, helped along by a successful vaccination rollout. GDP will exceed its pre-pandemic level by the last quarter of 2021. Real GDP growth should remain vigorous at 3.2 percent in 2022, before easing gradually towards a medium-term rate of about 1 ½ percent. The mission estimates that the economy should return to its pre-pandemic trend by 2026, with minimal scarring, if any. [1]

Risks to the outlook are broadly balanced but subject to substantial uncertainty. On the downside, a renewed flare-up of the pandemic, driven by, e.g., the emergence of new variants of the virus, could pose short-term risks. Also, private sector vulnerabilities may crystallize with the phasing-out of government policy support. On the upside, domestic demand may grow faster if households spend a large share of the savings accumulated during the pandemic, while a faster-than-expected recovery in the Euro Area would bolster Dutch exports. Further out, financial sector risks from high real estate exposures and valuations may materialize. Among commercial properties, the crisis has affected rental income expectations, also by accelerating structural shifts in demand for retail and office space, yet with rather limited effect on prices to date. Residential real estate markets remain tight with potential price corrections more likely to lower consumption than to affect mortgage quality, given the record of strong performance of residential mortgages across the cycle.

Near-term priority: pivot to targeted support to the economy

As the recovery strengthens, the authorities are appropriately transitioning to more targeted policy support measures aimed at sectors still facing restrictions; but they should remain ready to reactivate broader support programs if necessary.

• Under current plans, the main broad support programs, notably the NOW, are scheduled to expire at the start of October 2021. This decision is justified by the strength of the labor market, where vacancies currently exceed the number of unemployed individuals, and the high proportion of the population who have been vaccinated, which is expected to enable most businesses to operate under close-to-normal conditions, supported by the new “corona pass.”

• However, the evolution of the pandemic remains uncertain. For that reason, the mission welcomes the government’s decision to keep its expanded loan guarantee program in place, offer generous grace periods and maturities for the repayment of tax debts, and retain targeted support measures for industries where some restrictions remain in place. The mission also encourages the authorities to remain ready to reintroduce broader policy instruments if substantial downside risks materialize.

Forward-looking and targeted policies should help ease the road to normalization. Such policies include:

• Supporting viable firms. Ensuring that viable firms avoid unnecessary bankruptcies is important. The mission encourages the authorities to consider policy proposals for supporting viable but challenged firms through active state engagement with other creditors in restructuring efforts.
• Facilitating the mobility of factors of production to expanding industries . Removing general support measures such as NOW may temporarily increase unemployment. Policies should foster the reallocation of the laid-off to new jobs. Ongoing initiatives to support training and career counselling are welcome developments in this respect and should flexibly meet post-pandemic labor demand. In addition, a new law aiming to facilitate debt restructuring for companies in financial difficulties has been approved. Efficient restructuring and insolvency procedures will facilitate capital reallocation towards viable firms.
• Fostering investment . Supporting the adaptation of business investment to structural changes would help strengthen the recovery and support growth in the medium term. Public support to R&D would help boost investment in technology, and selected public capital projects could crowd in private investment. Establishing a credit bureau would help improve funding for SMEs, facilitating their investment activity.

Financial sector policies should encourage continued financing for viable borrowers and the use of available buffers to recognize impaired exposures. With about a quarter of NFC bank lending to sectors most affected by the pandemic, some businesses may be challenged once government’s pandemic support programs expire. Within established frameworks, banks should pro-actively offer debt forbearance to viable borrowers on a case-by-case basis. Losses deemed unavoidable should be acknowledged by deploying provisions and capital buffers while maintaining a prudent profit distribution policy. The authorities should ensure that banks can play an active role on these fronts.

In the medium-term: boost potential growth and address areas of vulnerability

The Dutch fiscal position remains strong despite the impact of the pandemic, enabling the government to support growth in the medium term. After three consecutive years of surplus, the fiscal balance turned to a deficit of 4.3 percent of GDP in 2020 and a projected 6.1 percent in 2021. Based on current policies, the budget deficit is projected to decline to 2 percent of GDP in 2022 as extraordinary support measures are rolled back, and to vanish by 2025. Public debt is expected to stay below the Maastricht benchmark of 60 percent of GDP in 2021, before falling back to below 50 percent in the medium term. The replenishment of fiscal space, thus, can take place while allowing the government to support a resilient, green and inclusive economy. Especially:

• Raising public investment in the Netherlands’ first-rate education system would help address skills shortages, as well as persistent inequalities in school achievement among children of different socio-economic backgrounds, which may have been accentuated by the pandemic. In percent of GDP, expenditure on pre-primary education is one of the lowest among EU countries, while expenditure on primary education has declined in the past decade. Teacher-to-student ratios are also significantly below EU averages in pre-primary, primary and secondary education. Against this background, the authorities’ recent announcement of new spending worth 8.5 billion euros (about 1 percent of GDP) to support a National Education Plan is welcome. Additional structural investments in education could help the Netherlands stay among frontier countries in terms of educational outcomes and reduce inequality.

• Increasing public spending in basic research would help maintain the Netherlands’ position as an innovation leader and generate positive spillovers. While the Netherlands’ total spending on R&D is in line with the EU average, direct public support to R&D is below that observed in frontier countries. The launch of the National Growth Fund, with R&D one of the main targeted areas, is an opportunity the boost this kind of investment. The authorities should also support further development of digitalization, which proved its worth during the pandemic. Likewise, public support for greener technology among Dutch firms would foster a more sustainable economy, while creating new growth opportunities. Next Generation EU funds, while relatively modest in the case of the Netherlands, should in part be deployed in these areas.

Ensuring financial stability entails a close monitoring of risks in the real estate market and addressing challenges for financial institutions from low interest rates.

• The housing market has continued to tighten during the pandemic, reflecting longstanding imbalances between supply and demand and lower borrowing costs. The activation of floors for risk weights applied to mortgage lending from 2022 is welcome and may be complemented by additional measures to limit riskier forms of housing debt by, e.g., further reducing loan-to-value ratios over time. To further the ongoing reduction of the subsidization of owner-occupied housing, in addition to continuing the progressive moderation of the deduction of mortgage interest payments, the authorities could consider options such as gradually increasing imputed rental income in Box 1 of the income tax or gradually moving the home and its corresponding mortgage to Box 3. Furthermore, it will be crucial to step up efforts to remedy an inelastic housing supply, as market imbalances are also sustained by structural rigidities, such as distorted planning incentives and restrictive building or zoning laws.

• Vacancy rates for commercial properties have picked up in the wake of the recession, but prices have continued to increase, as investment yields, despite some compression in recent years, have stayed attractive in relation to other asset classes. The authorities should contemplate options to better steer the investment cycle of commercial real estate and prevent the build-up of financial stability risks, potentially modelled on policies in place for residential properties. Furthermore, measures to preserve the value of existing buildings by incentivizing climate-friendly modernization or by facilitating the rededication of obsolete commercial structures for residential use should be pursued.

• Challenges for banks and insurers have been compounded by the interest rate declines since the start of the pandemic. Banks’ operating income has come further under pressure while non-bank financial institutions have shifted some of their portfolios towards riskier assets. Therefore, ongoing supervisory vigilance is warranted to recognize an undue build-up of risks and take appropriate countervailing measures at an early stage.

Reducing duality in the labor market can strengthen productivity growth and resilience to future shocks. Although the pandemic has had a comparatively limited impact on the Dutch labor market, the self-employed and workers with flexible contracts were shown to be especially vulnerable to job and income losses. Ensuring appropriate social protection, including a mandatory disability insurance for the self-employed as currently planned, is a step in the right direction. Policies should also continue realigning tax and other incentives across different types of employment and improve employment protection for workers in flexible contracts. Employing a larger share of the workforce on a more permanent basis would also incentivize employers and employees to invest in training, lifting long-term productivity.

The Netherlands’ ambitious climate change agenda can be further strengthened. The goal of reducing greenhouse gas emissions by 49 and 95 percent, by 2030 and 2050, respectively, relative to 1990 levels, is ambitious, and the government has already adopted a range of measures in pursuit of these goals. However, under current policies, national targets would likely not be achieved and may move further out of reach in the context of the new EU Green Deal (although the full implications of the latter for individual countries are still being worked out). So, policies need to be strengthened soon, given the long lags involved. Options to complement existing policies could include feebates or other instruments to reinforce carbon pricing across all sectors targeted in the 2019 Climate Agreement. In particular, consideration could be given to surcharges on CO2 emissions in the power sector while gradually removing taxes on residential and industrial use of electricity. It is important to address emissions in agriculture, which are disproportionate in relation to the size of the sector in the economy, and the built environment, where policies must induce responses by large numbers of firms and households and interact with structural imbalances. Care should be taken that vulnerable households are protected from disproportionate carbon pricing burdens. As noted above, additional public investment and well-coordinated planning and regulatory work will be needed to underpin the energy transition and act as catalyst for green private investment. [2] In this regard, the new resources included in the 2022 budget represent a positive step.

Maintaining the momentum in the implementation of the pension agreement is important. The reform of the second pillar will help stabilize contribution rates and encourage early enrollment by acknowledging the time value of money. This way the reform should help reduce intergenerational tensions in the system and smooth some of the procyclical effects of interest rate movements on private consumption. The reformed schemes will be better suited to deal with an evolving labor market, characterized by higher mobility and changing patterns of work. Given the pressure on the occupational pension system due to lower interest rates that have boosted liability valuations, further delays on implementation of the pension reform should be avoided.

Reforms of international and capital taxation underway should have positive implications. The wide use of special financial institutions for tax planning has come under scrutiny and prompted reform initiatives by the government aimed at tightening the rules, including the introduction of a cross-border conditional withholding tax and revisions to the tax treaty policy. These efforts are welcome and should continue. A broader reform of Box 3 that taxes actual rather than notional returns would achieve more equitable taxation across different assets, including those of renters and homeowners.

The mission wishes to thank its interlocutors in government agencies, the DNB, the CPB, the PBL, and the private sector for generously sharing their time and knowledge.