Public Information Notice: IMF Concludes Article IV Consultation with Aruba

May 26, 1999

On May 7, 1999, the Executive Board concluded the Article IV consultation with Aruba.¹

Background

In 1998, Aruba's real GDP grew at an annual rate of some 3 percent, while inflation remained subdued at about 2 percent. Comparable rates of satisfactory growth and low inflation have characterized the island's development since the mid-1990s, following a period of double-digit growth when an investment boom in the hotel sector brought about the transformation of Aruba into a tourism-based economy.

The outlook for satisfactory growth and low inflation had been threatened, however, by an undue relaxation of fiscal policy in 1996 and continued laxity through mid-1998. Deficits of more than 2½ percent were recorded in 1996 and 1997, reflecting a boost in expenditure and slippages in revenue collections. These deficits were in large part financed by the accumulation of public sector payments arrears, the stock of which reached more than 5 percent of GDP by mid-1998.

In order to restore budgetary discipline, a significant fiscal correction was undertaken in 1998, mostly through expenditure restraint. By year-end the budget deficit was reduced to less than 1 percent of GDP, and the buildup of arrears was partly reversed. Fiscal adjustment continued in the context of the 1999 budget, which aims to bring the public finances close to balance, in part as a result of stepped-up efforts to clear a multiyear backlog in tax collections. The outstanding arrears are also expected to be cleared in the course of 1999.

The objectives of the Central Bank of Aruba have continued to be the preservation of the fixed exchange rate of the Aruban florin to the United States dollar and the achievement of a strong net foreign asset position for the consolidated banking system. These assets fell below four months of (non-oil) merchandise import cover in early 1998, reflecting in part rapid domestic credit growth. In order to stem the loss of net foreign assets, the central bank-which had progressively moved away from the use of direct instrument of monetary policy-tightened monetary conditions in April 1998 by raising cash reserve requirements, setting the stage for a recovery of net foreign assets position at year end.

In 1998 the supervisory capabilities of the central bank were strengthened with the enactment of a new regulatory framework embodying the Basle Committee Core Principles for Effective Banking Supervision, and similar laws concerning the insurance industry are been finalized for parliamentary consideration.

Aruba's non-oil current account improved markedly in 1998 and registered a surplus of about 3 percent of GDP, as a result of strong earnings from tourism. Aruba has generally liberal external policies. In July 1998, the capital account was further liberalized, as licenses were discontinued for transaction below Af. 500,000 (Af. 200,000 for natural persons.)

The outlook for GDP growth in 1999 is about 4 percent, on upbeat prospects for tourism. Inflation is likely to remain subdued. In the future, economic growth in Aruba will depend on upgrading the quality of tourism and promoting the diversification of the economy, against the backdrop of stability-oriented fiscal and monetary policies.

Executive Board Assessment

Executive Directors noted that, for much of the past decade, Aruba's performance had been characterized by strong economic growth, moderate inflation, and a high level of employment underpinned by generally sound financial policies. However, this positive performance had been threatened by fiscal laxity in recent years. Directors stressed that the main challenges facing the authorities are to consolidate the ongoing efforts to return the public finances firmly to a sustainable course and to address outstanding structural issues.

Directors commended the authorities for the decisive action undertaken from mid-1998 to correct the fiscal imbalances. They welcomed the significant reduction of the deficit in 1998, and urged steadfast budgetary discipline to achieve a balanced budget in 1999. In this regard, they noted that the plans under way to control spending, including those to contain the public sector payroll and to rationalize the public investment program, were key to ensuring achievement of the fiscal objective for 1999. Moreover, Directors welcomed the authorities' efforts to strengthen tax administration and their intention to broaden the tax base. They felt that this was essential if fiscal consolidation over the medium term was to be achieved. In this connection, they urged the authorities to refrain from granting further tax holidays and loan guarantees, as they created open-ended fiscal commitments. In addition, Directors strongly endorsed the authorities' objective to clear domestic payments arrears by year-end, stressing the importance - for the restoration of good governance - of a prompt and transparent implementation of current plans.

Directors indicated that fiscal sustainability in the presence of unfavorable demographic trends would require far-reaching reforms in social entitlements, including in the pension and health systems. In this connection, they underscored the need to gradually increase the retirement age for all employees, and cautioned against the adoption of a new health scheme before its financial viability was ensured.

Directors agreed that the present exchange rate peg of the florin to the U.S. dollar had served Aruba well, and commended the central bank for its management of domestic liquidity, which had safeguarded confidence in the fixed exchange rate. They welcomed the recent measures taken by the authorities to increase reliance on market-based monetary policy instruments. Directors also welcomed the adoption of the legislative framework to strengthen the supervisory powers of the central bank on onshore and offshore financial institutions, as well as the measures taken to prevent money laundering. They noted that these measures would further enhance the transparency and integrity of Aruba's financial sector, in particular, and, more generally, their overall economic policies.

On structural issues, Directors commended Aruba for its generally liberal trade policies, and welcomed the relaxation of restrictions on some capital account transactions. In welcoming the recent privatization of the national airline, Directors emphasized the scope for further reducing the public sector's involvement in tourism and telecommunications.

Directors noted that deficiencies in Aruba's statistical base remained a serious obstacle to effective surveillance and policy design, and called for additional improvements, especially in the preparation of national accounts and labor market statistics.