Public Information Notice No. 99/97

Public Information Notice: IMF Concludes Article IV Consultation with Kingdom of the Netherlands - Netherlands

October 25, 1999

On October 15, 1999, the Executive Board concluded the Article IV consultation with the Kingdom of the Netherlands-Netherlands.¹

Background

The Netherlands posted a strong economic performance during the 1990s, based on sound macroeconomic policies and complementary and interlocking reforms to fiscal policy, social security, and labor and product markets. Robust real GDP growth was combined with strong job creation and falling unemployment, as well as increasing labor participation rates. After three years of above trend growth, activity is set to return to a more sustainable path in 1999 and 2000.

Economic activity remained strong in 1998, with real GDP expanding 3.8 percent. A slowdown that started mid-year (associated mainly with reduced foreign demand) was temporary, and growth picked up again towards the end of the year. Capacity utilization rates have fallen slightly since their peak in 1998, but tensions have appeared in segments of the labor market as the unemployment rate has continued to fall. Partly as a result, labor costs increases in manufacturing outpaced productivity gains for the first time in five years. Despite the tight labor market, however, consumer price inflation remained broadly unchanged, and indications are that wage demands have moderated somewhat. Competitiveness remained strong overall in 1998, although it declined somewhat vis-à-vis the euro area. Due to buoyant imports and a temporary slowdown in exports, the current account surplus fell to 5¼ percent of GDP.

Fiscal developments proved better than expected, as the deficit fell to 0.8 percent of GDP in 1998, despite a small overrun in expenditures above the real ceilings set in the medium-term fiscal framework. Although revenues were buoyant due to strong consumption growth, tax cuts resulted in a deterioration of the underlying fiscal position and provided a fiscal stimulus. In the latest projections, the deficit for 1999 will fall to below ½ percent of GDP.

With the cyclical position of the economy more advanced than most of the euro area, monetary conditions may pose difficulties for Dutch macroeconomic management. Monetary aggregates have continued to increase strongly: growth in private-sector credit accelerated to over 16 percent in 1998, and although mortgage credit expansion slowed through most of 1998, it accelerated again towards the end of the year, with growth rates remaining above 15 percent. House prices and the stock market index continued to post sharp gains, even though the latter has moderated recently.

Structural reforms, which have underpinned medium-term growth in output and employment, were extended and deepened in 1998. To promote further the reintegration of the long-term unemployed, schemes for temporary public-sector and subsidized employment were expanded, progress was made in formulating proposals for creating a single gateway for those seeking benefits, and new laws providing better protection for temporary and part-time employees were prepared. Progress in product-market reform has been slower, although in 1998 a strengthened Competition Law was enacted and the utilities sector was further liberalized.

The outlook for the Dutch economy remains favorable. GDP growth is expected to decline only marginally to around 3 percent by 2000, reflecting some easing of domestic demand. With the global economy picking up steam, export demand has recovered in the course of 1999, setting the stage for an improvement in the net foreign balance in 2000. Inflation is projected at 2¼ percent in 1999, with the increase over 1998 mainly due to higher import prices, as a result of the weaker euro and higher oil prices. Inflation is not expected to decline in 2000, as demand pressures continue to build. In fact, the continued tightness in the labor market imparts a risk of putting upward pressure on wages and prices, eventually undermining profitability and competitiveness. A correction in housing prices could adversely affect consumption. On the other hand, high rates of capacity utilization together with a revival in export markets could stimulate investment more than expected.

Executive Board Assessment

Executive Directors commended the authorities for their sustained implementation of sound macroeconomic policies and comprehensive structural reforms. Directors noted that the mutually reinforcing effects of these policies and the broad consensus among social partners on key policy reforms had contributed to a prolonged economic expansion, accompanied by substantial job creation and a decline in the unemployment rate to one of the lowest in the EU. At the same time, firm expenditure restraint had permitted tax reductions to proceed along with fiscal consolidation, with favorable implications for public debt dynamics.

Directors agreed that the Dutch economy was likely to continue to grow at above trend rates in the near term, benefiting from recovery in world demand and high consumer confidence, and monetary conditions that from the perspective of the Dutch economy, are relatively easy. Under the present circumstances, most Directors considered that the authorities should closely monitor the possibility of intensifying inflationary pressures and sustain the momentum of their structural reforms in product, labor, and financial markets. Although wage inflation had not risen, labor markets had continued to tighten. Some Directors pointed to the rapid rise in real estate price and credit aggregates, especially mortgages, as evidence of possible incipient overheating. Other Directors noted, however, that inflation remained subdued, and the signs of possible overheating are difficult to assess; they considered that what the situation requires is vigilance.

Directors supported the authorities' approach of conducting fiscal policy within a medium-term framework with transparent rules. They agreed that by capping expenditure growth in real terms, the framework had contributed to tighter control over spending and facilitated fiscal consolidation in recent years. With strong growth and improved revenue prospects, most Directors encouraged the authorities to aim for a further improvement in the structural fiscal balance and to avoid any additional fiscal stimulus. They felt that further deficit reduction would be consistent with the short-term demand management requirements and the authorities' medium-term objectives. In particular, it would constitute a useful step toward dealing with the fiscal challenges associated with an aging population, by accelerating the reduction in the public debt-to-GDP ratio and allowing more room for the automatic stabilizers to operate. Directors supported the planned tax reforms and the accompanying reduction in the revenue-to-GDP ratio. They welcomed the objectives of broadening the tax base while shifting the tax burden from direct and indirect taxes, which will improve incentives. Some Directors also recommended that the large tax deductions for mortgage interest should be reviewed. Directors urged the authorities to resist pressures to move forward the tax reform scheduled for 2001.

Directors commended the authorities' progress in improving the functioning of the labor market. They agreed that the challenge now is to enhance the employment prospects of the unskilled, the old, and the partially disabled. They welcomed the various initiatives under way to provide financial incentives for workers to make the transition from welfare to work. Directors welcomed the institution of an earned income tax credit and urged the authorities to ensure that the credit is well targeted and sufficiently large to reduce the very high marginal tax rates. They also supported the authorities' plans to reform the social security administration and emphasized that sufficient, coordinated, and properly focused financial incentives would be key to the success of these reforms. Directors felt that with respect to older or partially disabled workers, the focus of attention should shift away from early retirement and income maintenance to improving job prospects. Directors welcomed the authorities' intention to keep the effectiveness of their social programs under review.

Noting that product market reforms had been less far reaching than in labor markets, Directors encouraged the authorities to press ahead to broaden the scope for such reforms, and to ensure that their initiatives are implemented in a timely manner.

Directors noted that recent developments in the financial sector had raised several important challenges for supervisors. In light of rapid growth in credit and strong housing price increases, they urged the authorities to monitor carefully the quality of loan portfolios and assess the financial system's vulnerability to macroeconomic shocks. Many Directors welcomed the establishment of the new Council of Financial Supervisors to increase cooperation among existing supervisory agencies ,while some suggested merging them into a single supervisory agency.

Directors reiterated their praise for the authorities' continued support for the principles of free international trade and their exemplary record in official development assistance, which had remained above the United Nations norm.