Public Information Notice No. 01/46

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

May 17, 2001

On May 7, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation discussions with the Kingdom of the Netherlands—Netherlands Antilles.¹

Background

Traditionally based on financial offshore and oil refining inflows and tourism, the Antillean economy is relatively undiversified and has suffered from the decline of these inflows during the past 15 years and the high incidence of hurricanes in the 1990s. Adjustment to these shocks has been hampered by labor and product market rigidities, high administrative and tax burdens, and inefficiencies in public enterprises. Moreover, by the mid-1990s budget deficits increased to levels that could only be financed through arrears to the civil servants' pension fund and the Netherlands, leading to an erosion of investor confidence. Consequently, the economy has been in recession during 1998-2000, unemployment has risen sharply, and many people have emigrated. Even though headline inflation accelerated briefly in 2000 due to indirect tax and energy price increases, the peg to the U.S. dollar has kept underlying inflation low. Competitiveness has suffered and the balance of payments and the budget have been supported by sizable official capital inflows.

Fiscal adjustment undertaken since late 1999 has so far included the following measures: an increase in the turnover tax from 2 percent to 5 percent, the reversal of the 1998 tax relief package, the dismissal of some 20 percent of civil servants, and the suspension of vacation allowances and salary increases in the civil service. However, a weaker economy, high severance payments, delays in settling outstanding claims and arrears, and disruptions of tax administration, implied that the overall budget deficit in 2000 still exceeded available financing. With most of these problems also affecting this year's budget, the planned reduction in the deficit to less than 2 percent of GDP is not forthcoming. Instead, without additional measures it is likely to rise to 5 percent of GDP.

For the past three decades, the key monetary policy target has been the exchange rate peg to the U.S. dollar. In 1999, reserve requirements replaced quantitative controls as the preferred instrument of monetary policy, but ceilings on bank credit to the government nonetheless remained in place. Some banks are, however, not complying with the reserve requirement. In response to deteriorating loan performance, the central bank has intensified supervision over the financial system.

During the past year, several structural reforms have been implemented. A drastic streamlining of the public sector is nearing completion. Labor market rigidities have been tackled by the abolition of the dismissal permit and more flexible application of the work week. Import quotas and production monopolies have been abolished, and the market protection regime is being phased out. A framework for privatization and legislation supporting the development of electronic commerce have been adopted. With respect to the international financial sector, commitments have been made to adhere to international guidelines regarding harmful tax competition and a self-assessment of supervision of the sector has been initiated.

Executive Board Assessment

Executive Directors noted that the Netherlands Antilles' economic performance has weakened since the mid-1990s, reflecting declines in the offshore and oil refining sectors and hurricane damage. A prolonged recession, high unemployment, a pick-up in inflation, and a tide of emigration have ensued. Directors considered that a fuller and more sustained response to the exogenous shocks would have been appropriate. At the same time, they recognized that policymakers had to deal with the small size and undiversified nature of the Antillean economy, as well as with the possibility that residents had of emigrating to the Netherlands. Directors regarded a combination of structural reform, well-targeted public investments, and determined pursuit of macroeconomic stability as critical preconditions for sustained economic growth and job creation. They urged the authorities to reinvigorate adjustment efforts, building on progress made since late 1999.

Directors recognized the authorities' efforts to address the deteriorating fiscal situation. They generally considered that fiscal policy should avoid giving a contractionary impulse in the short term, but also underscored the need to prevent the budget deficit from rising above last year's level of 3.25 percent of GDP, by improving tax collection and reducing spending. Even with the deficit contained, considerable financial support from the Netherlands will still be required. Directors observed that, to be effective, such support should be phased in line with the implementation of the authorities' adjustment program.

Directors supported the authorities' medium-term objective of achieving budget balance, with public investment continuing to be largely financed by development assistance. Directors encouraged the authorities to simplify the tax system, starting in the 2002 budget, and to reconsider spending priorities so as to facilitate a reduction in the tax burden while redirecting spending to development purposes. They commended ongoing steps to reform the civil service. Directors observed that medium-term fiscal sustainability would require the extension of budget discipline throughout the broader public sector, settlement of all intergovernmental debt and arrears, and successful pension and health care reforms. Directors encouraged early implementation of plans to privatize the public pension fund.

Directors noted that the long-standing exchange rate peg to the U.S. dollar had kept inflation low. They supported the continuation of the peg at its current level and urged the authorities to improve competitiveness through structural reforms. With regard to the banking system, Directors noted that the lack of competition and absence of secondary markets hampered the conduct of monetary policy. They emphasized the need to ensure compliance with monetary policy requirements and welcomed the strengthened supervision of the domestic and international financial sectors, notably with regard to nonperforming loans and more frequent on-site inspections of the domestic financial sector. Directors welcomed the authorities' intention to complete a Fund-assisted self-assessment of supervision in the offshore financial sector in the near term. They praised the authorities' efforts to combat money laundering and encouraged continued focus on this issue.

Following the progress made so far, Directors emphasized the need to improve the functioning of the labor and product markets, including through more efficient provision of public services, and to continue to pursue trade liberalization. Directors highlighted the desirability of cutting the administrative and regulatory burdens on the private sector, not overburdening public enterprises with incompatible objectives, addressing domestic skills shortages through all available means, and expediting the passage into law of competition and regulatory frameworks.

While welcoming the authorities' commitment to adopt the GDDS as a framework to improve statistics, Directors called on the authorities to address data weaknesses, in particular by broadening the coverage of public sector data and accelerating the provision of data on the national accounts and the balance of payments.