Public Information Notice No. 06/83

Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with the Kingdom of the Netherlands - Netherlands

July 31, 2006

On July 26, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Kingdom of the Netherlands - Netherlands.¹

Background

The Netherlands is coming out of a period of slow or negative economic growth. Average annual growth in 2001-03 was 0.5 percent, the slowest rate in any three-year period since the beginning of the 1980s. Deteriorating external competitiveness, combined with weak foreign demand, restrained exports and growth overall.

A hesitant recovery started to take hold during 2005. Employment and consumption through end-2005 were weak compared with previous expansions, with a recovery at the start of 2004 failing to gather steam. But with foreign demand more robust, exports, though tempered by the lagged effects of real exchange rate appreciation, drove a mild recovery. Perhaps most important, the growth of private consumption, investment, and GDP gained traction in the second half of 2005. Business and consumer confidence also strengthened. Employment in 2005 recorded a more sustained rise than at any time since 2001.

Inflation remained in check, with little pressure from wages as the social partners sought to boost external competitiveness. Year-on-year CPI inflation averaged 1.7 percent in January-May 2006. Wage growth was subdued: the economy-wide wage moderation agreement for 2004-05 explicitly targeted low wage growth with competitiveness in mind. Recent economic performance suggests that competitiveness is not a particular threat to sustaining economic recovery, a point reinforced by the current account surplus.

After breaching the Maastricht deficit ceiling in 2003, the authorities achieved considerable fiscal consolidation. The general government deficit narrowed to 0.3 percent of GDP in 2005 from 3.2 percent in 2003. This reflected underlying structural adjustment of some 2.5 percentage points of GDP, largely the result of expenditure restraint.

The financial sector is generally sound but somewhat colored by developments largely related to real estate. Banks' capital adequacy remains strong, and other indicators have been improving. Pension funds are, on average, close to their required coverage ratios that come into effect in January 2007. In the insurance sector, earlier stress tests performed for the IMF's Financial System Stability Assessment (see Country Report No. 04/312) indicated that shocks, except the most extreme ones, could be absorbed. However, credit quality has reportedly deteriorated with the continued expansion of mortgages. In addition, households have also become more sensitive to interest rate changes: the ratio of mortgage debt-to-GDP is high, the proportion of mortgages subject to an interest rate adjustment within two years has increased, and the percentage of newly provided loans with loan-to-value ratios exceeding 100 percent has also been increasing significantly. A small bank failed in December 2005, without systemic repercussions.

In addition to the near-term outlook, the discussions focused on key measures to ensure fiscal sustainability with population aging, while building a solid foundation for sustaining growth and safeguarding financial stability. In this context, the discussions benefited from official studies on related issues. Work on the financial sector included a continued follow-up on the recommendations made in the FSSA.

Executive Board Assessment

Directors were encouraged that the economic recovery is gathering steam, supported by the strong polices of recent years, including a turnaround in public finances and structural reforms in a number of key areas—among them health care, disability, and financial supervision. Looking ahead, Directors agreed that ensuring a solid foundation for sustained economic growth would require in particular ensuring the sustainability of public finances in the face of an aging population, safeguarding financial stability, and undertaking further structural reforms to raise labor participation, hours worked, and overall productivity. Directors also noted that continued wage moderation would help to take full advantage of the global upturn.

Directors welcomed the authorities' comprehensive study on population aging and recommended early action to contain the medium-term risks and to take advantage of the current favorable economic environment. They therefore recommended achieving a general government surplus of at least 1 percent of GDP by 2011. However, to achieve fiscal sustainability in the face of an aging population will also require sustainability-enhancing structural reforms—including, for example, a rise in the retirement age and linking it to changes in life expectancy, and Directors encouraged the authorities to put these reforms in place on a timely basis.

In view of medium-term fiscal requirements and with the upturn well in train, Directors noted that the 2007 budget could turn somewhat expansionary. They encouraged the authorities to pursue at least a neutral fiscal stance this year and next and to use any revenue overperformance or below-budget expenditure outturns for deficit reduction.

Directors commended the strong fiscal framework, noting that it meets or exceeds the good-practice standards according to the recent ROSC. They also welcomed the independent and central role of the Bureau for Economic Policy Analysis (CPB) as a best-practice example of separating the political and technical elements of macroeconomic policy. They nevertheless encouraged the authorities to consider the refinements to the framework recommended by the ROSC related to the operations of the expenditure ceilings and the budgetary fund based on gas revenues.

Directors noted that the financial sector remains sound and welcomed the new Financial Supervision Act, the strengthening of the risk orientation of supervision, and the ongoing analytical work on financial stability, including a new round of stress testing. They noted with concern the emerging vulnerabilities in the mortgage sector, but were encouraged by the authorities' efforts to strengthen the code on mortgage lending and monitoring and enforcing compliance.

Directors appreciated the authorities' responsiveness to the recommendations of the Financial System Stability Assessment. More broadly, they encouraged the authorities to assess whether rent controls and administrative allocation mechanisms for housing appropriately served their intended purposes. On pension supervision, Directors agreed on the merits of specifying a one-year recovery period should shortfalls from the minimum coverage ratio occur, but recognized that escape clauses allowing for a longer period are necessary too.

Directors welcomed the considerable efforts already made by the authorities to raise labor participation and overall productivity, but felt that there is still room for further reforms-regarding, for instance, still generous unemployment benefits. They also encouraged the authorities to find new ways of lessening inactivity traps and stimulating demand for low-skilled labor, including through changes in the minimum wage and its links to several social benefits. Directors also urged the authorities to make employment protection legislation less stringent, noting that it acts as a tax on new hiring and labor reallocation and can hamper innovation. They encouraged the authorities to continue with their efforts to increase competition and reduce red tape as important steps to enhance productivity and boost innovation.

Directors commended the authorities for their strong commitment to Overseas Development Assistance.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.