IMF Policy Paper: Kingdom of the Netherlands— curaçao and Sint Maarten: Staff Report For The 2014 Article IV Consultation Discussions
Author: International Monetary Fund. European Dept.
Publication Date:
27 Aug 2014
eISBN:
9781484336304
ISBN:
9781484336304
Language:
English
Keywords:
ISCR; CR; center; aggregate consumer price index; debt ratio; real GDP; current account; Sint Maarten authorities; debt relief; monetary policy; exchange rate; Pension spending; Fiscal stance; Global
Download PDF (4.5 MB)

Kingdom of the Netherlands-Curaçao and Sint Maarten: 2014 Article IV Consultation-Staff Report; and Press Release

Abstract

Kingdom of the Netherlands-Curaçao and Sint Maarten: 2014 Article IV Consultation-Staff Report; and Press Release

Introduction

1. Curaçao and Sint Maarten share many similarities but also important differences. Both are small open island economies but, while Sint Maarten’s economy is essentially tourism-based, Curacao’s is more diversified, featuring also an international financial center (IFC), a transshipment port, a dry dock, and the oil refinery. Trading partners are also different: Sint Maarten relies mostly on tourists from the US and Europe, while Curaçao has important trade and tourism links also with close-by Venezuela and Latin America. Having been established as autonomous countries (out of the dissolution of the Netherlands Antilles) as recently as late 2010, both need to right-size and increase the effectiveness of their administrations. But while Curaçao needs to extract efficiency gains from merging the two pre-existing levels of governments (the Netherlands Antilles’ central government and Curaçao’s island government), Sint Maarten needs to expand its capacity to perform some of the functions previously carried out by the Netherlands Antilles’ central government.

2. Both countries face many of the challenges of other Caribbean islands (Figure 1), especially in terms of boosting growth while safeguarding external stability. This is particularly the case for Curaçao, which has trailed its regional peers at least since the early 2000s. Sint Maarten has done better, benefiting from a boom in cruise tourism which, however, may face diminishing returns and could also adversely impact the quality and appeal of stay-over tourism. On the plus side, both countries’ public debt is low, thanks to the 2010 debt relief, whereby the Netherlands took over all the Netherlands Antilles’ outstanding public debt in exchange for a significantly smaller amount of very long-term/low-cost debt issued by the two new countries.

Figure 1.
Figure 1.

Key indicators for Curaçao and Sint Mciarten in a Regional Comparison

Citation: IMF Staff Country Reports 2014, 239; 10.5089/9781484336304.002.A001

Sources: IMF World Economic Outlook, CBCS, National Authorities; and IMF staff calculations.

3. Against these challenges, staff’s advice is predicated on an analytical framework based on the fixed exchange rate. Curaçao and Sint Maarten form a currency union, whose currency— the Netherlands Antilles Florin, or guilder (NA.f)—has been pegged to the US dollar at 1.79 since 1971. Since the dissolution of the Netherlands Antilles, there has been some debate whether the two countries should keep the currency union (the two island nations are far apart—over 550 miles—and trade between them is limited). This debate, partly economic and partly political, appears to have subsided of late in favor of the status quo. But even if, in consideration of their economic differences and geographic distance, the two countries were in the future to decide to adopt separate monetary arrangements, they would still be best served by a fixed exchange rate regime, given their small open economies. Such a regime helps by preventing unnecessary exchange rate uncertainty, but it also affords very limited scope for active monetary policy. It thus puts a premium on creating and keeping fiscal buffers, and requires maintaining competitiveness and flexibility primarily via structural reforms.

4. Major data gaps hamper effective macro-economic analysis and surveillance. National account data are produced only with very long lags. In Curaçao, there is no official breakdown for GDP into its demand components after 2009, while for Sint Maarten there are nominal series, but these often seem difficult to reconcile with all the available information.1 Balance of payments data for the union as a whole are not consistent with those for the two component countries, and there are no data on the two countries’ international investment position—a key input in the assessment of the sustainability of the union’s external position.

Recent Economic Developments And Outlook

A. Recent Economic Developments

5. The union’s current account deficit has declined since the last Article IV Consultation discussions in 2011, but remains a source of vulnerability. In part this improvement reflects tightened monetary and, especially, fiscal policies in line with staff advice (Annex I). Curaçao’s fiscal adjustment, in particular, appears to have triggered a significant retrenchment in private domestic demand—as witnessed, for example, in the imports of cars, which declined by 12 percent in 2013 after growing by 18 percent over the previous 3 years (Figure 2). At 16 percent of GDP, the current account deficit remains large (see left chart below), pointing to lingering competitiveness issues (Box). Individual country data, which the Central Bank of Curaçao and Sint Maarten (CBCS) however cautions are likely incomplete, suggest that the deficit stems from Curaçao (right chart below). Despite double-digit deficits, there have been no pressures on the guilder and the union’s international reserves have consistently met the CBCS’ objectives in terms of coverage of imports of goods and services, reflecting strong capital inflows. However, these inflows are adding to net external debt, as non-debt creating FDI have averaged a modest 2 percent of GDP over 2009-13 (see Debt Sustainability Analysis, DSA).

Figure 2.
Figure 2.

Curaçao: Current Accourt Devdopments

Citation: IMF Staff Country Reports 2014, 239; 10.5089/9781484336304.002.A001

Sources: CBCS; National authorities; IMF World Economic Outlook; and IMF staff calculations and estimates.
uA01fig01
Sources: CBCS, and IMF Staff calculations. For 2009 the low current account deficit reflects debt-relief inflows.

6. Growth has remained lackluster in Curaçao, while a recovery from the global recession appears underway in Sint Maarten. Curaçao’s real GDP is estimated to have contracted by about ½ percent on average per year over 2011-13, reflecting—in addition to long-standing structural weaknesses (discussed below)—the continued decline in the IFC, the slow global recovery, and necessary fiscal adjustment in 2012-13. After contracting by an estimated 1¾ in 2011, Sint Maarten’s real GDP is estimated to have grown by an average of 1¼ percent over 2012-13, benefiting from the ongoing recovery in the US (which accounts for 60 percent of its tourists) and the construction of the Simpson Bay causeway. Private investment spending has reportedly remained subdued, including as a result of policy uncertainty (Sint Maarten has had three governments in the past three years and new elections are scheduled for August 2014).

B. Outlook and Risks

7. The improving global outlook is expected to support activity in the near term. Increasing tourism expenditure would boost activity in both countries, and especially in Sint Maarten, which could grow by about 2 percent, given the much larger share of tourism in its GDP. Curaçao may revert to positive growth (about ½ percent) this year if the planned construction of a new hospital starts without further delay.

8. Growth should accelerate in the medium term, especially if structural bottlenecks are finally addressed. Curaçao could grow by around 1-1¼ percent as the decline in the IFC bottoms out, the tourism sector continues to expand, and a sizeable pipeline of budgeted large public infrastructure projects is implemented. Sint Maarten could grow by around 2½ percent in the medium term, based on current projections for growth in demand of the tourist origin countries. Faster and sustained long-run growth would require structural reforms that enhance both countries’ competitiveness and flexibility (see page 12).

uA01fig02

Medium-term Growth Outlook (%)

Citation: IMF Staff Country Reports 2014, 239; 10.5089/9781484336304.002.A001

Sources: IMF WEO; and staff projections.

9. Risks are tilted towards the downside, especially for Curaçao (see Risk Assessment Matrix, RAM). Both countries would be affected if the euro area recovery proves weaker than anticipated, for example as a result of recent geopolitical tensions. Further disruption of economic activity in Venezuela might affect Curaçao’s ability to raise funds for the necessary upgrade of the Isla refinery in time for the expiration of the current lease to PdVSA in 2019. Failure to overcome its institutional gaps could weigh on Sint Maarten’s growth potential. An orderly normalization of US interest rates would lead to some capital outflows and pressures on the union’s international reserves, but should be otherwise manageable in light of the banks’ ample liquidity (see below) and the two governments’ access to low-cost funding from the Netherlands. If US rates increase more rapidly, however, pressures on international reserves could prove more intense (as incentives to circumvent existing capital controls and bring money out of the country would increase) and may require a sharp policy tightening, resulting in weaker growth. Upside risks, on the other hand, stem primarily from stronger than expected growth in the US and Europe and earlier and larger than expected benefits from ongoing attempts at diversification (catering tourism to faster-growing developing markets in Asia and Latin America, a revitalization of the dry dock and the ship repair business, or new activities such as Curacao’s new data center for cloud computing).

10. The peg appears solid but over time could come under pressure if competitiveness-and flexibility-enhancing reforms are not implemented. Curaçao’s (and the union’s) current account deficit is expected to continue to decline steadily, reflecting rebounding external demand, coupled with slightly declining oil and food prices and still subdued private domestic demand (Figure 2). It is essential, however, that this improvement is supported by reforms boosting both countries’ competitiveness and their capacity to adjust to shocks, since pressures on international reserves can be expected to increase over time. In particular, the debt-relief related inflows, which have thus far provided significant support to international reserves, are slated to decline gradually over the next few years and to turn into outright net outflows in 2019 (see chart to the right), as the debt issued by Curaçao and Sint Maarten as partial offset for the debt relief begins to mature. In 2019 the lease of Curaçao’s oil refinery to Venezuela—which currently accounts for some 16 percent of FX income—is also set to expire, as are some preferential tax treatments for companies in Curaçao’s IFC (another major source of FX for the union).

uA01fig03

Flows from the Netherlands’ debt relief will reverse in 2019

(% of Union’s GDP)

Citation: IMF Staff Country Reports 2014, 239; 10.5089/9781484336304.002.A001

Sources: CBCS; and IMF staff calculations.

Reducing Vulnerabilities And Creating Buffers

Macroeconomic policies should be steered towards supporting continued external adjustment (especially in Curaçao) and creating fiscal buffers to deal with possible shocks.

A. Fiscal Policy

Background

11. As a quid-pro quo for the 2010 debt relief, both countries agreed to a rule-based fiscal framework. This consists of a “golden rule” (i.e., borrowing only for investment) and an “interest burden rule” (i.e., a cap on the ratio of debt service to revenue). Compliance with these rules is assessed by the Netherlands-headed Council for Financial Oversight (CFT in Dutch). Only once the CFT ascertains compliance does it permit borrowing, in which case the Dutch treasury stands ready to offer financing at long maturities and its own borrowing rates.

12. Initially both countries failed to comply with the requirements of the framework, because their budgets were not consistent with a current balance from a multi-annual perspective and/or because of deep procedural flaws (e.g. Sint Maarten’s budgets for 2011, 2012 and 2013 were approved by Parliament only very late in the year or even after the year’s completion). This led the CFT to issue a series of advices/warnings and, eventually, injunctions for remedial measures to both the government of Curaçao (mid-2012) and of Sint Maarten (September 2013).

13. More recently, however, the framework has gained traction and helped steer both countries’ fiscal policies in the right direction:

  • Curaçao has put its public finances on a sustainable footing, including by addressing decisively its age-related fiscal pressures. Following the CFT injunction, Curaçao reformed the basic pension system by increasing the general retirement age from 60 to 65 (with very limited grandfathering and a short transition period) and overhauled the health care system by (i) introducing a basic medical insurance scheme (now covering some 80 percent of the population), (ii) raising premiums by 2.9 percent, and (iii) lowering the medicine bill by some 16 percent (by favoring generics and changing the co-pay system). The authorities also embarked on an ambitious plan to gradually decrease the number of public servants from around 4200 (in 2011) to a target of 3350 in 2017, to exploit the scope for synergies and streamlining from the merger of the former Netherlands Antilles government and the Curaçao island government. The fiscal adjustment was completed on the revenue side by the introduction of an additional sales tax category of 9 percent for luxury goods and an overhaul of the property tax, including to increase its progressivity. In its 2013 annual report, the CFT estimates that this adjustment improved Curaçao’s long term fiscal position by some 10 percent of GDP, relative to a no-policy change scenario.

  • Sint Maarten has brought its current budget in balance in the context of the 2014 budget, and achieved some improvement in its financial management. Faced with the daunting task of setting up a new administration, Sint Maarten initially needed some correction to achieve the current balance, even though it benefited from more benign demographics.2 The government increased the turnover tax rate (from 3 to 5 percent) in 2011, shifted its share of the health insurance premiums onto the employees, and tried to reign in the wage bill (by freezing bonuses and the cost of living adjustment in 2013) and expenditures on subsidies. The 2014 budget was also approved by Parliament in January of this year, which—while still not quite timely—represented a major improvement over previous years’ processes.

14. These improvements have allowed the CFT to certify compliance with the framework and paved the way for significant borrowing by both countries from the “standing subscription” window offered by the Dutch treasury. In 2014, Curaçao plans to borrow some NA.f 436 million (8 percent of GDP) to pre-finance the entire cost of the construction of a new hospital. Sint Maarten plans to borrow NAf143 million (8 percent of GDP), to finance planned investment (including the purchase of a new government building, which has laid incomplete and unused for many years) and to replenish its bank deposits, which were run down over the last three years when the government was not allowed to borrow by the CFT.

Staff’s Views

15. Both countries should entrench recent gains and overperform on the balanced current budget rule to build fiscal buffers. The current fiscal framework is beneficial for both countries, as it gives them access to an independent auditor and very cheap funding. However, since the current level of low borrowing costs cannot be taken for granted, the interest burden rule does not provide a sufficiently conservative benchmark to ensure continued debt sustainability. Thus both countries should aim at maintaining current surpluses in the order of ¾-1 percent of GDP over the medium-term. Based on current investment plans, this would ensure that public debt peaks under the baseline at about 37 percent of GDP in Curaçao and 32 percent of GDP in Sint Maarten (see DSA), thus creating the fiscal space that both countries need, given their vulnerability to sizeable shocks in the future (e.g., the renovation/clean-up of the refinery in Curaçao, or a weather-related shock to Sint Maarten). It is also important to ensure that public investments have a sufficiently high internal social return, irrespective of how low the costs of borrowing might be.

16. Curaçao must extend the 2013 reform of the old age pension to the public sector workers’ pension system in a timely manner, given the latter’s fast deteriorating financial position.3 Sint Maarten’s needs in this area are less pressing, given its younger population.4 Nevertheless its government has appropriately set out to increase the general retirement age to 62, with a motion to this effect currently in Parliament. Considering foreseeable demographic pressures, a further gradual increase of the retirement age to 65 could be considered.

17. Sint Maarten needs to strengthen tax collection. This is essential to sustain the necessary expansion of the administration in line with its increased responsibilities post-autonomy. Yet revenue, which stands at only 18.5 percent of GDP, compared to over 21 percent of GDP for other Caribbean countries, failed to keep pace with economic growth in the past few years. To tackle this apparent decline in tax compliance, the tax administration needs more suitably trained tax inspectors and administrators. Synergies could also be exploited with the strong collection efforts of social funds.

18. Transparency and oversight of SOEs need to be improved and a clear dividend policy established. There is an obvious tension between keeping state-owned enterprises (SOEs) at arm’s-length, thus minimizing undue political interference, and ensuring that they maximize the interest of the public shareholder. Some SOEs have in practice soft budget constraints, and translate their accumulated inefficiencies and above-market wages into higher costs of doing business for the rest of the economy (e.g., Curaçao’s Aqualectra). Even when they are profitable, in the absence of a solid governance framework, SOEs might gear their operations towards maximizing their own short-term profits, including by minimizing their contribution to the public budget (this is, for example, the case for Sint Maarten’s airport and harbor companies). Therefore, the governance of SOEs must be improved, including—as a start—by ensuring the timely availability of reliable financial statements and establishing a clear dividend policy.

19. A further shift from direct to indirect taxation in the medium term would be desirable. To boost competitiveness, both countries should consider a further and gradual shift of taxes from income to consumption, along the lines of the 2009 FAD technical assistance, and replace the existing turnover tax—with its negative cascading effects—with a value-added tax (VAT). This has served well many other Caribbean countries.5

Authorities’ Views

20. Authorities in both countries agreed with the need to create fiscal buffers and strengthen their medium-term fiscal position:

  • In Curaçao, they emphasized that negotiations on pension reform with public sector unions are ongoing, and that they see scope for further expenditure savings.6 They acknowledged that SOEs’ continued financial woes, despite the greater and timelier pass-through of their input costs to retail prices, imply that more work is needed in this key area, which has important implications for the economy’s overall efficiency and competitiveness.

  • In Sint Maarten, they intend to strengthen tax administration by deploying new IT systems and additional tax inspectors, and centralizing the tax office. They also expect to enhance administrative effectiveness (and generate some savings) by moving most government departments into the new building. Finally, they see merits in staff’s suggestion to introduce a further gradual increase of the retirement age to 65 in the draft pension reform bill, and pledged to consider it carefully.

21. Both authorities also agreed in principle with the merits of shifting the tax burden towards consumption and away from income. In Curaçao, however, they indicated that they intend to fully pursue their efficiency-enhancing reforms first, as these might provide scope for an overall reduction of the direct tax burden over time. In Sint Maarten they noted that it is essential to proceed with care, and as much as possible in close coordination with the French side, to avoid any revenue loss from implementation pitfalls, lack of reliable data, and/or tax arbitrage.

B. Financial Sector Policies

Background

22. Ample bank liquidity has continued to fuel rapid credit expansion, especially in Curaçao, until late 2013 (Figure 3). Absence of government bonds to invest in, low interest rates prevailing abroad, and continued large inflows from the debt relief operation have resulted in ample and growing liquidity for domestic banks, fueling rapid credit growth. When this started to exert pressures on international reserves, the CBCS attempted to induce banks to reduce lending by raising reserve requirements multiple times (to 17.5 percent as of May 2014) and, as from March 2012, by imposing temporary bank-level credit ceilings, which have since been recalibrated and renewed every six months. These measures notwithstanding, credit growth continued unabated in Curaçao until late 2013, when it abruptly turned negative. Since banks kept excess reserves throughout and the ceilings were first not observed and then undershot, it would appear that the slowdown in credit reflects not CBCS measures per se but a reduction in credit demand (likely triggered by the reduction in disposable income from the fiscal adjustment) and a more cautious supply of loans by banks (including because of the acceleration in non-performing loans, NPLs, see below).

Figure 3.
Figure 3.

Curaçao and Sint Maarten:Credit Developments

Citation: IMF Staff Country Reports 2014, 239; 10.5089/9781484336304.002.A001

Sources: CBCS; and IMF staff calculations.

23. Banks still have relatively healthy capital levels, but NPLs are on the rise. At end-2013, NPLs jumped to 11.9 percent, from 8.6 percent in 2010, and there is a growing concern about asset quality in general. So far, NPLs seem to be concentrated in certain sectors (tourism and air transportation), but there is anecdotal evidence—no hard data—that the sustained growth in mortgages, combined with steady inflows of Dutch retirees and IFC professionals, may have created froth in some segments of the real estate market in Curaçao. As of end 2013, banks report adequate capital (12 percent tier-1 capital ratio) and liquidity (30 percent liquid asset ratio), but one bank has been intervened (reportedly because of the stress caused by a defaulting airline). The situation warrants continued close monitoring by the CBCS.

Staff’s Views

24. The CBCS is appropriately trying to slow down credit growth, but should do so more consistently and rely on more standard sterilization tools:

  • Dealing with excess liquidity: The CBCS should be prepared to pay a higher interest rate on its certificates of deposits even though this would lower its profits. It could also raise reserve requirements further, while simultaneously increasing the interest it charges banks for liquidity. Finally, it could use macro-prudential tools to contain growth of specific types of loans, e.g. reducing maximum loan-to-value ratios to slow down the growth in mortgages. Over time, it should gradually eliminate remaining limits on outward investments by pension funds. This would allow the excess liquidity to flow out of the system gradually, removing distortions on domestic interest rates.

  • Refraining from direct financing of non-financial companies: While raising reserve requirements and imposing bank-by-bank credit ceilings, the CBCS has continued to provide funding to private corporations and SOEs (the liquidity thus created is now bigger than the banks’ excess liquidity which the CBCS is trying to control— chart to the right). This funding is not part of a standard central bank toolkit and moreover is not justified in a situation where the central bank is concerned with excess liquidity resulting in overall excessive and subpar lending.

uA01fig04

Credit extended by the CBCS created additional liquidity

(NA.f Million)

Citation: IMF Staff Country Reports 2014, 239; 10.5089/9781484336304.002.A001

Sources: CBCS and Fund staff calculations.

Authorities’ Views

25. The authorities agreed with the thrust of the staff advice. They reported that they do plan to increase reserve requirements further and raise interest rates on their CDs, as needed, as well as to further alleviate over time the restrictions on outward investments by pension funds. On the financing of SOEs, CBCS management indicated that this policy was initially conceived as a way to facilitate the development of a corporate debt market, but that it has since been discontinued and that they intend to divest their holdings of non-financial companies’ debt as soon as market conditions allow.

Increasing Flexibility, Competitiveness, And Growth

Increasing growth and resilience to shocks requires dealing with long-standing structural bottlenecks, including stifling red tape and inflexible and dysfunctional labor markets.

Background

26. Both countries suffer from a rigid labor market and high costs of doing business. Labor laws are very rigid. For example, laying off workers requires the approval of the labor ministry, even for bankrupt companies. Welfare support for the unemployed is quite generous (for example, in Curaçao it is reportedly roughly equivalent to what one would earn from a minimum wage job once free medical insurance, rent and other subsidies are factored in, and can be received for an unlimited amount of time). And there are pervasive wage indexation clauses, which can lead wages to diverge from productivity, thus harming competitiveness. Employers in both countries, as well as independent observers, decry a cumbersome permit regime, with unclear procedures and responsibilities, which results in long and unpredictable delays.

27. These structural weaknesses have been detrimental to economic performance, especially in Curaçao, whose more diversified economy needs greater scope for reallocation of labor from declining sectors to growing ones. Curaçao’s growth has been weaker than its regional peers’ since at least the early 2000’s (see Figure 1), and unemployment higher (currently at 13 percent). But limited price and labor market flexibility also adversely affect the competitive position of Sint Maarten, as underscored by the recent spell of high inflation, especially vis-à-vis the US, its key source market (see box).

28. Little progress has been achieved on competitiveness-and flexibility-enhancing reforms since the previous consultations (Annex I):

  • In Curaçao, many structural bottlenecks appear to have in fact worsened. The still incomplete merger of the two levels of government in the Netherlands Antilles’ structure, for example, has reportedly generated additional uncertainty as to which agencies retain the responsibility for processing business permits and licenses in the new setup. The capacity of the administration to audit and control also appears to have weakened, which is potentially leading to greater abuse of the welfare system.

  • In Sint Maarten, there appears to be more focus on monitoring active job search and to improve training opportunities for unemployed. But the labor market remains overly regulated, especially when it comes to work permits for foreigners, and receiving permits to open and operate a business still takes a fairly long time.

Staff’s Views

29. Price and labor market flexibility are important avenues through which both economies are expected to adjust to external shocks, given that the fixed exchange rate regime and the current fiscal framework—both of which have served the countries well—constrain the scope for stabilization policies.

30. The labor market must be rendered more flexible and dynamic, especially in Curaçao. Welfare support for unemployed should be limited in time and eligibility requirements (including active job search) enforced vigorously, as Sint Maarten has sought to do. Both countries should render labor dismissal laws more conducive to cyclical shifts in labor demand, so as to raise employment durably, and ease restrictions on hiring foreign workers while enforcing adequate labor conditions, to facilitate FDI and the associated inflow of financial resources and know-how.

31. The costs of doing business need to be lowered. In particular, the business licensing and permit regimes should be substantially streamlined. This would also help bringing more activity out of the shadow economy. Both governments could consider introducing automatic approval for some classes of permits/licenses if they are not processed in a set period of time. The efficiency and governance of public utilities and other SOEs need to be enhanced, to lower direct costs of production and reduce distortions, including in the labor market.

Authorities’ Views

32. The business environment needs to be strengthened. This is important also to support external adjustment. In Curaçao, the focus is on improving governance and performance of SOEs, and proposals are being considered to speed up license and permit procedures by tasking the Chamber of Commerce with the relevant issuing authority (staff cautioned that this may raise issues of conflict of interests, as incumbents would effectively be called on to authorize the entry of potential competitors). In Sint Maarten, the authorities are launching an online business license information system, which they expect will lead to a significant streamlining of the application procedures. Reduced red tape would also result into stronger competition and put downward pressures on domestic prices.

33. While labor market regulations do result in suboptimal outcomes, reforming them is difficult and there is scope to make progress within the current system. Authorities in both countries, for example, noted that rigid labor dismissal laws in practice result in the proliferation of short-term contracts, with potential perverse effects on workers’ security. At the same time, they felt that forging the necessary consensus for reform is politically difficult given both countries’ heterogeneous governing coalitions and thin majorities. Nevertheless, Sint Maarten authorities reported that soon-to-be-released official survey results will show that unemployment has declined markedly, to around 8 percent as of 2013, and attributed this progress to their intensified controls of eligibility for various unemployment benefits (including active search for jobs) and greater focus on training for unemployed. Both authorities considered that further easing hiring of foreign workers would aggravate the domestic unemployment situation.

Some Questions And Answers On Staff Analysis

The question and answer format of this section is intended to probe further into the reasoning behind staff recommendations.

34. Question: On the call for relaxing constraints on hiring foreign workers, would this not exacerbate the unemployment problem? Unemployment is already high in both countries. Making it easier to hire foreign workers would reduce the chances for local unemployed people to find jobs. Foreign workers also often work long hours in conditions which are not ILO-compliant, thus undercutting the islands’ social fabric and workers’ rights.

35. Answer: Liberalizing the hiring of foreign workers is necessary to ensure that firms can have access to all the skills needed in a modern economy, which the two islands are unlikely to produce, given their small size. Even when the skills required for a particular job are available locally, a foreign firm may still want to bring in some foreign workers in order to operate on the islands, for example because these workers have firm-specific know-how and/or experience in the firm’s operations elsewhere. In the presence of overly restrictive regulations, for instance quantitative targets on the number of foreign workers, this firm can decide to locate elsewhere. In today’s highly globalized economy, therefore, the alternative for the local economy is between having a firm operate competitively with a mix of foreign and local workers versus not having the firm at all. Clearly, the former outcome is more beneficial to the local economy, including because foreign workers can provide effective on-the-job training to local workers. Thus less restrictions on foreign workers should over time result in greater investment and employment for local workers. Finally, as regards the possibility that foreign workers undercut local labor conditions, there needs to be greater enforcement of labor laws more generally to ensure that no workers, local or foreign, are abused. The still incomplete capacity to enforce such standards by the two administrations should not be a reason to block hiring of foreign workers, especially those who have special expertise and contribute positively to the local economy.

36. Question: Would not the use of more standard sterilization tools result in higher sterilization costs? Raising the interest rates on certificates of deposits, currently near zero, to— say—some 0.75 percent would cost approximately NA.f 1.5 million per year. This would negatively impact the CBCS’ operational profit (around NA.f 3.5 million for the last two years).

37. Answer: Yes, but it would also increase transparency and reduce other distortions. Raising the interest rate on certificate of deposits is a more efficient, more transparent and less distortionary way to absorb the system’s excess liquidity than the current bank level credit ceilings, which are a rather brunt instrument and expose the CBCS to lobbying for exemptions. The central bank’s mandate is, first and foremost, to conduct sound monetary policy. It is, therefore, quite common for central banks to utilize their profits for effective monetary policy. If absorbing excess liquidity is deemed an important enough monetary policy objective, the central bank needs to be prepared to incur the associated costs, even if this results in less transfer of seignorage to the government.

38. Question: On the advice to over-perform on the current balance rule, does this imply that the rule-based fiscal framework is not sufficient to ensure sustainability? Currently public debt is very low in both Curaçao (around 31 percent of GDP) and Sint Maarten (24 percent of GDP), especially in a regional comparison, and the debt service is well within the cap imposed by the interest-burden rule. Thus the rule-based fiscal framework, which is widely seen as appropriate for the two countries, does not require going beyond a balanced current account, and doing so would be unduly contractionary.

39. Answer: The current low interest rates cannot be assumed to be permanent, which means that the interest burden rule does not presently provide a sufficiently prudent benchmark for debt sustainability. Moreover, both island countries are vulnerable to external shocks and have no scope for monetary stabilization given the currency peg. Thus they need to build up fiscal buffers. Both governments have ample room to increase revenues (e.g. improved tax collection in Sint Maarten) and/or reduce expenditures (e.g. rightsizing of the public apparatus in Curaçao), so that maintaining a surplus of the current budget to the tune of ¾ to 1 percent of GDP, as advocated by staff, should be feasible. As to whether this would be unduly contractionary, it needs to be kept in mind that fiscal multipliers are small in small open economies, so that the stimulus that would result from unwinding the current balances all the way down to zero would likely be very small.

40. Question: Might the liberalization of outward investment by pension funds not result in a loss of FX reserves? Liberalizing the current restrictions for the pension funds to invest abroad would lead to an outflow of funds from the economy and hence would lower international reserves.

41. Answer: There is indeed a risk of disruptions and pressures on FX reserves. Staff advice is therefore for such liberalization to proceed gradually. It is important to keep in mind the rationale for liberalization. The impediments to outward investments by pension funds distort local interest rates and can generate locally a search for yields, resulting in a build-up of risks to financial stability. Moreover, they unduly limit the pension funds’ capacity to pursue greater returns and risk diversification on their investments. This is especially problematic given the domestic economies’ small size and their vulnerability to large shocks. Failure to appropriately diversify can ultimately result in significant shortfalls between the pension funds’ obligations and their resources, which would have to be borne by higher taxes or higher contributions by workers—both of which would be detrimental to growth and jobs.

Staff Appraisal

42. The authorities of both countries have made important efforts to strengthen their underlying fiscal positions. Curaçao, in particular, has decisively tackled the spending pressures from its ageing society, with difficult but necessary reforms of the general pension and health system. Sint Maarten has attempted to expand its administrative capacity while keeping costs in check, in particular by freezing bonuses and cost-of-living adjustments in 2013, and has appropriately embarked on a reform of the pension system to safeguard its strength from foreseeable, albeit not imminent, demographic pressures.

43. Looking forward, they should continue to gear fiscal policy towards supporting ongoing external adjustment and building buffers. Curaçao should reform the public sector pension system, achieve further efficiency gains in the public apparatus, and improve the governance of its public companies. Sint Maarten needs to strengthen its tax administration to tackle declining tax compliance and to fund its newly acquired functions. The latter could also be further bolstered by increased contributions to the budget by public companies. The next government after the coming elections should build on the current administration’s efforts to keep public wage developments in check, including by reviewing the existing indexation mechanisms. These policies would allow both countries to maintain public debt at sustainable levels despite important investment needs, and build buffers to respond to future shocks. Keeping public sector wage growth firmly in line with productivity is also important for its signaling effect on private sector wages.

44. The central bank should encourage prudent lending behavior and closely monitor banks’ deteriorating asset quality. Banks’ excess liquidity should be sterilized through a more aggressive use of certificates of deposits, and further reserve requirement increases as appropriate. Over time, the existing limits and penalties on outward investment by pension funds should be gradually removed. As planned, the central bank should divest its holdings of non-financial corporates’ bonds, and refrain from direct financing of SOEs in the future. To underpin the sustainable development of Curaçao’s IFC and reduce risks, the authorities are encouraged to further strengthen the implementation of the Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) international standards.

45. Significantly greater effort is needed in tackling structural impediments to growth and job creation. A dynamic private sector, which is the linchpin of sustained growth in the medium term, requires tackling the maze of permits and licenses, which has hampered investment and innovation, especially in Curaçao. Rigid labor laws and the system of welfare payments for unemployed should be reviewed, to shift emphasis from protecting jobs to protecting workers, facilitate needed cyclical adjustments in the workforce, and ensure adequate incentives and support for job search by the unemployed. Restrictions to hiring foreign workers should be removed, while at the same time ensuring that all workers (local and domestic) are afforded adequate labor conditions.

46. These policies and reforms are necessary to increase the economies’ flexibility, competitiveness, and capacity to withstand shocks. This is essential to underpin the peg, which has provided both countries with a stable macroeconomic environment since 1971, and in light of the limited scope for active stabilization policies.

47. Finally, staff urges both governments to improve the statistical infrastructure and data. Presently available data are not adequate for effective macroeconomic analysis and surveillance. This hinders an accurate diagnosis of the problems and the identification and calibration of the most appropriate policy responses. Both countries’ statistical agencies are making efforts to improve on the situation, but more investments, including in human capital, are needed. Staff encourages the authorities to give this issue the strategic priority it deserves, and pursue timely advances including, where appropriate, through technical assistance.

48. It is proposed that the next Article IV consultation discussions with Curaçao and Sint Maarten will be held in 24 months time.

Competitiveness

Competitiveness indicators offer a mixed picture, though on the whole Curaçao seems to face more challenges than Sint Maarten:

  • A comparison of the real effective exchange rates (REERs) with their estimated equilibrium values (charts below) suggests that, though on a depreciating trend, Curaçao’s REER remained slightly overvalued as of end 2013, while Sint Maarten’s appears to be below its equilibrium level, despite some upward trend due to its recent relatively high inflation. The equilibrium values are derived from a PPP-based panel estimation of a sample of Caribbean and South and Central American countries for the period 1985-2013. These should be treated with caution as many relevant variables (e.g., net foreign assets) had to be left out of the model because of data limitations.

    uA01fig05

    Curaçao: Real Effective Exchange Rate

    (Index, REER: 2007 = 100)

    Citation: IMF Staff Country Reports 2014, 239; 10.5089/9781484336304.002.A001

    uA01fig06

    Sint Maarten: Real Effective Exchange Rate

    (Index, REER: 2007 = 100)

    Citation: IMF Staff Country Reports 2014, 239; 10.5089/9781484336304.002.A001

  • The countries’ shares in world exports have been on a secular decline, though recently at a slowing rate (in 2012 they have recovered slightly). Given both countries’ relative specialization, with Sint Maarten in particular basically exporting only tourism, this metric might be misleading: these shares would be expected to be falling, regardless of the two countries’ competitiveness, if world trade in goods that the two countries do not produce increases. Comparing the two countries’ export performance only with that of their Caribbean peers (possibly excluding Trinidad and Tobago, which is a relatively large energy exporter) does give a more favorable picture, suggesting that, as far as tourism is concerned, the two countries are doing relatively well (charts below).

uA01fig07
Sources: Caribbean Tourism Organization, National authorities, World Bank Development Indicators, and IMF staff calculations.

Curaçao’s wide (though declining) current account deficit also points to underlying competitiveness issues (see text chart on page 4). To the extent that its share of stay-over tourists in the Caribbean is bouncing back from its 2010 trough, Curaçao’s lingering competitiveness woes and overall lackluster growth seem to stem from an inability of the economy to absorb effectively declining productivity in other major sectors, such as the oil refining and financial sectors, and relocate effectively workers from declining to more promising activities, as attested by the stubbornly high unemployment.

This underscores the importance of competitiveness-enhancing structural reforms. In particular, greater wage and price flexibility would allow both countries to enhance their competitiveness, reduce unemployment, and increase their economies’ resilience to shocks. This is especially important given the limited room for policy maneuver resulting from the fixed exchange rate.

Table 1.

Curaçao: Selected Economic and Financial Indicators, 2009-15

article image
Sources: Data provided by the authorities; and IMF staff estimates.
1/

Based on IMF staff estimates of deflators.

2/

Contribution to GDP growth.

3/

Data from 2009-2010 reflect the fiscal operations of the local island government. Data from 2011 onwards refer to the new island government that has integrated the fiscal operations of the previous central government of the Netherlands Antilles.

Table 2.

Sint Maarten: Selected Economic and Financial Indicators, 2009-15

article image
Sources: Data provided by the authorities; and IMF staff estimates.
1/

Based on IMF staff estimates of deflators.

2/

Contribution to GDP growth.

3/

Data from 2009-2010 reflect the fiscal operations of the local island government. Data from 2011 onwards refer to the new island government that has integrated the fiscal operations of the previous central government of the Netherlands Antilles.

Table 3.

Curaçao and Sint Maarten: Monetary Survey, 2007-13 1/

(In millions of Netherlands’ Antilles Guilders; end of period)

article image
Sources: Central Bank of Curaçao and Sint Maarten, IMF staff calculations.
1/

Data prior to 2010 is estimated based on data for the Netherlands’ Antilles.

Table 4.

Curaçao and Sint Maarten: Financial Soundness Indicators, 2007-13

(in percent)

article image
Source: Central Bank of Curaçao and Sint Maarten.
Table 5.

Curaçao and Sint Maarten: Balance of Payments, 2008-19

article image
Sources: Central bank of Curaçao and St. Maarten; and IMF staff projections.1/ Overall numbers are the sum of the two countries’ BOP.
Table 6.

Curaçao: Macroeconomic Framework, 2008-19

article image
Sources: Central Bank of Curaçao and St. Maarten; and IMF staff estimations and projections.
1

Data from 2008-2010 reflects the fiscal operations of the local island government. Data from 2011 onwards refers to the new island government that has integrated the fiscal operations of the previous central government of the Netherlands’ Antilles.

Table 7.

Sint Maarten: Macroeconomic Framework, 2008-19

article image
Sources: Central Bank of Curaçao and St. Maarten; and IMF staff estimations and projections.
1/

Data from 2008-2010 reflects the fiscal operations of the local island government. Data from 2011 onwards refers to the new island government that has integrated the fiscal operations of the previous central government of the Netherlands’ Antilles.