Kingdom of the Netherlands-Curacao and Sint Maarten: 2016 Article IV Consultation Discussions-Press Release; Staff Report and Informational Annex

The currency union of Curaçao and Sint Maarten has important strengths, including a high level of development, good infrastructure, and relatively low public debt. However, preserving these going forward will require surmounting some critical challenges. GDP per capita is already at high-income country levels, but the islands must combat lackluster growth and high unemployment levels by addressing weak competitiveness and improving the investment environment. The fiscal situation remains relatively stable, following the debt relief in 2010, but sustained efforts on fiscal and structural reforms are required to lock in gains and ensure continued fiscal and debt sustainability. The authorities' structural reform plans are welcomed, but continuity in policy will be essential going forward, particularly in the context of the upcoming elections in both countries, scheduled for September 2016.

Abstract

The currency union of Curaçao and Sint Maarten has important strengths, including a high level of development, good infrastructure, and relatively low public debt. However, preserving these going forward will require surmounting some critical challenges. GDP per capita is already at high-income country levels, but the islands must combat lackluster growth and high unemployment levels by addressing weak competitiveness and improving the investment environment. The fiscal situation remains relatively stable, following the debt relief in 2010, but sustained efforts on fiscal and structural reforms are required to lock in gains and ensure continued fiscal and debt sustainability. The authorities' structural reform plans are welcomed, but continuity in policy will be essential going forward, particularly in the context of the upcoming elections in both countries, scheduled for September 2016.

Background

1. Macroeconomic conditions in Curaçao and Sint Maarten are similar to those in the Eastern Caribbean Currency Union (ECCU) countries, with some important differences. Curaçao and Sint Maarten formed a currency union following the dissolution of the Netherlands Antilles in 2010, and kept the guilder, which has been pegged to the U.S. Dollar at 1.79 since 1971. Both islands suffer from stagnant growth, with growth rates trailing regional peers for nearly a decade. Nevertheless, per-capita GDP remains among the highest in the Caribbean (US$26,457 for Sint Maarten and US$20,587 for Curaçao in 2015). While the Union’s current account deficit has steadily declined over the last few years, external sustainability continues to be challenged by persistent large current account deficits (predominantly from Curaçao). As in most ECCU countries, credit growth has been negative since 2013, despite ample liquidity in the banking system, which was in part fueled by large portfolio investment inflows from the Kingdom of the Netherlands. Both countries have made significant progress on fiscal consolidation and are now fully compliant with the legislated fiscal rules. After considerable assistance in the form of debt relief from the Netherlands in 2009–10, public debt ratios in Curaçao and Sint Maarten are now low by regional standards.1

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Source: WEO; and IMF Staff Estimates.

2. Efforts have been made to implement the policy recommendations from the 2014 Article IV Consultation discussions, however, progress has been slow (Box 1). Considerable progress in reducing risks associated with pension funds and state-owned enterprises (SOEs) has been made, and additional reforms are forthcoming. While neither island has formally adopted a VAT as recommended by the technical assistance provided by the IMF’s Fiscal Affairs Department in 2009, the fiscal position has benefited from progress in keeping public wage developments in check. The central bank has also made steady progress in implementing monetary and financial policy recommendations to ensure financial stability. Less progress has been made however, in implementing recommendations to improve labor market conditions.

Progress on 2014 Article IV Policy Recommendations

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3. Staff urges the authorities to implement measures to improve the quality of statistics, to better support effective macro-economic surveillance. There is significant room for improvement in the coverage and timeliness of data, in particular on national accounts, public finance in GFS format, and international investment positions (IIP). In both countries, staff noted large data gaps with GDP estimates, with lags as far back as 2006 for various expenditure components.2 Besides, with no reliable deflator, or deflators by sector, the real GDP series are derived based on the consumer price index. In addition, some components of Sint Maarten’s balance of payments (BOP) statistics have been compiled as the difference between the Union and Curaçao’s, inevitably resulting in large unexplained swings in the island’s BOP developments in certain years.

Recent Economic Developments

4. Economic performance remains weak in both countries. For several years now, both countries have experienced lackluster growth, trailing behind regional peers. Curaçao experienced modest growth in 2015 of 0.1 percent, reflecting a turnaround from the contraction of 1.1 percent in 2014. Growth in Curaçao mainly reflected an increase in investment (both public and private), driven largely by the construction of the new hospital and the upgrade of road infrastructure. Meanwhile, the economy of Sint Maarten expanded by 0.5 percent in 2015, a slowdown compared to the 1.5 percent recorded in 2014. The expansion in Sint Maarten’s GDP mainly reflected an increase in stay-over tourist arrivals, though at a slower pace than in 2014. With the exception of the recent expansion project at the Princess Juliana International Airport, there was no major private investment in 2015, underscoring the need to boost investor confidence. Unemployment in both countries remains relatively high at 11.7 percent and 8.9 percent for Curaçao and Sint Maarten, respectively. However, youth unemployment is estimated to be significantly higher, in the region of 30 percent for Curaçao and 25 percent for Sint Maarten.

Curaçao and Sint Maarten vis-à-vis Regional Peers (2015)

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Sources: National Authorities; CBCS; WEO; and IMF Staff Estimates.

5. Inflation remains subdued, reflecting low pressure from international commodity prices. Following a period of moderate inflation during 2010–14, averaging 2.2 percent in Curaçao and 2.8 percent in Sint Maarten, inflation in Curaçao stood at -0.5 percent in 2015 and 0.3 percent in Sint Maarten, largely reflecting lower international oil prices. However, core inflation in Curaçao, which excludes food and energy, decelerated only modestly from 1.3 percent in 2014 to 1.1 percent in 2015.3

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Current Account

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 276; 10.5089/9781475527285.002.A001

Sources: WEO; and IMF Staff Estimates.

6. The Union’s current account deficit improved in 2015, for the fifth consecutive year, but remains in double-digits. The Union’s current account deficit narrowed to 10.9 percent of GDP in 2015 from 11.5 percent in 2014, reflecting a significant improvement in Sint Maarten’s external position, which was mostly offset by the deterioration in Curaçao. Sint Maarten recorded a surplus of 2.2 percent of GDP in 2015, relative to a deficit of 10.5 percent in 2014, primarily reflecting lower oil prices and higher tourism arrivals. In contrast, Curaçao’s current account deficit widened to 15.3 percent of GDP in 2015 from 11.9 percent in 2014, largely due to lower refining and transportation exports, and lower bunkering activities with the decline in oil prices. These were only partly offset by lower oil imports associated with the decline in oil prices.

7. Curaçao and Sint Maarten were both fully compliant with their fiscal rules in 2015.

Both countries complied with the rules-based fiscal framework, which comprises an “interest burden rule” (a cap on the interest payments to revenue ratio), and a “golden rule” of borrowing only for investment. Nonetheless, the public debt of the Union increased from 30.5 percent of GDP in 2013 to 41.5 percent of GDP in 2015—partly but not entirely reflecting pre-financing—and fiscal performance for the two countries diverged noticeably.

  • a. Curaçao’s fiscal position deteriorated in 2015 with its primary balance widening to 1.7 percent of GDP from 0.7 percent in 2014. This reflected an increase in capital expenditure, with the construction of a new hospital, and budgetary transfers to cover operational deficits of the SEHOS hospital and the national health insurance fund. The tax-to-GDP ratio moderately recovered to 25.7 percent in 2015, ending a four-year downward trend, due to improved tax compliance and increases in property tax rates. With interest payments at around 1 percent of GDP (or around 3½ percent of total government revenue), the overall fiscal deficit was 2.8 percent of GDP in 2015. The government issued three long term loans during 2014–15, totaling NAf 526 million (or 9.3 percent of 2015 GDP) to pre-finance the new hospital, resulting in a rapid buildup in public debt to 44.3 percent of GDP at end 2015 (compared with 34.6 percent in 2010).

  • b. In contrast, Sint Maarten’s underlying fiscal position improved in 2015 with lower spending and higher tax revenues. The primary deficit narrowed to 0.6 percent of GDP in 2015, from 3.9 percent in 2014, largely due to a decrease in capital spending and lower wage bill (which declined to 10.1 percent of GDP from 10.6 percent in 2014). Tax revenues increased to 20.3 percent of GDP from 19.7 percent in 2014, largely reflecting higher taxes on income and profits. The debt ratio declined to 36.5 percent in 2015 from 37.1 percent at end 2014.

Curaçao: Operations of the Government

(in percent of GDP)

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Sources: CBCS; and IMF Staff Estimates.

Sint Maarten: Operations of the Government

(in percent of GDP)

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Sources: CBCS; and IMF Staff Estimates.

8. Credit growth remained weak despite ample liquidity in the banking system. Despite robust deposit growth, which has led to further accumulation of bank reserves to well above the regulatory requirement, private sector credit remains weak.4 This in part reflects a deterioration of asset quality (¶9), which has dampened banks risk appetites. Meanwhile, as credit demand remained subdued with long term investment decisions deterred by macroeconomic uncertainties, bank lending to private sector remained flat in 2015.

9. Despite a recent deterioration in asset quality and profitability, the banking sector appears to be generally stable, supported by adequate capital buffers. The nonperforming loans (NPL) to total loans ratio remains elevated at 11.3 percent in 2015, as bank asset quality deteriorated during the recent economic downturn.5 This, along with a lower net interest margin and increased competition among banks, has negatively affected bank profitability. Banks’ capital buffers, however, appears to be adequate with a capital adequacy ratio of 13.6 percent in 2015, above the 10 percent regulatory requirement. Some local banks have recently reported a loss of correspondent banking relationships (CBRs), which calls for a proactive policy response by the authorities (¶34).

Outlook and Risks

10. Growth is expected to pick up slightly in the near term. Real GDP growth in 2016 is expected to reach 0.5 percent in Curaçao and 0.7 percent in Sint Maarten. For Curaçao, economic activity is projected to accelerate reflecting continued economic recovery in their main trading partners (especially the U.S.) and a continuation of both private and public investment projects (e.g. the hospital construction). Higher growth in Sint Maarten reflects expectations for higher private spending, particularly in the tourism and transportation sectors, and a moderate increase of tourism flows. Meanwhile, inflation is expected to accelerate gradually to 0.8 percent in Curaçao and 1 percent in Sint Maarten, as the effect of lower oil prices is countered by an increase in prices in the U.S. and the Netherlands, the Union’s main trading partners.

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Medium-Term Growth Outlook 1/

(YOY percent change)

Citation: IMF Staff Country Reports 2016, 276; 10.5089/9781475527285.002.A001

Sources: WEO; and IMF Staff Estimates.1/ Growth rates for Curaçao and Sint. Maarten are based on IMF staff estimates of deflators.

11. Medium-term prospects remain broadly positive but will depend on the authorities’ efforts to address structural bottlenecks. Over the medium term, growth is expected to moderately pick up to 0.9 percent and 1.3 percent for Curaçao and Sint Maarten, respectively. The expansion in both countries will mainly depend on the timely implementation of structural reforms aimed at attracting more FDI, relaxing restrictions on hiring foreign labor, and reducing costs of doing business (¶18–21).

Selected Medium-Term Indicators

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Sources: Central Bank; and IMF Staff Estimates.

12. On the external side, the Union’s current account deficit is projected to gradually improve over the medium term. The deficit is expected to narrow in 2016, reflecting projections for lower oil prices and higher tourism receipts, notwithstanding higher imports of construction material related to public investment projects (particularly the construction of a new hospital in Curaçao). Given adequate external financing, including from foreign direct investments, debt issues, and a decrease in foreign assets, the Union’s net international reserves are projected to increase in 2016. Going forward, the Union’s external imbalances are expected to gradually decline as tourism demand picks up. Nevertheless, given the reliance on a narrow scope of products and markets, considerable risks remain, underscoring the need to improve competitiveness, reduce vulnerabilities to external shocks, and build external buffers to ensure external sustainability going forward. Staff estimates, which are based on limited data and subject to considerable uncertainty, suggest that Curaçao’s REER is somewhat undervalued, while that of Sint Maarten is somewhat overvalued (Annex II).

13. On current policies, Curaçao’s fiscal position is expected to gradually improve, but public debt will continue to build up. The primary deficit is projected to narrow to 1.4 percent of GDP in 2016, and will further decline to 0.8 percent of GDP over the medium term, as the hospital construction gradually winds down. The tax-to-GDP-ratio is projected to decrease moderately as another round of profit tax rate cut (from 25 percent to 22 percent) became effective in 2016, with revenue losses expected to be only partially offset by reduced deductions and strengthened compliance.6 The government’s current account balance (after accounting for the consumption of fixed capital, i.e. depreciation), is just above zero in 2016. Close expenditure management and strict budget execution will be needed to ensure compliance with the fiscal rules (¶26).

Curaçao: Selected Medium-Term Fiscal Indicators

(In percent of GDP)

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Sources: Central Bank; and IMF Staff Estimates.

14. Sint Maarten’s fiscal position is expected to improve, with higher revenue mobilization. The primary deficit is expected to decline slightly to 0.1 percent of GDP in 2016, from 0.6 percent in 2015. The tax -to-GDP ratio is expected to increase to 20.5 percent in 2016, from 20.3 percent in 2015, based on stronger tax collection (including on casino tax). Other revenues are also expected to increase in 2016, with the projected receipt of dividends from the central bank. The debt-to-GDP ratio will increase marginally to 36.7 percent of GDP at end 2016, relative to 36.5 percent at end 2015.

Sint Maarten: Selected Medium-Term Fiscal Indicators

(In percent of GDP)

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Sources: Central Bank; and IMF Staff Estimates.

15. Risks to the macroeconomic outlook are tilted to the downside (Annex I). Continued low growth in the euro area could negatively affect Curaçao and Sint Maarten through trade, tourism, remittances, and investment channels. Persistent strengthening in the U.S. dollar could lead to further appreciation of the REER, and a loss in competitiveness vis-à-vis European and Canadian tourists. Reduced financial services by global/regional banks could result in disruptions to banking services, hindering cross-border financial transactions. Given the close trade relationship, Curaçao remains vulnerable to a further disruption of economic activity in Venezuela (Annex IV). Other downside risks include slow implementation of planned structural reforms, an outbreak of Zika, and a natural disaster in Sint Maarten. Upside risks include improving economic prospects in the U.S. generating tourism for Sint Maarten, higher investment flows through major tourism projects, and spillover and productivity gains through higher public investment if managed prudently.

16. With the current low levels and favorable public and external debt dynamics for Curaçao and Sint Maarten, the Debt Sustainability Analysis (DSA) finds the risk of debt distress low, but the debt paths are sensitive to shocks (Annex III). In Curaçao, while public debt is already on an upward trend, a combined macro-fiscal shock7 could add another 10 percentage points to its debt-to-GDP ratio. Besides, under a full-blown Venezuela shock scenario (where all trade links between the two countries are removed and the refinery business comes to a complete stop in 2019), Curaçao’s debt-to-GDP ratio could end up 7½ percentage points above the baseline by 2021. In Sint Maarten, the debt-to-GDP ratio is projected to increase by 10 percentage points under a hurricane scenario (assuming a 10 percent of GDP increase in government expenditure in 2017 to cover post-disaster reconstruction needs). Both island’s significant vulnerability to shocks calls for the authorities’ sustained efforts on reforms to strengthen their fiscal frameworks, build policy buffers, improve external competitiveness, and unlock growth potential.

Policy Discussions

A. Growth and Competitiveness

Background

17. Both economies continue to operate below capacity, exhibiting low convergence towards potential growth. Labor productivity growth remains low, negatively impacting output growth and competitiveness (text chart), particularly in Curaçao, where labor productivity growth has averaged –0.2 percent over 2012–15. Meanwhile, broader competitiveness indicators are mixed, pointing to high labor costs, subdued inflation and a moderate increase in the number of stay-over tourist arrivals (but a decline in market share) in both countries (Annex II).

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Labor Productivity

(Index, 2007=100)

Citation: IMF Staff Country Reports 2016, 276; 10.5089/9781475527285.002.A001

Sources: National Authorities; and IMF Staff Estimates.
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Curaçao: Output Gap

Citation: IMF Staff Country Reports 2016, 276; 10.5089/9781475527285.002.A001

Sources: Central Bank; and IMF Staff Estimates.1/ Using Hodrick-Prescott filter
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Sint Maarten: Output Gap

Citation: IMF Staff Country Reports 2016, 276; 10.5089/9781475527285.002.A001

Sources: Central Bank; and IMF Staff Estimates.1/ Using Hodrick-Prescott filter

Policy Discussions

18. The mission welcomes the authorities’ ambitious plans to strengthen competiveness and reinvigorate their economies through important structural reforms. In Curaçao, the National Development Plan 2015–30 aims at encouraging foreign direct investment, stimulating priority sectors with potential for higher value added (including the free zone, maritime and aviation sectors), ensuring inclusive quality education, and promoting good governance. In Sint Maarten, where tourism represents the highest share of the economy, a tourism authority has been recently established and a development plan is currently being discussed, to diversify the tourism sector, reduce its seasonality, and increase value-added.

19. Given the Union’s small population base, a flexible labor market equipped with appropriate skills is needed to improve competitiveness and growth potential. In Curaçao, labor market reforms should focus on addressing restrictive dismissal laws and protective work permit policies (for foreign labor) that hinder labor market flexibility (Box 2). Although the labor market in Sint Maarten is less restrictive, efforts are needed to improve efficiency and timeliness in granting required permits for foreign workers. To address mismatches in skills, the authorities in both islands have recognized the need to refocus the education system. The mission recommends renewed efforts to improve vocational education and develop targeted training programs to strengthen skills and improve productivity. The Sint Maarten authorities have recently embarked on a government-sponsored employment program to address high youth unemployment. Close monitoring and assessment of program deliverables will be critical to ensure the effective deployment of public resources.

Labor Market Issues

Low growth and high unemployment underscore the need to address declining labor market productivity and improve labor market flexibility in the Union. Unemployment remains high, especially among the youth in both Curaçao and Sint Maarten. At the same time, the work force cannot adequately meet the demand for labor. The focus of labor market policy, including on flexibility, has shifted frequently and contributes to uncertainty.

Education systems and technical and vocational training are currently not fully aligned to meet the countries’ needs. This exacerbates issues related to small populations and migration, which also contribute to a mismatch between the supply and the demand for labor. There are also limited quality technical and vocational training institutions and no certifying institutions. The authorities also recognize the need for greater focus on building soft skills and on career mentoring to help better prepare young people for the work place.

Generous welfare benefits act as a disincentive to employment in the formal sector contributing to a high reservation wage, particularly in Curaçao. Unemployment benefits in Curaçao often exceed the minimum wage, covering, among other things, housing, healthcare costs, and provide subsidies for water and electricity. This could incentivize persons to work in the informal sector while collecting benefits. Although Curaçao has implemented reforms to reduce fraud and now requires that persons receiving welfare undergo training and actively seek employment, controls are often weak. Sint Maarten’s welfare benefits are less generous at approximately 67 percent of the minimum wage.

Restrictions on hiring foreign workers limit the ability to fill employment gaps. Both countries require that persons seeking employment are sponsored by an employer, and that the employer initiates the application for the work permit. In addition, the employer must show that the vacancy was advertised in the local market without success. In Curaçao, the Permit department is faced with a number of challenges, including an insufficient budget, understaffing, and inadequate office space, which has led to a backlog in permits, beyond the six weeks’ maximum required by law. While Sint Maarten processes work permits in 2 weeks, the process is lengthened by the need to first obtain a landing permit, which can take 3–4 weeks.

Dismissal laws are also inflexible in both countries. This has encouraged the use of short-term contracts rather than the creation of stable employment. As such, even where the skills required are available locally, these posts may not be filled, given the limited job security they provide.

20. Staff emphasized that improving the business climate is critical to reigniting investor confidence, promoting private sector activity, and attracting foreign direct investment. The mission therefore welcomes the authorities’ efforts in both islands to rationalize business licensing requirements, reduce transportation costs, and promote fair competition. The mission also endorses the authorities’ plan to proactively address red tape through centralization and streamlining of business registration processes, and to improve efficiency in government services and reduce transaction costs. In addition, maintaining a stable political environment and ensuring policy continuity is critical to promoting long term business investment decisions.

21. Staff urged the authorities to quickly advance implementation of energy sector reforms geared toward cost reduction and long term sustainability to improve competitiveness and build resilience. As in many other Caribbean islands, energy costs are high in Curaçao and Sint Maarten, where high reliance on imported-fossil-fuel-based generation increases their vulnerability to external shocks.8 The authorities in both islands have recognized, through their national development plans, the importance of diversifying the generation mix through the development of renewable energy. Follow through with steadfast implementation is critical to reducing energy costs and achieving a stable, sustainable and clean energy future. Moreover, the energy sector regulatory framework needs to be strengthened in Sint Maarten by introducing an independent regulator.9

22. Authorities’ views. The authorities concurred with staff about the importance of removing impediments to private sector activity by enhancing the doing business and labor market conditions. They stressed that vocational education and skills training are among the key priorities for addressing skills mismatches, unlocking growth, and improving competitiveness over the medium term. Regarding energy sector reforms, the authorities noted that several initiatives for renewable energy have been considered, including wind and solar power, seawater cooling, and “waste-to-energy”, under their national development plans.

B. Strengthening Fiscal Framework and Building Buffers

Background

23. The Union has a rules-based fiscal policy framework monitored by the Board for Financial Supervision (Cft in Dutch). Each island submits its budget to the Cft, who verifies the realism of the assumptions and the adherence to the rules-based framework, and if necessary recommends changes to the budget. The Cft’s function is reviewed every three years, to ascertain whether there remains a need for continued oversight and the accompanying low-cost “standing subscription” borrowing arrangement, which allows both countries to borrow at prevailing rates in the Dutch capital market. The most recent review was undertaken in 2015, which extended the Cft’s function till 2018.

Policy Discussions

24. Staff proposed that the current rules-based framework be strengthened to ensure fiscal and debt sustainability. While the framework provides a strong basis for containing short-term fiscal risks, it does not provide a sufficient medium term anchor for debt sustainability. A strengthened fiscal framework is particularly important in the context of the upcoming 2018 review of the Board for Financial Supervision (Cft in Dutch) oversight function and the current low-cost “standing subscription” borrowing arrangement.10 If the agreement was to be discontinued following the review without an agreement for the refinancing of debt incurred under the current access to low rate financing, net flows from the Dutch borrowing arrangement could turn negative, resulting in higher interest costs going forward. The increase in borrowing costs, would over time erode the gains from debt relief and put public debt on an upward trend. Moreover, rising interest costs will make it increasingly difficult to satisfy the “interest burden rule” and accelerate debt accumulation. Hence, staff proposes that the rules be supported by adopting a medium-term macro-fiscal framework that includes a primary balance target consistent with a long-run debt anchor of 40 percent of GDP, which is around the median level of developing and emerging countries. The 40 percent of GDP target is also the benchmark debt ratio used in the standard Fiscal Monitor long-term adjustment needs scenario for emerging market economies, and is consistent with the debt norm proposed by the Cft for Curaçao and Sint Maarten.

25. In addition, the fiscal framework should allow adequate flexibility and be complemented by improved effectiveness of public spending and capacity building to strengthen public institutions and fiscal discipline. Staff’s proposed strengthened framework would ensure the flexibility needed to accommodate the investment in skills development, crucial to unlocking growth, and allows adequate flexibility to accommodate temporary deviations over economic cycles and in the case of natural disasters and other emergencies. The fiscal framework should also include a corrective mechanism with clearly spelt out fiscal measures to correct for any temporary deviations from the target.

(i) Curaçao

26. To mitigate medium-term risks, staff discussed with the authorities a fiscal framework that envisages a 1.5 percent of GDP adjustment phased evenly over 2017–19. This framework is anchored by a 40 percent of GDP long term debt target, and is operated via targets on the primary balance. The adjustments in the primary balance needed for the public debt to gradually decline and stabilize at 40 percent could be achieved by: (i) improving tax compliance (0.5 percent of GDP), (ii) reducing personnel expenditure through attrition and implementation of merit-based salary increments (0.4 percent of GDP), and (iii) containing national health insurance expenses through cost restructuring (0.6 percent of GDP). In this respect, the authorities have made significant efforts to strengthen tax administration (¶29). Important progress has also been made in improving the financial performance of state-owned enterprises, except for the financially-challenged postal corporation, for which an action plan is being finalized (Box 3). However, despite recent reforms, the national health insurance fund (BVZ) remains in deficit and heavily reliant on budgetary transfers, which could pose a risk to medium-term fiscal sustainability (¶29 and Annex V).

uA01fig08

Curacao: Baseline vs. Active Scenarios

(in percent of GDP)

Citation: IMF Staff Country Reports 2016, 276; 10.5089/9781475527285.002.A001

Sources: Staff projections.

(ii) Sint Maarten

27. Staff recommended that policy focus on building fiscal buffers for natural disasters, and strengthening institutional capacity to support prudent fiscal management and preserve fiscal and debt sustainability. As public debt in Sint Maarten is projected to remain below 40 percent of GDP under staff’s baseline scenario, staff does not envision a need for immediate upfront fiscal consolidation. However, unlike Curaçao, Sint Maarten lies within the Hurricane belt, underscoring the need to build fiscal buffers for natural disasters. The authorities agree with staff’s recommendation to set aside budget resources annually as precautionary savings for natural disasters, and indicate that while the annual budget already includes a buffer for natural disasters, unspent amounts are not saved. The staff recommended the authorities establish a dedicated account for this purpose to support immediate rehabilitation needs. The mission proposes that the authorities target saving a minimum of 0.1 percent of GDP per annum, relative to staff’s baseline projections, based on estimated damages from previous natural disaster events in the region. In this regard, the authorities agree that this goal can be achieved through measures to improve tax administration, and mobilize revenues. In addition, future consideration could be given to replacing the sales turnover tax with an efficient and sufficiently broad based value added tax (VAT). While the authorities do not see much room to adjust expenditures, staff encouraged the authorities to explore measures to contain the wage bill, which remains above 10 percent of GDP, to make room for other critical spending, including on human capital development.

uA01fig09

Sint Maarten: Baseline vs. Baseline with Savings Scenarios

(in percent of GDP)

Citation: IMF Staff Country Reports 2016, 276; 10.5089/9781475527285.002.A001

Sources: Staff projections.

28. Staff welcomes the authorities’ capacity building efforts, particularly to improve tax administration and public financial management (PFM), and achieve compliance with the fiscal rules. The mission welcomes steps taken by the authorities in Curaçao to improve tax administration, by reducing backlogs in tax assessments and the treatment of objections, rationalizing tax receivables, as well as efforts to improve compliance (including the introduction of fiscal cash registers). Staff encourages Sint Maarten to implement similar measures and, importantly, to take steps to develop human capacity in tax administration. Further efforts are needed in both islands to improve budget formulation and cash flow management, and other key areas highlighted in the 2015 Public Expenditure and Financial Accountability (PEFA) assessments, supported by the Cft. Addressing these weaknesses will require a clear action plan supported by systematic technical assistance to assist the authorities to implement the plan. It is also critical that both governments implement measures to support the production of timely fiscal and macroeconomic statistics, essential to public policy formulation.

29. Staff welcomed the progress made in reducing risks associated with state-owned-enterprises (SOEs) and social security systems. The financial position of SOEs has improved significantly, however, further steps should be taken to address deficit making institutions, in particular Curaçao’s post office, and to ensure transparency and good governance (Box 3). Recent reforms to the social security and pension systems have helped mitigate short term risks, but policy focus should shift toward addressing medium to long term system shortfalls, and ensuring their sustainability. Strong efforts are also required to reduce risks related to increasing healthcare costs.

Fiscal Risks and State-owned Enterprises

State-owned enterprises (SOEs) are a key source of fiscal risk for Curaçao and Sint Maarten. Risks related to unexpected changes in macroeconomic variables are relatively low, following the debt relief program, which assures low cost financing in local currency. However, SOEs present a potentially significant source of fiscal risk, underscoring the need to ensure transparency and accountability within these institutions, and for measures to address inefficiencies.

At the time of the 2014 Article IV Consultation discussions, staff identified several issues related to transparency and oversight of SOEs. For Curaçao, above-market wages and other inefficiencies translated into a high cost of doing business. While in Sint Maarten, in the absence of a clear dividend policy, profitable SOEs minimized their contribution to the public budget.

Since then, Curaçao has made significant progress in strengthening the financial position of SOEs. The financial situation in all but one of four high-risk state-owned enterprises has improved significantly over the last two years, based on reforms instituted by the authorities.

  • Aqualectra, the utility company, took steps to better align employee compensation with market norms, and to ensure that prices reflect the full pass-through of oil prices. Importantly, Aqualectra has been able to recover losses from previous years by adding a “recovery price” to the regular price. The authorities are also negotiating the return of assets, previously distributed to the refinery at no cost.

  • Analytic Diagnostic Center, the medical laboratory, in addition to realigning employee compensation, took steps to reduce overstaffing, improve the invoicing process, contain operational costs, and improve debt collection.

  • Curaçao Dry Dock Company (CDM) settled claims from previous employees, related to poor working conditions and underpayment, and prospects for the company have improved with the signing of a LOI with an international strategic partner. The partnership is expected to bring in new investments and increase the Dry Dock’s capacity to meet the demand for its main line of business, ship repair services.

  • CPost, the post office, remains a high-risk entity as the action plan, developed to improve its financial position, has not been fully implemented. The cost of providing services remains higher than revenues, with losses amounting to NA f. 3–4 million guilders (US$1.7 million – US$2.2 million) annually. This in part reflects discounts to the government and the Social Security Bank, making the plans politically challenging to implement.

In Sint Maarten, SOEs have historically not been a drain on government resources. The authorities have recently drafted a dividend policy to provide a framework for remitting dividends to the government. While the draft policy identifies the relevant financial ratios that can be used to determine whether a dividend can be paid to the government, the decisions to pay a dividend and the amount are left to the shareholders. The authorities believe that the SOEs are better able to decide when they can pay a dividend, based on their position and future plans, and prefer not to set explicit terms.

30. Authorities’ views. The authorities agreed in principle on the appropriateness of staff’s proposed medium–term fiscal framework, but were of the view that, while 40 percent is a reasonable target, the decision on the level of the debt target should be left to the individual governing authorities. In the area of tax administration, the Sint Maarten authorities highlight human capital as the most significant challenge, and note that the need to balance the current budget constrains spending on skills development and capacity building, therefore limiting progress in this area. The authorities are taking steps to integrate the tax administration function, which is currently separated into two departments, the Tax Assessment Department and the Audit and Control Department. They are also exploring the possibility of utilizing the financial tax software system shared by the Dutch municipalities (Bonaire, St Eustatius, and Saba) and Curaçao. This would not only be an improvement over the current system, which is outdated, but would allow for shared costs. They recognize the potential benefits from adopting a VAT but indicate their first priority is improving tax administration.

C. Maintaining Financial Stability

Policy Discussions

31. The financial sector is generally stable with no imminent systemic risk, supported by strengthened supervision at both sector and institution levels. The central bank’s Early Warning Monitoring System has been enhanced to allow better assessment of financial sector soundness and to enable the central bank to perform regular stress tests to assess financial sector resilience. A risk-based rating model is also embedded in the system to detect financial sector weak spots, complementing targeted supervision. Stability indices, on financial sector soundness, tracked by the central bank for the domestic banking, insurance and pension sectors (which account for approximately 95 percent of total financial sector assets) have remained stable over the past five years. 11 However, given macroeconomic uncertainties going forward and recent deterioration in bank asset quality and profitability, staff encouraged the authorities to continue their efforts to strengthen financial oversight (especially in the non-bank sector), through on-site and off-site supervision.

32. Sustained efforts are needed to strengthen the AML/CFT framework in line with the FATF standard and mitigate perceived ML/TF risks. In this regard, the authorities have recently updated their AML/CFT legislation and issued new compliance guidelines and criteria to the financial institutions based on FATF recommendations. An action plan to address strategic deficiencies identified following Sint Maarten’s assessment of its AML/CFT framework by the CFATF is currently under review. The authorities are encouraged to fully address remaining regulatory gaps and ensure effective risk-based implementation of the AML/CFT regime.

33. Some small local banks in Curaçao have recently experienced a loss of CBRs. While existing CBRs with large European banks could provide a temporary buffer in the short run, staff encouraged the authorities to continue monitoring the status of CBRs and address reputational risk by strengthening their compliance with AML/CFT and transparency of tax information standards.

34. Staff continued to emphasize that the central bank should refrain from direct lending to SOEs, which could cause market distortions. The central bank embarked on an asset purchase program to build a portfolio of corporate bonds with an ultimate goal to create a substitute for the conduct of open-market operations, as the short term government security market dried up since 2010.12 There has been no new purchase since 2012 and currently there are two loans (both to SOEs) in the portfolio. Staff has urged the authorities to restrain from further central bank direct lending and to continue their efforts to further develop a corporate bond market, to provide financing alternative to bank financing for SOEs and private entities, and to create more local investment opportunities.

35. Authorities’ views. The authorities concurred with staff about the importance of strengthening financial regulation and supervision. They noted that draft legislation to harmonize and update prevailing supervision laws, which is in the last phase of the legislative process, will enable the central bank to execute its supervisory tasks more effectively, and a new Chart of Accounts reporting system will further strengthen the central bank’s oversight function. The authorities expressed their deep concerns over the recent and potential further loss of CBRs and are committed to proactively identifying and addressing vulnerabilities in the financial sector.13 Regarding the central bank’s lending to SOEs, the authorities committed to bring it to a close once the two existing loans mature.14

Staff Appraisal

36. The economic recovery and a stronger fiscal position have helped reduce near-term risks. Curaçao ended a three-year recession in 2015, despite the deterioration in macroeconomic conditions in Venezuela—one of the island’s main trading partners. Expansion in Sint Maarten’s economy continued into the fourth consecutive year, despite a modest deceleration. The Union’s external and fiscal imbalances have also declined, with favorable external conditions and the authorities’ fiscal consolidation efforts, but vulnerabilities to external shocks remain given its reliance on a narrow scope of products and markets.

37. However, risks to medium-term growth prospects remain to the downside. Continued low growth in the euro area could have serious economic repercussions for Curaçao and Sint Maarten through various channels, given that both islands remain heavily reliant on the euro area. Further disruptions in Venezuela could worsen Curaçao’s growth prospects and balance of payments if no alternative export markets are identified. Meanwhile, a loss of CBRs could hinder cross-border transactions, adding to the macroeconomic uncertainties. In addition, slow progress in implementing needed structural reforms also poses an important downside risk to growth prospects going forward.

38. Unlocking growth through economic diversification and investment promotion is therefore imperative in this environment. In this respect, the authorities’ national development plans are an important step toward charting a clearer direction for strategic sectors and markets and removing impediments to private sector activity. Implementation of the plans is key, in particular, on decisive structural reforms to improve the labor market and doing business conditions, as well as energy sector reforms to diversify energy generation via renewable sources.

39. A sound medium term fiscal framework will help reinforce macro stability anchored by the fixed exchange rate. With the limited effective monetary and exchange rate policy instruments, given the fixed exchange rate regime, fiscal policy is the authorities’ only available option to cushion economic shocks. A sound medium term fiscal framework, equipped with clear objectives and targets and supported by a proven track record could improve credibility, bolster investor confidence, and promote investment.

40. In this regard, important structural fiscal reforms are needed to further strengthen fiscal discipline. In particular, weaknesses in tax administration and public financial management have been identified in both islands. Staff welcome the authorities’ efforts to strengthen tax administration to enhance revenue mobilization, improve taxpayer services, and increase tax compliance. These are important prerequisites for future tax policy reforms contemplated by the authorities. In addition, an action plan is greatly needed to ensure timely and decisive implementation of measures to strengthening public financial management, in line with PEFA assessment recommendations.

41. Strengthened financial supervision has become more important given increasing international scrutiny. The authorities are advised to strengthen risk-based financial supervision and effective implementation of cross-border tax information sharing, as well as AML/CFT frameworks in line with international standards. In a context of evolving regulatory requirements and enforcement landscape, Curaçao and Sint Maarten’s ability to strengthen transparency, including in Curaçao’s international financial center, will help reduce the perceived reputational risks. A stable financial sector is also critical to supporting economic growth and private sector activities.

42. Capacity building is needed to strengthen public institutions. Policy implementation has been greatly challenged by capacity issues in both islands, as in most other Caribbean small states. Investment in human capital development is critical to strengthening public institutions and improving productivity. Staff urge the authorities to engage with their international partners in seeking technical assistance to support capacity building.

43. Data provision should be improved to allow adequate surveillance. The statistical offices in both countries expressed concerns over lack of capacity, ability to hire qualified personnel, and delays in data submission from the private sector and government entities. While some efforts have been made to streamline data collection and digitalize surveys, staff highlights the need to allocate additional resources to increase personnel and obtain technical assistance to address shortcomings.

44. Staff recommends that the next Article IV Consultation discussions with the Kingdom of the Netherlands—Curaçao and Sint Maarten be held on the 24-month consultation cycle.

Figure 1.
Figure 1.

Key indicators for Curaçao and Sint Maarten in a Regional Comparison

Citation: IMF Staff Country Reports 2016, 276; 10.5089/9781475527285.002.A001

Sources: IMF World Economic Outlook, CBCS, National Authorities; and IMF Staff Estimates.1/ Unweighted average of indices for Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia and St. Vincent and the Grenadines.
Table 1.

Curaçao: Selected Economic and Financial Indicators, 2011–21

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Sources: Data provided by the authorities; and IMF staff estimates.

Based on IMF staff estimates of deflators.

Excludes consumption of fixed capital.

Table 2.

Sint Maarten: Selected Economic and Financial Indicators, 2011–21

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Sources: Data provided by the authorities; and IMF staff estimates.

Based on IMF staff estimates of deflators.

Excludes consumption of fixed capital.

Table 3.

Curaçao and Sint Maarten: Monetary Survey 1/

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

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Sources: Central Bank of Curaçao and Sint Maarten, IMF staff calculations.

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

Table 4.

Curaçao and Sint Maarten: Financial Soundness Indicators, 2007–15

(in percent)

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

Curaçao and Sint Maarten: Balance of Payments, 2011–21

(In millions of US dollars)

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Sources: Central Bank of Curaçao and St. Maarten; and IMF Staff Estimates.