Abstract
This Selected Issues paper and Statistical Appendix explores four policy issues—fiscal policy, public sector pension reforms, monetary management, and labor market performance—which are crucial for understanding the recent performance of the economy of the Netherlands Antilles and which will need to be addressed to restore the prospect of durable economic growth. The paper reviews experience with fiscal adjustment in the Netherlands Antilles, focusing in particular on the 1996–97 adjustment program. The paper also analyzes the sustainability of the public pension system of the country.
IV. New Instrument Mix For Monetary Management25
78. Monetary policy in the Netherlands Antilles has managed to safeguard the peg to the U.S. dollar, which has been in place at an unchanged rate since 1971, despite the emergence of large fiscal imbalances during the 1990s. In this context and given the small open nature of the economy, adequate control over domestic credit is crucial, as credit growth has been observed to spill over into higher imports, which in turn has put pressure on international reserves (Figure 1). Direct monetary controls, combined with restrictions on capital flows, have been the preferred instruments of monetary control so far. Recognizing that they have not always been effective—as indicated by persistent excess liquidity of commercial banks—and have hampered the functioning of financial markets, the central bank initiated a shift toward increased reliance on indirect instruments of monetary control in 1998. As described below, monetary developments over the past two years may have been auspicious for the timing of this shift, but the more active use of minimum reserve requirements in the course of 1998 appears to have been effective. Even so, the shift has only been partial, since the lack of fiscal consolidation has forced the central bank to maintain a ceiling on credit to the government. Thus the full benefits of the increased use of indirect instruments are unlikely to be felt soon and will also depend on further refinements in the operation of the minimum reserve requirement and the development of interest rate sensitive instruments of monetary , management. Without this, it may not be possible to address decisively the excess liquidity problem.
NETHERLANDS ANTILLES Domestic Credit Growth and Overall Balance of Payments
Citation: IMF Staff Country Reports 1999, 065; 10.5089/9781451800982.002.A004
Source: Bank van de Nederlandse Antillen, Quarterly Bulletin.A. Monetary Developments During 1997–98
79. After contracting in 1996, money demand increased moderately during 1997–98 and its composition shifted markedly toward time deposits. Broad money increased by 2.6 percent and 3.6 percent in 1997 and 1998, respectively. Time deposits grew by 12.9 percent in 1997 and 7.7 percent in 1998, while savings deposits first declined in 1997 by 1.1 percent, before resuming growth at 3.4 percent in 1998. The shift toward time deposits was induced by a relative increase in interest rates on these deposits as banks were facing stronger competition for financial savings from the non-bank sector, where instruments were offered that were tied to the increasing yield on government securities. The increase in near-money also reflected a reticence to invest in government securities and in real assets, against the background of the deteriorated state of public finances and uncertainty about the course of economic policies. In part this explains the increase in savings deposits in 1998, even though yields on these deposits hardly changed.
80. Monetary policy in 1997 was conducted against the background of a loss of control of credit in 1996 and geared at rebuilding net foreign assets and official reserves. During 1996, net domestic assets of the banking system increased by 6.8 percent, despite a decline in domestic credit to the government, contributing to a drop in net foreign assets by NA f. 96 million and a decline in import coverage of official reserves from 2 months to 1.5 months. The loss of control was caused by a circumvention of private credit ceilings through sales of loan portfolios abroad and willingness by banks (and their clients) to pay the apparently insufficiently high penalty rate for exceeding the credit ceilings. In response, this loophole was closed and penalty rates were increased in an attempt to limit the increase in private sector credit to 3.5 percent over the period November 1, 1996 to December 31, 1997. The ceiling on credit to the government was maintained at its October 1996 level.
81. While the tightening of monetary controls appeared to have been effective in restricting credit growth in 1997, it was assisted by a weakening of economic activity which curbed demand for credit By the end of 1997, net domestic assets were up by only 0.3 percent relative to end-1996 and net international reserves had increased by NA f. 49.7 million, allowing official reserves to recover to 1.9 months of imports. Claims on the private sector fell by 0.6 percent, which can be attributed largely to the decline in real GDP by an estimated 0.7 percent. The pace of mortgage expansion fell from 10.6 percent in 1996 to 6.9 percent in 1997, while consumer loans were cut by 5.9 percent and business loans by 0.3 percent.
82. Domestic credit to the government, while not exceeding the October 1996 ceiling, did not decline as targeted in the 1996–97 macroeconomic adjustment program. This was the consequence of the failure to correct fiscal imbalances and to deposit NA f. 40 million in a sinking fund to be held at the central bank and established to cover the expected increase in the pay-as-you-go obligations of the civil servants pension system.
83. During 1998, monetary policy met its objectives, even though private sector credit resumed growth, in line with the modest recovery in economic activity. The ceiling on credit to the government was maintained at its October 1996 level, while credit to the private sector was permitted to expand by 2 percent over the amount outstanding at end-September 1997. By the end of the second quarter of 1998, however, net domestic credit to the private sector, mainly in the form of consumer and business loans, had already increased by the allowed 2 percent. Anticipating the risk that the ceiling was likely to be breached, monetary policy was tightened in August 1998. The ceiling on private sector credit growth between end-June and end-December 1998 was set at ¼ percent. In addition, the minimum reserve requirement was raised from 4 percent to 6 percent in September 1998, to 6.5 percent in October, and again to 8 percent in November, to mop up excess liquidity of the banking system. This strategy proved successful as credit to the private sector contracted somewhat, recording an overall increase of 1.4 percent for the year, thus remaining below the revised ceiling of 2¼ percent.
84. Net domestic credit to the government was kept below its ceiling during 1998. Movements in net bank credit to the government largely followed changes in its deposit balances as banks remained reluctant to extend new credit to the government, given the unsustainable fiscal situation. Reflecting this volatility, net credit to the government first declined and then expanded by 38 percent during the second quarter of 1998, but by end-1998 it remained 17 percent below its ceiling. This was in part the result of a large disbursement of project aid from abroad which was deposited at the central bank and expected to be spent during the first few months of 1999. Excluding this deposit—which cannot be used to finance the budget deficit—net domestic credit to the government was near its ceiling at end-1998.
85. Noteworthy is the decline in other items net of the banking system recorded in 1998. This mainly reflects the increase in liabilities as a result of provisioning for nonperfoming loans which rose by 20 percent during 1998, a development attributed to three consecutive years of weak economic activity.
86. Thus, developments during 1997–98 indicate that while weak economic activity facilitated monetary control, the more active use of the minimum reserve requirement appeared to have contributed to checking private sector credit growth. Admittedly, private sector credit growth never exceeded its ceiling, thus lending support to the hypothesis that the penalties for exceeding the credit ceiling were binding. However, in looking at monthly data on credit developments, it should be noted that credit to the private sector declined in the two months when reserve requirements were increased. With hindsight, as credit growth remained below the ceiling, the monetary tightening during the last four months of the year may have overshot.
B. Increased Reliance on Indirect Instruments
87. The central bank disposes of a full array of instruments of monetary control, but has favored three principal instruments for monetary management during 1997 and 1998:
The monetary cash reserves requirement (MCR), which establishes separate limits on credit to the private sector and net credit to the government for each bank and progressive penalties for exceeding these ceilings. To help prevent monetization of the deficit, the ceiling on net credit to the government has been kept constant at its October 1996 level. Ceilings for private sector credit growth are set with reference to money demand projections and a net foreign assets objective.
The minimum reserve requirement, which is aimed at controlling the liquidity in the domestic banking system. It requires the commercial banks to place a noninterest bearing deposit on a blocked account with the central bank during the maintenance period.
The “B-9” policy, which impose limits on the liquid net foreign asset position of the commercial banks. Under this policy the central bank imposes a minimum and a maximum limit on the amount of net claims on nonresidents in foreign currencies that may be held by commercial banks. The policy is aimed at controlling net outward investment and concentrating net foreign assets at the central bank. Banks must submit information on their net foreign asset position on a weekly basis.
88. Several other instruments available to the BNA for the conduct of monetary policy have been used only to a limited extent or not at all:
BNA certificates of deposit (CD), which are made available each month to individual banks. Interest rates offered on CDs are published each month and CDs are negotiable among domestic banks, although the secondary market is still very thin.
Repurchase agreements (REPO), which allow commercial banks to buy securities from the BNA’s portfolio under the condition of a repurchase of these securities after a specified period of time. For the time being, the REPO facility is not active.
Discount window, which permits commercial banks to rediscount paper that meets certain standards at an officially announced discount rate. Use of this facility is being discouraged by the central bank and only a limited amount is outstanding.
Liquid asset requirements, which oblige banks to hold a specified share of assets in liquid instruments, mainly cash and government securities. These requirements are actively used, but mainly as a prudential tool (see Section C).
89. During 1998, the central bank initiated important steps toward increased reliance on indirect instruments of monetary control. To drain excess liquidity from the banking system in preparation for the removal of the ceiling on private sector credit, minimum reserve requirements were raised in successive steps to 8 percent during 1998. To mitigate the adverse impact on banks’ operating costs from these increases and to help develop an active interbank money market, the central bank permitted banks to acquire and hold 25 percent of the minimum reserve requirement in the form of BNA certificates of deposit. At the same time the maximum limit on the net foreign asset position (B-9 position) was abolished, even though banks are still required not to run negative net foreign asset positions.
90. While the new monetary policy framework in place for 1999 represents an important step toward a market-oriented monetary policy, it entails some significant drawbacks in its present form:
The monetary cash reserve requirement is still formally in place, even for credit to the private sector. The fact that no limit has been announced does not prevent the central bank from reinstating a limit if it deems it to be necessary to control credit growth. This sends an intransparent signal to the banking sector indicating uncertainty about the effectiveness of the indirect instruments on behalf of the monetary authorities.
The continuation of the ceiling on credit to the government causes a segmentation of financial markets and prevents the effective market-based determination of yields across the spectrum of financial assets.
The minimum reserve requirement is subject to variation on a monthly basis without prior warning and balances must be maintained on a day-to-day basis. Variations in minimum reserve requirements are generally seen as a crude instrument of monetary policy. If changes are too frequent and without prior warning, banks will be induced to hold excess precautionary balances, which might be seen as excess liquidity and lead to counterproductive tightening. In addition, unremunerated reserves constitute a tax on the banking sector and, as such, have distortionary effects. Finally, the effectiveness of changes in reserve requirements in controlling credit is somewhat mitigated by the lags involved in its operation (currently two months).
91. Without much risk of loss of control, further refinements to the present monetary framework could be implemented to remove some of its drawbacks. While the continuation of ceilings on credit to the government may be necessary as a transitory compromise until fiscal consolidation takes hold, the minimum cash reserve requirement for private sector credit appears to be redundant and could be abolished. In addition, to allow a more accurate assessment of the liquidity of the banking system, daily averaging of minimum reserve requirements could be considered. This would obviate the need for banks to hold excess balances at the central bank out of precautionary motives. In addition, minimum reserve requirements should be varied less often and short-term control of liquidity should be left to other instruments. Some remuneration of reserves could be considered to help reduce banks’ operating costs and intermediation spreads.
92. Nonetheless, fully market-based operation of monetary policy is complicated by the limited size of the domestic financial market and the oligopolistic structure of the banking system. The financial sector is highly concentrated, with one bank accounting for over 55 percent of all assets, and four banks covering 75 percent of assets. This structure imparts some monopoly power to banks, allowing them to pass on excess costs incurred as a result of higher reserves requirement to their customers. On the other hand, the structure of the banking system has led to a leader-follower model in which the smaller banks do not deviate from the interest rates set by the dominant, large bank. As a result, there is no effective competition on lending rates and most of the smaller banks have developed niche markets. Thus, sending signals to the banking sector through interest rates is less effective in controlling the extension of credit than in a more competitive environment.
C. Assessing Excess Liquidity
93. The concurrent use of two different concepts to measure the liquidity of the banking system in the Netherlands Antilles, each with their own drawbacks, has caused some confusion about the extent of an apparently persistent excess liquidity problem. Since liquid asset requirements have been imposed for prudential reasons, any holdings of assets that qualify to meet these requirements in excess of statutory prescriptions have been considered excess liquidity. Given the shallowness of secondary markets, however, most of these assets cannot be considered as truly liquid. Thus the amount of commercial bank deposits held at the central bank in excess of reserve requirements appears to be a more meaningful concept to gauge the potential for unchecked credit expansion. Even this concepts has its disadvantages, though, resulting from the manner in which the reserve requirement policy is being implemented.
94. On the prudential definition of liquidity, commercial banks have increased their excess liquidity position continuously during 1997–98 (Figure 2). Assets qualifying to meet these requirements comprise interbank deposits, time deposits at the central bank, and treasury bills. It is not at all certain that some of these assets are as liquid as supervisory purposes would require. It can be argued, for instance, that treasury bills, under the present circumstances of unsustainable fiscal imbalances should not be considered liquid assets. In addition, liquid asset requirements have distortionary effects as the banking system is compelled to favor particular classes of assets.
95. Looking at commercial bank deposits at the central bank in excess of minimum reserve requirements, excess liquidity has diminished considerably over the past year (Figure 2). Commercial banks’ available deposits at the central bank show a decline during 1998, mainly attributable to the growth in outstanding certificates of deposit, thanks to their increasing yield over this period. Even so, some excess liquidity appears to be remaining, despite repeated increases in minimum reserve requirements. This may well be the result of the frequent variations in the minimum reserve requirements without prior notice, which in the absence of daily averaging of reserves has forced banks to hold precautionary balances at the central bank.
NETHERLANDS ANTILLES Excess Liquidity: Commercial Banks
(In Millions of NA Guilders)
Citation: IMF Staff Country Reports 1999, 065; 10.5089/9781451800982.002.A004
Source: Bank van de Nederlandse Antillen.Prepared by Luc Everaert and Fabrice Lenseigne.
