Statement by Age Bakker, Executive Director, and Ester Barendregt, Senior Advisor to the Executive Director for the Kingdom of the Netherlands—Netherlands

The staff report for the Netherlands’ 2009 Article IV Consultation describes the economic developments and policies. State interventions in the financial sector have been broadly appropriate and consistent with a sound fix-it-and-exit approach. Measures have included capital injections, nationalization, and government guarantees. Although systemic risks have been addressed effectively and risk-weighted capital ratios are above required minima, building up equity to levels deemed more adequate in regulatory reform proposals and brisker lending to support the economic recovery may require banks to tap considerable extra capital.

Abstract

The staff report for the Netherlands’ 2009 Article IV Consultation describes the economic developments and policies. State interventions in the financial sector have been broadly appropriate and consistent with a sound fix-it-and-exit approach. Measures have included capital injections, nationalization, and government guarantees. Although systemic risks have been addressed effectively and risk-weighted capital ratios are above required minima, building up equity to levels deemed more adequate in regulatory reform proposals and brisker lending to support the economic recovery may require banks to tap considerable extra capital.

January 11, 2010

Introduction

The Netherlands authorities thank staff for their appraisal of the Dutch economy as well as the informative exchange of views during the meetings.

The Dutch economy, as many others, has gone through a turbulent and challenging period. With its relatively large and international financial sector, the Netherlands was highly exposed to the global financial distress. Being an open economy, the country was particularly affected by the adverse economic developments following from the financial crisis.

For this governmental period, which started in 2007, the government based its budgetary framework on an estimated annual trend growth of 2 percent. It planned to improve the structural balance from a deficit of 0.2 percent of GDP in 2007 to a surplus of 1 percent in 2011. The budget memorandum for 2009, drafted right before the collapse of Lehman, still envisaged this budgetary path to be on track, foreseeing a surplus of 1.2 percent of GDP.

The financial crisis and the following deep recession have thoroughly changed the economic landscape. Negative growth was recorded for four quarters. Growth returned to positive numbers (quarter-to-quarter) in the third quarter of 2009 and is expected to further pick up. However, the outlook for the budget is exceptionally negative by Dutch standards: the budget deficit has increased sharply and is expected to rise further to 6 percent of GDP in 2010. In these circumstances, and against the backdrop of continued fiscal challenges related to ageing, measures have been taken to curb the deficit and a fundamental review of all government spending programs and the tax system is underway. These steps underline the government’s commitment to the continued sustainability of Dutch public finances.

Response to the crisis

In the exceptional economic and financial climate, the government has taken a range of measures to address the immediate challenges which the crisis posed.

First, large-scale financial sector interventions were made (mostly in 2008), driven by the need to maintain financial stability, totaling over EUR 80 billion (adding to the public debt, although it is expected that these interventions will be mostly recouped when the economy recovers). Second, the government decided to let automatic stabilizers do their work, disregarding the normal deficit limit of 3%, and outlays for unemployment benefits were allowed to increase without undertaking compensating measures. Third, temporary and focused stimulus measures were taken as part of a coordinated European response. The combined effect of the stimulus measures and automatic stabilizers amounts to an increase of the budget deficit by EUR 50 billion over 2009 and 2010.

Economic outlook

It seems that the worst is behind us. Several indicators, including increased confidence among consumers and producers, point to improving economic conditions. At the same time some effects of the crisis may have a lagged impact in 2010, such as rising unemployment and deteriorating public finance. The most recent projections of the Netherlands Bureau for Economic Policy Analysis (CPB) are slightly better than staff forecasts for 2009 at -4 percent, and show a more substantial improvement for growth in 2010 at 1.5%. This more optimistic outlook is driven by the stark turnaround in world trade figures since mid-2009.

There are a few specific issues with respect to the economic outlook which merit attention.

First, the impact of the economic crisis on unemployment has been more modest than expected, so far. The government, in response to the crisis, has subsidized temporary reduced working hours arrangements, stimulating companies to keep employees while obliging them to invest in their education. The Netherlands being a knowledge-based economy dependent on highly educated labor, and labor market conditions being tight before the crisis, companies are hesitant to lay off employees. In this respect they were helped by an improved economic outlook and better than anticipated profitability, caused partly by lower incidental remunerations and fewer hours worked. Also, a stronger than expected discouraged worker effect is noticeable. Consequently, unemployment forecasts have been revised downward substantially, for 2009 to 5 percent (national definition, which is 1- 1.5 % higher than the ILO definition) and for this year to 6.5 percent.

Second, after considerable private wealth loss in 2009, private wealth is expected to recoup in 2010, contributing to consumption growth. The wealth loss in 2009 was due to substantial equity losses and a moderate decline in house prices. With the recent upward movement in stock prices and with house prices, as explained in staff’s analytical note, broadly in line with fundamentals the outlook for private wealth is more positive for 2010.

Third, staffs analysis points to a credit crunch since 2007 and the likelihood that financial tightening may reduce economic growth in 2008–2010. We have our doubts about the firmness of these conclusions, since our statistics indicate that the year-on-year growth of loans granted by banks to non-financial institutions from mid-2007 through 2008 has been unusually high. That said, the Dutch authorities recognize the importance of a healthy credit market for restoring economic growth, and they have taken measures to stimulate granting of bank loans, especially to small and medium enterprises.

Fiscal exit and structural reforms

The dramatic deterioration of the fiscal situation has prompted the Dutch government to present a supplementary policy agreement in March 2009, accompanying the fiscal stimulus measures described above. The agreement sets out a medium-term framework for stabilizing the economy in 2010, starting fiscal consolidation in 2011, and for further improving the budgetary position thereafter.

The Netherlands has a well-tested set of budgetary rules in place. These credible and transparent rules will be instrumental in achieving the necessary fiscal consolidation in the coming years. Moreover, the government has recently submitted to Parliament a Deficit Reduction Act to speed up the budgetary adjustment. This new rule, to be enshrined in national law, ensures progress towards medium-term objectives agreed in the context of the European excessive deficit procedures.

Staff recommends refinements of Dutch fiscal rules to attenuate their procyclicality. We agree that excluding cyclically sensitive outlays from the expenditure ceilings can be helpful. However, we fear that formalizing exceptional circumstances in which discretionary stimulus is allowed, may lead to increased political pressures. Since Dutch budgetary principles prescribe that the rules cannot be changed during the game (the governmental period), staff’s recommendations are taken into consideration by a high-level advisory group on the budgetary policy framework for the next government.

For the fiscal exit the government is firmly committed to implement the recommendations in the framework of the European excessive deficit procedure. To this effect the government has put in place a strategy to reduce the deficit below the 3 percent threshold value by 2013 and to further improve the budgetary position towards agreed medium term objectives thereafter. Concrete measures undertaken by the government include the decision, in line with staff’s recommendations, to withdraw the stimulus measures in 2011, provided that the economy has sufficiently recovered from the crisis (the latest economic forecasts indicate that this is likely the case). In addition, expenditure cuts of 0.3% of GDP are foreseen for 2011. Furthermore, the government intends to moderate wages in the public sector.

The government agrees with staff’s assessment that the fiscal sustainability gap has increased considerably over the last years, due to the crisis and higher than expected increases in ageing-related spending. In this respect the government has proposed a sustainability package, amounting to 1.3% of GDP. First, the pension age will be increased from 65 to 66 years in 2020 and to 67 in 2025, giving employees and employers sufficient time to prepare. Privately funded pension plans (the second pillar) will also disburse 2 years later at the age of 67. Second, public reinsurance of healthcare will be phased out so that health insurers will bear greater risks, thus improving cost effectiveness. Third, mortgage-interest-deductibility for high-priced homes will be abolished above a certain cap. These measures will help to reduce the sustainability gap, which staff estimates at 8% of GDP.

However, the government agrees that more fundamental reform will be needed to maintain long-term sustainability. To that end, the government has engaged in a Fundamental Budgetary Review. Twenty working groups will make proposals for savings of up to 20 percent of budget expenditure. Such an approach has been very successful in the eighties in achieving a substantial reduction in the size of the public sector. The working groups cover all areas of government policy, including housing, labor market, innovation, energy and safety. They are complemented by a study on the structure of the tax system. In this fundamental budgetary review, there are no taboos. In order to stimulate creativity and a critical attitude, working groups are chaired by current or former top-ranking officials from a different policy field. Moreover, each working group has an obligation to work out at least one scenario that could result in budgetary savings of 20 percent in their area. Working groups are expected to report in spring 2010, so that results can be incorporated in the preparations for the 2011 national budget where possible.

Financial sector situation and exit

The global financial crisis has hit the Dutch financial sector hard, and the authorities have had to take exceptional measures to maintain financial stability. We are pleased with the constructive remarks by staff on the Dutch approach.

Staff expresses concerns that Dutch banks - like several European counterparts - have low equity capital relative to unweighted assets. In our view, this can be largely explained by the use of IFRS accounting in Europe, which obliges banks to consolidate more assets on their balance sheet than their American peers who report according to US GAAP (the denominator of the capital ratio is therefore larger for European banks). Moreover, the risk-weighted capital level of Dutch banks remains well above the regulatory minimum. Nevertheless, the authorities agree that banks should continue to increase the level and quality of capital. Positive developments in this respect are that recent capital issuances, disinvestments and ‘derisking’ have already increased the BIS ratio by approximately 2 percent between 2008 and the third quarter of 2009. Moreover, after the large losses incurred in 2008, profitability has stabilized at break-even point in 2009.

The Dutch authorities envisage a phased and tailor-made exit strategy for the financial sector interventions. Systemic liquidity support should be unwound first, followed by guarantee schemes and then government participations and schemes for toxic assets. This would make the transition more gradual and thus help maintain financial stability.

More specifically, the following is envisaged. Government guarantees for bank bonds with a maturity of up to five years will be phased out gradually, striking a balance between continuing the facility as a back-up option and preventing extended support for unsustainable business models. The Dutch facility was recently extended until 30 June 2010, with an increase in the guarantee fee to create a gradual and price-based exit. Although the facility is expected to close in 2010, the further design, timing and sequencing of exit strategies will depend on market developments. A revival of alternative funding sources such as the covered bond market and securitization markets could accelerate the withdrawal of public support. Furthermore, exit strategies will need to be coordinated with other EU countries.

Capital injections and asset facilities have been designed in a flexible manner and contain institution-specific exit conditions and price-based incentives, such as increasing fee structures. A timely repayment of capital injections is desirable, but repayment should be sustainable from a prudential perspective and should not endanger credit supply to the real economy. Dutch banks have recently repaid a significant part of the received government support, partly by issuing new equity which demonstrates the regained market access. End 2009, ING, AEGON and SNS REAAL repurchased respectively € 5 billion, € 1 billion and € 185 million of state owned Core Tier 1 securities.

As for acquired institutions (Fortis Bank Netherlands/ABN AMRO Bank Netherlands, insurance company ASR), the government is committed to re-privatize these as soon as possible. As a precondition, the institutions should first be able to obtain medium term financing at reasonable cost and markets should be sufficiently stabilized. The sale of Fortis Bank Netherlands/ABN AMRO Bank Netherlands is not expected before 2011. Finally, the government will ensure that any exit strategies are communicated to market participants well in advance. Clarity is an important condition to further improve market access of financial institutions, and credible exit strategies require realistic deadlines.

Staff welcomed our authorities’ efforts to create a voluntary private sector code of conduct. Under this code, remuneration is to be based on long-term performance; compensation committees are to develop explicit corporate remuneration policies. It is worth mentioning that the code introduces a relative cap on executive remuneration. This relative cap requires that executive remuneration should remain below the average remuneration of the relevant peer group.

Kingdom of the Netherlands: Netherlands: 2009 Article IV Consultation: Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for the Kingdom of the Netherlands: Netherlands
Author: International Monetary Fund