Statement by Menno Snel, Executive Director for the Kingdom of the Netherlands—Netherlands and Robert Mosch, Advisor to Executive Director, May 1, 2013

The Netherlands is an AAA euro area (EA) economy with significant private sector imbalances. The main policy challenge is to restore growth and manage downside risks while allowing for an orderly adjustment of private sector balance sheets. A focus on medium-term objectives will cement policy credibility and mitigate uncertainty. The financial system must reduce its dependence on wholesale financing, and banks reliant on public sector support need to wind down this support. Reforms in the labor markets and human capital will be important in safeguarding the economy’s growth potential.

Abstract

The Netherlands is an AAA euro area (EA) economy with significant private sector imbalances. The main policy challenge is to restore growth and manage downside risks while allowing for an orderly adjustment of private sector balance sheets. A focus on medium-term objectives will cement policy credibility and mitigate uncertainty. The financial system must reduce its dependence on wholesale financing, and banks reliant on public sector support need to wind down this support. Reforms in the labor markets and human capital will be important in safeguarding the economy’s growth potential.

We thank staff for their thorough analysis of the Dutch economy. The Dutch authorities appreciated the constructive discussions during the mission, and share the main gist of the staff report.

On the policy agenda

Since the start of its term at the end of 2012, the Dutch government has pursued an ambitious agenda of structural reform and budgetary consolidation. Currently, reforms of the pension system, health care, labor market and housing market are being implemented.

To increase the sustainability of the pension system, the retirement age will be gradually increased from 65 to 67 years and indexed to life expectancy. The pace of retirement age increases has been stepped up to three months a year until 2018, and four months a year thereafter. The subsidy for pension savings will be better targeted by eliminating the favorable fiscal treatment for annual income above EUR 100,000.

Wide-ranging measures have been introduced to stem the rise in health care costs. Over the government’s term, growth of health care expenditures will be cut back by EUR 5 billion (0.8% of GDP). Health care insurers and providers will bear more risk, entitlements will be cut back and co-payments will increase.

On the labor market, several measures are being taken to counter unemployment. For instance, the government will support initiatives for retraining and measures to increase job-to-job mobility. Specific measures will be introduced to reduce youth employment and promote re-integration of older unemployed workers. The pace of reforms will be gradual to take account of the current low growth environment and consumer confidence, and in order to lessen any potential negative impact in the short term. The government will also take measures that aim to achieve a better balance between flexible and permanent employment by increasing the protection for temporary workers while reducing rigidities for permanent workers.

As part of a wide-ranging reform, the implicit subsidy to the housing market is being cut back by half. Mortgage Interest Deductibility (MID) has been limited to 30-year amortizing mortgages, and the rate at which the mortgage is deductible will be gradually lowered starting January 1, 2014. Also, the Loan-to-Value (LTV) ratio is being lowered from 106% to 100% in six years – gradually, so as to not be procyclical in a downward housing market. Although assets of households are significantly larger than their liabilities, these measures will be instrumental to address risks that may arise from high household debt. An important element of reforms in the rental market is to bring current subsidized rents more in line with market values, thereby improving allocational efficiency and realizing a better targeting of public resources.

Given the impact of reforms, the government has actively pursued broad support. The current political situation, with the government lacking a majority in the Senate, and low consumer confidence require an inclusive decision making process. A gradual and inclusive approach is a general feature of successful reforms. In recent months, the government managed to reach agreement with opposition parties on the reform of the housing market, and with labor unions and employers’ federations on the reform of the labor market and health care system.

On staff’s assessment

While we share the main thrust of staff’s appraisal, we would like to offer the following comments.

Staff seems to ignore the sound fundamentals of the Dutch economy when it compares the Netherlands to countries which are under market pressures. Among other things, the current account surplus, the funded pension system with assets over 100% of GDP, the government debt ratio below OECD average, the strong competitiveness position, and the high labor participation rate do not warrant such a comparison. Indeed, international rankings such as the OECD’s Programme for International Student Assessment (PISA), the competiveness indicators of the World Economic Forum, and the ranking in the Doing Business report would call for a more balanced description.

We see little argument to consider the budgetary policy being excessively procyclical, as staff suggests. Automatic stabilization is an important element of the Dutch budgetary system. By letting the budget balance deteriorate from a surplus at the onset of the crisis to current sizable deficits, the budget has provided support to the real economy. Moreover, interventions in the financial sector, which resulted in a rapid increase in government debt and government guarantees, have supported the functioning of the financial system. Although the original aim was to bring the deficit within the 3% limit in 2013, the government decided not to take additional measures for 2013 as economic conditions have deteriorated. The deficit is likely to surpass the 3% limit for the fifth consecutive year in 2013.

For 2014, the government remains committed to a deficit within the European limit of 3% of GDP. Whereas in 2013 cyclical conditions will warrant an extension of the EDP deadline (the nominal budget deficit will likely stay above 3% of GDP even as the structural budget balance will improve), this is not the case in 2014. Without additional measures, the structural budget balance is set to deteriorate. Surpassing the 3% limit while also not improving the underlying budgetary position could jeopardize the credibility of the medium-term consolidation plan as well as the recently reformed EU governance framework.

Regarding the characterizations of the authorities’ views, we feel that the short descriptions do not always do justice to the information and views shared with staff during the mission. In our view, staff could have elaborated in more detail on the extensive discussions and on the information provided. This would portray a more nuanced view than currently follows from these paragraphs. More specifically, a recurrent theme over the past year has been the IMF’s emphasis on the cyclical nature of the current economic situation, whereas the authorities take the view that economic growth will be lower for an extended period of time, which argues against back loading the necessary budgetary adjustment and structural reforms.

Staff mentions that structural measures will be needed to reduce the current account surplus. However, it is not clear why and how the current account surplus should be reduced by policy measures in the short term, since there are no indications that the Dutch current account surplus is the result of underlying distortions. Therefore, before action is taken in an effort to reduce the surplus, a much better understanding would be needed of the underlying mechanisms that are responsible for the structural surplus. For example, as staff mentions, data on the current account should be treated with great caution due to statistical issues. In this respect, we also note that some of staff’s other recommendations, such as limiting household debt related to the housing market, could actually result in an increase of the surplus.

On the financial sector

We generally agree with staff’s assessment of macroprudential policy and supervision in the Netherlands, including the recent reforms to the macroprudential framework and supervision. Table 6, on implementation of the main recommendations of the 2011 FSAP, shows that the results of the FSAP continue to be relevant for financial stability policy in the Netherlands. The new Financial Stability Committee, which met for the first time in December 2012, should prove to be a strong forum to discuss macroprudential issues at the national level. The three elements of a new supervisory approach – cultural change, stronger risk-based supervision, and macro, sectoral, and thematic assessments of risk – are based in large part on international best practices compiled by the Fund. We add to this list the extensive top-down and bottom-up stress testing of the financial sector by DNB (the Dutch Central Bank), which is a critical tool in assessing the resilience of the financial sector. DNB is currently undertaking an ongoing asset quality review (AQR) of commercial real estate, also meant to identify pockets of distress and ensure adequate valuations by banks.

We concur with staff’s identification of the financial stability risks. As staff points out, a renewed escalation of the European debt crisis remains the major risk, and unanticipated shocks to domestic confidence or persistently low growth could also have a clear impact on the outlook. In its most recent Overview of Financial Stability, DNB has also emphasized the risks for banks and pension funds of the low interest rate environment, banks’ retail funding gap and the use by banks of secured funding, which can shift risks between investors. Finally, current policies are in line with staff’s recommendation for proactive measures to shore up capital from private sources. The Netherlands plans to use the national discretion available in CRD4 to introduce additional SIFI buffers and Systemic Risk Buffers to address risks within the banking system.

In line with staff’s recommendation, the authorities took steps to reduce procyclical elements of the pension system. Measures have already been implemented to reduce the volatility in the market-based discount rate due to illiquidity of interest swap markets for long horizons. Furthermore, by lengthening the recovery period and smoothing benefit reductions, the procyclical impact of decisions has been limited. In addition, the Dutch authorities are working towards a new regulatory system as part of reforms to safeguard the sustainability of pension contracts. Even though this financial supervision framework is based on marked valuation, the reforms are expected to help reduce the procyclicality of contributions and benefits. Day-to-day volatility will be smoothened through several adjustment mechanisms.