Kingdom of the Netherlands—Aruba: Staff Report for the 2015 Article IV Consultation Discussions

This 2015 Article IV Consultation highlights that Aruba has been recovering from a severe double-dip recession. The economy faced two major shocks over the past five years—the global financial crisis and shutdown of the Valero oil refinery in 2012. After a strong recovery in 2013 with growth reaching 4.75 percent, the pace of activity moderated in 2014. In 2015, growth is projected to rise to 2.25 percent. The tourism sector—the mainstay of the Aruban economy—is envisaged to grow, albeit at a slower rate. Moreover, domestic demand is slated to recover notably amid subsiding policy uncertainty and as key public-private partnership projects move forward.

Abstract

This 2015 Article IV Consultation highlights that Aruba has been recovering from a severe double-dip recession. The economy faced two major shocks over the past five years—the global financial crisis and shutdown of the Valero oil refinery in 2012. After a strong recovery in 2013 with growth reaching 4.75 percent, the pace of activity moderated in 2014. In 2015, growth is projected to rise to 2.25 percent. The tourism sector—the mainstay of the Aruban economy—is envisaged to grow, albeit at a slower rate. Moreover, domestic demand is slated to recover notably amid subsiding policy uncertainty and as key public-private partnership projects move forward.

Introduction

1. Aruba is a highly open, tourism-dependent economy, with one of the highest living standards in the Caribbean (Box 1). Over 85 percent of the economy depends directly or indirectly on tourism, making Aruba the third most tourism-dependent country in the world. As a reflection of this marked dependence on external economic conditions, the volatility of Aruba’s growth has been among the highest in the region. However, the fixed exchange rate regime against the USD (unchanged since 1971), supported by conservative fiscal, credit, and prudential policies, ensured low inflation and had kept imbalances in check until recent years (Figure 1).

Figure 1.
Figure 1.

Regional Comparison

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

Sources: Central Bank of Aruba; CBS; World Economic Outlook, and IMF staff calculations.

2. The main policy challenge is rebuilding policy space while supporting the ongoing recovery. Repeated shocks have resulted in a double-dip recession which has eroded the authorities’ fiscal policy space. Public debt increased substantially to over 80 percent of GDP in 2014, a level beyond what is considered prudent for a small economy like Aruba which is highly vulnerable to external shocks. Steadfast fiscal consolidation, relying on both revenue and expenditure measures, is needed to durably set debt on a downward trajectory. Maintaining financial stability and safeguarding competitiveness, in part by advancing the structural reform agenda, would help ensure a steady recovery.

A01ufig01

Growing Fiscal Imbalances Amid Lower Growth

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

Source: CBA and staff calculations.

3. Past Fund advice focused on ensuring fiscal sustainability through the development of a medium-term adjustment program. In particular, recommendations underscored the need to improve the financial situations of Aruba’s pension and health care schemes. The authorities undertook key entitlement reforms in 2014 and have presented a medium-term budget plan which aims to attain a small fiscal surplus by 2018. Notwithstanding these efforts, however, additional measures and determined implementation will be needed to achieve the authorities’ ambitious fiscal targets.

Recent Developments, Outlook, and Risks

A. Recent Economic Developments

4. Aruba is recovering gradually from a severe double-dip recession. The economy suffered two major shocks over the past five years: the global financial crisis and closure of the Valero oil refinery in 2012 (Figure 2). After a strong recovery in 2013, with growth at 4¾ percent, the pace of activity moderated in 2014. Despite very strong tourism growth, the loss in momentum reflected a broad-based contraction in domestic demand due to waning confidence, fiscal policy uncertainty, and investment delays. The unemployment rate is estimated to have remained broadly flat in 2014 at about 7½ percent. Recent data indicate positive but low headline inflation rates at around ½ percent, below the average of the last decade (2½ percent).

Figure 2.
Figure 2.

Aruba: Growth and External Imbalances

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

5. While external imbalances remain elevated, they have improved recently. The current account (CA) deficit is estimated to have narrowed to 7½ percent of GDP in 2014 with the non-oil CA in surplus, largely reflecting developments in the tourism sector. Both the net international investment position (IIP) and external debt have improved in 2014, and roll-over risks are mitigated as 90 percent of the debt is long-term, half of which is owed to parent companies. Aruba’s gross international reserves cover around 3¾ months of imports and 35 percent of broad money.

A01ufig02

Gross International Reserves

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

Sources: CBA and IMF staff calculations.

B. Outlook and Risks

Staff views

6. Growth is projected to rise to 2¼ percent in 2015. The tourism sector—the mainstay of the Aruban economy—is expected to continue to grow, albeit at a slower pace than over the past two years. At the same time, domestic demand is poised to recover appreciably as policy uncertainty subsides and key public-private partnership (PPP) projects move forward (Green Corridor, Ring Road 3). Hedging contracts set by the utility company above the current level of global oil prices are limiting downward inflationary pressures, and along with the 11¾ percent energy tariff increase and the introduction of the health-care levy in late 2014, inflation is expected to increase to ¾ percent in 2015. While the overall CA balance is expected to remain in deficit, buoyant tourism exports would help reduce its size to −3½ percent of GDP in 2015.

7. Under the baseline scenario, real GDP is expected to reach its pre-recession level only by 2019. Market diversification is expected to keep real growth in tourism exports steady at around 1¾ percent, but the large and lingering gaps in investment and non-tourism exports (both of which are still 40 percent below their pre-recessions peaks) due to the termination of oil refining activities will be filled only gradually. The CA deficit is expected to narrow in line with contributions from the services balance, but remain sizable due to income and transfer outflows, and continued oil trade deficits. External debt is projected to remain close to 95 percent of GDP.

8. Risks to the outlook are broadly balanced and mainly external (see RAM). The closure of the oil refinery implies a narrower economic base and even greater dependence on tourism. This concentration risk is compounded by the fact that around 55 percent of tourism originates from the U.S. Therefore, while global economic conditions matter, Aruba is most susceptible to spillovers associated with U.S. slowdowns. In particular, notwithstanding the usual confidence bands around estimated elasticities, model-based estimates suggest that each 1 percentage point temporary decline in U.S. growth would drag Aruba’s growth lower by 2 percentage points for two years (Box 2). A deepening of Venezuela’s economic crisis is also a risk given that it is Aruba’s second most important source of tourists. However, the appreciable decline in global oil prices and faster U.S. growth represent upside risks. In the medium term, while renewable energy investments could boost growth prospects, this upside is balanced by potential implementation delays. Over the longer term, the lifting of the U.S. travel ban to Cuba could have implications for Aruban tourism.

Authorities’ views

9. The authorities broadly agreed with the staff’s diagnosis of the economic outlook and risks. They were confident that robust tourism growth would continue to underpin a steady recovery going forward. While the authorities generally concurred with staff’s analysis quantifying the importance of U.S. spillovers, they pointed out that continued efforts to diversify tourists from within the U.S. and the ongoing success in catering to a progressively more upscale market are factors which have most likely increased Aruba’s resilience in recent years. They acknowledged the risks surrounding Venezuela, but pointed to strategies to overcome potentially adverse developments including initiatives to expand access to other Latin American markets (for example, Chile and Peru). The authorities agreed that Cuba’s entry into the tourism market is a longer-term consideration, in part because of the country’s lack of requisite infrastructure.

Rebuilding Policy Space and Supporting the Recovery

The main policy challenge is to rebuild fiscal space while ensuring a steady recovery through safeguarding financial stability and maintaining competitiveness.

A. Fiscal Policy: Ambitious Consolidation Needed

Background

10. Following a rapid deterioration during 2008-2012, the fiscal deficit narrowed to 5¼ percent of GDP in 2014. Policies that were originally intended to be countercyclical, along with a structural decline in output growth, have led to a significant worsening of the overall balance by 11 percentage points of GDP over 2008-2012 (Figure 3). In particular, expenditures increased sharply, with wage-related costs accounting for about one-third of the cumulative increase (2¾ percent of GDP over 2008-2012), and revenue performance suffered primarily because of the reduction in the business turnover tax (BBO) rate from 3 percent to 1½ percent in 2010. In 2014, while revenue performance was largely in line with expectations, expenditure restraint in the purchase of goods and services together with the pension reforms yielded important savings. Nevertheless, public debt surpassed 80 percent of GDP in 2014.

Figure 3.
Figure 3.

Aruba: Fiscal Developments, 2008–14

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

Sources: Aruban authorities and IMF staff estimates.

11. The authorities undertook major structural reforms in 2014 to address the fiscal challenges (Box 3). First, as a result of the general (AOV) pension reform, premiums were raised and a gradual increase in the retirement age (to 65 years) was initiated. Second, the capital shortfall of the public administration (APFA) pension system was made whole, the accrual period and franchise contributions were modified and, as with the AOV, the retirement age will gradually increase. Third, a levy was introduced to partially offset the fiscal costs of the health care system (AZV).

A01ufig03

Aruba: Composition of Government Revenue, 2008–2014

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

Sources: Aruban authorities and IMF staff estimates.
A01ufig04

Aruba: Composition of Government Revenue, 2008–2014

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

12. Fiscal consolidation is planned to continue this year. Guided by a cabinet-approved nominal expenditure ceiling, the authorities’ proposed budget plan aims to reduce the 2015 deficit to 3¾ percent of GDP. Savings are expected to come mostly from entitlement reforms, supported by a reduction in the number of public sector employees (for a total of 1½ percent of GDP). However, measures underpinning ¾ percent of GDP of the planned adjustment are yet to be identified. Specifically, while the authorities’ draft 2015 budget accounts for additional revenue from the health-care levy, it does not factor in the projected increase in the underlying cost of providing health services (¼ percent of GDP), nor does it fully account for higher debt service costs (½ percent of GDP). Thus, staff forecasts a deficit of 4½ percent of GDP in 2015.

13. Over the medium term, with the current policies, deficits would remain elevated, and debt would continue to rise. Under the baseline scenario (without additional measures), the fiscal deficit narrows modestly, reflecting the savings achieved through entitlement reforms (APFA, AOV, AZV) enacted in 2014 and other past measures. However, debt is projected to exceed 90 percent of GDP by 2020, making debt dynamics vulnerable to even small shocks (Appendix I). For example, even a mild U.S. slowdown could significantly reduce Aruban growth. Under such a scenario, debt could easily soar to over 100 percent of GDP by 2020 (text chart below). Going forward, these risks may be further compounded by contingent liabilities associated with any new PPPs.

Staff’s views

14. The authorities’ medium-term objectives are satisfactory, but current measures are insufficient to achieve them. Aruba’s exposure to external shocks, a narrow economic base, a fixed exchange rate regime, and sizable interest burden highlight the need to rebuild fiscal space. Noting that the fiscal policy anchor is the overall balance, the entitlement reforms implemented by the authorities and their ambitious medium-term adjustment path (culminating with a small surplus in 2018) are welcome. However, fiscal efforts should be sustained at least until 2020 to attain a surplus of 1½ percent of GDP, which will help bring down public debt to slightly above 70 percent of GDP. Nevertheless, these medium-term objectives will most likely not be achieved with current measures (text table below). Without additional measures and steadfast implementation, deficits would remain elevated, and debt would continue to trend upwards over the medium term. Elections scheduled for 2017 pose an additional risk to achieving these targets. Therefore, expeditiously establishing a strong and effective medium-term fiscal framework would enhance the credibility of these plans.

A01ufig05

Aruba: Fiscal Deficit, 2014-18

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

A01ufig06

Aruba: Gross Debt, 2014–18

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

15. Achieving these fiscal targets will require additional revenue and expenditure measures, including further entitlement reform:

  • Revenues. Additional revenue measures are needed given the size of the authorities’ planned adjustment. In particular, international comparison suggests that there is scope for increasing revenue from indirect taxes. For example, estimates suggest that each 1 percentage point increase in the BBO rate could yield about Afl. 60 million (about 1.3 percent of GDP) in additional revenues. Current efforts to improve revenue administration and to reduce tax arrears would yield tangible benefits only over the medium term. More generally, a thorough review of the tax system seems warranted given its complexity (due in part to a legacy of myriad tariff rates which can differ even for goods within the same broad category) and the disproportionate reliance on direct taxation.

  • Expenditures. On the expenditure side, given the large size of the wage bill (compensation of employees corresponds to nearly 50 percent of tax revenue), a key priority is to introduce measures to permanently reduce wage-related expenses. Efforts should focus on slowing wage drift due to automatic raises and promotions for time in grade, as well as modifying public sector workers’ benefits and allowances. Steadfast adherence to the consolidation plan would also appreciably reduce interest expenses by more than ½ percentage point of GDP in 2020. Furthermore, as Aruba is a very open economy, the envisaged fiscal consolidation (underpinned by current expenditure curtailments and greater tax revenues) is not likely to be a major drag on growth.1

  • Entitlement programs. Further measures are needed to ensure that the costly universal health care system (AZV) becomes self-financing. In particular, the authorities should consider introducing modest user fees to rationalize demand for certain health care services, such as emergency room visits for non-urgent care.

  • PPPs. Any further costs associated with newly approved PPP should be fully accounted for in a medium-term fiscal framework.

Fiscal Adjustment 2014–2020

article image
Source: Aruban authorities and staff estimates.

Staff’s proposal coincides with the Amended 2015 Budget Plan up to 2018 (see text).

Authorities’ views

16. The authorities broadly agreed with the need for fiscal consolidation. Contrary to staff, they are of the view that their medium-term fiscal adjustment plan contains sufficient measures to meet their targets and without budget support or soft loans from the Netherlands. They noted that previous decisions made as part of the tripartite social dialogue, which facilitated the entitlement reforms, somewhat limit maneuver for additional reforms in the near term. Nevertheless, the authorities see revenue measures as important to the fiscal consolidation effort, and have therefore assembled a commission to study tax reform. Proposals, including on how to streamline the complex tax system, are expected in a few months. They are also optimistic on significant one-off revenues from the accumulation of tax debt. The authorities are also focusing on increasing expenditure efficiency and are in the process of finalizing a consultant to conduct a public expenditure review. In addition, they plan to continue to rationalize the wage bill by limiting new hires, introducing flexible (including part-time) work arrangements, and providing outplacement services to some public employees. The authorities are in close consultation with the Netherlands on how to tailor to Aruba’s specific circumstance a fiscal council involving external budgetary oversight.

B. Monetary and Financial Sector Policies: Preserve Stability

Background

17. Monetary policy remained unchanged during 2013–14. Despite the pegged exchange rate regime, restrictions on capital mobility (dating back to 1986) allow for some monetary control in Aruba.2 The Central Bank of Aruba’s (CBA) main policy instrument is the reserve requirement (RR), which has been kept constant at 11 percent since January 2010 in light of adequate reserves, deflation, and economic slack. Credit growth declined slightly to 4¼ percent in 2014 from 5 percent in the previous year, and the banking system is awash with excess liquidity (6¾ percent of GDP in 2014), a reflection of anemic demand and lack of competition among banks.

18. Commercial banks have weathered the double-dip recession without major strains. The banking sector’s return on equity was 18½ percent in 2014, afforded by sizeable interest rate margins which reflect, in part, an oligopolistic market structure (Box 4). The capital adequacy ratio (CAR) has been on the rise since 2011 and exceeded 24 percent as of 2014, well above the regulatory minimum of 14 percent. The non-performing loans (NPL) ratio declined to around 6 percent in 2014. The authorities’ latest stress test results show that even under the most severe credit shock, the CAR of the aggregate banking sector remained above the regulatory minimum. The CBA has widened the supervisory umbrella to include insurance brokers in 2014. After significant efforts to enhance the AML/CFT framework, Aruba was removed from the Financial Action Task Force (FATF) and Caribbean FATF follow-up processes.

Staff’s views

19. The current accommodative monetary policy stance remains justified given projected low inflation and moderating growth rates, as well as evidence of slack in the economy. Aruba’s foreign exchange reserves are currently adequate to safeguard the pegged exchange rate regime. In case demand picks up and signs of overheating appear (such as rapid credit growth, though this is a very low risk at this point), the authorities should stand ready to mop up the excess liquidity by increasing the RR. Monetary tightening may also be warranted if gross international reserves run the risk of dipping below any of the reserve adequacy thresholds monitored by the CBA.

Authorities’ views

20. The authorities plan no near-term change in the monetary policy stance and are contemplating moves to enhance policy transmission. Within the next year, the CBA is considering an overnight facility to help manage excess banking system liquidity by providing commercial banks with daily inter-bank rates. Relatedly, a new bank has been granted a license and expected to begin operations by the end of the year, which should increase competition within the sector. The authorities are planning on further strengthening their prudential framework by broadening the supervisory perimeter to encompass securities trade.

C. Safeguarding Competitiveness and External Stability

Background

21. Aruba appears to have sustained competitiveness in tourism. Its Caribbean market share in stay-over tourism has continued to rise in tandem with growth in visitors’ nights (Figure 4). Aruba’s reputation as a high-end destination and the predominance of time-share participants among repeat stay-over visitors provide revenue stability. In addition, the authorities’ marketing efforts, access to new U.S. hubs, and additional airlift capacity from South America have improved the tourism sectors’ resilience. Electricity costs do not appear to be out of line with its regional competitors.

Figure 4.
Figure 4.

Aruba: Competitiveness

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

22. The real effective exchange rate has been on a depreciating trend since mid-2011. Reflecting a narrow production base and the large need for imports that is typical to island economies, the CA norm shows a sizeable deficit of 5½ percent of GDP. While the 2014 CA deficit exceeds this norm by two percentage points, EBA-Lite estimates, which take Aruba’s very open economy into account, suggest an overvaluation of 4 percent, that is, an exchange rate that is broadly in line with fundamentals. The narrowing of the CA deficit over the medium-term is projected to prevent a further deterioration of the net IIP position (−103 percent of GDP at end-2014). However, stabilizing the net IIP position at such high levels and maintaining sizable CA deficits, even if justified by fundamentals, poses both stability and financing risks.

23. Structural competiveness portrays a more nuanced picture. Aruba’s labor market is highly regulated with cumbersome lay-off procedures, including a lengthy (2-3 months) process for obtaining a termination permit, which is often associated with hefty severance pay (based on years of service and final salary) and court settlements favoring employees. Temporary workers can only be hired through an agency for up to 12 months (after which they gain permanent status). A temporary worker can only be rehired for the same position after a three-month pause. Costs of doing business are high as establishing a new enterprise could take 4-6 months and involves complicated procedures across multiple government entities. Obtaining the necessary licenses and permits seem to be especially arduous in the construction and restaurant sectors. Banks impose fees for many types of financial transactions, and it can sometimes take 2-4 months to open a bank account, making access to finance and business operations costly and burdensome. To address some of these issues, the Aruba Investment Agency (Arina), has been established to expedite the processing of permits and licenses.

Staff’s views

24. Improving price and structural competitiveness will strengthen the ongoing recovery. While recent initiatives to diversify the tourism market are welcome, with the U.S. accounting for around 55 percent of tourists, there is scope for further diversification. Increasing labor market flexibility and reducing the costs of doing business would not only further improve Aruba’s competitiveness, but would also help its adjustment to external shocks and facilitate diversification. The authorities’ plans to set up a second windmill park will likely reduce utility costs, thereby enhancing competitiveness.

Authorities’ views

25. While the authorities generally agreed with staff’s analysis, they did not consider structural competitiveness to be a major impediment. They highlighted many sources of strong non-price competitiveness relative to their Caribbean peers including Aruba’s location, educated population, high standards of living, safety and security, the Dutch legal system, and modern infrastructure such as port facilities for cruise lines. Aruba is also one of the few countries in the region where U.S. customs and border patrol offers clearance at the airport facilitating travel back to the U.S. (recently expanded to include private aircraft). Relatedly, the authorities are working on achieving EU/Schengen preclearance to ease travel to Europe.

Boosting Long-Term Growth Potential

Aruba needs to increase productivity and labor market participation to sustain growth potential.

Background

26. After a strong performance up to and throughout the 1990s, each major recession was associated with structurally lower growth. Average real GDP growth exceeded 7 percent over 1987-2000. However, especially in the aftermath of the latest double-dip recession, Aruba’s growth trend decreased notably reflecting a structural decline in productivity. While many of its peers that also rely heavily on the labor-intensive tourism sector have had similar experiences, Aruba stands out in part because of the additional permanent productivity losses related to the closure of the oil refinery. Taken together, estimates of Aruba’s potential growth rate therefore have decreased, relative to pre-recession levels, to around 1½-1¾ percent.

A01ufig07

Aruba: Real GDP

(Millions of local currency)

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

Sources: CBA; and IMF staff calculations.
A01ufig08

Aruba: Growth Accounting

(Percent)

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

Source: CBA; and staff calculation.Note: Other factors: capital, labor and capacity utilization. Hotel occupancy rate was used as a proxy to calculate capacity utilization, and labor force was approximated by 15-60 year old population.

27. Aruba faces several headwinds to longer-term growth. Absent new migration, Aruba’s working age population is projected to decline, and at a pace faster than its peers—to 60 percent in 2040 from 70 percent in 2015. However, making up the shortfall via migration (which has also been on a downtrend), is likely to pose pressures on the housing market and existing infrastructure.

A01ufig09

Working Age Population Projection

(Pecent of total population, 2010=100)

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

Source: United Nations.
A01ufig10

Working Age Population Change and Migration Projection

(Pecentage points)

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

Source: United Nations.

28. The authorities are pursuing a new engine of growth centered around renewable energy. Capitalizing on Aruba’s location and abundant solar and wind resources, the government of Aruba’s vision includes: (i) making Aruba even more dependent on renewable energy (which would reduce reliance on heavy fuel oil usage), (ii) transforming Aruba into a business platform between the U.S., Latin America, and Europe, and (iii) promoting a knowledge-based economy. While renewable (primarily wind) currently supply around 17 percent of total energy needs, the planned second windmill park could raise the share to around 35 percent. The Netherlands Organization for Applied Scientific Research (TNO), with its Caribbean Branch Office in Aruba, is advancing research and education focused on renewable energy technologies both locally and throughout the region.

Staff’s views

29. The looming demographic challenges and declining productivity calls for labor market action. Aruba needs a comprehensive labor market reform to increase both participation and productivity. More effective targeting of social benefits could also increase the labor force participation rate, while supporting ongoing fiscal consolidation efforts. But even with reforms, bleak demographic prospects imply a need to rely on migrant workers, arguing for the development of sustainable migration policies.

30. Developing the renewable energy sector offers promising potential but is not without challenges. Given Aruba’s natural resources, developing a capital- and technology-intensive renewable energy sector offers the right long-term path for economic diversification. However, skilled-labor shortages may pose a challenge to the success of this initiative. Given the likely upfront investment needs of these initiatives, these projects should be financed through FDI as much as possible.

Authorities’ views

31. The authorities are confident about Aruba’s growth prospects from the renewable energy sector. They emphasized that rather than a quantitative expansion of tourism, they are deliberating pursuing a growth strategy focused on upgrading existing tourism facilities, improving infrastructure, revitalizing urban spaces, and increasing dependence on renewable energy for production to further improve the quality of Aruba as a destination. In addition, they view renewable energy to play a catalytic role helping Aruba to grow into a business gateway to South America in knowledge- and technology-intensive industries. The authorities pointed out that the Rocky Mountain Institute recently joined efforts with the Carbon War Room to help achieve the goal to become completely independent of fossil fuels by 2020 for electricity and potable water generation. They anticipate that the share of renewable energy will increase to 40 percent in 2018, in part supported by their recent partnership with Philips which through innovation will promote energy efficiency. However, they acknowledged that scaling up wind energy substantially further presents challenges, and are therefore researching storage technologies (flywheel and underwater compressed air) to help ensure their renewable energy targets will be met. The authorities are also cognizant of the skilled labor constraints, but see scope to bring back Aruban engineers working abroad. They agreed with staff on the importance of financing through FDI.

32. The authorities remain cautiously optimistic regarding the outcome of ongoing offshore gas exploration. For the exploration, development, and production of oil and gas, the government of Aruba signed a production sharing agreement with REPSOL which has recently partnered with Total and BG Group. REPSOL’s initial interest was the result of its success in Venezuela where a large gas pocket was discovered. 3D seismological mapping in the continental seabed have been concluded and subsequent analysis is currently underway. If gas reserves are found, production would only begin in the long run.

Staff Appraisal

33. Aruba’s gradual recovery from the double-dip recession is underway. After a strong initial tourism-led rebound, the economy lost momentum in part due to heightened fiscal policy uncertainty. Looking ahead, a broad-based recovery underpinned by robust tourism activity, the mainstay of the Aruban economy, and robust domestic demand is envisioned. However, real GDP is projected to reach its pre-crisis peak only by the end of the decade.

34. The main near-term risks to the outlook are external in nature. Given its high dependence on tourism, the Aruban economy is vulnerable to spillovers associated with global slowdowns. As they are the most important sources of tourists, Aruba is particularly susceptible to downturns in the U.S. and Venezuela. Over the medium term, timely implementation of renewable energy investments could boost growth prospects.

35. Putting debt on a downward trajectory is an immediate policy priority. Although major structural reforms have been initiated, public debt surpassed 80 percent of GDP in 2014. Attributes such as Aruba’s vulnerability to external shocks, the predominance of the tourism sector, and the exchange rate peg call for the urgent rebuilding of fiscal policy space. While the authorities’ ambitious medium-term adjustment plan is welcome, sustained fiscal effort at least until 2020 is warranted to durably set debt on a downward path. There is a need to establish a formal medium-term fiscal framework to enhance the credibility of these plans.

36. Additional revenue and expenditure measures are needed to achieve the desired fiscal consolidation. Without additional measures, fiscal deficits would remain elevated, and debt would continue to rise over the medium term. Therefore, given the size of the fiscal adjustment, additional revenue effort in the form of greater indirect tax collection appears warranted. With regards to expenditure, a priority is to reduce wage-related expenses given the large size of the wage bill. Further measures to ensure that the health care system becomes self-financing should also be considered. PPP-related expenditure commitments should be fully accounted for.

37. The accommodative monetary policy stance is appropriate. Given projected low inflation and moderating growth rates, as well as evidence of slack in the economy, staff currently sees no need for monetary tightening. If, however, signs of overheating appear, the authorities should stand ready to tighten the monetary policy stance appropriately.

38. Competitiveness needs to be safeguarded to ensure a stable recovery. Initiatives to diversify markets and efforts to promote Aruba’s reputation as an upscale destination have continued to reap dividends as evidenced by the uptrend in visitor nights and Aruba’s growing share in the Caribbean tourism market. Given that the U.S. accounts for 55 percent of tourists, however, staff sees further scope for market diversification. To further improve competitiveness and preserve external stability, Aruba would need greater flexibility in the labor market and more enabling business conditions. It will be important to finance prospective growth initiatives, including those associated with renewable energy, through FDI.

39. It is envisaged that the next Article IV consultation discussions with Aruba will be held on a 24-month cycle.

Aruba: Basic Facts

Aruba is a small Caribbean island 29 kilometers off the northern coast of Venezuela. The 180 square kilometer island is densely populated, inhabited by 106,795 persons (2013). Unlike many other Caribbean islands, Aruba is situated outside of the hurricane belt, benefitting from consistently sunny skies, prevailing cooling trade winds, and a constant temperature (27°C), which along with its world renowned beaches, makes it a popular vacation destination all year round.

After being granted status aparte in 1986, Aruba became an autonomous country within the Kingdom of the Netherlands (together with Curaçao, Sint Maarten, and the Netherlands itself). The political system is based on the Dutch model with some English common law influence. Prime Minister Eman, is serving his second four-year term in office with a 13 out of 21 seat majority in the Parliament; next elections are due in 2017.

Aruba has one of the highest standards of living in the Caribbean with GDP per capita at $24,429 in 2013. Aruba’s currency, the florin (AWG or AFL), has been pegged to the US dollar since 1971 (1.79 Afl. to the dollar). The economy is largely dependent on tourism which directly and indirectly accounts for about 85 percent of GDP, with most visitors coming from the United States, Venezuela, and Canada. The Valero oil refinery closed in 2012, leading to a significant loss of output (of around 8 percent of GDP).

Aruba: The Impact of External Spillovers

As with other small open island economies, Aruba is highly sensitive to global economic conditions. In particular, Aruban growth is one of the most volatile in the region, with external factors accounting for almost 60 percent of its growth volatility.

Aruba’s economy is especially susceptible to external demand fluctuations:

  • Each 1 percentage point temporary decline in global growth (excluding the U.S.) would drag down Aruban growth by about 2 percentage points.

  • More importantly, while each 1 percentage point temporary decline in U.S. growth would also drag down Aruban growth by about 2 percentage points—in contrast to its peers—it also depresses growth in the following year as well.

  • Put differently, a 1 percentage point temporary decrease in U.S. growth would lead to about a 4 percentage point cumulative decline in Aruban growth over two years.

  • Notwithstanding the usual confidence bands around such point estimates, the results highlight that even a moderate U.S. slowdown could sharply reduce Aruban growth.

The fact that Aruba is a highly tourism-dependent economy with a large share of its tourists originating in the U.S. sheds light on these results. In particular, Aruba is subject to two mutually reinforcing types of concentration risk:

  • One good: With the end of oil refining, the economy has become even more dependent on one good (service), tourism (with a contribution to GDP of about 85 percent),

  • One market: Over 55 percent of tourists originate in the U.S.

A01ufig11

The Impact of External Demand Shocks on Growth

(Percent)

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

Source: Staff calculations.Note: Figure depicts the peak of Aruba growth impulse response function to the two external growth shocks. ABW denotes Aruba, whereas ATG, BHS, BRB, DMA, GRD, JAM, KNA, LCA, and VCT, denote Antigua and Barbuda, the Bahamas, Barbados, Dominica, Grenada, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, respectively.
A01ufig12

Aruban Growth: Impact of 1 percentage point lower U.S. growth

(Percent)

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

Source: Staff calculations.
A01ufig13

Tourism and Travel Contribution to GDP, 2013

(Percent)

Citation: IMF Staff Country Reports 2015, 116; 10.5089/9781475582697.002.A001

Source: World Travel and Tourism Council (wttc.org).Note: ABW denotes Aruba, whereas ATG, BHS, BRB, DMA, GRD, JAM, KNA, LCA, and VCT, denote Antigua and Barbuda, the Bahamas, Barbados, Dominica, Grenada, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, respectively.

Aruba: Reform of Entitlement Programs

In 2014, the authorities took significant steps towards restoring the sustainability of their pension and health care systems.

The pension system reform consisted of two elements:

  • First, the authorities aimed to stem the losses of the general (AOV) pension fund, as well as to build a legal reserve that would safeguard its sustainability. To achieve this, reforms were implemented in steps. On January 1, 2014, premium income limits increased from Afl. 65,052 to Afl. 85,000, and premium rates increased from 12½ to 13½ percent. On January 1, 2015 premium rates increased further to 14½ percent, and the minimum retirement age began a process of increasing to 65 from 60 years in six-month increments over 10 years. With these reforms, after sizeable initial savings, premiums are expected to fully cover costs beginning in 2017.

  • Second, the authorities sought to restore the sustainability of the public administration (APFA) pension system. Pension limits, premiums, and the retirement age were raised in line with the AOV reforms. In 2014, the government also signed a loan agreement with the APFA pension fund to repay the bulk of its long-standing debt to the pension fund over 5 years adding 3½ percent of GDP to the public debt stock but restoring APFA’s long-term sustainability.

  • To reform the health system (AZV), a 1 percent levy was introduced to limit its fiscal drain. While the levy will help offset health expenses, in the absence of further measures, overall health care costs are expected to rise, in part owing to an ageing population.

Aruba: Overview of the Financial System

Aruba’s financial sector is sizeable with assets of about 210 percent of GDP in 2014. Commercial banks dominate the sector with nearly half of total assets. The rest of the financial system is divided among pension funds, insurance companies, and bank-like institutions.

The four commercial banks are foreign owned subsidiaries of (parent) banks located in Curaçao. Hence, they are supervised by both the Central Bank of Aruba (CBA) and by the Central Bank of Curaçao and St. Maarten. The banks are largely funded by resident deposits, which account for over 80 percent of liabilities. More than 60 percent of banks’ assets are loans to the private sector. They also invest in government securities. Aruba also has two off shore banks with assets of 7 percent of GDP, which are only engaged in banking activities with non-residents. After banks, pension funds form the next largest component of the financial sector, dominated by the civil service pension fund (APFA), which has assets of over 50 percent of GDP.

Aruba’s financial system differs in key respects with those in the region: (i) the size of its financial sector, including its banks, is notably smaller than its peers, (ii) there are no (fragile) indigenous banks, and Aruban commercial banks are subject to dual supervision, (iii) in contrast to those in the Eastern Caribbean Currency Union (ECCU), Aruban banks are better capitalized, are substantially more profitable, and have lower NPL ratios and lower exposure to a highly-indebted sovereign, and (iv) Aruban off shore banking operations are small relative to peers, and credit unions are tiny.

Selected Banking Indicators: Aruba and the ECCU, 2013

article image
Source: CBA and ECCB.Note: NPL ratio: non-performing to total loans;Public sector loans: public sector to total loan ratio.

Aruba: Financial System Overview, 2014

article image
Source: Centrale Bank van Aruba (CBA), APFA, and staff estimates.

Includes general (unallocated) reserves

Preliminary data for 2014.

Data refers to 2012.

Table 1.

Aruba: Selected Economic Indicators, 2012–16

article image
Sources: Aruban authorities; and IMF staff estimates and projections.

Includes net acquisition of non-financial assets.

Table 2.

Aruba: Baseline Scenario: Medium-Term Outlook, 2010–20

(Percent change, unless indicated otherwise)

article image
Sources: Aruban authorities; WEO; and IMF staff estimates and projections.Note: Volatility in public investment is due to decrease and depletion of the Development Fund.
Table 3.

Aruba: Fiscal Operations of the Central Government, 2008–16 1/

(Percent of GDP, unless indicated otherwise)

article image
Sources: Aruban authorities; and IMF staff estimates and projections.

The table is presented on adjusted cash basis.

Table 4.

Aruba: Central Bank Survey, 2010–16

(Millions of Aruban florins)

article image
Sources: Central Bank of Aruba; and IMF staff estimates.
Table 5.

Aruba: Monetary Survey, 2010–16

(Millions of Aruban florins)

article image
Sources: Central Bank of Aruba; and IMF staff estimates.
Table 6.

Aruba: Balance of Payments, 2010–20

(Millions of U.S. dollars, unless indicated otherwise)

article image
Sources: Aruban authorities; and IMF staff estimates and projections.

Includes revaluation changes.