Kingdom of the Netherlands—Aruba: Staff Report for the 2017 Article IV Consultation Discussions
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
15 Jun 2017
eISBN:
9781484304389
ISBN:
9781484304389
Language:
English
Keywords:
ISCR; CR; discussion; IMF staff calculation; growth prospect; stay-over arrival; hotel capacity; growth projection; GIMF model; Caribbean; Global; central bank of Aruba
Download PDF (1.1 MB)

Aruba: 2017 Article IV Consultation-Press Release and Staff Report

Abstract

Aruba: 2017 Article IV Consultation-Press Release and Staff Report

Introduction

1. Aruba is a small open economy with high living standards. Aruba’s per capita income, at about USD 24.1 thousand, is one of the highest in the Caribbean. Over 85 percent of the economy depends on tourism, making Aruba very vulnerable to external shocks. The fixed exchange rate regime against the U.S. dollar (unchanged at 1.79 florins to the dollar since 1986), supported by conservative fiscal, credit, and prudential policies, kept balances in check until the late 2000s. Three recessions since the Global Financial Crisis and the government’s policy response to them have led to a rapid increase in public debt.

2. The Aruban People’s Party (AVP) currently holds the majority in the parliament. The AVP won the 2013 elections and holds 12 of the parliament’s 21 seats, while the opposition party of Electoral Movement of People (MEP) holds 7. Prime Minister Mike Eman is currently serving the final year of his second consecutive term. Elections are scheduled for September 2017.

3. The main policy challenges are to build policy space and boost growth. Public debt is around 85 percent of GDP. This is beyond a level that is considered prudent for a small open economy, which is highly vulnerable to external shocks, and has a narrow economic base, a fixed exchange rate regime, and sizable interest payments. Policies should strike a balance between lowering debt and building policy space with boosting potential and actual growth.

4. Past Fund advice focused on ensuring fiscal sustainability and improving competitiveness (Appendix VIII). Recommendations underscored the need for fiscal consolidation and called for advancing the structural reform agenda—including labor market reform, improving the business climate and further developing the renewable energy sector—while maintaining financial stability. The authorities undertook key entitlement reforms in 2014 followed by other broad-based as well as one-off fiscal measures, which resulted in a marked improvement in the fiscal balance.

Recent Developments, Outlook, and Risks

A. Recent Developments

5. Aruba entered a recession around mid-2015. Real GDP contracted by 0.5 and 0.2 percent in 2015 and 2016, respectively.1 Weakness in activity was broad-based in 2016. Domestic demand contracted by 3.0 percent. Exports grew only 0.3 percent due to weak tourism and shrinking non-tourism exports. Imports contracted by 3.5 percent, reflecting weak demand, on the back of fiscal consolidation and weak tourism growth.

A01ufig2

Contributions to Real GDP Growth

(percentage points)

Citation: IMF Staff Country Reports 2017, 155; 10.5089/9781484304389.002.A001

Sources: Aruban authorities and IMF staff calculations.

6. Stay-over tourist arrivals have been weak since mid-2015. This is mostly related to a collapse in the flow of Venezuelan tourists—Aruba’s second largest tourist market—who have faced more restrictive travel policies. Tourist arrivals from the U.S.—Aruba’s largest tourist market—also moderated, mostly because Aruba’s hotel capacity has remained flat, but also due to the opening of Cuba to U.S. tourists. Domestic factors, including a perception of higher petty crime, a new tourist levy and the Zika virus outbreak could have also marginally affected the U.S. arrivals.

A01ufig3

Stay-Over Tourist Arrivals by Origin

(percent y/y)

Citation: IMF Staff Country Reports 2017, 155; 10.5089/9781484304389.002.A001

Sources: Central Bank of Aruba, Caribbean Tourism Organization and IMF staff calculations.

7. The Aruban refinery is expected to reopen in 2019. It had closed in 2012, but a contract has been signed with Citgo, a US subsidiary of Venezuelan oil company (PDVSA), to rehabilitate and reopen it. Citgo is currently studying the existing installations and staff expect that the rehabilitation process will start in late 2017 and will last about two years. The value added from the refinery to the Aruban economy—at about 6 percent of GDP after it is in full operation—includes job creation and higher consumption, in addition to the refinery’s investment and production activities.

8. Inflation remains very low. The economy was in deflation in 2016—consistent with weak domestic demand, but also due to low energy prices. Inflation was also low over 2012-2015.

A01ufig4

Inflation and Unemployment rate

(percent)

Citation: IMF Staff Country Reports 2017, 155; 10.5089/9781484304389.002.A001

Sources: Aruban authorities and IMF staff calculations.

9. The unemployment rate has been on a declining trend, but is not a reliable measure of slack. It could be biased down and continue to decline over time, in part due to population aging. Outmigration and brain drain could have also played a part in lowering the unemployment rate.

10. Real wages have been stagnant across the entire income distribution since 2006. This is consistent with the weak macroeconomic performance. On the other hand, stagnant real wages also imply that income inequality has not materially changed over the past decade.

A01ufig5

Monthly Real Wages by Percentile

(Aruban florins; 2010 prices)

Citation: IMF Staff Country Reports 2017, 155; 10.5089/9781484304389.002.A001

Sources: Aruban authorities and IMF staff calculations.

11. Fiscal consolidation has continued. The overall deficit, at 1.6 percent of GDP in 2015 and 2016, was a fraction of its level in 2014. The primary balance was at its second consecutive year of surplus in 2016. The improvement is the result of structural and one-off policies.

A01ufig6

Government Balance

(percent of GDP)

Citation: IMF Staff Country Reports 2017, 155; 10.5089/9781484304389.002.A001

Sources: Aruban authorities and IMF staff calculations.
A01ufig7

Composition of Government Debt

(percent of GDP)

Citation: IMF Staff Country Reports 2017, 155; 10.5089/9781484304389.002.A001

Sources: Aruban authorities and IMF staff calculations.

12. Public debt remains high. Elevated government deficits over 2010-2014—caused mainly by a double-dip recession and the government’s policy response to it—resulted in public debt reaching around 85 percent of GDP in 2016, broadly evenly split between foreign and domestic. Large interest payment obligations on debt—about 4½ percent of GDP in 2016—crowd out essential public spending, and the high level of debt limits the fiscal space for countercyclical policy.

A01ufig8

External Debt

(percent of GDP)

Citation: IMF Staff Country Reports 2017, 155; 10.5089/9781484304389.002.A001

Sources: Aruban authorities and IMF staff calculations.

13. External debt continues to decline. In 2015, external debt declined mostly due to falling private sector debt. The authorities plan to finance their fiscal deficit entirely domestically in 2017 and rollover part of their external debt with domestic debt. This would imply a further decrease in external debt in 2017. Rollover risks are low, as about 90 percent of the external debt is long term.

14. EBA-lite estimates suggest that the external position is stronger than implied by fundamentals. Imports have contracted more than exports largely because of weak growth (after about two years of recession). This has turned the current account balance into a surplus of 7.0 percent of GDP in 2016. Due to a narrow production base and a large need for imports that is typical of island economies, the CA norm shows a deficit of 3¼ percent of GDP. EBA-Lite estimates, suggest an exchange rate undervaluation of about 17 percent. However, much of this is due to large swings in Venezuela’s currency and inflation. Excluding Venezuela, the Aruban florin appears broadly in line with fundamentals (Appendix V).

A01ufig9

Real Effective Exchange Rate

(index; 2010=100)

Citation: IMF Staff Country Reports 2017, 155; 10.5089/9781484304389.002.A001

Sources: IMF staff calculations.

15. International reserves have increased. Gross reserves have surpassed 35 percent of GDP, which is about 5¾ months of imports and 40 percent of broad money.

A01ufig10

Gross International Reserves

Citation: IMF Staff Country Reports 2017, 155; 10.5089/9781484304389.002.A001

Sources: Aruban authorities and IMF staff calculations.
A01ufig11

Money and Credit

(percent)

Citation: IMF Staff Country Reports 2017, 155; 10.5089/9781484304389.002.A001

Sources: Aruban authorities and IMF staff calculations.

16. Monetary policy2 was unchanged during 2015–16. The central bank (CBA) has kept the reserve requirement ratio—its main policy instrument—at 11 percent since 2010 given adequate international reserves, deflation, and weak GDP growth.

17. The banking system remains resilient. Banks maintain elevated capital buffers, have relatively low non-performing loans, and are profitable. Credit growth was 1.8 percent in 2016, up from -0.2 percent in 2015.

18. Aruba has a broad range of social safety nets. These include universal healthcare, pensions, unemployment benefits, transport subsidies, and cash transfers to low-income families and single mothers. The 2017 budget included 1.2 percent of GDP in transfers to universal healthcare and 1.3 percent of GDP in cash transfers and various social programs.

B. Outlook and Risks

Staff’s views

19. Real GDP growth is projected to rise to 1.9 percent in 2017, and stabilize at 1¾ percent over the medium term. Domestic demand is expected to firm up in 2017 due to the refinery-related investments and associated job creation, and as key PPP investment projects move forward. In addition, the tourism sector is expected to start recovering, partly boosted by better growth performance in the United States. Higher domestic demand and expected increases in imported inflation associated with global energy prices would stop current price deflation. Nonetheless, inflation would only reach 0.6 percent in 2017. Over the medium term, improvements in exports, PPP and private investments, and consumption are expected to stabilize real GDP growth to about 1¾ percent.

Aruba: Short-term Growth Projections

(Percent of GDP, unless indicated otherwise)

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Sources: Central Bank of Aruba; and IMF staff estimates.

20. Risks to the outlook are tilted to the downside. Delays or cancellations of refinery-related investments by Citgo remain a notable risk. A continued deepening of Venezuela’s economic crisis, poses a downside risk to tourism, as does a significant increase in global oil prices to domestic demand. Further strengthening of the US dollar would significantly impact Aruba’s external competitiveness, while weaker-than-expected global growth would reduce tourist arrivals. Over the medium term, a larger shift of U.S. tourists to Cuba could have negative implications for Aruba. On the upside, demand for shared-economy services could pick up (Appendix IV).

Authorities’ views

21. The authorities expected a stronger economic outlook than staff. They were confident that tourism growth is picking up and believed the already-initiated refinery-related investments will reach full swing before the end of 2017. These plus the PPP investments and other significant infrastructural private investments, result in a real GDP growth projection of 3.4 percent for 2017 by the authorities—1½ percentage points stronger than staff’s projection. The authorities’ medium-term growth projections are also higher than staff’s. They acknowledged the risks associated with Venezuelan tourist arrivals, but pointed to strategies to overcome potentially adverse developments such as initiatives to expand access to other Latin American markets, including Chile and Peru. They believed that Cuba’s effect on Aruba’s tourism market is a longer-term consideration, in part because of Cuba’s lack of requisite infrastructure to compete with Aruba in the upscale market.

Building Policy Space and Boosting Growth

A. Fiscal Policy: Making the Targets Credible

The authorities’ fiscal targets are appropriate, but additional measures are needed to achieve them.

Background

22. Fiscal targets are based on the overall balance. As per an agreement between the Aruban government and the Board of Financial Supervision of Aruba (CAFT), appointed by the Netherlands and Aruba, fiscal targets have been set in terms of the overall fiscal balance plus acquisition of financial assets. This CAFT definition of the overall balance is also commonly known in Aruba as the “financial balance”. It was set at -0.5 percent of GDP in 2017 and 0.4 percent of GDP for 2018, corresponding to an overall balance of 0.1 and 1.0 percent of GDP, respectively (figure).

A01ufig12

Authorities’ Fiscal Targets

(percent of GDP)

Citation: IMF Staff Country Reports 2017, 155; 10.5089/9781484304389.002.A001

Sources: Aruban authorities and IMF staff calculations.

23. The authorities met their fiscal targets in 2015 and 2016. The overall government deficit of 1.6 percent of GDP in both 2015 and 2016 were in line with targets. The improvement is due to reform policies in recent years and one-off measures. There has been an improvement in tax administration, and a spending cap that was introduced on goods and services. On the structural side, as a follow up of the general (AOV) pension reform (2011), premiums were raised and a gradual increase in the minimum retirement age (to 65 years) was initiated in 2014. The capital shortfall of the public administration’s pension system (APFA) was made whole (2014), the accrual period and franchise contributions were modified (2011) and, as with the AOV, the retirement age will continue to gradually increase. Finally, a levy (BAZV) was introduced and further increased (2011, 2014, 2015) to partially offset the fiscal costs of the health care system (AZV). Despite all these reform policies, the authorities had to meet their fiscal targets by the help of some one-off measures—a foreign grant in 2015 and intensification of collection of outstanding taxes in 2016.

Staff’s views

24. Going forward, the authorities’ fiscal targets are appropriate, but achieving them critically depends on the strength of economic activity. Based on current laws, the overall fiscal balance should be improved to +0.1 percent of GDP in 2017, followed by continued improvements, which would result in an overall balance of +1.3 percent of GDP in the medium term. If these targets are met, public debt—currently at about 85 percent of GDP—would be put on a downward path. The 2017 budget assumes real GDP growth of 3.4 percent. If such a strong growth performance materializes, the authorities would meet their fiscal target in 2017. This growth projection, however, faces significant downside risks, especially due to possible delays in the refinery-related investments. Staff has a more moderate real GDP growth projection of 1.9 percent in 2017. Consequently, staff projects a lower overall balance than the authorities’ target (table, chart, and Table 4a). In a downside risk scenario (Table 4b), in which the refinery investments would not occur, growth would be weaker and fiscal targets would be missed by large margins both under staff’s and authorities’ assumptions (adjusted by staff to exclude the refinery). Going forward, it would be easier to monitor the fiscal targets, if they are set in nominal (florin) terms, rather than as percent of GDP because projections of GDP could differ.

Table 1.

Aruba: Selected Economic Indicators, 2013–2018

article image
Sources: Aruban authorities; and IMF staff estimates and projections.
Table 2.

Aruba: Baseline Scenario: Medium-Term Outlook, 2015–2022

(Percent change, unless indicated otherwise)

article image
Sources: Aruban authorities, and IMF staff estimates and projections.
Table 3a.

Aruba: Operations of the Central Government, 2012–2022 1/

(Percent of GDP, unless indicated otherwise)

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

This table is presented on adjusted cash basis.

Table 3b.

Aruba: Operations of the Central Government, 2012–2022 1/

(Millions of Aruban florins, unless otherwise indicated)

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

This table is presented on adjusted cash basis.

Table 4a.

Aruba: Fiscal Scenarios, 2015–2022 (includes oil refinery)

(Percent of GDP, unless indicated otherwise)

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

CAFT’s definition of overall balance, also called financial balance, includes net purchases of financial assets.

Reflects the authorities’ medium-term plan for expenditures and revenues.

Table 4b.

Aruba: Alternative Fiscal Scenarios, 2015–2022 (excludes oil refinery)

(Percent of GDP, unless indicated otherwise)

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

CAFT’s definition of overall balance, also called financial balance, includes net purchases of financial assets.

Reflects the authorities’ medium-term plan for expenditure and adjusts down revenues for lower growth.

Aruba: Fiscal Scenarios, 2015-2022 1/

(Percent of GDP, unless indicated otherwise)

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

Includes the oil refinery investment and production.

CAFT’s definition of overall balance, also called financial balance, includes net purchases of financial assets.

Reflects the authorities’ medium-term plan for expenditure and revenues, and nominal GDP projections.