Kingdom of the Netherlands—Curaçao and Sint Maarten: Staff Report for the 2018 Article IV Consultation Discussions

2018 Article IV Consultation-Press Release and Staff Report

Abstract

2018 Article IV Consultation-Press Release and Staff Report

Context: A Union at a Difficult Juncture

1. Economic conditions in Curaçao and Sint Maarten, two autonomous constituent countries within the Kingdom of the Netherlands which comprise a monetary union, continued to deteriorate over the past years. Negative external shocks further magnified the already-lackluster growth performance of both economies, exposing the underlying vulnerabilities and structural weaknesses. In Curaçao, the ongoing crisis in Venezuela—one of its main trading partners and just about 100km away—is taking a toll on the economy and creating major uncertainty for the outlook. In Sint Maarten, Hurricanes Irma and Maria had a devastating impact in September 2017, causing an estimated US$2.7 billion (over 250 percent of the island’s GDP) in damages and losses.

A01ufig1

Real GDP Growth

(Percent)

Citation: IMF Staff Country Reports 2019, 023; 10.5089/9781484395929.002.A001

Sources: Authorities’ data, IMF staff estimates, and IMF WEO database.

2. The political and institutional setting has been volatile. In Curaçao, political instability dominated most of the early part of 2017, culminating in early general elections in April 2017. Facing challenges on both the growth and fiscal fronts, the authorities are looking into ways to boost investment. To support Sint Maarten’s recovery, the Netherlands set up a reconstruction fund to be disbursed though a World Bank-administered Trust Fund, which became operational by July 2018. After a change of government following the hurricanes and early elections in February 2018, a new cabinet was sworn in in June, pursuing a program aimed at sustainable rebuilding and government restructuring.

Recent Economic Developments

A. Curaçao

3. Curaçao’s economy contracted in 2016–17, marking five years of recession in the seven years since gaining autonomy in 2010 (Table 1 and Figure 1). Spillovers from Venezuela have been the main drag on growth, as trade shrunk, stay-over tourism from Venezuela dropped, and the Isla refinery operated by the Venezuelan state-owned oil and natural gas company, PDVSA, was underutilized and undermaintained. The construction sector, with a few major projects, was one of few bright spots amid an otherwise broad-based slowdown. Weak performance continued in the first half of 2018, as low refinery utilization more than offset the uptick in tourism. Inflation was zero in 2016 but rose to 1.6 percent (12-month moving average, y/y) by end-2017 driven by international prices, reaching 2.2 percent in September 2018. The unemployment rate increased from 11¾ percent in 2015 to about 14 percent in 2017.

Figure 1.
Figure 1.

Curaçao and Sint Maarten: Real Sector Developments

Citation: IMF Staff Country Reports 2019, 023; 10.5089/9781484395929.002.A001

Sources: Authorities’ data, IMF WEO database, and IMF staff estimates.1/ The average for Antigua and Barbuda, Aruba, The Bahamas, Barbados, Dominica, Grenada, Jamaica, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines.2/ Latest data available over 2015–17.
Table 1.

Curaçao: Selected Economic and Financial Indicators, 2013–23

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Sources: Data provided by the authorities, and IMF staff estimates.

Excludes consumption of fixed capital.

The 2016 figure refers to July–December 2016.

4. Curaçao’s fiscal position worsened significantly, triggering corrective actions as stipulated by the rules of the union’s fiscal supervision framework (Table 2 and Figure 2). The current balance turned to a deficit of 0.6 percent in 2017 (from a surplus of close to 1 percent of GDP in 2015), as nontax revenues declined and spending on goods and services increased.1 The overall balance also worsened due to construction outlays on a new hospital (1½ percent of GDP). Gross public debt rose to 50 percent of GDP in 2017 (from 44 percent of GDP at end-2015), mainly driven by the arrears to the public pension fund (APC) and the Social Insurance Bank (SVB). Given the breach of the rule, which prohibits current budget deficits, Curaçao is required to compensate NAf 117 million (2 percent of GDP) for past deficits by achieving current budget surpluses starting in 2018.

Figure 2.
Figure 2.

Curaçao and Sint Maarten: Fiscal Developments

Citation: IMF Staff Country Reports 2019, 023; 10.5089/9781484395929.002.A001

Sources: Authorities’ data, IMF WEO database, and IMF staff estimates.1/ From 2016, the Social Insurance Bank (SVB) is included in both revenue and expenditure.
Table 2.

Curaçao: Government Operations, 2013–23

(Percent of GDP unless otherwise indicated)

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Sources: Data provided by the authorities and IMF staff estimates.

From 2016, the central government operations include the social security bank (SVB).

Includes transfers to cover the deficit of funds not integrated into the central government budget, such as those for social security/insurance.

The denominator is the average of total revenue in the previous three years.

B. Sint Maarten

5. Sint Maarten’s growth has been decelerating since 2014, and the real GDP is estimated to have contracted by about 4¾ percent in 2017 following Hurricane Irma (Table 3 and Figure 1).2 With major tourism infrastructure (including the airport and big hotels) destroyed, cruise and stay-over tourist arrivals declined by about 25 percent (y/y) in 2017. Preliminary data suggest that the recovery, particularly in stay-over tourism, remains slower than in other hurricane-affected regional peers. Inflation increased in 2017 to 2.2 percent. With about half of the labor force engaged in the tourism sector, the labor market was severely affected although various arrangements to keep employees, such as via training and other programs helped cushion the impact. Total insurance claims amounted to about NAf 1 billion, of which about two thirds were paid by end-September 2018.

Table 3.

Sint Maarten: Selected Economic and Financial Indicators, 2013–23

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Sources: Data provided by the authorities; and IMF staff estimates.

Excludes consumption of fixed capital.

The 2016 figure refers to July–December 2016.

A01ufig2

Stay-over Tourist Arrivals

(Percent change relative to the same period of the previous year)

Citation: IMF Staff Country Reports 2019, 023; 10.5089/9781484395929.002.A001

Sources: Authorities’ data, Caribbean Tourism Organization, and IMF staff calculations.

6. While Sint Maarten’s fiscal position was improving prior to Hurricane Irma, the large drop in tourism-related revenues and increase in expenditures significantly worsened the 2017 fiscal accounts (Table 4 and Figure 2). The 2017 overall deficit reached 3½ percent of GDP, including about 2 percent of GDP in Irma-related expenditures. The liquidity shortfall was initially met by a drawdown in government deposits and eventually supported by a loan from the Netherlands of NAf 50 million. Gross public debt remained at about 34 percent of GDP by end-2017. In March 2018, the Kingdom Council of Ministers (the executive body of the Kingdom of the Netherlands) allowed for a temporary deviation from the balanced budget rule in 2017–18. To support the island’s recovery, the Netherlands set up a €550 million reconstruction fund (about 65 percent of GDP), committing up to €470 million to be disbursed through a World Bank-administered Trust Fund until 2025. The operations of the Trust Fund are gradually stepping up, with three projects amounting to about US$103 million over 2018–23 approved as of mid-December 2018 and other projects under preparation.3

Table 4.

Sint Maarten: Government Operations, 2013–23

(Percent of GDP unless otherwise indicated)

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Sources: Data provided by the authorities and IMF staff estimates.

Includes transfers to cover the deficit of funds not integrated into the central budget, such as those for social security/insurance.

The denominator is the average of total revenue in the previous three years.

C. The Monetary Union

7. The external position of the union has deteriorated since 2015 (Table 5). The current account deficit continued to widen to 15 percent of the union GDP in 2017, as tourism receipts declined in both countries while imports increased in Curaçao due to higher oil prices and construction activities. In Sint Maarten, lower imports and insurance payouts kept the current account positive in 2017. Official reserves stood at US$1.3 billion (about 4½ months of imports) as of November 2018. External debt is estimated at about 74 percent of GDP in 2017, half of which is the government debt (in local currency) to the Netherlands. Curaçao’s and Sint Maarten’s real effective exchange rates (REERs) steadily appreciated in recent years. Staff’s assessment, while complicated by data availability, suggests that the external positions of Curaçao and Sint Maarten are moderately weaker than justified by medium-term fundamentals and desirable policies (Annex II).

Table 5.

Curaçao and Sint Maarten: Balance of Payments, 2013–23

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

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Sources: Centrale Bank van Curaçao en Sint Maarten, and IMF staff estimates.
Table 5a.

Curaçao: Balance of Payments—Current Account, 2013–23

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

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Sources: Centrale Bank van Curaçao en Sint Maarten, and IMF staff estimates.
Table 5b.

Sint Maarten: Balance of Payments—Current Account, 2013–23

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

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Sources: Centrale Bank van Curaçao en Sint Maarten, and IMF staff estimates.
A01ufig3

Monetary Union: Current Account

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 023; 10.5089/9781484395929.002.A001

Sources: Centrale Bank van Curaçao en Sint Maarten, and IMF staff calculation.

8. Broad money expanded strongly, and private credit grew despite the economic downturn in 2017 as excess liquidity remained high (Table 6 and Figure 3). The surge in demand deposits, likely reflecting inflows of post-hurricane insurance payouts, drove the growth in broad money supply. The increase in business and consumer loans in Curaçao more than offset the decline in private credit in Sint Maarten in 2017. Overall, private credit growth slowed in the first months of 2018. After keeping its pledging rate (at which commercial banks borrow from the central bank) at the historical low level of 1 percent since end-2008, the Centrale Bank van Curaçao en Sint Maarten (CBCS) increased it twice since 2017 to 2 percent, following the U.S. Federal funds rate hikes (given the exchange rate peg to the U.S. dollar).

Figure 3.
Figure 3.

Curaçao and Sint Maarten: Monetary Developments

Citation: IMF Staff Country Reports 2019, 023; 10.5089/9781484395929.002.A001

Sources: Centrale Bank van Curaçao en Sint Maarten, IMF WEO database, and IMF staff calculations.1/ For countries with differentiated reserve requirements (RR), the RR for commercial banks and domestic currency is shown.
Table 6.

Curaçao and Sint Maarten: Monetary Survey, 2010–17

(Millions of the Netherlands Antillean guilders unless otherwise indicated)

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Sources: Centrale Bank van Curaçao en Sint Maarten, and IMF staff calculations.

9. Past weaknesses in the financial sector oversight have become evident. The CBCS has intervened by placing three financial institutions under emergency administration (including the largest private insurer and private pension administrator in Curaçao since July 2018) and has been providing short-term liquidity to some commercial banks (though there is high excess liquidity in the banking system). Financial conditions of the banking sector deteriorated in 2017 (Table 7), including an increase in the NPL ratio. While the introduction by the CBCS of a New Chart of Accounts Reporting System for credit institutions in July 2016 created a break in the indicators and a data quality control is underway, preliminary data suggest that the net income of the banking sector was negative as of end-2017 (e.g., ROA was -0.5 percent) but improved somewhat in the first quarter of 2018, along with some improvements in the capital and NPL ratios.

Table 7.

Curaçao and Sint Maarten: Financial Soundness Indicators, 2010–17

(Percent unless otherwise indicated)

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Source: Centrale Bank van Curaçao en Sint Maarten.

As of 2017:Q3; the financial indicators have not been produced for 2018 given the data quality control planned for the beginning of 2019.

10. Financial innovations are gaining traction. Curaçao officially licensed the first casino operating on a cryptocurrency platform in 2017. The first cryptocurrency investment fund was approved for listing on the Dutch Caribbean Securities Exchange in February 2018, and bitcoins are being accepted at a local supermarket. In August 2018, the CBCS signed a Memorandum of Understanding with a Barbados-based Fintech company to explore the feasibility of the CBCS issuing a digital currency, to facilitate digital financial payments within the monetary union.

Outlook and Risks

11. Curaçao’s economy is expected to start recovering in 2019 but remain on a subdued growth path. The staff’s baseline—conditional on a continued negative outlook for Venezuela (as in the October 2018 World Economic Outlook)—assumes that (i) the Isla refinery would continue operations after the contract with PDVSA expires in 2019 but at a low capacity (given the lack of information on the new arrangement at this stage), and (ii) the gradual recovery in tourism will continue. Staff expects real GDP to contract further by 2 percent in 2018, before stabilizing at an average annual growth of 0.4 percent over the medium term, broadly in line with the CBCS projections. The negative output gap, estimated at about 2 percent in 2018, is expected to narrow gradually; however, absent major structural reforms, potential growth is estimated to remain negative and near zero (Annex III). Inflation will stabilize at 2½ percent.

A01ufig4

Curaçao: Real GDP Growth and Estimated Contributions

(Percent)

Citation: IMF Staff Country Reports 2019, 023; 10.5089/9781484395929.002.A001

Sources: Authorities’ data, and IMF staff estimates and projections.

12. Sint Maarten’s real GDP is projected to contract by 8½ percent in 2018 in the staff’s baseline scenario, assuming a decline of about 45½ percent (y/y) in tourist arrivals. A combination of the recovery of the tourism industry and the strong investment for reconstruction is projected to turn output growth positive in 2019, and then to stay slightly above its historical trend of 1.8 percent real GDP growth over the medium term, remaining somewhat below regional peers. After a projected acceleration to 2¾ percent in 2018,4 inflation is projected to remain at around 2 percent over the medium term. There is, however, significant uncertainty about the growth path given limited information about the amount, types, and timing of reconstruction activities. The large gap between reconstruction needs (estimated at US$2.3 billion) and identified public and private financial resources (around US$1.2 billion) persists, slowing the pace of recovery.5

13. The union’s current account deficit is projected to gradually narrow over the medium term but remain high compared to regional peers. Curaçao’s current account deficit is expected to improve slightly as tourism receipts increase and construction-related imports decline. In Sint Maarten, post-hurricane construction imports are expected to keep the current account deficit in double digits as a share of GDP in 2018–20. Official reserves would stabilize close to 4 months of imports, in line with regional peers (Annex II).

A01ufig5

Current Account Balance and Official Reserves

Citation: IMF Staff Country Reports 2019, 023; 10.5089/9781484395929.002.A001

Sources: Centrale Bank van Curaçao en Sint Maarten, IMF WEO database, and IMF staff estimates.

14. Risks to the outlook are mainly on the downside, reflecting external vulnerabilities and domestic structural weaknesses (Annex IV, Risk Assessment Matrix).

  • For the union, weaker-than-expected global growth could curb tourism demand, slowing the much-needed tourism sector recovery. A stronger U.S. dollar (due to tightening of global financial conditions) could negatively impact the islands’ competitiveness vis-à-vis non-U.S. tourist markets. The high current account deficit, especially if it widens further, and high excess liquidity in the banking system, if directed toward greater investments abroad, could pose a risk to external stability. A slow progress in strengthening financial sector oversight, AML/CFT frameworks, and central bank governance could lead to further losses of correspondent banking relationships (CBRs). The risk of cyber-attacks on public and other agencies is elevated due to weak IT systems and capacity.
  • For Curaçao, the continuing crisis in Venezuela is the main risk, causing also major uncertainty about the refinery’s future. On the upside, quickly identifying a strategic partner for the refinery could boost growth and investment, while regional and cruise tourism could benefit from the recent port expansion and expected resumption of operations by a local air carrier.
  • For Sint Maarten, where hurricanes remain a major risk, slower-than-expected progress on reconstruction, including the airport, implementation risks, and lower-than-projected reinvestment of private insurance payouts pose further downside risks to the outlook and sustainability of the recovery. On the upside, availability of additional resources and faster implementation within well-defined priorities could speed up the recovery and raise growth.

Authorities’ Views

15. The authorities broadly agreed with staff’s views on the outlook and risks. In Curaçao, the authorities stressed the importance of the refinery as a key pillar of the economy and their efforts to secure short- and long-term solutions for its continued operations. They saw the ongoing infrastructure modernization and construction of new hotels, together with further investments in the tourism sector, as an upside risk to the outlook. On the downside, the authorities noted a risk of a refugee crisis from further disruptions in Venezuela. In Sint Maarten, the authorities pointed out the demand for hotel rooms and reconstruction, expecting hotel capacity to return to pre-hurricane levels by end-2020. They noted the downside risk from a hike in insurance premiums. Given the gap between the reconstruction needs and identified financial resources, the authorities’ Governing Program 2018-2022 “Building a Sustainable Sint Maarten” stresses the need to find sufficient financing resources for rebuilding of Sint Maarten, including through prioritization, raising income, cutting costs, and seeking additional funding.

Policy Issues

A. Fiscal Policy: Strengthening Fiscal Frameworks, Ensuring Fiscal Sustainability, and Building Resilience

16. Curaçao and Sint Maarten need to urgently adopt a medium-term fiscal framework with a long-term debt anchor. Fiscal challenges facing both economies and mixed compliance have exposed the shortcomings of the current rules-based framework. This includes the lack of a fiscal anchor, drawbacks of the balanced current budget rule, rigidities in capital spending, the lack of a well-defined ‘escape clause’ which allows for deviations from the rules in the face of major shocks, and stipulations to build fiscal buffers (Annex V). A well-designed fiscal framework should have a fiscal anchor linked to the final objective of fiscal policy (debt sustainability) and an operational rule (or rules) on fiscal aggregates, such as spending rules, that are under the control of the government. As recommended previously, the level of 40 percent of GDP can be used as a desirable long-term debt anchor; a further specialized assessment would be needed to look into both the country-specific design and calibration of the fiscal framework and rules.6

17. In both countries, fiscal risks should be addressed through structural measures and greater fiscal transparency.

  • Budgetary arrears vis-à-vis the social security and pension funds have become endemic. While greater fiscal discipline and tight spending controls would prevent future arrears, further reforms to ensure financial viability of the social security funds and the healthcare systems are needed.
  • Reliance on one-off non-tax revenues from state-owned enterprises (SOEs) undermines fiscal discipline and potentially creates quasi-fiscal costs and contingent liabilities by shifting costs outside the budget. A clear framework for SOEs, including a predictable and balanced dividend policy, would need to be put in place.
  • Fiscal transparency, reporting and coverage would need to improve significantly, to facilitate policy analyses and assess financing and liquidity needs, including by adopting international standards on government finance statistics (Government Finance Statistics Manual). It is important that the budgets have a comprehensive coverage to transparently and consistently account for social security funds, and in the case of Sint Maarten, also include the Dutch fund for reconstruction purposes. Use of extra-budgetary funds, including for investment, should be avoided; at a minimum, their data should be consolidated with the budget, and a coherent public investment management framework developed. Budgetary decisions should be aligned with the governments’ policy priorities.
A01ufig6

Stock of Government Domestic Arrears

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 023; 10.5089/9781484395929.002.A001

Sources: Authorities’ data, and IMF staff calculations.

Curaçao: Significant Fiscal Deterioration and Risks Call for a Strong Structural Response

18. Curaçao’s fiscal position is expected to improve from 2018, though falling short of the needed adjustment to compensate for the 2017 deficit (Table 2). The authorities are implementing a package of measures focused on multi-year cuts in personnel expenditure, across-the-board reductions in spending on goods and services, and revenue administration. The measures aim to achieve a cumulative current budget surplus of NAf 117 million in 2018-20. Staff projects the current balance to improve by about 2½ percentage points of GDP in 2018, but still not reaching the current budget surplus expected in the amended 2018 budget.

Curaçao: Fiscal Projections and Comparison

(Millions of NAf)

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Includes depreciation.

19. Additional structural fiscal measures would be needed to put the public debt on a sustainable downward path. Even with the authorities’ target current balances expected to record surpluses over the medium term, the overall budget deficit will remain at about 1¼ of GDP in the staff’s baseline. Importantly, this masks a continuing deterioration of the SVB accounts (which the authorities stopped consolidating in their reports in 2018), assumed to be covered through the SVB reserves. In the staff’s baseline, the new hospital will have a negative fiscal impact as its higher operating costs are not fully offset by cost-saving measures (Annex VI). Gross public debt will decline slowly, remaining at about 47½ percent of GDP by 2023 (Annex VII). To bring debt down closer to 40 percent over the medium term, an improvement in the overall balance of about 1¾ percent of GDP relative to the baseline would be needed in 2019–23. A tighter fiscal policy stance would also help strengthen external stability.

Curaçao: Fiscal Scenarios

(Percent of GDP unless otherwise indicated)

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Authorities’ definition: includen depre dation.

20. Staff discussed a possible strategy to create space for fiscal buffers and public investment through further structural reductions in current spending and greater revenue mobilization. To support this effort and make it sustainable, the adjustments would need to be accompanied by structural improvements in revenue administration, adjustments in public services provision (such as through a comprehensive public expenditure review), organization of public administration, and stronger public financial management.

  • Public sector wage bill. With about one quarter of total employed working in the public sector, Curaçao’s public sector wage bill (at close to 12½ percent of GDP) is among the highest in the region. Reducing it closer to the regional average by 2023 would generate about 1½ percent of GDP in savings. Such reduction could be achieved through attrition, a hiring freeze, review of non-wage benefits, preferably within a broader civil service reform to modernize service delivery and make it more efficient and performance-oriented. The envisaged CARTAC technical assistance (TA) on personnel/payroll controls could contribute to this end.
  • Health and social insurance. The persistent deficits of the largest health and social insurance schemes call for further measures (Annex VI). Despite past reforms, the general old-age pension fund (AOV) remains underfunded, and the APC struggles to meet its target coverage ratio. Consideration should be given to further increasing the retirement age. Despite expected savings on medical services, further cost-cutting measures should be identified to offset the higher operating costs of the new hospital (especially if contributions do not rise). The design of some social welfare schemes (like sickness insurance and unemployment benefits) appears to create serious disincentives to work and would need to be reformed. Ensuring that the operations of the new hospital would be budget-neutral and the AOV is more self-sustainable are assumed to provide additional savings of ¾ percent of GDP by 2023.
  • Revenue administration reforms could help mobilize additional revenue of 0.2 percent of GDP annually, supported by TA in this area. Additional revenue from better tax administration could be saved to increase the fiscal buffers.
  • Fiscal buffers and public investment. The created fiscal space, in addition to providing a fiscal buffer, would allow a gradual increase in public investment over the medium term.
A01ufig7

Public Sector Wage Bill, 2017

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 023; 10.5089/9781484395929.002.A001

Sources: Authorities’ data, IMF WEO database, and IMF staff estimates.

Authorities’ Views

21. Maintaining a balanced current budget is one of the authorities’ main priorities, and they emphasized their continuing efforts to compensate for the 2017 deficit, in line with the agreement with the Cft (the Dutch-led Financial Supervision Board). They pointed out the multi-year nature of the ongoing cuts in personnel expenditure and across-the-board reductions in spending on goods and services and expressed readiness to look into possible implementation of the staff’s recommendations for further structural reductions and reforms. The authorities were mindful of the need to reduce the government debt closer to 40 percent of GDP and are considering options to reduce the large stock of arrears to the APC. They have embarked on technical assistance in revenue administration from the CARTAC, stepped up tax collection efforts, and noted the need to simplify tax filing and legislation. Sharing the concern about sustainability of social security schemes, the authorities are discussing solutions, including to reduce some non-contributory pension programs although excluding a further increase in the retirement age. They took note of the recommendations concerning the use of extra-budgetary funds, including for investment which they plan to finance primarily through privatization proceeds.

Sint Maarten: Post-Hurricane Response Requires Clear Prioritization and Strengthening Fiscal Resilience, with Critical Donor Support

22. After a significant deterioration in 2018, Sint Maarten’s fiscal position is expected to improve from 2019, as the economy recovers, and the envisaged measures are enacted (Table 4).7 The fiscal outturn in the first nine months of 2018 has been better than envisaged in the budget, with revenue collection overperforming budget expectations. Spending remained contained, reflecting in part delays in filling public sector vacancies. The stronger base would lead to higher revenue in 2019 compared to the authorities’ draft budget. The 2018 budget amendment and the 2019 draft budget include some measures to contain spending such as enacting a civil service pension reform and lower personnel costs.

Sint Maarten: Fiscal Projections and Comparison

(Millions of NAf)

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IMF projections incorporate Special Projects financed through Grants from the Trust Fund; these are not included in the authorities’ budget.

Social security payments to civil servants were reclassified from transfers to compensation.

Excludes depreciation.