Kingdom of the Netherlands—Aruba: 2019 Article IV Consultation Discussions— Press Release and Staff Report

2019 Article IV Consultation Discussions-Press Release and Staff Report

Abstract

2019 Article IV Consultation Discussions-Press Release and Staff Report

Context

1. Aruba is one of the most tourism-dependent countries in the world. About 87 percent of the economy depends directly or indirectly on tourism, making Aruba’s growth volatile and markedly dependent on external conditions. With U.S. tourists currently accounting for almost 70 percent of stay-over tourism, the economy is particularly sensitive to the U.S. business cycle.

2. Several recessions over the past decade have weighed on the fiscal position. The global financial crisis and its aftermath and the end to oil refining in 2012 have weakened activity and increased fiscal deficits and debt—including through the government policy response to these shocks. In 2014, the authorities undertook significant entitlement reforms to address the fiscal challenges and made efforts to diversify the economy. Nonetheless, growth remained lackluster and the economy entered a recession in 2015. At the same time, the sustainability of public finances remained a concern—by end-2017, public debt reached 86.7 percent of GDP, up from about 42 percent in 2008.1

3. A new government was sworn in by end-2017. Prime Minister Wever-Croes of the Movimiento Electoral di Pueblo (MEP) has entered the second year of her four-year term. The MEP leads a coalition with two junior parties, holding a 12-seat majority in the 21-seat parliament. The next election is in 2021.

4. The government devised a reform agenda with fiscal consolidation as a key pillar. Facing a deteriorating fiscal position, it focused on “crisis management”, by temporarily increasing turnover taxes (Annex VI), while devising a home-grown medium-term fiscal consolidation plan—the Financial Economic Memorandum. The plan served as the basis of a new agreement with the Netherlands, made in November 2018, that pinned down fiscal targets for 2019 and the medium term (Annex VII).2

Recent Economic Developments

5. Aruba’s economic recovery continued, though at a slowing pace. Following a contraction in 2015 and a modest rebound in 2016, real GDP expanded by 2.3 percent in 2017 on the back of strong public consumption and buoyant tourism growth—with cruise visitors and U.S. tourist arrivals more than offsetting the effects of falling tourism from Venezuela (Figure 1). Aruba’s tourism market share grew, supported by the devasting hurricanes in other parts of the Caribbean and its tourism exports continued to be robust in 2018. Despite this, growth is estimated to have slowed to 1.2 percent in 2018, largely because of weaker public consumption, a slight delay in the implementation of key investment projects, and a pick-up in import growth. Unemployment increased from 7.7 percent in 2016 to 8.9 percent in 2017, despite relatively strong growth that year. Inflation was in negative territory in 2016–17, but rose to 3.6 percent in 2018, mainly due to increases in the turnover tax rate (mid-2018) and oil prices.

uA01fig01

Real GDP and Real Tourism Exports

(Percent change)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: Central Bank of Aruba and IMF staff estimates.
uA01fig02

CPI

(Percent change and percentage points)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Source: Authorities’ data.
Figure 1.
Figure 1.

Aruba: Real Sector Developments

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: Authorities’ data, Caribbean Tourism Organization, IMF WEO database, and IMF staff estimates.1/ Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Grenada, Jamaica, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines.2/ Data up until October 2018.3/ Latest data available between 2015–2018.

6. Fiscal deficits and debt have remained high. The overall deficit increased by 1.4 percentage points to 3 percent of GDP in 2017, mostly because of a decline in non-tax revenues and an increase in current expenditures (Figure 2). The deficit moderated to 2.2 percent of GDP in 2018 mainly due to increases in revenues—supported by continued economic recovery and the turnover tax rate hike in mid-2018—as well as reductions in current expenditures. Public debt reached 84.5 percent of GDP in 2018. The Debt Sustainability Analysis (DSA) shows that Aruba’s public debt sustainability risks remain significant, although the debt-to-GDP ratio is expected to decline gradually over the medium term. Aruba is particularly sensitive to adverse shocks to growth and a failure to carry out the needed fiscal reforms as its historical policies have led to the high public debt ratio (Annex IV).

Figure 2.
Figure 2.

Fiscal Sector Developments

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: Authorities’ data, IMF WEO database, and IMF staff estimates.1/ Net acquisitions of non-financial assets.

7. The current account balance has moderated. The surplus declined to 1 percent of GDP in 2017, from 5 percent of GDP in 2016 as the deterioration in the trade and income balances more than offset the improvement in the service balance brought about by tourism growth. The smaller current account surplus and modest financial outflows led to a loss of US$29 million in reserves in 2017—the stock stood at 4.9 months of imports at end-year. In 2018, the current account registered a deficit of 0.5 percent of GDP, mostly due to a decrease in the income balance. Reserves nudged up to 5.1 months of imports, helped by an increase in foreign direct investment (FDI) and portfolio inflows. Aruba’s external debt fell by close to 4 percentage points of GDP to 102.5 percent in 2017 and is estimated to have fallen further to 99.3 percent of GDP in 2018 as the government reduced external borrowing.

8. Private sector credit has picked up. It rose by close to 4 percent in 2017–18, up from 1.8 percent in 2016, mainly supported by steady growth in mortgages (Figure 3). The latter is partly driven by the remodeling of houses for alternative tourism accommodations and a pent-up demand to build houses brought about by a backlog of applications for land. Asking prices for houses have been relatively stable in recent years.

Figure 3.
Figure 3.

Aruba: Monetary Developments

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: Central Bank of Aruba, IMF WEO database, and IMF staff estimates.1/ For countries with differentiated reserve requirements (RR), the RR for commercial banks and domestic currency is shown.

Outlook and Risks

Staff Views

9. Growth is projected at 0.7 percent in 2019, and 1.1 percent over the medium term. The fiscal consolidation plan—while essential to put public debt on a downward trajectory—will lower real GDP growth in 2019.3 However, this effect will be mitigated by continued strong growth in tourism from the U.S., and the implementation of multiple large investment projects (including the airport, utilities, hospital, and hotels) in 2019 and subsequent years. Over the medium term, real tourism exports are expected to grow steadily at around 1.2 percent, and together with contributions from domestic demand, growth is expected to increase to 1.1 percent, broadly in line with the historical average. Inflation is projected to fall to 1.8 percent in 2019 as the base effect of the turnover tax rate hike disappears, and oil prices decrease, before gradually rising towards 2.2 percent over the medium term.

uA01fig03

Real GDP

(Percent and percentage points)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: Authorities’ data and IMF staff estimates.

10. The current account balance is forecast to decline further in 2019 before gradually improving through the medium term and will remain high relative to regional peers. Staff foresees a deficit of 1.7 percent of GDP in 2019, followed by shrinking deficits, and then a small surplus in the outer years. This path is largely driven by high imports in 2019–21 associated with the implementation of above-mentioned infrastructure projects. In the medium term, robust tourism growth, brought about by an anticipated increase in hotel capacity, and reduced oil imports for electricity generation—due to the implementation of energy saving technologies—are the main drivers. The increased demand for foreign workers in the tourism sector will likely lead to positive spillovers for the rest of the region, due to increased remittance outflows (Annex X). By 2024, reserves would stand at around 5 months of imports, in line with regional peers.

uA01fig04

Current Account Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: IMF WEO and IMF staff estimates.
uA01fig05

Reserve Coverage

(Months of next year’s imports)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: IMF WEO and IMF staff estimates.

11. Risks to the outlook are tilted to the downside. Aruba is susceptible to a possible downturn in the U.S. economy. Risks from the crisis in Venezuela have largely materialized over the last few years as bilateral trade saw disruptions and Venezuelan tourist arrivals declined sharply. Nevertheless, Aruba has managed to absorb the crisis impact by diversifying both suppliers and tourist markets. The Venezuelan immigrant and refugee influx appears to have been limited so far, although available estimates of these flows are highly uncertain. A worsening crisis that leads to sizable refugee inflows would put pressure on labor markets and infrastructure and may cause tourists to postpone plans or seek other destinations. The planned fiscal consolidation would address important medium-term downside risks but could have greater-than-expected effects on growth in the near term. On the upside, the implementation of needed structural reforms as well as investments in energy-saving technologies and renewable energy would boost potential growth (Annex II, RAM). Albeit a somewhat remote possibility, a re-opening of the refinery would bring associated investments and employment gains.

Authorities’ Views

12. The authorities broadly agreed with staff’s assessment of the outlook and risks. They noted that robust tourism growth has underpinned economic activity in 2017–18, and they foresee tourism as continuing to play a key role going forward. At the same time, the authorities expect multiple planned and ongoing investment projects to boost the economy. As a result, they do not see a need to actively mitigate any adverse growth effects from their fiscal consolidation plan. The authorities acknowledged the risks from the Venezuela crisis. So far, the effects from immigrants and refugees have been relatively limited. Notwithstanding the limited effects of the crisis to date, the authorities noted that they are discussing financing of their contingency plan with both the European Union and the United Nations High Commissioner for Refugees. The contingency plan aims to prepare them in case there is a worsening of the crisis and a potential “mass influx” situation. The authorities agreed that the reopening of the refinery is an upside risk and, given the highly uncertain situation, they have not factored it in the budget or in any forecasts.

Policy Issues

13. The key policy challenges are: (A) Continuing fiscal consolidation and underlying reforms to put public debt on a downward trajectory; (B) maintaining international reserve buffers and safeguarding financial stability; (C) removing structural impediments to sustained and inclusive growth; and (D) bridging data gaps for effective policy making.

A. Maintaining the Momentum on Fiscal Reform

Background

14. The new agreement with the Netherlands has established Aruba’s fiscal targets. These fiscal targets were set in terms of the “financial” balance, defined as the overall fiscal balance plus net acquisition of financial assets.4 For 2019, the target was set at -0.5 percent of GDP; this corresponds to an overall balance of 0 percent of GDP. A financial balance of 0.3 percent of GDP was set for 2020, increasing to 1.0 percent in 2022 and beyond. These map into an overall balance of 0.7 percent and 1.4 percent of GDP, respectively.

uA01fig06

Authorities’ Fiscal Targets 1/

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

1/ Authorities’ nominal GDP.Source: Authorities’ data.

15. The 2019 approved budget is in line with the authorities’ target and envisions sizable tightening. It foresees a balanced budget, 2.3 percentage points of GDP tighter than the 2018 outcome (text Table).5 The adjustment comes mainly from the revenue side:

  • Revenues. The large upfront revenue increase of 2.3 percent of GDP would come mostly from indirect taxes (Annex VIII): the full-year impact of the mid-2018 turnover tax increase (+1.4 percent of GDP), an increase in excise taxes on alcohol, tobacco, and cider in early 2019 (+0.3 percent of GDP), and the introduction of an excise tax on sugary drinks in mid-2019 (+0.3 percent of GDP). Direct tax revenues are expected to decline by 0.4 percent of GDP as a result of the early 2019 simplifications to the personal income tax (-0.3 percent of GDP) and reform of property taxes (+0.3 percent of GDP); the expected collection of tax arrears through improvements in tax administration (+1.2 percent of GDP); and base effects (-1.6 percent of GDP).6

  • Expenditures. Savings are expected to come from reductions in the transfers to the General Health Insurance (AZV)7 and in capital spending. However, these are fully offset by increased spending elsewhere in the budget, leading to zero adjustment from the expenditure side.

Central Government Fiscal Plan, 2019–2022

(Percent of GDP)

article image
Source: Authorities’ data.

The authorities’ financial balance is defined as the overall fiscal balance plus net acquisition of financial assets.

GDP figures are based on the 2019 budget document and the authorities’ assumptions of one percent nominal growth for 2019 and beyond.

16. The authorities are embarking on an ambitious fiscal adjustment program. Their projections show a cumulative adjustment of 3.7 percent of GDP over 2018–22 under the assumption of nominal GDP growth of 1 percent per year. On the revenue side, they plan to boost tax revenues including through broadening the tax base via a shift from direct to indirect taxation. On the expenditure side, savings are expected to come mainly from reductions in the wage bill, transfers to AZV,8 capital spending, and goods and services which are partially offset by increases in other current expenses and interest payments. This adjustment would put public debt on a firm downward trend.

Staff Views

17. Staff supports the authorities’ fiscal consolidation efforts. While good progress has been made in implementing reforms, staff noted that the announced measures appear insufficient to achieve the authorities’ targets. Staff built a baseline scenario based on the available and quantifiable information on the authorities’ plans:

  • For 2019, the baseline takes on board the authorities’ expenditures, as specified in the budget, but builds in higher transfers to AZV based on AZV’s own deficit projections. On the revenue side, it incorporates the effects of the income and property tax reform as well as the tax increases on tobacco, alcohol, and cider, and the new tax on sugary drinks, but estimates a lower yield for the full-year impact of the mid-2018 turnover tax increase than the authorities.9 Also, the baseline does not incorporate the projected collection of the sizable amount of tax arrears as the authorities have not put in place a concrete strategy on how this would come about. Thus, staff projects a higher fiscal deficit than the authorities, at 0.8 percent of GDP (chart).

  • Over the medium term, staff projects deficits that are also larger than the authorities’ targets despite staff’s higher nominal GDP growth path.10 This largely derives from staff’s higher expenditure projections, as the authorities have not specified reform measures and their plans for a reduction in the wage bill by an average of 3.0 million Aruban Florins per year seem too ambitious. As in 2019, the baseline also does not factor in arrears collection for the medium term.

uA01fig07

Overall Balance as Percent of GDP

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: Authorities’ data and IMF staff calculations.
uA01fig08

Public Debt as Percent of GDP

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: Authorities’ data and IMF staff calculations.

18. Additional measures of about 1.7 percent of GDP are needed to achieve the authorities’ targets. Staff recommended that the additional consolidation be achieved through a mix of expenditure and revenue measures, while creating space for growth-friendly expenditure and protecting capital spending. Effective prioritization and sequencing of reforms are also important to mitigate potential adverse effects of the consolidation. Staff encouraged the authorities to identify and execute a few, easy-to-implement measures first, while ensuring that reforms are equitable, transparent, and well-communicated to ensure their durability. Staff discussed with them a set of potential measures to close the gap, some of which were identified in previous Fund advice:

Revenues

  • There is scope to increase tax revenues through indirect taxes. The authorities could follow up on the recommendations of a recent technical assistance mission on tax policy carried out by the Fiscal Affairs Department (FAD) of the IMF and introduce a value-added tax (VAT) with a uniform rate of 10 percent to replace the current various indirect taxes (Annex VIII).11 Efforts to improve revenue administration would also yield tangible benefits.

uA01fig09

Tax Revenue 2018

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: IMF WEO database and IMF staff calculations.
uA01fig10

Aruba: Composition of Tax Revenues 2018

(Percent of total revenues)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Expenditures

  • The government wage bill needs to be contained further. Staff recommended a comprehensive review of the wage bill—more than 36 percent of total revenues in 2018—to understand its main drivers (including compensation vs. employment) and to put in place lasting measures that address the root causes of its structurally high level.

  • Other current spending could be rationalized. This category includes education wage subsidies, fees for public private partnerships (PPP), subsidies to public transportation, transfers to social programs, and cash transfers to low income individuals. It is large—6.4 percent of GDP—and accounts for much of the increase in total spending over the past decade. Staff proposed that the authorities review such spending with an eye on efficiency enhancement and better targeting.

  • Further measures to ensure that healthcare does not pressure the government’s budget should be considered. Population aging poses a risk that the healthcare system would remain budget dependent (Annex IX). Aruba could contain costs through more preventive care; it could also introduce targeted user-fees for certain services and/or reduce entitlements for non-essential treatments. If the recent increase in the health sales tax is reversed, it needs to be replaced by a measure generating equal revenue.

  • There is much room to improve the quality of public spending on education. An efficiency frontier analysis shows that for secondary education, outcomes do not reflect the high level of spending (text panel chart).

uA01fig11

Compensation of Government Employees 1/

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

1/ The numbers for Aruba exclude wage subsidies.Sources CBA; IMF WEO database and IMF staff calculations.
uA01fig12

Government Wage Bill as a Share of Total Revenue 1/

(Percent)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

1/ The numbers for Aruba exclude wage subsidiesSources: CBA; IMF WEO database and IMF staff calculations.
uA01fig13

Aruba: Government Expenditures and Change, 2007–18

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Source: Authorities’ data.

19. The envisaged fiscal consolidation, while sizable, is not likely to be a major drag on growth over the medium term, although this consolidation is expected to have adverse short-term growth effects. Compared to the historical experience of other countries, Aruba’s adjustment is indeed large (Annex IV). But Aruba’s own historical data reveal that even with large adjustments, the negative effects on growth appear to have been relatively small on average. Empirical work on Aruba and other Caribbean countries shows medium-term fiscal multipliers to be small, partly because of their highly open nature.12 Specifically, the cost to real GDP over 4–5 years from higher consumption taxes or lower government consumption of 1 percent of GDP is estimated to be close to zero. On impact, though, the multipliers are estimated to be larger. Hence, attention should be given to providing targeted and effective social safety nets to the vulnerable and less well-off during the adjustment process. Should the authorities deliver on staff’s recommended measures and gradually close the fiscal gap of 1.7 percent of GDP from now through the medium term—through introducing the VAT and rationalizing the wage bill and other spending—growth would be marginally lower over the near term than in the baseline (see active scenario in text tables). Structural reforms to boost growth (see section C) would also support fiscal consolidation over the medium term.

uA01fig14

Real GDP Growth and Change in Overall Balance

(Percent change and percentage points)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: Authorities’ data and IMF staff estimates.
uA01fig15

Government Education Expenditure 1/

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Source: FAD Expenditure assessment tool.1/ The blue lines in charts 2–6 refers to the frontier. Latest value available.

20. Staff sees the frontloaded nature of the adjustment as justified, but downside risks will need to be carefully managed. There were slippages in meeting fiscal targets in earlier years (Annex VII), public debt is high, there is already a reform momentum, the near-term outlook of the most important economic partner, the U.S., is favorable, and Aruba is still benefiting from tourism diversion from the hurricane-hit Caribbean. At the same time, the envisaged large infrastructure investment projects would cushion potential adverse effects in the short term.13 In short, it is prudent to adjust in good times. At the same time, the authorities should consider putting in place a contingency plan to cushion the economy if the adverse growth effects of fiscal consolidation proved larger than expected. While still adhering to the targets, this plan could entail changing the composition of the adjustment in the short term including through preserving capital and social spending.

Additional Fiscal Adjustment Needed to Fill the Gap Between the Authorities’ Fiscal Plan and Fund Staff Baseline Scenario

(Percent of GDP)

article image
Source: Fund staff estimates.

21. Fiscal efforts should be guided by a robust medium-term framework with a clear objective. Staff welcomed the authorities’ formulation of medium-term projections. The focus going forward should be on further developing a robust medium-term fiscal framework (MTFF). Such a framework would: (i) strengthen multi-year fiscal discipline and help the government take into account both the short- and medium-term impact of new policies; (ii) facilitate the setting of medium-term fiscal measures to achieve the objectives; and (iii) provide early warning signals about fiscal sustainability and looming fiscal risks, thereby enabling timely actions, if needed. Broadening the coverage of fiscal data beyond the central government would ensure a more complete assessment of the government’s impact on the economy and any attendant risks.14 After the adjustment period, a formal fiscal rule could be considered to safeguard fiscal sustainability and create fiscal space. These reforms could be reinforced by establishing a unit to improve macro-fiscal analysis.

Aruba: Fiscal Scenarios, 2019–2024

(Percent of GDP, unless otherwise indicated)

article image
Sources: Aruban authorities and IMF staff estimates.

22. There is a need to coordinate across agencies the strategies for budget financing and debt management. In 2019, the authorities decided to rely fully on domestic markets to meet their gross financing needs and their preference is to continue to do so over the medium term. While domestic debt issuance provides an opportunity for the government to develop a domestic debt market, staff indicated that deficit financing should avoid crowding out private sector credit or unduly pressuring central bank’s foreign reserves (see also ¶24). Staff also emphasized the importance of an asset-liability management framework that would help clarify the desired government-debt portfolio, capture cost-risk tradeoffs, provide more predictability to the financial system, and minimize macro-financial risks.

Authorities’ Views

23. The authorities stressed the importance of achieving their fiscal targets to put debt on a sustainable path. They reiterated their commitment to fiscal reforms and took keen note of staffs proposed revenue and expenditure measures. The authorities agreed with staff on the importance of effective prioritization and sequencing. They suggested that while there could be merit in eventually considering a formal fiscal rule, the emphasis now should remain on strengthening the budget process to achieve the government policy objectives and fiscal targets. The authorities underscored the good progress made in developing a medium-term debt management strategy and highlighted that enhanced capacity and technical assistance from the IMF could be required to move to a medium-term budget framework.

B. Preserving Reserve Buffers and Financial Stability

Background

24. The Central Bank of Aruba (CBA) recently announced an increase in the reserve requirement ratio, its main policy instrument. Effective May 2019, the CBA will raise the ratio to 12 percent of deposits from 11 percent, the rate it had kept constant since 2010 given adequate reserves, modest economic growth, and deflation. There is no evidence of capital outflows in high-frequency data and the CBA does not currently see pressures on international reserves. Rather, the decision to raise banks’ reserve requirement was mainly driven by the CBA’s desire: to increase international reserve coverage relative to the IMF’s risk-weighted measure (the ARA metric); and to stem potential forward-looking pressures brought about by the central government’s decision to finance all of 2019’s borrowing needs domestically—a shift in government financing from foreign to public private partnerships (PPPs): there are no explicit guarantees, most existing projects are at stages where central government exposure is limited and, as per the new agreement with the Netherlands, Aruba will not enter into any new PPP commitments through 2021. Staffs understanding is that the motivation of the latter is more to limit the impact on current expenditures through user fees, rather than to limit any potential contingent debt liabilities.

25. Staff’s assessment is that the external position of Aruba is broadly in line with fundamentals. The 2018 current account balance was close to its estimated norm, although the fiscal balance remained below its desired value (Annex III). Over time, continued fiscal consolidation together with completion of ongoing investment projects and the attendant increase in tourism would be expected to improve the current account balance. Removing structural impediments to growth, such as those discussed in section C below, would be key to increasing investments over the medium term. The Florin appears to be roughly fairly valued on a variety of metrics, including the EBA-lite, and its current valuation does not appear to hinder competitiveness (see ¶31 for a discussion on tourism).

uA01fig16

Banks Capital Adequacy and Non-Performing Loans (NPLs)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Source: Central Bank of Aruba.
uA01fig17

Interest Rate Margin, Commercial Banks

(Percentage points)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Source: Central Bank of Aruba.

26. The banking sector remains sound. Banks enjoy healthy profits and interest rate margins remain sizable, which reflect, in part, weak competition among banks. The capital adequacy ratio (CAR) of 32 percent is double the regulatory minimum, and CBA’s stress tests reveal high capital resilience to severe shocks. Banks have liquidity buffers that largely surpass the regulatory requirements, continue to see declining non-performing loans, and set loan-to-value ratios on mortgages at safe levels. While a high CAR mitigates financial sector risks, it could indicate anemic demand or lack of viable business projects. The latter is reinforced by the fact that banks are flushed with excess liquidity (excess reserves rose to almost 15 percent of GDP in 2018) and credit growth is relatively modest.15 Discussions with the authorities and stakeholders suggest that the high CAR is in part a result of a lack of bankable projects outside of the tourism sector, and also relates to the CBA’s large exposure rule, which requires banks to maintain high capital buffers in case of large exposures to a single debtor or connected group of debtors. The upcoming results from the financial inclusion survey could shed more light on possible issues and policy solutions.

uA01fig18

Commercial Banks’ Claims on the Central Bank

(Billions of Aruban Florins and percent)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: Central Bank of Aruba and IMF staff estimates.

27. Financial sector oversight has been progressing. Over the years, the CBA has shifted to a risk-based approach to supervision, from a compliance-oriented one, thereby allocating supervisory resources to institutions with the highest risk profiles. After significant efforts to enhance the anti-money laundering and combating the financing of terrorism (AML/CFT) framework, Aruba was removed from the Financial Action Task Force (FATF) and Caribbean FATF follow-up process in 2014. Preparations are ongoing for the 2020 Caribbean FATF (CFATF) assessment, which will take place under the revised FATF standards that focus on effectiveness and implementation of AML/CFT measures. To date, Aruban banks have not been affected by the withdrawal of Correspondent Banking Relationships in the Caribbean. Aruba was recently moved to the European Union tax haven blacklist, due to unmet tax reform commitments. The authorities have already made the required legislative amendments to be removed from the list, which parliament approved on April 4, 2019.

Staff Views

28. Foreign exchange reserves are currently adequate to safeguard the peg but should be increased over the medium term to maintain the foreign exchange reserve ratios in the recommended range. They are well-above the levels suggested by a variety of simple metrics, and only slightly below the floor of the recommended range of 100–150 percent of the Fund’s risk-weighted measure, the ARA metric. Sustained fiscal consolidation and implementation of structural reforms to raise growth (as per ¶s 36–39) would reduce trade and financial outflows thereby supporting reserve accumulation and the current account balance.

uA01fig19

Reserve Adequacy

(Reserves as a percent of target)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: Authorities’ data and IMF Staff estimates.Note: values >100 indicate reserves in excess of the metric recommended level.

29. Monetary policy should remain data dependent. Staff sees the CBA’s move to raise banks’ reserve requirement as prudent and does not expect any potential negative effects on activity given that banks have excess liquidity—if applied to 2018, a 12 percent required reserve ratio would still imply excess liquidity above 14 percent of GDP. Going forward, the CBA should continue to be vigilant, standing ready to tighten policy if incoming data or expectations point to downward pressures on international reserves. However, in the absence of such pressures, the CBA should be prepared to stimulate activity if downside risks materialize—for example, if the growth effects of fiscal consolidation turn out to be larger than anticipated. In this case, an unwinding of the increase in required reserves may be warranted.

Authorities’ Views

30. The CBA reiterated its commitment to maintaining reserve buffers and financial stability. CBA officials emphasized that the recent increase in banks’ reserve requirement is a testimony to the CBA efforts to maintain sufficient international reserve coverage. They also stressed that, over the medium term, balance of payments stability and foreign reserve adequacy will be ensured by a combination of reforms and policy measures. These include the fiscal reform package, government financing decisions, renewable energy and efficiency improvements, and enhancing service-oriented tourism activities. The authorities see the financial system as prudently regulated. Additionally, they stressed that it remains of utmost importance for Aruba to maintain a high level of compliance with international best practices in supervision and AML/CFT. To prepare for the upcoming CFATF they are currently conducting an AML/CFT national risk assessment with help from the World Bank and are working on an update of their AML/CFT state ordinance.

C. Unlocking the Potential for High and Sustained Growth

Background

31. Aruba’s tourism sector—the main growth engine—has been competitive. The island’s share of overall stay-over tourism in the Caribbean has been the third largest at around 16 percent (Annex X). Aruba’s reputation as a high-end destination coupled with timeshare arrangements among repeated stay-over tourists has ensured high and stable revenues. At the same time, and partly reflecting lower input costs, the cost to tourists is slightly lower than in other Caribbean countries—the Week at the Beach Index, which captures the average cost of food and lodging, puts Aruba in a competitive position.16

uA01fig20

Week at the Beach Index, January 2019 1/

(12 month moving average, Bahamas=100)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Source: IMF staff calculations.1/ Week at the Beach Index (W@TB)” measures the average cost of a 7-day-trip in 3 country’s beach destinations The Index is a composition of an average hotel price (3 to 4 ‘bubble’ rating) from TripAdvisor and over 80 million crowdsourced data on meals, taxi fares, water, coffee, and beer.

32. Aruba may be close to a saturation point where additional tourists bring smaller growth benefits. Staff’s empirical analysis shows that tourist arrivals have a positive effect on growth (Annex X). However, it also identifies an “exhaustion” effect, pointing to potentially diminishing returns from additional tourists. Aruba’s very high tourism density in terms of both population and land area; limited availability of still-to-be-developed land; the need for foreign labor and potential pressures on infrastructure; and leakages through imports and foreign labor remittance outflows, are all potential explanations of such effect.

33. The authorities are pursuing new engines of growth. In the past, they have made sizable efforts to develop the renewable energy sector and reduce oil-dependency. Going forward, they plan to diversify the economy by promoting investments in sectors that have potential—the “promising sectors” initiative. Given the limited size and availability of physical land and local markets, the authorities see digitalization and technology as the way forward. Hence, the initiative focuses on pursuing technological innovations in agriculture, developing a knowledge-based economy and specific niche products within tourism, among others.

uA01fig21

Renewable Energy (Wind and Solar)

(Percent of total energy/power production)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Source: Authorities’ data.
uA01fig22

Heavy Fuel Oil in Electricity Generation

(Barrels per day)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Source: Authorities’ data.
Staff Views

34. Aruba should maintain its high-end tourism brand, while striving to diversify tourism sources. Rather than just a quantitative expansion to tourism, Aruba should focus on offering high quality services and physical tourism infrastructure to maximize spending per visitor. The focus on renewable energy in production will further bolster competitiveness and the economy’s resilience. Strengthening tourism linkages with the local economy would minimize leakages. Continued efforts to diversify the tourism base including to Latin American countries (besides Venezuela) are encouraged. Ongoing efforts to expand and modernize the health care system could create opportunities for medical tourism.

35. The “promising sectors” initiative is welcome, but several structural challenges need to be addressed. Staff supports the authorities’ efforts to diversify but, in doing so, and particularly in carrying out the “promising sectors” initiative, the authorities should be mindful of potential fiscal costs and contingent liabilities. Also, for diversification efforts to reap dividends, Aruba will need to tackle several structural impediments to growth related to the business environment, governance, and labor markets (¶s 36–39).

uA01fig23

Stay-Over Visitors by Origin

(Percent)

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Sources: Central Bank of Aruba, Caribbean Tourism Organisation
uA01fig24

Business Survey Results 1/

Citation: IMF Staff Country Reports 2019, 148; 10.5089/9781498318006.002.A001

Source: Authorities’ data.1/ In general, do you believe that the current legislation in Aruba strengthens/stimulates the capacity of the private sector to create jobs and to offer greater opportunities for a thriving economy?

36. Reforms to improve the business climate need to be reinvigorated. A recent business survey reveals that 64 percent of firms perceive current legislation as impeding job creation and a thriving economy.17 Several national ordinances were identified as problematic but the two most cumbersome were Establishment of Businesses and Permits and Licensing—about 70 percent of firms believe they create unnecessary red tape. Staff emphasized that addressing these challenges is necessary to stimulate investment, productivity, and growth.

37. Addressing potential governance vulnerabilities, including corruption, is paramount. Respondents to the same survey perceive problems regarding the procedures surrounding the ordinances, including lack of transparency and efficiency and elements of unequal treatment. At the same time, preliminary results from the recent CBA-conducted survey on perceived corruption raises some concerns—almost 70 percent of respondents agree that there is corruption in public institutions in Aruba. The CBA plans to launch a follow-up survey in November 2019 to hone in more deeply on problem areas identified in the first survey and the authorities are working on a proposal for an anti-corruption strategy. Staff welcomed these efforts and underlined that such a strategy should include the identification of core challenges (based on the surveys’ results), targeted measures to address those, a timeline with performance targets, implementation infrastructure and budget allocation.

38. Policy should protect the worker—not the job—and bolster human capital. Labor market regulations are rigid. Procedures for terminating employment contracts appear cumbersome and costly—creating disincentives for voluntary resignations and hiring, thereby impeding labor mobility and job growth. Policy should promote labor market flexibility and at the same time provide effective protection to workers. Severance pay could be replaced by an unemployment insurance program. Additionally, there is a need to strengthen vocational training and better align education curricula with private sector job needs.

39. There is a need to reverse brain-drain. Much of the authorities’ diversification focus is in skill-intensive sectors but there are domestic skill-shortages. The authorities should foster an enabling environment to encourage skilled Arubans working abroad to come back.

Authorities’ Views

40. The authorities concurred on the need to diversify the economy. They acknowledged that there is a limit to how much further the tourism sector can expand. Thus, they are working on a “High Value Low Impact” model for tourism growth which aims at targeting affluent visitors and increasing their on-island spending. Efforts are also being made to attract more tourism from countries in South America. At the same time, the authorities are working on an action plan to promote domestic and foreign investments in the “promising sectors”.

41. The authorities acknowledged the need for further structural reforms. To speed up the process of getting business permits and licenses and, more generally, to enhance the ease of doing business, the authorities are in the process of introducing an “e-Government” platform. The e-Government strategy includes a redesign and digitization of key government administrative procedures to improve the citizen experience of government services and facilitate doing business in Aruba. A digital “one stop shop” to facilitate licensing is one of the priority projects. Regarding labor markets, the authorities’ focus is currently on addressing youth unemployment and issues with other vulnerable parts of the population who are currently outside the labor force. They recognize the need to attract skilled labor and pointed out that they have modified the immigration laws in 2018 to facilitate the employment of non-residents with bachelor’s degree and higher. They are taking measures to address corruption and governance issues through the establishment of a Bureau of Integrity, Integrity Chamber, and a Corporate Governance Code.

D. Improving Data Quality to Better Inform Policies

Staff Views

42. Data gaps and quality hinder effective policy-making and transparency of public sector operations, while making it difficult to fully assess governance vulnerabilities. Areas needing upgrading are labor statistics, public finances, and public debt. Staff welcomes the good progress made in revising the national accounts. Deflators for the expenditure components of GDP need to be prepared. Staff encouraged the authorities to seek technical assistance from CARTAC— the Caribbean Regional Technical Assistance Center—in this regard. Aruba should aim to be covered in key comparative indicators such as the World Bank’s Doing Business and Worldwide Governance Indicators, and Transparency International Corruption Perceptions Index, while recognizing limited local capacity to make quick progress.

Staff Appraisal

43. Aruba’s economic recovery continues, although at a slowing pace. Following negative growth in 2015 and a modest pick-up in 2016, output has gained momentum over the past two years supported by strong growth in tourism from the U.S., which more than compensated for declining tourism from Venezuela. The economic recovery is foreseen to continue, underpinned by buoyant tourism activity and the coming on stream of multiple large investment projects in 2019 and subsequent years.

44. Risks to the outlook are skewed to the downside. A deepening crisis in Venezuela that leads to large immigrant and refugee inflows would put pressure on Aruba’s infrastructure, labor markets, and tourism. Aruba is also vulnerable to a cyclical downturn in the U.S. economy and the short-term growth effects of Aruba’s fiscal consolidation may turn out greater than expected. On the upside, the implementation of needed structural reforms would boost potential growth and, although a remote possibility, the reopening of the refinery could bring associated investments and job gains.

45. The authorities are making good progress in implementing their fiscal reform agenda. They are encouraged to sustain reform momentum to keep the public debt ratio on a downward path. Reforms should be prioritized, sequenced, equitable, and well-communicated to ensure their durability. Attention should be given to ensuring that social safety nets remain effective and adverse growth effects remain manageable.

46. Additional measures are needed to achieve the authorities’ fiscal targets. The additional adjustment should contain a mix of tax reforms and expenditure rationalization. The fiscal measures in 2019 are expected to deliver a large upfront increase in revenues but it will be important to strike a balance between revenue increases and expenditure restraint in subsequent years. Tax reform efforts could follow previous IMF advice and emphasize broadening the base and shifting toward indirect taxation—a VAT could be introduced in this regard. Expenditure rationalization should minimize adverse growth effects and protect capital spending and essential government services. The priorities are to rationalize the wage bill, improve the efficiency of other public spending, and contain increasing healthcare costs.

47. Having a robust fiscal framework is paramount. It is essential to further develop a formal medium-term fiscal framework to enhance the credibility of the consolidation plan. Eventually, a formal fiscal rule could be considered to preserve sustainability.

48. The strategy for budget financing and debt management needs to be finalized. Financing should avoid crowding out private sector credit or unduly pressuring international reserves. It is crucial to develop an asset-liability management framework to guide financing decisions, including the desired composition of the government-debt portfolio, and to help assess implications of alternative financing options.

49. The monetary policy stance and financial sector supervision and regulation remain appropriate. The CBA’s policy decisions should remain data driven, balancing domestic and external stability considerations. Tightening is warranted if incoming data or expectations point to downward pressures on international reserves. In the absence of such pressures and should risks to growth surprise on the downside, the CBA could consider unwinding the increase in reserve requirement. Banks remain sound and liquid under a solid supervisory and regulatory framework.

50. Aruba’s external position is broadly in line with fundamentals. In the medium term, the current account is expected to improve due to increasing tourism and continued fiscal consolidation. International reserves are adequate to safeguard the peg but should be raised over the medium term to maintain sufficient coverage.

51. Aruba should maintain its high-end tourism brand and diversify tourism sources. The “exhaustion effect” necessitates a focus on increasing spending per visitor, including through offering high quality services and adequate physical tourism infrastructure. Diversification of tourism sources beyond the U.S. would reduce concentration risks.

52. There is a pressing need to address structural challenges. The authorities are making efforts to diversify the economy including through the “promising sectors” initiative. To maximize the benefits of such efforts, Aruba will need to pursue structural reforms that: improve the business climate and reduce red tape; foster labor market flexibility while protecting workers; enhance human capital; and address governance vulnerabilities—though welcome efforts in this area are already underway. Increasing renewable energy use and energy efficiency and FDI-attracting structural reforms would further boost competitiveness.

53. Bridging data gaps would make policy-making more effective. Good progress has been made in revising the national accounts. Efforts need to continue with a focus on compiling deflators for the expenditure components of GDP. CARTAC technical assistance could help in this regard. Aruba should strive to be covered in key international surveys like Doing Business and Transparency International.

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

Table 1.

Aruba: Selected Economic Indicators, 2014–2024

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

Aruba: Baseline Scenario: Medium-Term Outlook, 2014–2024

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

Aruba: Operations of the Central Government, 2014–2024 1/

(Percent of GDP, unless indicated otherwise)

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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, 2014–2024 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.