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  3. IMF Publishes Preliminary Conclusions On 2008 Article IV Consultation With Netherland Antilles

IMF Publishes Preliminary Conclusions On 2008 Article IV Consultation With Netherland Antilles

by Amanda Banks, for, London

02 July 2008

The International Monetary Fund (IMF) has this week published the preliminary conclusion to its 2008 Article IV Consultation with the Netherland Antilles.

A long period of stagnation appears to have ended in the Netherlands Antilles, the IMF began.

Economic growth accelerated sharply in 2007 and is likely to remain strong in 2008, at about 3%.

Growth will be shored up by a fiscal stimulus, ongoing investments in the construction and tourism sectors due to improved investor confidence, and gains in tourism due to the euro appreciation and increased capacity.

Sustaining investor confidence would be important for ensuring that growth remains above historical norms in the medium term, they continued.

The mission projects growth in the islands now comprising the Netherlands Antilles to moderate to some 21⁄2% by 2011. This is cautiously optimistic, and is predicated on recovering export markets, increased capacity from recent infrastructure investments, and—owing to the introduction of a fiscal rule and debt forgiveness—improved business confidence.

Fiscal policy needs to balance the twin objectives of preserving competitiveness and remaining sustainable, the consultation went on.

The IMF statement continued:

"This calls for low tax, wage, and social contribution rates relative to competitors to attract business; yet, wages, pensions, and safety nets need to remain competitive with the Netherlands to attract and retain skilled labor. At the same time, public finances need to make room for commitments arising from entitlement policies.

"Transforming the large current budget deficits to balance will require measures on both the revenue and expenditure side.

"On revenue, measures could include broadening the tax base, continued improvements in collection, and hard budget constraints on public enterprises.

"In this regard, the proposed reforms of tax policy and administration and plans to adjust tariffs automatically and improve oversight of public enterprise finances are steps in the right direction. On expenditures, there will be a continued need for social transfers to mitigate the impact of high prices on vulnerable sections of society, and, absent reforms, transfers for entitlements.

"Therefore, fiscal adjustment would need to rely on rationalizing the civil service and processes in the new political structure and limiting wage increases to productivity growth.

The IMF said the introduction of a balanced budget rule and fiscal supervision starting 2009 is welcome, but implementation will be key. The report added:

"Although balanced budget requirements were not observed in the past, the prospects of successful implementation have improved due to the merger of different layers of government, the participation of the Kingdom of the Netherlands in the supervisory body, and a reduced expectation of future bailouts post-dissolution. Nevertheless, it will be important to ensure proper accountability and insulate the supervisory body from political pressure.

"Debt relief and its implications for liquidity will have to be managed judiciously to avoid hurting financial sector balance sheets. If debt relief takes the form of large buybacks of government securities, the economy could be flooded with liquidity beyond its capacity to absorb, just as new investment opportunities (government securities) diminish due to the fiscal rule.

"The options for monetary tightening are limited, given already-high reserve requirement ratios. Conventional sterilization would be cost-prohibitive, hurting the BNA's balance sheet, and therefore the budget.

"It would also imply a transfer of liabilities from the government to the BNA, defeating the purpose of debt relief. Forcing institutional investors with large holdings of government securities to invest these amounts locally—given the scarcity of alternate domestic assets—would drive down domestic interest rates, and endanger balance sheets (again, with eventual fiscal consequences).

"Alternative domestic assets for investment will take time to develop, and may not be of the size and risk-return profile ideal for institutional investors. Banks could invest these sums abroad, but may instead seek higher rates of return by on-lending these funds domestically.

"This could translate into pressure on bank balance sheets as banks undertake more risky lending, and further increase asset prices. Unduly rapid domestic credit expansion could—in the extreme—also fuel an import boom that could undermine the BNA's exchange rate target.

"The financial sector is broadly healthy, but institutions and supervisors face a more difficult environment in the period ahead. Financial institutions' profit margins are under pressure from both intensified competition and—as a side-effect of debt relief—lower income from high-yielding government securities. Since banks may face incentives for greater risk-taking to maintain profitability, the BNA will need to be especially vigilant to guard against a deterioration in lending standards.

"In this environment, speedy parliamentary consideration of draft laws to upgrade the legal framework for financial sector supervision would be welcome.

"Structural reforms will be the most important tool to improve competitiveness, preserve investor confidence, and sustain higher living standards. The draft tripartite protocol and the SEI contain useful proposals, that depend on implementation as a package to yield the desired results.

"Tax policy changes will need to balance the impact on budget revenue versus competitiveness. The preliminary tax reform proposals appropriately aim for a revenue-neutral rebalancing of the tax burden, with lower income and corporate tax rates—which would improve competitiveness—and higher indirect tax rates.

"Personal income and corporate tax rates are high by regional standards, with the tax burden borne disproportionately by the largest firms and workers, deterring foreign investors and skilled labor.

"The impact on the poor could be mitigated by carefully targeted income subsidies, within the constraints of a fiscal rule.

"A simplification of the tax regime through the elimination of exemptions and streamlining of rates would improve collection and level the playing field. In addition, the tax authority should persevere with its efforts to negotiate double taxation agreements, which are important for the competitiveness of the international financial sector.

"The draft tripartite protocol to improve productivity and living standards is encouraging, but implementation will be key.

"The strategy emphasizes 'flexicurity' to help individuals protect themselves as 'lifetime' employment diminishes, and puts the onus on all parties to contribute collectively to improving productivity in a way that would create jobs, upgrade skills and improve living standards.

"For example, dismissal and work permit regulations act as taxes on hiring, and their relaxation would allow businesses to hire productive workers, create jobs and invest in upgrading skills and productivity, thus improving living standards over time.

"While the planned increase in minimum wages will affect competitiveness in the tourism sector, this could be mitigated by some of the measures envisaged in the draft reform package.

"While improvements have been made in compilation, there is scope for further shortening the lag in producing statistics and improving dissemination.

"Long-standing plans to improve dissemination are now underway, but the production of additional core statistical indicators remains stalled for want of funding, a situation that should be rectified."

The IMF then went on to conclude:

"The pending decision on how to produce statistics for St. Maarten after dissolution should take into account the large overhead costs and time required to form a separate statistics agency. Earlier dissemination of preliminary financial sector data would be helpful.

"In this context, BNA plans to automate and accelerate the frequency of reporting by institutional investors are welcome."

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