WILLEMSTAD--St. Maarten and Cura�ao face an increasing current account deficit that has "widened to worrisome levels," the recently concluded International Monetary Fund (IMF) Article IV mission to the countries stated in its preliminary report delivered on Monday. Cura�ao is seen as "primarily responsible" for the increasing deficit.
If left unaddressed, this ultimately would increase the vulnerability of the joint currency ? the Netherlands Antilles guilder ? in the future, as international reserves are still "comfortable" now, IMF mission head Daniel Kandan said at a press conference in Cura�ao on Monday. "Strong measures" will be needed to facilitate external adjustment.
He was accompanied by Sebastian Weber and Longmei Zhang.
According to the findings, the current account deficit gap primarily reflects low competitiveness, rapid credit growth, and inadequate pass-through of increases in international food and oil prices to consumer prices. Credit growth should be reduced to help cool domestic demand pressures.
"Strong fiscal efforts are required to address pressures related to aging and institutional build-up, and to support external adjustment. Deep structural reforms are also needed to increase wage and price flexibility and competitiveness, and to improve the business environment," according to the report.
Fiscal tightening of some 2-3 per cent of the gross domestic product (GDP) is needed over the near to medium term to support the efforts to reduce the current account deficit.
"Given the relative size of Cura�ao and data suggesting that it is primarily responsible for the widening of the current account deficit, the bulk of the adjustment will need to come from Cura�ao," said the IMF report.
Significant tightening is already expected in Cura�ao for 2011, which is "a step in the right direction."
Scope for savings on expenditure on goods and services arising from the merger of the former Netherlands Antilles apparatus and that of the Cura�ao government appears "substantial, given pronounced under-utilisation of budgeted amounts for this category in the 2011 budget."
In St. Maarten, the IMF says the scope for reducing expenditures appears limited, given institutional gaps. However, tax reforms as well as compliance-increasing measures being developed probably will need to be moderately revenue-enhancing.
Outlook and risks
The IMF expects low growth to persist over 2011-2012. In St. Maarten, continued declines in stay-over tourism have offset the strong rebound in cruise tourism. In this context, it is expected that the GDP will be "broadly flat" in both countries in 2011, and grow by 0.75 per cent in Cura�ao and 0.5 per cent in St. Maarten in 2012.
Alongside this, unemployment rates are expected to stay elevated. Inflation is expected to stabilize around 2.75-3.5 per cent in both countries. The current account deficit is expected to improve somewhat, but remain substantial.
But some pickup is likely over the medium and long term if needed reforms are implemented promptly. Overall, the mission projects growth rising to about two per cent in both countries by 2016, still on the low side. Low exposure to the faster-growing Asian and Latin American countries will limit upside potential in both countries.
Aging will weigh on potential growth over the medium and long run. Space constraints may also limit the long term scope for increasing tourism, which would particularly affect St. Maarten.
"Against this background, Cura�ao and St. Maarten must seize the moment and implement policies to mitigate external vulnerabilities, entrench fiscal soundness, and advance structural reforms to enhance competitiveness and growth," according to the report.
In addition, the IMF said structural reforms to generate wage and price flexibility and improve the business environment will be needed to realize durable gains in competitiveness.
Relax limits on foreign investment
Ensuring that credit grows more slowly than nominal GDP will help curb the current account deficit, added the IMF. "Relaxing limits on foreign investment by domestic non-bank financial institutions would help contain credit growth and domestic demand."
Under current rules, domestic non-bank financial institutions can invest no more than 40-60 per cent of their assets abroad without penalty. This has "forced" pension funds and insurers to invest large portions of their portfolios in bank deposits. Recent global turmoil also has caused them to invest more in local instruments. In turn, ample deposits have "stimulated rapid credit growth, boosting domestic demand and contributing to the current account deficit."
Incentives for lending to the private sector have intensified with debt relief and the new fiscal rules, which have substantially reduced the scope for banks to invest in public debt.
The mission welcomes the Central Bank of Cura�ao and St. Maarten's plans to gradually relax the limits. The recent increase in reserve requirements is also a step in the right direction and the IMF recommends further measures by the Central Bank to help reduce credit growth, including higher reserve requirements and risk weights or tougher provisioning rules.
Budgets on track
The 2011 fiscal outturns in both countries are "on track" with the fiscal rules. St. Maarten, like Cura�ao, is "also on track" to achieve a balanced current budget outcome in 2011, according to the IMF.
Including capital expenditure, Cura�ao is expected to run a balanced overall budget, while in St. Maarten significant delays in major planned infrastructure spending will imply an overall deficit of 0.5 per cent of GDP, well below the 5.25 per cent of GDP deficit budgeted for 2011.
IMF said welcome efforts were anticipated in the 2012 budgets and beyond to ensure continued adherence to the fiscal rules.
For 2012, St. Maarten faces "significant spending pressures" related to institutional build-up, and substantial efforts are underway to streamline current spending to match current revenues. Plans are "well advanced" to set up a new national health insurance scheme with premiums and coverage adjusted to ensure sustainability ahead of the onset of spending pressures.
Public debt appears "sustainable" in both countries over the medium term, assuming continued adherence to the fiscal rules. Thanks to debt relief from the Dutch Government, debt-GDP ratios are "relatively low."
The IMF projections, assuming continued adherence to the fiscal rules, indicate that for Cura�ao, the debt ratio is on a slightly declining path over the medium term, while, for St. Maarten, debt rises temporarily in the near term on account of substantial public investment, but stabilises thereafter.
Also, the mission said comprehensive tax reforms that would help enhance competitiveness by reducing rates on labour and profits were being prepared in both countries. "Rebalancing from direct to indirect taxes would also support productive activity and moderate consumption, thus contributing to a reduction of the underlying current account deficit."
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