WASHINGTON, USA – On end of lapse-of-time date, July 24, 2023, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV discussions with the Kingdom of the Netherlands – Aruba.
Economic activity rebounded strongly. Real GDP grew by 27.6 percent in 2021 and further expanded by 7.3 percent in 2022, reinforced by the recovery of tourist arrivals following the lifting of the restrictions introduced during the pandemic. Inflation has moderated and was 4.9 percent in April, driven by imported energy and food prices and the increases of electricity and water tariffs in August 2022.
The unemployment rate decreased to 6.6 percent by June 2022 and appears to have fallen further in subsequent months. The banking sector remains well-capitalized, liquid, and profitable. Banks have been lending at a slow pace in 2022 which picked up in early 2023. The strong tourism recovery contributed to further improving the external and fiscal positions. Public debt has declined.
The economy is expected to grow at a moderate pace in 2023 as the post-pandemic rebound in tourist arrivals wanes. Inflation is projected to decelerate with slowing domestic demand and lower international commodity prices. The overall fiscal balance is expected to display a surplus in 2023 and over the medium term, reducing the central government debt to 71 percent of GDP by 2028. The current account surplus is projected to narrow over the medium term as tourism growth moderates, averaging 8.1 percent of GDP. Foreign reserves are expected to remain adequate at around 7.9 months of total imports by 2028.
Risks to the outlook are tilted to the downside. A steeper-than-expected global slowdown, especially in the US, could reduce tourist arrivals. Climate change is an ever-present risk through both rising sea levels and more volatile weather events. Domestically, risks to the outlook are largely related to the potential of insufficient fiscal adjustment (which would raise financing needs and slow the pace of debt reduction).
Executive board assessment
The Aruban economy recovered strongly from the pandemic. This reflects a quick return of tourists following the lifting of restrictions introduced during the pandemic. High global energy and food prices have boosted inflation, but these effects are now reversing. In 2023, the economy is expected to expand at a moderate rate and inflation should decelerate. Risks to the outlook are tilted to the downside. The external position is assessed to be substantially stronger than the level implied by fundamentals and desirable policies. Substantial revisions to 2018-19 GDP point to potential measurement problems in the National Accounts data and represent an important capacity development need.
The planned tightening of fiscal policy in 2023 is appropriate, considering the strength of the recovery. The plan to keep nominal current expenditure at last year’s level while introducing several tax measures to increase revenues will help improve the country’s fiscal position. The authorities are encouraged to quickly introduce their remaining agenda for tax reform to ensure the 2023 fiscal target can be comfortably met. A contingency plan should be developed, to be activated if revenue inflows begin to fall below those levels assumed in the budget.
Fiscal surpluses will be needed over the medium term. A broad-based value-added tax should be introduced to replace the current indirect tax system and there is scope to improve tax compliance. Containing the wage bill, reprioritizing spending on goods and services, and streamlining transfers and subsidies would all create fiscal space to improve the social safety net and increase capital spending. The planned public expenditure review, undertaken by the World Bank, should help inform these efforts.
Long-term fiscal risks related to the pension system need to be tackled. Increasing the contribution rate and/or reducing the replacement rate would help bolster the solvency of the system.
Strengthening the medium-term fiscal policy framework would anchor the path for debt reduction. A well-designed medium-term budget framework – guided by a debt anchor and pre-determined escape clauses for unexpected events – would support fiscal discipline and sustainability. It would also allow the authorities to communicate their medium-term plans more effectively. A sound debt management strategy would help mitigate macro-financial risks.
The Central Bank of Aruba (CBA) is encouraged to reduce the reserve requirement rate over time. With declining inflation and foreign reserves at adequate levels, there is scope to lower reserve requirements over time to avoid disincentivizing a deepening of financial intermediation.
The CBA needs to remain vigilant to vulnerabilities in the financial system. Close monitoring of underwriting standards of real estate lending is warranted. Formally introducing a cap on the loan-to-value and debt service-to-income ratio for borrowers, and further developing a comprehensive macroprudential policy framework would help identify and manage risks. These efforts should be supported by better, more granular, timely data, including on non-bank financial institutions. A more structured approach to liquidity and solvency stress testing, that is firmly tied to a range of underlying macroeconomic scenarios, would be valuable. Aruba should move quickly to adopt Basel II international standards.
There is scope to improve the Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) and international tax transparency frameworks. This would involve strengthening technical compliance and the effectiveness of the AML/CFT framework and resolving issues related to the implementation of the Organization for Economic Cooperation and Development (OECD) standards on the exchange of tax information.
Supply-side reforms are needed to raise potential growth. Policies to increase the value added of tourism will be critical to support medium-term growth. Reforms that remove obstacles to doing business, promote greater labor market flexibility, boost productivity, and lessen gender gaps in the labor market will all be important.
The authorities are encouraged to bring governance framework in line with the United Nations Convention Against Corruption. This should include improving the capacity of the Integrity Bureau, establishing codes of conduct for public servants, and requiring detailed asset declarations from senior public servants.
Increasing resilience to climate change is a priority. A concrete action plan for adaptation would help prioritize infrastructure investments that improve the physical resilience of low-lying areas. These investments should be incorporated into the overall medium-term fiscal framework. Progress should be accelerated in costing climate change adaptation needs and developing a national climate resilience strategy.