WASHINGTON, USA — The executive board of the International Monetary Fund (IMF) has concluded the Article IV consultation with Aruba and considered and endorsed the staff appraisal without a meeting on a lapse-of-time basis.
Aruba is a highly open economy with a long history of macroeconomic stability. Over eighty percent of the economy depends directly or indirectly on tourism making Aruba the second highest tourism-dependent country in the world. The long-standing fixed exchange rate against the US Dollar, supported by conservative fiscal, credit and prudential policies, has provided macroeconomic stability by maintaining low inflation over the years and keeping imbalances checked until recent shocks.
The economy faced two major shocks in the last four years: the global financial crisis, which hit Aruba’s tourism sector in 2009, and the shutdown of Valero oil refinery for a total of 27 months during 2009-12 reflecting poor profitability. Although tourism rebounded quickly partly thanks to aggressive market diversification efforts, real GDP took a second dip in 2012 by close to 1.25 percent after increasing by 3.75 percent in 2011. Output remains 12 percent below its pre-crisis level, with recovery slower than others in the Caribbean region.
The external sector has held up well through these shocks. The non-oil current account (CA) balance, which mostly reflects developments in the tourism sector, has improved since mid-2000 reaching a balanced position in 2012. The overall CA balance, however, after being in surplus for years, showed volatilities in recent years reflecting oil sector developments. In 2012, it recorded a surplus of 5 percent of GDP.
The fiscal position worsened significantly in recent years. Preliminary data suggests that the overall fiscal balance recorded a deficit of 8.5 percent in 2012. Notwithstanding measures taken in the pension and health sectors and efforts to collect tax arrears, the deficit widened sharply from pre-crisis years due to the tax rate cut and increased current expenditure. Fiscal consolidation is appropriately planned to start this year.
In 2013, real output is projected to grow by 1.25 percent. Robust tourism growth and some pick-up in consumption from projected deflation will support the subdued near-term recovery. A two percent deflation is projected in 2013 reflecting large utility price reductions in late 2012, and declining food and energy prices. The CA balance is projected to record a deficit of 9.5 percent of GDP in 2013 due to the loss of oil exports.
Executive Board Assessment
In concluding the 2013 Article IV consultation with Aruba, executive directors endorsed the staff’s appraisal, which made the following observations:
Aruba is recovering slowly from recent shocks. Two major shocks in the last four years, the global financial crisis and the shutdown of oil refining by Valero, have caused a recession that is deeper than in most other Caribbean countries. Although tourism, the mainstay of Aruban economy, rebounded quickly, Valero’s shutdown has left harder-to-fill gaps in investment and non-tourism exports, with real GDP projected to reach its pre-crisis level only in 2018.
Downside risks dominate in the near-term, but medium-term prospects could be brighter. With a high dependence on tourism and oil imports, Aruba faces downside risks from renewed weaknesses in the global economy and higher oil prices. In the medium-term, there are upsides from resumption of oil refining by Valero, and large scale investment in renewable energy.
Putting the fiscal deficit on a downward path is an immediate policy priority. The authorities’ efforts to counter the recession through cuts in the business turnover tax rate and higher current expenditure have rapidly increased central government’s deficit and debt. In the absence of exchange rate policy options, rebuilding fiscal space is urgent. A reduction of the overall deficit to 6 percent of GDP in 2013 is appropriate. To ensure this outcome, directors recommend resisting possible expenditure pressures during the election year.
In the medium term, ambitious fiscal consolidation is needed. Without additional measures, the central government’s fiscal deficit is projected to remain elevated posing risks to public debt sustainability. Financial deficits of the old age pension system (AOV) and payments for investment projects under the Public Private Partnerships (PPP) are likely to further widen the deficit beginning as early as 2014. A consolidation of around 8 percent of GDP during 2014-18 is appropriate, which would bring debt down to below 60 percent of GDP. To contain fiscal pressures from financial liabilities of the AOV and the PPP, it is important to implement further pension reforms and put a limit on the size of the PPP-related expenditure commitments.
External competitiveness needs to be strengthened to ensure a steady recovery. Aruba has managed to maintain its competitiveness in tourism through recent shocks partly due to authorities’ strong initiatives to diversify source markets. With the US accounting for 60 percent of tourists, directors see further scope for market diversification. To ward off risks from a large negative net international investment position, and elevated financing requirements, Aruba would also need to strengthen its price and structural competitiveness through higher flexibility in the labor market and more enabling business conditions.
The accommodative monetary policy stance is appropriate. With slack in the economy, projected deflation and subdued credit growth, directors see no need for monetary tightening. The banking system’s excess liquidity has increased substantially since mid-2012. In case credit demand picks up, a very low risk at this point, the authorities would need to mop up the excess liquidity by increasing the reserve requirement.