December 2, 2019

The monetary union of Curaçao and Sint Maarten (the Union) has been grappling with negative shocks and is facing significant challenges. Curaçao is in a protracted recession owing to significant spillovers from the Venezuela crisis, which has exposed long-standing structural rigidities and weaknesses in public finances. Sint Maarten’s recovery after the devastating 2017 hurricanes has been uneven, given small island constraints and structural impediments exacerbated by frequent bouts of political instability. Wide-ranging reforms are needed in both countries.

I. Recent Developments and Short-term Outlook

Cura çao

Curaçao is facing a fourth year of recession due to continued spillovers from the Venezuela crisis. Despite robust growth in tourism, real GDP declined by 2.2 percent in 2018 as the Isla refinery effectively shut down production in the first half of 2018, negatively affecting supporting sectors (although largely retaining its direct employment). The unemployment rate increased to 21.2 percent in early 2019 and GDP is expected to fall by 2 percent this year. Inflation increased to 2.7 percent in October 2019, in part due to switching to more expensive fuel suppliers and tax measures introduced in September.

Cura çao’s fiscal position improved in 2018 following expenditure containment measures, but still fell short of meeting the fiscal rule. Zero indexation and tighter transfers reduced the current fiscal deficit in 2018, but still triggered an Instruction from the Kingdom in 2019 as it fell short of the balanced current account rule. In 2019, the government also signed the Growth Accord with the Netherlands setting out revenue and expenditure measures, implemented short-term revenue measures and introduced a 3:1 attrition rule for central government employment. These measures and a one-off tax windfall from the tax sharing system with the Netherlands led to a fiscal current account surplus in the first 9 months of 2019.

The recession is projected to deepen in 2020 . Based on a cautious assumption that the refinery will close in end-2019 when the contract with PDVSA expires, GDP could contract by 4½ percent in 2020 despite a positive contribution from tourism. Inflation is projected to accelerate to 3.7 percent in 2020 driven by indirect tax measures.

Sint Maarten

Sint Maarten is gradually recovering from the devastating 2017 hurricanes. GDP fell by an estimated cumulative 16.9 percent in 2017−18 as tourism plummeted, although a construction surge financed by large private insurance payouts partially mitigated the shock. A recovery of tourism in 2019 is projected to support GDP growth of 5 percent, although the broad recovery is constrained by the gradual absorption of Trust Fund resources. Inflation is estimated to have increased to 2.9 percent in 2018, in part driven by higher oil prices, but declined to 0.6 percent in the first half of 2019 according to published data.

Due to the hurricanes, the overall fiscal deficit widened to 3¾ percent of GDP in 2018 but started to improve this year . Revenue has been recovering while spending remained contained, largely due to delays in capital spending. None of the budgeted capital projects, including the tax and public financial management (PFM) reforms, have been implemented so far due to the late budget approval and a delay in external project financing. Without liquidity support, the fiscal liquidity buffer is likely to decrease in Q4 due to scheduled payments, posing the risk of payment arrears. Staff estimates that government debt increased from 44½ to 53¾ percent of GDP between 2016 and 2018.

Real GDP is likely to grow by nearly 3 percent in 2020. The projections assume that the airport and hotel reconstruction will be completed by 2022, leading to a continued recovery in stayover tourism. Cruise tourism is however expected to decline in 2020 due to scheduled changes in cruise itineraries. Inflation is expected to ease to 1.3 percent in 2019, driven by low resource utilization and international prices and remain around 2 percent afterwards in line with U.S. inflation.

The Union

The external position of the Union worsened in 2018. The current account deficit (CAD) widened to 20.6 percent of the union GDP driven by stronger imports in Curaçao, in part due to a higher oil bill. In addition, the trade balance in Sint Maarten was affected by 2017 hurricanes as they reduced exports, particularly receipts from tourism and increased imports. Staff estimated that external debt reached 174 percent of union GDP in 2018. International reserves declined from 4.1 to 3.7 months of imports of goods and services between end-2018 and mid-October 2019. The pressure on reserves was cushioned in part by substantial drawdown of foreign assets of the private sector. The external position of both countries is assessed to be weaker than warranted by fundamentals and desired policy settings.

II. Pursuing Fiscal Reforms and Strengthening the Framework

The Growth Accord between Curaçao authorities and the Netherlands presents an opportunity to improve public finances. Staff’s baseline projections assume a rollout of the new general spending tax (ABB), continuation of wage policies, the implementation of an early retirement plan for civil servants and containment of other expenditure in 2020. Despite the measures, the overall fiscal deficit is projected to expand to 3.7 percent of GDP as the recession deepens.

Consistent implementation of good quality measures will be key for reaching medium-term sustainability in Curaçao. The authorities should consider broadening the ABB’s base to domestically produced goods in conjunction with a comprehensive tax offset mechanism, in line with advice from the recent IMF technical assistance mission. The early retirement program should be accompanied by a broader civil service reform that structurally reduces the number of positions to secure long-term savings. Moreover, Curaçao would benefit from implementation of PFM reforms, including strengthening of expenditure controls and better incorporation of fiscal risks. The authorities should compile timely information on balance sheets of all public sector entities and keep track of arrears and guarantees. An envisaged investment guarantee fund (Invest-Curaçao) involves significant risks and would require a cautious approach, including proper risk management and strong supervision capable of assessing the risks. Strong public communication of measures is critical for their social acceptance.

In Sint Maarten, the sustainability of public finances hinges on the implementation of several critical reforms. The authorities have prepared plans in many areas such as tax policy and tax administration, PFM and pension and health systems, but their implementation has been lagging, in part due to political differences and lack of financing. Suboptimal organizational structures and procedures and outdated IT systems pose fiscal and business continuity risks. The revenue and PFM reforms need to be implemented as a matter of priority and it is critical to secure financing for their implementation. These reforms would help with fiscal consolidation and support the authorities’ efforts to eliminate the endemic arrears to the domestic sector. Reforming the civil service pension system should improve its sustainability and generate budget savings. The current health system is financially unsustainable, and its envisaged reform is a step in the right direction, although it needs to be done in a way that prevents long-term fiscal risks.

Both countries would benefit from introducing long-term fiscal anchors and broader Fiscal Responsibility Frameworks. The government debt-to-GDP ratios could be used as long-term anchors supported by operational rules with targets for the primary balance and current expenditure. The debt target should be set at a relatively low level (for instance 40 percent of GDP), which would provide more fiscal space in the event of negative external shocks. Due to significant external risks, the framework should contain clearly articulated escape clauses defining the circumstances justifying deviations from targets while retaining sustainable policies. As meeting a long-term fiscal anchor would require primary surpluses, it might be compatible with the golden rule over a longer time horizon, although compensation for past deficits could take longer than envisaged in the current framework.

III. Pursuing a Supportive Monetary Policy and Strengthening the Financial Sector

Monetary policy needs to support the exchange rate peg. In the short term, the CBCS should develop the policy rate communicating the stance of monetary policy in line with recent IMF technical assistance and be prepared to increase interest rates to prevent capital outflows. Monetary policy instruments and operations need further development: the CBCS should widen operations with its certificates of deposit and introduce an overnight credit standing facility. The governments of Curaçao and Sint Maarten should consider operationalizing the Treasury Single Accounts in the CBCS. Over the longer term, the authorities should consider revising the current standing subscription framework to allow the development of domestic debt markets.

Financial system vulnerabilities need to be addressed. The protracted recession has increased financial system fragilities in Curaçao. Whereas the system-wide capital buffer is at its regulatory minimum, it varies across banks. The authorities should agree on a plan to address fragilities as a matter of priority and encourage higher provisions against non-performing loans. A comprehensive review of the bank resolution framework and strengthening of supervision are needed to improve governance in the financial sector. To improve transparency, the CBCS should prepare and publish a Financial Stability Report. The authorities should prioritize efforts to bolster stability of the financial system over seeking progress in the fintech area.

IV. Enhancing Potential Growth, Overcoming Small Island Constraints, and Strengthening Resilience to Natural Disasters

In both countries, broad structural reforms are needed to address long-standing structural impediments and increase potential growth. Reform priorities include improving the business environment (facilitating construction and other permits, business licenses and cutting red tape); increasing labor market flexibility while fine-tuning safety nets and addressing skills gaps; and boosting the implementation capacity of the public sector. Both countries should update their tourism master plans setting out a long-term vision for the sector. Sint Maarten should continue its rebuilding efforts with the “Build Back Better” principle and develop a comprehensive Disaster Resilience Strategy drawing on the expertise of international partners. Moreover, stronger economic integration in the Union, e.g. building common institutions such as financial sector infrastructure, would improve resource allocation and the functioning of the Union.

V. Strengthening Governance

Both countries need improvements in governance frameworks.The recent passage of AML/CFT legislation in Sint Maarten is an important step in the right direction. In both countries, effective implementation of the AML/CFT framework will be key for reducing risks. Both countries need to provide adequate resources to the relevant AML/CFT entities and increase public awareness of the issues, e.g. through a national forum. The national risks assessments in both countries will be instrumental for detecting gaps. To reduce opportunities for corruption, both countries need to strengthen institutions and ensure strong implementation of existing laws and procedures. The authorities should make efforts to operationalize the Integrity Chambers.

VI. Medium-Term Outlook and Risks

Curaçao’s medium-term outlook is challenging. Marginal growth would stabilize at suboptimal ½ percent in the medium term, reflecting weak productivity growth. Despite the fiscal measures assumed in the baseline projections, current fiscal deficits may persist through 2024, implying a sizeable financing gap over the projection period in the absence of financing. Government debt would increase to 62.1 percent of GDP in 2021 and decline only gradually to 61.1 percent of GDP by 2024. Debt sustainability could be subject to risks stemming from contingent liabilities.

In Sint Maarten, fiscal deficits are likely to persist despite the continued economic recovery. GDP is likely to converge to around 2 percent over the medium term, supported by a gradual improvement in aid absorption. Better tax administration and revenue growth reflecting the post-hurricane recovery would help increase tax revenue from 18⅔ percent of GDP in 2018 to 20⅔ percent of GDP in 2024. However, given the slow pace of reforms, the current fiscal deficits in Sint Maarten are likely to persist through 2023. Government debt would increase to 60⅓ percent of GDP by 2024 in part due to the airport reconstruction loan from the European Investment Bank.

The Union’s external position would remain weak. The Union’s CAD is projected to decline from 20.6 percent of GDP in 2018 to 11.2 percent of GDP by 2024. The external debt of the Union is projected to increase to slightly above 190 percent of GDP in the medium term, although the risks are mitigated by substantial foreign assets.

There are risks to the projected growth outlook both in Curaçao and Sint Maarten. In Curaçao, finding a new operator for the refinery would improve the short-term outlook significantly. On the downside, a closure of the refinery and the planned fiscal adjustment measures could deepen the recession more than projected. Delays in putting together a consistent and credible framework supported by broad-based fiscal and structural measures could exert pressure on the exchange rate. In Sint Maarten, political instability and small island capacity constraints could delay reconstruction of the airport, constrain absorption of the TF resources, and stall critical reforms, which would delay the recovery and undermine the sustainability of public finances. Sint Maarten also remains vulnerable to natural disasters. On the other hand, tourism recovery and growth effects from airport reconstruction could be stronger than expected. Weaker growth in the U.S. and the EU could reduce tourism and growth in both economies.

As an illustration, staff developed alternative scenarios in which both countries reach the debt target of 40 percent of GDP in 10 years in order to bolster debt sustainability. In Sint Maarten, this objective—in conjunction with building a fiscal buffer—would require achieving a primary surplus excluding grants of about 0.9 of GDP by 2024, requiring an ambitious additional fiscal consolidation of 2.1 percent of GDP relative to the baseline projections. In Curaçao, this objective would need a primary surplus of slightly over 2 percent of GDP by 2024, requiring additional fiscal adjustment of around 2¼ percent of GDP, although stronger growth or a longer timeframe would reduce the needed fiscal adjustment. A gradual adjustment approach would be preferable, although it depends on availability of financing. To avoid increasing the tax burden further, additional fiscal measures should be focused on expenditure.

VII. Capacity Building and Improving the Data Framework

Significant capacity building supported by adequate resources is needed to enable the reforms. In both countries, capacity limitations constrain policy implementation and lead to data gaps that hamper effective macroeconomic analysis and surveillance. Better planning, addressing the weaknesses in IT systems, tax administration, and PFM would improve policy implementation and contribute to stronger growth. Given capacity limitations, both countries need to set priorities and realistic timelines supported by accountability for implementation. In Sint Maarten, building macro-fiscal capacity would aid budget preparation and overall policy making. The recently acquired membership in CARTAC by Sint Maarten presents an opportunity to support the authorities’ capacity building efforts. In both countries, major improvements in statistics are needed to inform policymaking. The authorities should address the shortages of human and financing resources limiting data collection coverage and timeliness, particularly for the National Accounts in both Curaçao and Sint Maarten.

The mission expresses gratitude to all Curaçao and Sint Maarten authorities and all counterparts for their warm hospitality, cooperation and candor.