June 28, 2024
Curaçao’s economy expanded strongly, continuing its pivot towards a tourism-led growth model. Efforts to safeguard recently created fiscal space are welcome, while healthcare and pension reforms are needed to mitigate medium-term fiscal risks. Sustaining the positive momentum and raising potential growth requires reforms and investments that increase value added from tourism, seize opportunities in renewable energy, strengthen formal labor markets, and improve the business climate. Financial stability risks have further diminished and external balances of the Monetary Union of Curaçao and Sint Maarten continue to improve.
Curaçao’s economy expanded by 4.2 percent in 2023, continuing its pivot towards a tourism-led growth model. Growth outperformed expectations, driven by a strong increase in stayover tourism and tourism-related construction activity. Private investment more than offset a mild fiscal contraction, and fiscal balances achieved the second overall surplus in a row. Average headline inflation declined sharply to 3.5 percent in 2023, from 7.4 percent in 2022, in line with international oil prices and declining inflation in the US, Curaçao’s main trading partner. Core inflation remained somewhat elevated, reflecting strong demand for tourism-related services. Unemployment declined to below pre-pandemic levels, albeit job creation was predominantly lower-skill and informal, and credit growth remained subdued, reflecting the structural shift to a tourism-based economy. The current account improved markedly on the back of lower oil prices and higher tourism receipts but remained elevated.
The authorities’ policy agenda is advancing, supported by the landspakket. The agreed wind-down of the insolvent life insurer ENNIA struck an appropriate balance between safeguarding financial and social stability but implies significant fiscal transfers over the longer term. Notable progress on the landspakket, a structural reform package agreed with the Netherlands, has been achieved regarding risk-based supervision of the financial sector, improving efficiency in tax administration, accelerating business permitting, and investing in digital infrastructure of schools. Efforts to regulate the gaming industry are starting to pay off, with record applications for new licenses under the reformed conditions. Reforms to make Curaçao’s highly expensive health care more affordable have been broadly identified.
Outlook and risks
Growth is projected to further accelerate in 2024 before gradually converging to 1.5 percent in the medium-term. Stayover tourism will continue to drive growth in 2024 due to new airlifts and further expansion in hotel capacity, also supported by fiscal expansion given a strong catch up in the public wage bill. Growth is expected to moderate to 1.5 percent over the medium-term, given saturation in tourism flows in light of the island’s carrying capacity, sustained population decline, and subpar investment and productivity growth – assuming no further reforms and diversification. Headline inflation is projected to decline mildly to 3.2 percent in 2024 and continue falling thereafter, before reaching 2.1 percent by 2027, in line with the moderation in international oil prices. Fiscal accounts are expected to generate additional space to settle a bullet loan in 2025 and then return to the zero net operational balance. The current account deficit would improve in the medium term but remain elevated.
Risks to the outlook are broadly balanced. External risks include an abrupt global slowdown which would negatively impact tourism arrivals and receipts, albeit a faster disinflation process and more resilient growth in trade partners could boost external demand. Upside domestic risks include a successful expansion in renewable energy, including progress on the floating wind park and hydrogen production, additional high-end accommodation capacity, and earlier-than-expected expansion in marinas. On the downside, delays in public investment would weigh on growth, while higher-than-expected core inflation fueled by tourist spending on services could dent competitiveness. Buffers include access to favorable refinancing conditions on the Dutch capital market, subject to compliance with the fiscal rule, which grants the island substantial fiscal space, notably for capital and emergency spending.
Safeguarding Fiscal Space and Managing Medium-Term Spending Pressures
Efforts to safeguard recently created fiscal space will help secure compliance with the fiscal rule. Overall surpluses in 2022 and 2023 helped reduce debt and granted access to favorable financing terms from the Netherlands. On the back of unwinding pandemic wage cuts and increasing investments in 2024, staff expects the central government overall balance to decline to close to zero, from a 1.3 percent of GDP surplus in 2023, implying a positive fiscal impulse of 2 percent of GDP. The authorities are planning to fully repay a bullet loan in 2025 drawing on both liquidity reserves and a small overall surplus, achieved through moderation in expenditures. The overall balance is expected to gradually widen to a deficit of 0.6 percent over the medium term due to an expansion in investments under the Road Maintenance Plan amid growing capacity to implement infrastructure projects. Public debt would continue to decline given favorable interest rate growth differentials, reaching 54 percent of GDP in 2029.
Continued improvements in revenue collection and streamlining expenditure are welcome. To improve capacity and attract staff, the 2024 budget foresees fully unwinding pandemic freezes which would raise the wage bill by 1 percent of GDP (still below pre-pandemic levels). Measures to overcome capacity constraints are welcome but need to be balanced against preserving fiscal space and avoiding procyclicality, and consideration could be given to a more gradual increase. Building on past success, administrative improvements by the tax authority could further boost revenue collection. This is particularly pertinent as personal income taxes dropped by 0.6 percent of GDP in 2023, reflecting real wage decline and composition shifts to lower-wage employment. The envisaged tax reform, including the possible introduction of a value added tax, could further enhance efficiency and equity and modernize the tax system, while weighing these efforts against a relatively high tax burden compared with peers. In line with the landspakket, centralizing and harmonizing the procurement of goods and services, and systematically scrutinizing transfers to state owned enterprises would further improve planning and financial management.
Healthcare and pension reforms are needed to lock in a sustainable expenditure path and mitigate medium-term fiscal risks. Growing health and old-age pension deficits, partly exacerbated by an aging population, pose risks to the sustainability of public finances.
Health. Curaçao’s health care expenses, around 13 percent of GDP, stand out relative to regional peers and surpass the OECD average. Recent initiatives to incentivize the use of generics and expand primary care and triage prior to hospital admission are commendable, and more needs to be done to put the system on a sustainable path. A wide set of reform options has already been identified by various stakeholders, with challenging implementation decisions ahead. Given per capita health expense significantly above peers, notably on curative care, staff sees important efficiency gains on the spending side. These include additional volume and price measures for pharmaceuticals, further expansion of primary care to contain hospital visits, streamlining of laboratory services, and improvements in preventive care and in the operations of the Curaçao Medical Center. Revenue side reform options would imply a deeper revamp of the health system and include a broadening of the contributor base, including working migrants and dependents, increasing co-payments, allowing for price differentiation for privately insured (as practiced with patients from neighboring islands), exploring options to charge for add-on services, with a possible secondary, private insurance market for these services, and expanding the potential in medical tourism.
Pensions. Shortfalls in the old-age pension system are expected to widen with the continued increase in the old-age dependency ratio. The authorities’ considerations on raising the pension age from 65 to 67 and linking future increases to life expectancy are welcome. Continued expansion in employment and broadening the contributor base would further help closing the gap.
Medium-term fiscal planning would help steer public debt towards the desired anchor while creating space for investment, including in climate adaptation. Operationalizing the recently adopted debt anchor of 50-55 percent of GDP with corresponding multi-year targets could improve the budgeting process, avoid volatile arrears build-up and redemption, and make space for priority investments, including in adaptation, over the longer term.Rising sea level would imply that parts of Curaçao’s coastline are permanently flooded whereas others are exposed to storm surges.Staff estimates that the cost of sea level rise can be equal to 3.3 percent of GDP annually without adaptation, while effective coastline protection is feasible in Curaçao at an estimated 0.6 percent GDP annually.
Reinvigorating Potential Towards a Diversified Tourism Economy
Curaçao has only recently exited a decade of negative growth, recovering from deep structural changes. The decline of the country’s offshore financial sector and closure of the oil refinery led to negative potential growth for a sustained period, arrested only by the recent boom in tourism. Sustaining the positive momentum and raising potential growth requires reforms across four pillars: increasing value added from tourism, seizing opportunities in renewable energy, strengthening formal labor markets, and improving the business climate.
Investing in infrastructure would help boost value added from tourism. To mitigate future constraints from the island’s carrying capacity, efforts should be directed towards moving up the value chain via high-end resorts and complementary recreational attractions that would increase daily spending of both overnight guests and cruise tourists, an example being three new marinas constructed to boost yachting, guided by the National Export Strategy. Improving tourist experiences would require investments in infrastructure to allow for timely ground transportation and adjustments to regulatory frameworks to absorb the influx in tourists, including the heavily regulated transportation sector.
Seizing opportunities from renewable energy would lift growth while reducing the island’s carbon footprint. Curaçao has one of the highest electricity prices in the region and uses imported fuel to generate a significant share of its energy. A successful energy transition has the potential to lower both electricity prices and current account deficits. Renewable electricity generation has expanded since 2000, and an additional wind farm, operational by the end of 2024, would lift the share of renewable electricity generation to 50 percent. A planned solar park and upgrades to older wind parks would further increase the share to 70 percent by 2027. To reach the goals of the National Energy Policy, more investment in grid and storage is needed as well as revised pricing to better incentivize decentralized solar production. The envisaged floating offshore wind park of 5-10GW for hydrogen production would be a game changer.
Boosting public investment to achieve the above growth pillars requires ramping up capacity in public investment management. Capacity in planning and execution must be addressed to administer the needed increase in public investment. A centralized investment planning unit to lead in the appraisal of projects would be essential to create a pipeline of projects across sectors and build absorption capacity. Such a pipeline would also enable crowding-in private capital, given ample domestic liquidity.
Strengthening formal labor markets and skills would help offset population decline. Labor market policies should be targeted towards mobilizing the underemployed and attracting graduates back to the island, and consideration could be given to integrating migrants into the formal labor market. With deteriorating skill sets, as older cohorts are more educated than younger cohorts, investments in education are needed to lift the overall skill level and reduce skill mismatches in the labor market. Progress on related reform targets by the landspakket on combating the informal sector, improving educational quality, and better linking the education system to the labor force could be accelerated.
Improving the business climate could unleash productivity growth. Total factor productivity declined at 1 percent per year between 2010 and 2019. Productivity enhancing measures are essential to achieving sustainable growth and diversification, well-specified in the landspakket. Building on recent successful reforms to expedite business permits and enhance digitalization, regulation can further be streamlined to reduce red tape and address sector bottlenecks to further enhance productivity.
Lowering corruption vulnerabilities and reputational risk and strengthening the AML/CFT regime are welcome. Increased cross-border financial flows, expansion of the gaming industry, as well as listing on the European Union’s list of non-cooperative jurisdictions for tax purposes pose significant ML/TF and related reputational risks. A swift approval of stricter gaming regulation, as suggested in the new gaming law currently debated in parliament, could help mitigate possible concerns about the sector. Staff welcomes the ongoing efforts to improve monitoring cross-border payments by the tax authority, CBCS, Financial Intelligence Unit, and the Gaming Control Board.
The Monetary Union of Curaçao and Sint Maarten
The external balance of the Union is expected to continue improving. The Union’s current account deficit narrowed to 15.4 percent of GDP in 2023 from 18.8 percent of GDP in 2022 due to a decline in international oil prices. Going forward, lower oil prices, stronger travel receipts, and an increase in renewables would support further contraction of the Union’s current account deficit towards 8.3 percent of GDP in the medium term. The deficit will continue to be financed by private investment inflows and decumulation of assets abroad. The stock of international reserves would remain broadly stable and adequate over the medium term, while adequacy measures would decline gradually. The recent FX transaction by the CBCS, which realized valuation gains by selling one third of its gold reserves and re-investing in 30-year US Treasury bonds, altered the composition of international reserves while preserving the overall level, including gold. Given still sizable deficits and a sustained real effective exchange rate appreciation, staff’s preliminary assessment suggests that the external position was weaker than implied by fundamentals in Curaçao.
The monetary policy stance is appropriate and continues to support the peg. In line with global monetary policy tightening, the CBCS increased its benchmark rate to 5.75 percent in September 2023 (from 1 percent in May 2022) and has kept it unchanged since then, while continuing to absorb excess liquidity with certificates of deposit. Recent declines in liquidity can be attributed to improved appetite for CDs and increased investments abroad. Even though credit growth declined further, including due to the one-off repatriation of a subsidiary’s loan book, and reached negative territory in real terms amidst monetary tightening, the transmission mechanism of monetary policy remains weak. Structural factors include the absence of interbank and government securities markets. The continued increase in mortgages, the only credit component to display growth, was accompanied by a broadly stable loan-to-value ratio. Further acceleration in mortgage credit could warrant introducing a macro prudential limit below the currently by banks self-imposed average ratio of 94 percent. While international reserves continue to serve as the main anchor for monetary policy, developments in core inflation, driven by tourism-related services, should be monitored closely.
The financial sector is sound and risks to financial stability have substantially diminished as the CBCS advances its reform agenda. Banks are highly liquid and adequately capitalized, and systemic risks to the financial sector are contained. Near-term risks to financial stability have substantially diminished with the agreement for a controlled wind-down of ENNIA and the start of the restructuring process, as well as the CBCS’s continued improvements in supervision, regulation, and governance. The CBCS’ financial reform agenda has advanced further, covering several pillars, including financial stability, crisis management, lender of last resort, and a deposit insurance scheme.
The IMF mission would like to thank the authorities for their cooperation and the candid and constructive discussions that took place during June 10-14.