June 7, 2022
Curaçao is recovering from the pandemic but faces multiple challenges, including strong inflation pressures stemming from the war in Ukraine. Policies need to be calibrated to support the inclusive recovery while achieving sustainability. Implementing the structural agenda embodied in the country package (landspakket) would be key for addressing many of long-standing structural challenges. Prioritization in line with capacity will be key for achieving the objectives.
Curaçao
Context and recent developments
Curaçao is recovering from the pandemic while facing inflation pressures fueled by the war in Ukraine. Following a protracted recession, positive growth is estimated to have returned at 4 percent in 2021, supported by a strong recovery in stayover tourism in the last quarter of 2021. Relatively high vaccination rates helped to soften the economic consequences from the wave of Covid-19 in early 2022. Stayover arrivals in April exceeded pre-pandemic levels, suggesting no long-term scarring from the pandemic or the war in Ukraine. Formal private sector employment declined in 2021, in part driven by supply-side factors and emigration, although there was some nascent positive dynamics in the second half of the year. Inflation increased to 3.8 percent in 2021 and likely accelerated further in 2022.
Outlook and risks
Growth is likely to strengthen this year, although the outlook is clouded by the war in Ukraine. Continued recovery in the hospitality sector in conjunction with higher private investment and favorable employment dynamics this year would support growth of about 6.5 percent. Higher import prices, in particular in fuel and food categories, are projected to push inflation to 6.8 percent in 2022, significantly higher than expected. This could disproportionally affect the vulnerable groups not covered by the existing social safety net and create a drag on the recovery as it erodes disposable income and increases costs of doing business. The outlook is subject to significant uncertainty and risks. A protracted war in Ukraine could keep energy and food prices elevated for an extended period, slowing growth and eroding purchasing power. Further supply chain disruptions and commodity price shocks could delay the recovery in investment.
Policies included in the draft 2022 Budget Amendment imply strong fiscal consolidation in 2022-23. Tight wage policies, in combination with stronger-than-expected inflation, will lead to significant reduction in labor compensation in real terms and support an adjustment of the overall fiscal deficit from 6 percent in 2021 to 0.9 percent in 2023. This adjustment, in combination with the recovery, would contribute to a reduction of public debt from about 90 percent of GDP in 2021 to about 76 percent of GDP next year.
Calibrating fiscal policy to foster recovery while achieving sustainability
Fiscal policies need better calibration to improve the quality of consolidation and avoid negative effects on growth. Budgeting adequate resources for structural reform implementation, protection of the vulnerable, and other critical areas will be key for improving quality of adjustment. Raising public investment from the currently low levels would increase employment, incentivize private investment, and support broad-based economic recovery and potential growth. A somewhat more gradual fiscal adjustment would be growth-friendly while still consistent with sustainability.
The authorities’ strong efforts to improve revenue administration have brought tangible results and need to be continued. Expanding tax administration’s resources and improving its business practices contributed to a significant pickup in revenue. Proceeding with the planned reorganization of the three revenue departments will further improve the capacity of tax administration. The authorities should subsequently consider introducing a fully-fledged VAT in place of the sales tax which would reduce distortions.
The inflation pressures stemming from the war in Ukraine warrant targeted support. Recently implemented reductions in fuel taxes require clear sunset clauses, while enhancing the social safety net to better target and more effectively protect the vulnerable. In view of higher food prices, the authorities could consider the continuation of the food program that was in place during the pandemic or other well-targeted measures.
Structural reform to modernize Curaçao’s civil service would work better than the current attrition and wage freeze policies. The 3-to-1 attrition policy was useful to reduce the overall government wage bill, but it has significant drawbacks as it is counterproductive in critical areas and reversible in non-critical areas. Both level and skill composition of government employment needs to be consistent with the effective delivery of public services. Implementing functional reviews under the landspakket would help achieve that objective. A benchmark study of employment benefits in the public sector entities, already envisaged under the landspakket, is needed to calibrate compensation to retain the required talent and incentivize performance.
Reforms of the health care and social security systems are needed to alleviate pressure on public finances and reduce fiscal risks. The cost of healthcare has been steadily rising in recent years, exerting pressure on the social security fund (SVB) and requiring higher budget transfers. Given the complexity of the health reform, prompt design and stakeholder consultations are the immediate priority. It will be important to provide the health sector with adequate resources to ensure health care continuity, especially in view of the inflation shock.
Strengthening medium-term fiscal framework
Incorporating a medium-term perspective into the fiscal framework would be key for securing fiscal sustainability. The authorities could consider moving towards a fiscal responsibility framework guided by a medium-term fiscal anchor and supported by operational rules for overall or primary fiscal deficits. In view of Curaçao’s high vulnerability to shocks, the debt objective should minimize the risk of debt distress. The fiscal responsibility framework would need support from an across-the-board strengthening of public financial management.
A significant improvement of public investment strategy institutions and management is needed. The investment framework requires a clear planning and decision-making process, adequate project appraisal, and monitoring and assessment schemes. Climate risk assessment and adaptation measures would be an important part of a well-designed framework.
Finding a new growth model and improving data
Curaçao is transitioning toward a more tourism-based economy. With a strong pipeline of new hotels, the hospitality sector is well-positioned to become the leading engine of growth. In addition, the authorities could explore options for developing other sectors, especially in the field of green energy production. This requires a substantial investment by both public and private sectors, which, in turn, needs better business climate and an improvement in the functioning of the labor market. Planned initiatives in the energy sector (e.g., establishing LNG plant) are promising, but require careful analysis. Deploying a guaranteed lending facility for viable SMEs in Curaçao would support the recovery.
It is necessary to provide adequate resources for data and information frameworks to enable taking more informed decisions. Current data gaps hamper effective macroeconomic analysis and policymaking. Improving data availability and timeliness requires adequate resources for the CBS and other data-related entities. Increasing information sharing across the public sector would improve policy effectiveness.
The Monetary Union of Curaçao and St. Maarten
Context and recent developments
The current account deficit (CAD) of the union eased to an estimated 24.1 percent of GDP in 2021. Despite the double-digit CADs, the stock of international reserves increased from US$1.3 in 2019 to US$1.8 billion, supported by significant financing from the Netherlands and financial account net inflows. The Central Bank of Curaçao and Sint Maarten (CBCS) has appropriately lifted Covid-19-related restrictions on foreign exchange transfers in January 2022.
Strengthening external and financial sector resilience.
Monetary policy continues to support the peg to the US dollar. It is important to continue to strengthen the transmission mechanism of monetary policy. The CBCS should continue to stand ready to absorb the excess liquidity if necessary. The planned review of the 60/40 investment rule should include a comprehensive review of the effects on the economy, including efficiency, pro-cyclicality, and the stability of international reserves, and a risk assessment at the level of institutional investors.
The financial system weathered the pandemic well, although financial vulnerabilities and risks remain elevated. The banking sector remains well-capitalized and liquid, but the longer-term effects of the pandemic on the asset quality are yet to be determined. Low profitability of the banking sector is a concern as it limits banks’ ability to build up buffers. Despite significant excess liquidity, credit growth remains close to zero given the uncertain macro environment, perceived lending risks and structural impediments such as weak information frameworks. Continued careful monitoring of banking system access to a sufficient number of correspondent banks will remain important for the healthy functioning of the system.
The CBCS has made significant progress in advancing its financial reform agenda. It invested significant efforts into transitioning to risk-based supervision, including in the AML/CFT area, improved its enforcement policy, increased its capacity to monitor liquidity, and carried out asset quality reviews in four financial institutions. The publication of the first Financial Stability Report is a substantial step forward. In cooperation with the government, the CBCS should promptly finalize the supervisory enforcement legislation.
It would be important to continue strengthening the AML/CFT framework. The National Risk Assessment (NRA) for Curaçao should analyze cross-border financial flows, including links to international financial centers and needs to be finalized and published soon. Sint Maarten needs to ensure appropriate resources for the upcoming NRA including fully funding and staffing the Financial Intelligence Unit and related law enforcement agencies.
The IMF mission would like to thank the authorities for their cooperation and the candid and constructive discussions that took place during May 18-25.