Central Bank: widening current account deficit is worrisome

POSTED: 01/3/12 4:04 PM

St. Maarten – The Central Bank published an extensive report about the economic developments in the year that is just behind us, and about the perspective for 2012. This article contains the report’s integral text.

According to the latest estimates of the Central Bank, the Curaçao economy contracted by 0.6% in 2011, down from a marginal growth of 0.1% in 2010. The economic contraction stemmed primarily from public spending. The latter is the result of a decline in public consumption outweighing the growth in public investments. The marked growth in public investment was related to the implementation of delayed SEI projects. Private spending, in contrast, expanded due to increased private consumption, but at a much slower pace than in 2010. Private investment posted zero growth in 2011 as no major investment projects were reported. The economic contraction was moderated by improved net foreign demand and the replenishing of inventories, in particular by the free-zone companies. The growth in net foreign demand was the result of the revival in exports of goods and services, which exceeded the rise in imports. The economic contraction was accompanied by a projected inflation rate of 2.3%, a deceleration compared to the 2.8% that was registered in 2010. The lower inflation was caused by, among other things, a reduction in domestic electricity prices.

An analysis by sector shows that the manufacturing, restaurants & hotels, wholesale & retail trade, and transport, storage & communication sectors performed well during 2011. Output expanded in the manufacturing sector as a result of an increase in real value added by the Isla refinery. After a prolonged shutdown of the refinery that began in March 2010, the refinery was in operation again in 2011.

The growth in the restaurants & hotels sector is attributable to a significant growth in stay-over

tourism. In particular, the number of visitors from the North and South American markets grew

considerably in 2011. Cruise tourism also expanded during 2011. The growth in stay-over tourism combined with higher consumer spending resulted in more activities in the wholesale and retail trade sector.

The analysis is based on sectoral data for the January – June period of 2011.

 

Activities in the transport, storage & communication sector increased due to gains in the air transportation and airport-related activities. Meanwhile, the harbor posted some mixed results. The number of ships piloted into the port rose, while cargo movements dropped. Value added growth in the financial services sector remained modest as activities slowed down in both the domestic banking and the international financial services sectors. In contrast, activities in the construction sector contracted because of fewer non-residential projects in 2011 compared to 2010.

Curaçao outlook for 2012

The projected global economic slowdown and recession in Europe will affect also the Curaçao economy in 2012. Weaker foreign demand will affect the activities in the tourism, transportation, and wholesale & retail trade sectors. In addition, the ongoing uncertainty and volatility in the international financial markets will have repercussions for the international financial and business services sector.

Against this background, real GDP is projected to contract by 0.5% in 2012. Both domestic and net foreign demand will weaken in 2012. The worsening in net foreign demand is caused by a decline in export of goods and services, moderated by a drop in imports. Moreover, private spending will be dampened by a decline in purchasing power, owing to the net effect of the tax reforms. Meanwhile, government spending will weaken because of fewer investment activities in 2012.

The inflation rate will accelerate to 3.8% in 2012 due mainly to the increase in the sales tax. The inflationary pressures will, however, be mitigated by the sales tax exemption on some fruits and vegetables and the expected weakening of international oil and food prices in 2012.

General economic developments in St. Maarten for 2011

According to the latest estimates of the Bank, the economy of Sint Maarten contracted by 1.5% in 2011. The economic contraction was accompanied by a higher inflation rate of 4.0% due mainly to the increase in the turnover tax. The latter impacted the purchasing power of consumers negatively.

An analysis by sector shows that activities in the restaurants & hotels sector declined owing to a decline in stay-over tourism. The contraction in stay-over tourism was related to a decline in time share capacity and airlift during 2011. Consequently, the number of stay-over visitors from North America and Europe declined, moderated partly by more visitors from South & Central America and the Caribbean. In contrast, cruise tourism recorded a marked growth.

The transport, storage & communication sector in Sint Maarten showed some mixed results. On the one hand, the number of ships piloted into the port rose while, on the other hand, airport-related activities dropped. The performance of both the construction and the financial services sectors was poor during 2011. Activities in the construction sector dropped in line with the decline in mortgages extended in Sint Maarten. Meanwhile, the poor results of the financial services sector were related to a decline in net income of the domestic commercial banks, caused by higher expenses.

The analysis is based on sectoral data for the January – June period of 2011.

 

Sint Maarten outlook 2012

In line with the unfavorable world economic outlook, Sint Maarten’s real GDP is projected to decline by 0.3% in 2012, considerably less than 2011. Expectations are that stay-over tourism will recover; however, this must be seen primarily in the context of the marked reduction in timeshare capacity in 2011, due to the closure of the Pelican Resort. For 2012, it is expected that the situation regarding the Pelican Club Beach Resort will stabilize. Beside the projected world economic slowdown, fiscal constraints of the public sector and low consumer and business confidence will affect domestic spending. Inflation will decelerate to 2.5% assuming no new tax increases.

Developments in the public finances of Curaçao

Curaçao is projected to achieve a current budget surplus of NAf.51 million in 2011.33 Total revenues are projected at NAf.1,718 million, while total expenditures will reach NAf.1,667 million. On the expenditure side, Curaçao realized savings on goods and services expenditures in 2011 due to efficiencies from the integration of the Netherlands Antilles and island territory of Curacao government operations. Including capital expenditures, Curaçao is expected to run a balanced overall budget in 2011.

In 2012, a NAf.45 million current budget surplus is expected, as Curaçao’s total revenues are projected to reach NAf.1,738 million, while total expenditures are projected to rise to NAf.1,694 million.

Public debt is projected to remain stable in 2011 and 2012.

Developments in the public finances of St. Maarten

Sint Maarten is projected to achieve a balanced current budget outcome in 2011. Including capital expenditures, however, the country will reach an overall deficit of ½ percent of GDP. The latter is considerably lower than the 5 ¼ percent of GDP that was included in the country’s budget because of significant delays in planned infrastructure spending. Public debt is projected to remain stable in 2011.

For 2012, no data was available at the time this report was written.

 

Balance of payments

 

In 2011, the current account of the balance of payments of the monetary union is projected to worsen due mainly to a decline in net current transfers received from abroad. The latter is attributable to the conclusion of the debt relief program in 2010. Consequently, no debt relief funds were transferred in 2011. In addition, net exports of goods and services are projected to decline in 2011 as the increase in exports is mitigated by a rise in imports. The drop in net foreign demand is, however, less pronounced than in 2010.

Exports of goods and services are projected to rise due to:

• Increased refining fee in 2011 as the Isla was operational again after a prolonged shut-down of the refinery during most of 2010;

• Increased foreign exchange revenues from bunkering activities related to higher international oil prices;

• Higher foreign exchange earnings from the tourism industry, particularly in Curaçao.

Imports of goods and services will increase because of:

• Higher oil imports reflecting increased international fuel prices;

• Increased imports by the wholesale & retail trade sectors reflecting higher international food prices, more private spending, and more tourism.

The income balance will register a deficit because interest and dividend paid to foreign investors will exceed income received on foreign investments. The deficit on the income balance will be, however, lower than in 2010.

In line with the increased current account deficit, the net foreign wealth of the private sector is estimated to have dropped in 2011. The change in the external financing of the private sector will be mainly due to a deterioration of the loans and credits balance. Also, the direct investment and portfolio investment balances are expected to have worsened in 2011.

The loans and credits balance is expected to deteriorate largely due to the withdrawal of funds abroad by domestic companies to finance part of their imports. In addition, some financial corporations in the monetary union will repatriate foreign assets to fund their local activities. The net trade credit balance will also worsen because of an increase in net trade credits on imports.

Net direct investments into the monetary union are projected to rise due mainly to increased claims of foreign direct investors on their subsidiaries in Curaçao and Sint Maarten, combined with the purchase of real estate by nonresidents in Curaçao and Sint Maarten.

The portfolio investment balance will worsen because the institutional investors will receive payments from matured debt securities that were issued by the former Netherlands Antilles and taken over by the Dutch government in 2010. However, given the uncertainty in the international financial markets, not all of these funds will be re-invested abroad. The capital inflow in 2011 will not be sufficient to cover the increased current account deficit, leading to a decline of net foreign assets (i.e., reserves) by NAf.243.9 million. Nevertheless, the import coverage will remain above the norm at 3.6 months.

Balance of payments outlook for 2012

In 2012, the current account deficit will remain practically unchanged compared to 2011. Net exports of goods and services will drop, albeit at a slower pace than in 2011. Meanwhile, the income and current transfer balances will improve in 2012 compared to 2011. The decline in net exports of goods and services can be ascribed to a drop in exports, mitigated by lower imports. Export of goods and services is projected to decline because of:

• Lower foreign exchange revenues from bunkering activities, reflecting a decline in international average fuel prices;

• Lower foreign exchange earnings from tourism activities owing to the economic contraction

in Europe and the economic slowdown in the United States (i.e., two main tourism markets for Curacao and Sint Maarten);

• Similar to 2011, a further decline in foreign exchange revenues from international financial services.

Imports will contract in 2012 due mainly to a decline in oil imports. The latter is caused by lower international fuel prices (hence, the decline in imports is due mainly to lower prices). In addition, merchandise imports by the wholesale and retail trade sector will contract as a result of a decline in the tourism sector and lower consumer spending in Curacao. The latter is the result of a decline in purchasing power because of the increase in the sales tax in Curacao in 2012.

The improvement of the income balance is related to increased interest income received on foreign investments, in particular the interest received on debt securities that were issued by the former Netherlands Antillean government (taken over by the Dutch government in 2010). Also, dividend and interest payments to foreign investors will decline in 2012.

Net current transfers will increase in 2012 because of less current transfers paid to abroad, mitigated by a decline in current transfers received from abroad.

The current account deficit will be financed mostly by external financing including loans and credits, direct investment, and portfolio investment.

The worsening of the direct investment balance can largely be ascribed to increased claims of foreign investors on their subsidiaries in Curacao and Sint Maarten. However, the increase in foreign direct investments into the monetary union will be less pronounced than in 2011, because of the economic recession in Europe (i.e., the Netherlands) and the slowdown in the United States.

The portfolio investment balance will deteriorate because not all matured debt securities will be reinvested abroad. In 2010, the Dutch government took over all remaining debt of the Netherlands Antillean government. Consequently, local institutional investors now have a claim on the Dutch government. In 2012 a significant amount of these debt securities will mature (approximately NAf.350 million). Given the uncertainty in the international financial markets, it is assumed that not all of the matured debt securities will be reinvested abroad.

The loans and credit balance will worsen in 2012 due to, among other things, the withdrawal of funds abroad by domestic companies to finance part of their imports. Also net credits received from abroad will increase in 2012.

Since the capital inflows will not be sufficient to cover the current account deficit, net foreign reserves are projected to decline further in 2012. Hence, the balance of payments will register a deficit of NAf.89 million, less pronounced than in 2011. The import coverage will remain adequate at 3.5 months in 2012.

Monetary developments

The monetary aggregates remained fairly stable in 2011 as a growth in net domestic assets was mitigated by a decline in net foreign assets. The latter was the result of the deficit on the balance of payments. The growth in net domestic assets was attributable mainly to an increase in net credit extended to the private sector.

Up till August 2011, the Bank did not actively deploy its monetary policy instruments to influence the domestic money market. The percentage of the reserve requirement, the main instrument, remained unchanged at 7.75%. During the biweekly auctions of certificates of deposit (CDs), the Bank aimed only at the refinancing of maturing CDs. The Bank’s official lending rate remained at 1.00%.

However, the developments on the current account of the balance of payments remained worrisome.

Since 2009, the Bank has pointed out on several occasions the imminent risks associated with a large current account deficit. This concern is particularly relevant in the case of small and open economies like Curacao and Sint Maarten that are vulnerable to economic shocks.

The debt relief program, which started in 2009, in fact masked the situation on the current account as this program resulted in increased net current transfers from the Netherlands. Now that the debt relief has been concluded, the vulnerabilities on our current account have become more apparent.

The deficit on the current account is still widening. Meanwhile, the economic growth of both

Curacao and Sint Maarten has stagnated while credit growth is exceeding economic growth, albeit at a slower pace. Together, these developments put additional pressure on our balance of payments.

Consequently, our foreign exchange revenues have been declining since February 2011.

Given these circumstances, the Bank decided to increase the reserve requirement percentage by two percentage points from 7.75% to 9.75% as of September 16, 2011. By increasing this percentage, the Bank absorbs excess liquidity in the domestic money market. As a consequence, credit growth is mitigated which ultimately confines a further deterioration of the current account and foreign reserves. In October, November and December 2011, the reserve requirement percentage was increased further by 0.25 percentage points each month to reach 10.50%, as of December 16, 2011.

Money growth is expected to moderate further in 2012, given the projected economic contraction in both Curaçao and Sint Maarten and the deficit on the balance of payments. Domestic liquidity will increase though as the Dutch government will pay off matured debt securities held by the local institutional investors in 2012. Given the uncertainty and volatility in the international financial markets, not all of these maturing securities will be reinvested abroad. Monetary tightening is expected to continue in 2012 to absorb excess liquidity in the domestic money market with the aim to limit a further deterioration of the balance of payments.

Despite the monetary tightening, the situation on the balance of payments will remain worrisome in 2012 as a result of the weak global prospects. As indicated by the IMF during its recent Article IV consultation visit to Curaçao and Sint Maarten, in addition to monetary tightening by the Central Bank, tighter fiscal policy is also necessary to reduce the current account deficit to sustainable levels.

Also, both governments need to take action in order to facilitate a fast recovery once the world economy starts to improve. The policy agenda needs to include measures to improve the investment climate and the competitiveness of the economies of Curaçao and Sint Maarten.

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