Public Information Notice No. 13/48

Public Information Notice: IMF Executive Board Concludes 2013 Article IV Consultation with the Kingdom of the Netherlands—Netherlands

May 10, 2013

On May 1, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Kingdom of the Netherlands.¹

Background

The Netherlands is an AAA euro area (EA) economy, but with significant private sector imbalances. It shares an AAA credit rating and relatively robust public finances with Germany, Finland, and Luxembourg. Its sovereign bonds enjoy safe haven status, and it has a growing net international asset position since 2008. However, it also has a highly indebted household sector, significant financial sector challenges, declining real estate prices, and weak domestic demand. As a result, the Netherlands’ GDP growth, unemployment, and public debt dynamics since the onset of the global financial crisis have diverged from other AAA EA economies.

The extended weakness in activity in the Netherlands reflects the slow deleveraging of the household and financial sectors. Prior to 2008, in the context of ample global liquidity, a favorable macroeconomic environment and supportive tax and regulatory incentives, households had accumulated substantial mortgage debt with generous loan-to-value

ratios and advantageous mortgage interest deductibility. Household debt as a share of disposable income doubled over the past decade—to the highest in the euro area—and drove up house prices to unsustainable levels. Meanwhile, banks’ assets-to-GDP rose to a peak of 4 times GDP by 2011 accompanied by a sharp increase in wholesale funding. Zoning and other restrictions prevented an adequate supply response to cool house prices. The global financial crisis of 2008 was the external trigger that led to a slow deleveraging spiral accompanied by falling confidence, declining house prices, and increasing financial strains. As a result, despite the recovery of global trade, a balance sheet recession has left GDP in the Netherlands below the 2008 level five years on.

Balance sheet adjustments in the context of weakness in the rest of the EA will continue to be a drag on the recovery and delay external adjustment. Despite the nominal 18-percent correction since the peak, a further decline in house prices is expected to weigh on consumer confidence and consumption. With the banking system highly exposed to the real estate sector and continuing to rely on wholesale funding, the adjustment of its balance sheets is still underway. Exports to the rest of the EA are expected to pick up only gradually against the backdrop of a slow EA recovery. This implies that under the baseline, following an estimated 0.9 percent contraction last year, output is projected to fall by an additional 0.5 percent in 2013 before recovering by 1.1 percent in 2014. Reflecting the need to shore up balance sheets, the current account surplus is expected to widen marginally through 2014. In line with these projections, the output gap will narrow only gradually over the forecast horizon.

The baseline outlook is subject to a number of downside risks. The interaction of household and bank balance sheets linked through changes in house prices makes the outlook subject to unusually large uncertainty. A drop in house prices in excess of what is currently assumed would further restrain both household consumption and lending by banks, and could in turn lead to a deepening cycle of falling house prices and deleveraging. Solvency requirements in pension funds also weigh on consumer confidence as benefits and contributions need to be adjusted procyclically. Persistent uncertainty about structural policies and the degree of procyclicality of fiscal policies could also act as a restraint on household spending decisions and postpone the recovery. External developments, especially in the rest of the euro area, that add to uncertainty, generate financial stress, weaken consumer confidence, and lower exports would affect activity adversely in the Netherlands (Figure 4). A more medium-term risk is that policy measures fail to avoid a decline in the economy’s growth potential. On the upside, a rapid reduction in uncertainty and a recovery in consumer confidence could help support the outlook.

Executive Board Assessment

Executive Directors commended the Netherlands’s track record of robust public finances and status as a safe haven. Directors noted that notwithstanding these strong fundamentals, the economy faces challenges from a highly indebted household sector, significant financial system stresses, still declining real estate prices, and weak domestic demand. Adverse external developments, especially in the euro area, could also pose risks. Directors agreed that policy priorities ahead should focus on restoring growth and managing downside risks while allowing for an orderly adjustment of private sector balance sheets.

Directors commended the authorities’ commitment to maintaining fiscal sustainability and welcomed the decision not to undertake any additional fiscal measures in 2013. In light of the ongoing economic uncertainty, most Directors recommended that fiscal policy should be more flexible, focus on structural targets, and allow automatic stabilizers to operate fully. The envisaged consolidation under the 2012 Update of the Stability Program remains appropriate and would ensure sustainable public debt dynamics over the medium term. Some Directors were of the view that the authorities’ emphasis on achieving the headline deficit target provided policy credibility and anchored expectations.

Noting the vulnerabilities facing the financial system, Directors emphasized the need to reduce its dependence on wholesale financing and increase bank capital from private sources. Building additional capital buffers will be important to guard against any systemic threats from the real sector as well reduce vulnerability to shocks. Directors commended the implementation of most Financial Sector Assessment Program (FSAP) recommendations and encouraged further action to strengthen domestic supervision and reporting. A clear framework for creditor hierarchy, at the EU level, which carefully establishes burden sharing between financial stability and protection of taxpayers, will also be important.

Directors underscored the need to remove housing market distortions. In this context, they saw need for unimpeded adjustment of house prices, transparent pricing of real estate sector risk, and avoidance of additional contingent liabilities by the government. Directors commended the steps taken to reduce maximum loan-to-value ratios and eliminate mortgage interest deductibility and called for further efforts in these areas after the market has stabilized.

Directors emphasized that labor market reforms as well as measures to increase productivity and raise human capital will be important to boost the economy’s growth potential. Reform efforts should focus on reducing the duality in labor markets and period of unemployment benefits. Channeling resources into research and development and improving the quality of education will also be essential.