Mission Concluding Statement 

Kingdom of the Netherlands: Staff Concluding Statement of the 2019 Article IV Consultation

December 6, 2018

An IMF team visited the Netherlands during November 27 – December 6, 2018, for the 2019 Article IV consultation. This statement describes the preliminary findings of the mission.

The Dutch economy has performed very well in recent years supported by a favorable external environment and prudent macroeconomic management. Progress with household and bank deleveraging has reduced vulnerabilities in the economy. However, imbalances in the households and corporate sector, and thus external imbalances, persist. Households remain highly leveraged and their consumption is constrained by stagnating disposable incomes. Developments in the corporate sector are diverging; the small and medium enterprise (SME) sector is stagnating while multinational corporations (MNCs) are accumulating high savings. The current cyclical upswing provides an opportunity for policies to focus on reducing imbalances and raising productivity growth, through boosting household disposable income, repairing private sector balance sheets, advancing reform of the pension system, and strengthening the SME sector. These policies would support domestic demand and potential growth and help reduce the large current account surplus.

A Positive Outlook but Challenges Remain

1. Economic growth remains strong but is expected to be lower in 2019 reflecting weaker global trade. The Dutch economy has grown above the euro area average over the past few years reflecting recovering consumption and investment and strong net exports. The labor market has tightened, and the unemployment rate has fallen to its lowest level in a decade. But slow productivity growth is constraining wage and income growth. Reflecting strong fiscal performance, public debt continues to decline. Overall the financial sector resilience has strengthened.

2. However, medium-term challenges are significant. Progress with tackling long-standing structural imbalances in the households and corporate sectors is lagging. Households remain highly leveraged and their consumption constrained by a stagnating disposable income. In the corporate sector, dominated by MNCs, investment is low and corporate savings are high, while domestic SMEs’ activity is stagnant. These factors also contribute to the large current account surplus.

3. The risks to the outlook are tilted to the downside. As a highly open economy, the Netherlands is vulnerable to rising global protectionism and threats to global demand. Disruptions to the global trade system, uncertainties surrounding fiscal policies in other euro area countries, a possible no-agreement Brexit, or weaker-than-expected global growth could affect exports and investment negatively. Furthermore, a sharp tightening of global financial conditions could weigh on the financial positions of still-leveraged households, that have large balance sheets which contributes to increased volatility of the economy, and could lead to heightened stress in banks due to their heavy reliance on wholesale funding.

An Opportunity to Address Imbalances

4. Using available fiscal space consistent with the European and national fiscal rules to reduce imbalances is desirable and would not jeopardize long-term fiscal sustainability. Strong economic growth and prudent fiscal policy have boosted fiscal space in recent years. The authorities’ 2019 budget includes measures to upgrade infrastructure, strengthen human capital, lower the labor tax burden, and reform international corporate taxation which are all welcome steps. This budget plan implies a modest stimulus, while over the medium term the structural balance will converge to zero, leaving substantial space with respect to the Stability and Growth Pact’s medium-term objective of a structural deficit of 0.5 percent of GDP. We recommend fully using this space to address imbalances, as detailed below. Such expansionary fiscal policy would support growth potential without undermining fiscal sustainability.

Boosting Domestic Demand - Household Disposable Income and Debt

5. Policies should aim at reducing labor market duality, boosting participation, and lowering the labor tax wedge further. Weak labor productivity growth and a high labor tax wedge have contributed to moderating wage growth and are putting pressure on household’s disposable incomes. Labor market duality dampens the wage growth over the business cycle and exacerbates strains in the pension system. Greater harmonization of the tax and social protection treatment of permanent employees, temporary workers, and the self-employed while increasing overall flexibility should be pursued and would improve equity and efficiency. A pension reform introducing the possibility for self-employed to pay a lower premium in exchange for a pension benefit that may vary depending on the level of risk they choose could also lower labor market duality. The planned decrease in the labor tax wedge and the increase in the lower VAT rates are welcome steps but there is fiscal space to lower the labor tax wedge further over the medium term. These additional measures could focus on supporting low-income and second wage earners; they would benefit household disposable incomes and help strengthen domestic demand growth.

6. To improve housing affordability and reduce household debt, policies should aim at increasing housing supply, tightening macro-prudential measures, and further reducing the debt bias in the tax system. Excessive mortgage borrowing has contributed to the accumulation of household debt. This should be addressed by liberalizing rent controls and improving means-testing for social housing to help optimize allocation and improve housing supply. In addition, private investment should be encouraged by further relaxing restrictions on zoning plans, simplifying administrative procedures for building permits and improving coordination at the subnational government level. Moreover, the maximum loan-to-value ratio should be set to no more than 90 percent and the debt service-to-income ratio should be capped to avoid pro-cyclicality in borrowing. The accelerated phasing down of the mortgage interest deductibility by 3 percent starting from 2020 is a welcome step and it should be pursued beyond its planned end-point in 2023.

Reforming Occupational Pensions

7. Pension reform along the lines advocated by the government would be beneficial. This reform has been on the table for several years and an agreement has remained elusive. While returns on pension fund assets have improved recently, protracted low interest rates and population aging will continue to put the defined-benefit second pillar pension system under financial stress and lead to intergenerational tensions. The current and past governments proposed a pension reform whereby collective defined-benefits schemes are replaced by defined-contributions contracts, complemented by provisions aimed at preserving appropriate risk pooling. Such a reform would provide greater predictability and transparency to the system, and we urge social partners to agree to it.

Supporting SMEs to Boost Business Investment

8. The SME sector has lost dynamism, partly due to skills shortages and hurdles in obtaining credit. SMEs growth has stagnated as companies are facing difficulties in hiring due to rigid regulation, the tight labor market, and skill shortages. Financing is limited to bank loans and borrowing costs for small firms remain higher than in peer countries. The creation of a credit bureau would help improve information and facilitate SMEs’ access to finance. Further investment in the digital economy and programs to support lifelong learning would also help SMEs adapt to new market conditions and reduce their costs. Public spending on R&D as a share of GDP is below the OECD average and, absent policy action, it is set to decline over the medium-term. Moreover, R&D support relies heavily on tax incentives, some of which favor incumbents over new and potential entrants. To support riskier and longer-term innovations, it is important to expand direct public spending on R&D through reallocation of spending within the budget, which could have positive spillovers to start-ups and young SMEs with growth potential.

Reducing Financial Sector Vulnerability

9. Despite significant improvements in soundness, banks and insurers remain vulnerable. Banks are profitable but still highly dependent on wholesale funding, with an aggregated loan-to-deposit ratio above 120 percent, compared to below 100 for the euro area. Continued building of capital and liquidity buffers should therefore remain a priority. While the leverage ratio is above the regulatory minimum, it is below the euro area average for significant institutions and should be strengthened. Insurance sector solvency has strengthened through consolidation while business has been further diversified. However, life insurers remain vulnerable in the low-interest environment given the still large share of guaranteed-return policies that need to be further reduced. Continued supervisory attention in this area is warranted.

10. Combating money laundering and financing of terrorism (AML/CFT) is challenging, given the Netherlands’ position as a financial and corporate center. Coordination between national authorities, investigators and other stakeholders, including at the global level, is needed to effectively tackle AML/CFT. Removing legal and operational barriers to information sharing with the European authorities is also critical for assessing AML/CFT risks at the European level.

The mission team would like to thank the authorities for their hospitality and support, as well as for open and fruitful discussions.