Mission Concluding Statement 

Kingdom of the Netherlands–The Netherlands: Staff Concluding Statement of the 2022 Article IV Mission

December 9, 2022

Washington, DC – December 9, 2022: An International Monetary Fund (IMF) mission, led by Mr. Bernardin Akitoby, met with the Dutch authorities on the Article IV consultation during November 28–December 9. The following statement was issued at the end of the mission:

The Dutch economy was more resilient than its peers during and after the pandemic. Reflecting the prevalence of telecommuting and a strong fiscal response, the Dutch economy experienced a less severe recession followed by a more robust recovery than the Euro area as a whole. Real GDP grew by 4.9 percent in 2021, surpassing its pre-pandemic level, as private consumption staged a vibrant recovery boosted by the release of accumulated savings and a strong labor market. Manufacturing capacity utilization returned to pre-pandemic levels by early 2022, and real GDP returned to its pre-pandemic trend in 2022:H1—a notable achievement. The labor market is tight with a low unemployment rate and high vacancies, although wages have not picked up strongly so far. Headline inflation remains high amid rising core inflation. Overall, the economy appears to be overheating, with the output gap estimated at 1½ percent. Russia’s invasion of Ukraine is posing new challenges, but the Netherlands has suffered a smaller decline in the terms of trade compared to the rest of the euro area. The government has taken several measures to address the rising cost of living. The financial cycle has started to moderate, accompanied by rapid cooling of a richly valued housing market.

Economic Outlook and Risks

Growth is projected to slow as high inflation weighs on consumption and external demand wanes. With the 2023 fiscal stance projected to be expansionary while financial conditions are expected to continue to tighten, real GDP growth is projected to slow to 0.6 percent in 2023 from 4.2 percent in 2022, mainly reflecting weaker demand in trading partners, eroded purchasing power, and tighter financial conditions. The effect of slower growth on the labor market could be softened, as structural labor shortages may dissuade employers from laying off workers. No scarring from the pandemic is expected. Growth in the medium term will be underpinned by public investment (averaging 3¾ percent of GDP over the next 5 years, including in the climate and housing areas) and reforms, including those in the National Recovery and Resilience Plan (NRRP).

Inflation is expected to peak in 2022 and moderate in 2023 with the activation of the energy price ceiling. The headline harmonized index of consumer prices (HICP) inflation, which has been largely driven by energy prices, is estimated to have peaked at about 14 y/y percent in 2022:Q3. The implementation of a price cap on households’ gas and electricity bills in January 2023 will notably reduce headline inflation from the average forecast of about 11.8 percent in 2022 to about 4.2 percent in 2023. Core inflation is projected to peak in 2023 at about 7.3 percent on average.

Given high uncertainty, risks to the outlook are tilted downwards, while risks to inflation are skewed upward. The main risks stem from an escalation of the war and associated sanctions, which could result in further increases in energy prices, energy disruptions in Europe and weaker external demand. Although the Netherlands has sufficient energy reserves to keep the country running, energy shortages elsewhere in the EU could trigger redistribution mechanisms of energy to other countries, thus exacerbating the energy crisis in the Netherlands. Growth spillovers from affected trading partners would place an additional drag. With further increases in commodity prices, especially if exacerbated by second-round effects from wage bargaining, inflation could become persistent, thus de-anchoring expectations, and eroding purchasing power. Furthermore, Euro area monetary policy tightening could heighten risks from real-financial feedback loops. Given the close synchronization of the business cycle with housing market developments, such risks are particularly prevalent in the case of a sharp downturn in house prices that would induce households to cut consumption to service their debts. On the upside, the use of large savings accumulated during the pandemic could help cushion private demand.

Fiscal Policy: Managing the Impact of Higher Energy Prices and Aggregate Demand

Extensive government measures have cushioned the impact of high energy prices but involve substantial fiscal stimulus that complicates the fight against inflation. The 2023 budget added fiscal measures amounting 2.4 percent of GDP, net of offsetting revenue measures. This support package is mostly targeted and mainly consists of social transfers to households and subsidies to SMEs. However, the gas and electricity price cap for small consumers in 2023 is not targeted. The government has stated its intention to explore additional coverage measures to offset the cost of the price cap and make the support more targeted. While measures that suppress energy prices (like the price cap) immediately lower prices for households and some SMEs, they mute price signals, reduce incentives for energy saving, and entail high costs. Therefore, the IMF mission welcomes the reestablishment of the standard VAT rate at 21 percent from January 1, 2023, the planned reversal of the energy tax reduction, and the increase of particular allowances, making the support more targeted. Nevertheless, additional measures to reduce the fiscal deficit would be desirable.

A non-expansionary or modestly contractionary fiscal stance in 2023 is warranted, considering high inflation and the tight labor market. This would imply that at least the fiscal cost of the price cap and other energy measures must be covered in the budget. If the support measures are not better targeted or other offsetting measures are not taken, this could entail a sizeable fiscal adjustment in 2023, which must protect public investment on the medium-term challenges (including climate change, housing, and education). The price cap could be better targeted, for example, by focusing on the most vulnerable households or by significantly reducing the amount of energy consumption at subsidized prices. Doing so will also protect public finances from fiscal risks stemming from high volatility in international energy prices, preserve price signals to a greater extent, and incentivize energy saving. The deficit reduction could also be supported by the contemplated changes to wealth tax and/or a one-time solidarity tax increases on high-incomes and businesses. The IMF welcomes the inter-ministerial policy report on wealth distribution [1] , which includes concrete policy directions to address the inequality induced by the current tax system. The removal of non-targeted tax measures to lower energy prices and the recently announced temporary solidarity contribution from the fossil fuel sector could help raise much-needed revenue for the large adjustment in these exceptional circumstances. However, ideally, one-off windfall taxes imposed ex-post are not preferred as they undermine tax certainty and can be complex to implement. The authorities could also consider devising a permanent, well-designed excess profit tax regime as part of regular corporate taxation.

Fiscal policy should remain flexible and evolve if risks materialize. An adverse shock scenario would trigger automatic stabilizers and help reduce economic hardship of households. A negative supply shock, such as the one driven by an adverse evolution of the war in Ukraine which results in stagflation with lower growth, but higher and more persistent inflation could necessitate a greater fiscal adjustment. On the other hand, materialization of a negative demand shock could call for a more limited fiscal adjustment, though the bar for discretionary measures would be high given current high inflation pressures. A severe correction in the housing market that could threaten financial stability, lower private demand, and potentially trigger a deep recession could require discretionary fiscal support.

Energy Security

The authorities are taking several welcome measures to ensure energy security, which remains a high priority. While no physical gas shortage is expected this winter, uncertainty on future supply remains high. A new floating LNG terminal at Eemshaven doubled the gas import capacity of the country, benefitting also other EU countries. Two new nuclear plants are planned, and the government intends to extend the KCB’s operating life beyond 2033. The authorities have established a 40 percent tax reduction on investments in gas in the North Sea to stimulate exploration and production. In June 2022, the Netherlands and Germany announced they will jointly drill for a new gas field in the North Sea, with gas production expected by end-2024. The authorities have also slowed the decline of gas production from small fields. A scheme to hedge gas prices has been also implemented, supporting gas storage. On the demand side, measures to promote gas savings (by tightening energy savings targets for businesses and lifting output restrictions to coal-fired power stations) and energy efficiency (extension of the National Isolation Program) are being implemented. The energy crisis in Europe has increased the desirability of the Netherlands gas production, the acceleration of the energy mix diversification, and energy saving. Boosting investment in clean energy, part of the NRRP, will also enhance energy security while contributing to the green transition.

Housing and Financial Stability

Continued close monitoring of risks in the housing market and addressing challenges for banks and non-bank financial institutions from tightening financial conditions are warranted.

• The cooling of a richly valued housing market calls for ongoing alertness towards emerging strains and readiness to deploy existing buffers if needed. Recently flagging house price momentum accentuates vulnerabilities from a residential real estate sector deemed overvalued on a broad range of metrics. A sharper correction in house prices could amplify risks of borrower distress in the event of an economic downturn against a background of high household indebtedness coupled with largely illiquid assets concentrated in pension and insurance claims, a quarter of mortgages facing an interest rate reset in the coming five years, a prevalence of interest-only mortgages, and overextended balance sheets of recent home buyers. At the same time, the large share of fixed-rate mortgages and long maturities provide some comfort. In this context, the authorities’ requirement to apply stricter conditions to risky mortgage loans from January 2022 is appropriate as it helps stabilize the housing cycle and creates a buffer that could be released to absorb potential credit losses. Likewise, efforts to increase awareness about the risks from interest-only lending among borrowers and lenders are welcome. Structurally, the Dutch housing market remains unbalanced, requiring determined policy intervention. Policy measures should strive to lessen incentives for households to live in highly leveraged, owner-occupied housing. The government’s program to address housing shortages and ensure affordability contains important elements to tackle underlying imbalances but the large role attributed to rent control could be re-evaluated.
• Risks accentuated by the energy crisis and tighter financial conditions require heightened vigilance, closing data gaps and advancing supervisory frameworks. Dutch financial institutions command considerable buffers, providing resilience. Still, elevated non-financial corporate debt could weigh on the balance sheets of financial intermediaries as credit and interest rate risks rise. Likewise, a rapid and disorderly adjustment of yields, accompanied by high financial market volatility and/or an economic downturn, may negate the benefits of interest rate normalization for banks and heighten pressures on non-bank financial institutions. To identify areas of vulnerability at an early stage, continued close monitoring is warranted, also with the help of tailored stress tests. To contain risks among non-bank financial institutions, the authorities should stand ready to deploy existing policy levers, work towards closing data gaps and actively contribute to international efforts to develop macroprudential policy frameworks that comprehensively address non-bank financial sector vulnerabilities. Finally, the ongoing occupational pension reform should be completed within the timeframe foreseen.
• With the financial cycle strengthening, increasing the counter-cyclical capital buffer (CCyB) was appropriate, but further tightening should avoid a pro-cyclical stance given high macro-financial uncertainty. Nominal credit growth has accelerated. Thus, raising the CCyB from 0 to 1 percent in May 2022 was appropriate to bring it closer to the 2 percent level considered neutral by the DNB and to lock-in capital buffers that can be released should financial stability risks materialize. Going forward, pausing a further tightening of capital-based macroprudential measures could be considered in view of a fluid macro-financial environment. In the medium term, avenues opened by the continued evolution of the EU macroprudential policy framework, such as sectoral systemic risk buffers, could be explored to refine and recalibrate the set of policy instruments at the disposal of the Dutch authorities.

Medium-term Challenges: Enhance Economic and Social Resilience

The authorities command substantial fiscal space to devote to medium-term challenges. The IMF mission welcomes the government’s use of ample fiscal space, given still low debt to GDP, to advance the green and digital transitions and to tackle structural challenges in the housing and labor markets, and the education system. The mission supports the ongoing deployment of the Climate and Transition Fund, new spending over two years to support the National Education Plan, and the launch of the National Growth Fund, with R&D and knowledge development as the main targeted areas. Structural investment and reform plans to allay housing and labor market shortages, reinforce the education system, and advance digitalization, as part of the National Recovery Resilience Plan (NRRP), are also welcome.

Climate Change

The Netherlands is committed to enhancing climate policies. The Dutch Climate Policy Program includes measures to guarantee standards and pricing, while stimulating renewable generation from wind and sun, phasing out coal, and reinforcing grid capacity. The NRRP earmarks 48 percent of its total allocation for the green transition. In line with last year’s consultation, the mission recommends reinforcing carbon pricing with harmonized feebates for industry and power; continued shifting of taxes away from electricity and onto residential natural gas; and transitioning from fuel to driving-related taxes.

The Netherlands represents a good practice for climate change adaptation, particularly to sea-level rise, with strong institutional capacity, financial resources, and knowledge support. Climate adaptation could be further strengthened by holistically integrating it into long-term planning frameworks of the government. Government action could further focus on adaptation with large positive externalities, removing barriers to private adaptation, and dealing with equity issues. The National Adaptation Plan could also benefit from highlighting the cost of market distortions for adaptation.

Further progress in tackling labor market duality could further increase resilience and boost labor participation and productivity. The authorities have taken steps to reduce differences between forms of employment through accelerated phasing out of the self-employed person’s tax deduction. Increases the childcare subsidies over the medium term, along with the minimum wage increase in 2023, should help offset rising costs and keep women in the labor force. Ongoing reforms of parental leave, including the expansion of parental birth leave and increasing the child-care allowance, could also facilitate full-time female labor force participation. The mission welcomes the NRRP’s planned reforms to support upskilling and job search and improve social protection for the self-employed, including introducing a mandatory disability insurance. We encourage the authorities to continue to realign tax and other incentives across different types of employment to help reduce labor market duality.

The renewed emphasis on digitalization would help reduce labor shortages, and support productivity. The Netherlands’ high degree of digitalization served the country well during the COVID-19 crisis. However, shortages of IT professional were reported even before the pandemic, while SMEs need faster adoption of digital technologies. The NRRP allocates 26 percent of the financing to invest in accelerating the digital transition by investing in quantum technology and digital upskilling and improving rail connectivity.

The mission welcomes the reforms of capital taxation. These reforms will reduce the prevalent disparity between effective taxes on different types of incomes and firms—that result in distortion and ample tax avoidance opportunities. Regarding the housing market, tax incentives to buyers could be reformed to help reduce demand for owner-occupied housing. A reform option would involve raising the value of imputed rents to market levels, which together with the planned taxation of actual returns, would achieve more equitable taxation across different assets.

The mission thanks the authorities and our other counterparts for the constructive policy dialogue and productive collaboration.