A strong bounce back from the pandemic
1.Economic activity rebounded strongly as the pandemic effects waned. Real GDP grew by 27.6 percent in 2021 and is estimated to have further expanded by 7.3 percent in 2022. This reflects a strong recovery of tourist arrivals following the lifting of the restrictions introduced during the pandemic. Inflation has moderated somewhat and was 4.9 percent in April, driven by imported energy and food prices and the increases of electricity and water tariffs in August 2022. The unemployment rate decreased to 6.6 percent in June 2022 and appears to have fallen further in subsequent months. The banking sector remains well-capitalized, liquid, and profitable although credit growth has been slow. The strong tourism recovery increased the current account surplus while foreign reserves remain adequate at 7.3 months of total imports at end-2022 for Aruba.
2.The fiscal balance has improved but public debt remains high. The fiscal deficit declined to 0.5 percent of GDP in 2022, from 16.2 percent of GDP in 2020. This reflects a combination of higher revenue—boosted by the economic recovery—and the rollback of pandemic-related spending measures. Central government debt declined from a peak of 112.3 percent of GDP in 2020 to 90.7 percent of GDP at end-2022. Aruba’s long-term foreign debt rating has been upgraded from BB to BB+ by Fitch in March 2023, on account of the post-pandemic economic and fiscal rebound.
Moderate positive outlook with high uncertainty
3.The economy is projected to grow at a moderate rate in 2023 and over the medium term. Real GDP growth is projected to slow to 2.3 percent in 2023, as the post-pandemic rebound in tourist arrivals wanes. Over the medium term, growth is projected at 1.1 percent. Inflation will decelerate to 3.2 percent by end-2023 due to slowing domestic demand and lower international commodity prices. The fiscal balance is expected to display a surplus in 2023 and over the medium term, reducing the central government debt to 71 percent of GDP by 2028. The current account surplus is projected to narrow over the medium term as tourism growth moderates. Foreign reserve coverage is projected to remain at around 7.1 months of total imports by 2028.
4. Risks to the outlook are tilted to the downside. A steeper-than-expected global slowdown, especially in the U.S., could reduce tourist arrivals. Similarly, geopolitical fragmentation could disrupt tourism, impact supply chains, or increase commodity prices which would lower growth and increase inflationary pressures. Climate change is an ever-present risk through both rising sea-levels and more volatile weather events. Domestically, risks to the outlook mainly stem from an insufficient implementation of the needed fiscal adjustment.
A continued need for fiscal consolidation
5.The envisaged government expenditure envelope in the 2023 budget is appropriate. The plan to keep nominal current expenditure at last year’s level while introducing several tax measures to increase revenue collections will further improve the country’s fiscal position. The authorities are encouraged to quickly introduce the remaining planned tax reforms in order to underpin their 2023 fiscal target. A contingency plan to reduce spending would help prevent adverse effects on the fiscal accounts in case revenue collection falls below budgeted.
6.The mission welcomes the authorities’ medium-term fiscal objective to maintain a fiscal surplus while making space for greater public investment. Based on the mission’s assessment, the recently implemented tax measures are not sufficient to achieve the authorities’ fiscal targets and further measures will be required to increase revenue mobilization and scale back recurrent spending. Additional revenue could be generated through introducing a broad-based value-added tax to replace the current indirect tax system and strengthening tax compliance. On the expenditure side, containing the wage bill, reprioritizing spending on goods and services, streamlining transfers and subsidies, and reallocating from current spending to the growth-enhancing public investment would all help. The planned Public Expenditure Review that will be undertaken by the World Bank would help inform these efforts.
7. Long-term fiscal risks stemming from the pension system need to be addressed. In the absence of further reforms, the pension system is expected to run deficits starting in around five to six years and its reserve will be depleted by the mid-2030s. This is despite efforts to improve the financial situation of the general old-age pension fund (AOV). There is a need, therefore, to further increase the contribution rate and/or reduce the replacement ratio to bolster the solvency of the system.
8.Strengthening the medium-term fiscal policy framework would help prioritize spending and anchor the path for debt reduction. A well-designed medium-term budget framework—guided by a debt anchor and pre-determined escape clauses that apply in extraordinary situations—would help crystalize trade-offs, shape strategic priorities, anchor expectations, and guide the development of the annual budget in a manner consistent with the government’s broader macro-fiscal objectives. It would also allow the authorities to communicate their medium-term plans more effectively. Developing a sound debt management strategy in parallel to the medium-term budget framework would lessen macroeconomic and financial stability risks.
Supporting intermediation and sustaining financial resilience
9. The mission encouraged the Central Bank of Aruba (CBA) to reduce the reserve requirement ratio over time. The increase in the reserve requirement ratio to 25.5 percent (from 7 percent in March 2020) has locked up liquidity and, alongside the withdrawal of fiscal support, has moderated aggregate demand pressures. With inflation now is declining and foreign reserves are at adequate levels, there is scope to lower reserve requirements over time to avoid disincentivizing a deepening of financial intermediation.
10.The CBA needs to remain vigilant to vulnerabilities in the financial system. While the overall financial stability risk is low, the increase in real estate lending to households raises potential concerns over risk management practices by lenders and the growing debt burden being taken on by households. Close monitoring of underwriting standards is warranted. Setting a cap on the loan-to-value and debt service-to-income ratio for borrowers could be a useful macroprudential tool to forestall an increase in risks to financial stability. More broadly, developing a comprehensive macroprudential policy framework, with accompanying tools, should help mitigate and manage vulnerabilities. Implementing such a framework would need to be supported by better, more granular, timely data, including on non-bank financial institutions.
11.The CBA is encouraged to further strengthen the financial regulatory and supervisory framework. The mission welcomes the CBA’s efforts to conduct risk-based supervision of the financial system, including thorough annual stress tests. However, further efforts are needed to enhance the financial stability framework. In particular, a more structured approach to liquidity and solvency stress testing that is firmly tied to a range of underlying macroeconomic scenarios would be valuable. Adopting the Basel II international standards would be also beneficial for enhancing monitoring and management of financial sector risks.
Addressing supply-side constraints to growth
12.Comprehensive structural reforms are needed to boost potential growth. Policies to increase the value added of tourism, Aruba’s main growth engine, and to enhance non-tourism activities are both critical to support medium-term inclusive growth and enhance resilience. In this regard, key priorities include:
- Ease of doing business. Reforms to remove obstacles to doing business, reduce red tape, and stimulate entrepreneurship will be important. The recently introduced “Business Policy Guidelines” and the efforts to enhance transition to the digital economy are steps in the right direction.
- Labor market reforms. Policies that promote labor market participation and hiring, address skills gaps, and enhance productivity are key to supporting economic activity and job creation over the medium term. The authorities should promote greater labor market flexibility such as the reduction of costs of dismissals while introducing an unemployment insurance program. Additionally, there is a need to strengthen vocational training and improve education outturns. Doing so would help address skills mismatches, boost productivity, and lessen gender gaps in the labor market.
13.Addressing governance issues is essential to strengthen the business environment.
- Governance. The recent CBA survey continues to indicate a widespread perception of corruption in Aruba. To address governance issues, the authorities are encouraged to bring the framework in line with the United Nations Convention Against Corruption, including improving the capacity of the Integrity Bureau and implement codes of conduct for public servants. Implementing robust asset declaration requirements for senior public servants will also assist in detecting corruption and support efforts at investigating, prosecuting, and confiscating of the proceeds of these crimes.
- AML/CFT framework. Efforts to enhance the country’s AML/CFT framework—reflected in the 2022 Caribbean Financial Action Task Force (CFATF)’s mutual evaluation on AML/CFT—are commendable. The authorities should continue strengthening technical compliance and the effectiveness of the AML/CFT framework, especially in the supervision of non-profits and non-financial business providers, including the establishment of a gaming authority entrusted with the licensing and vetting of management, shareholders and ultimate beneficial owners and the establishment of a regulatory framework for the licensing of virtual asset service providers in accordance with FATF standards. The authorities should also implement the legal framework related to beneficial ownership information held by the Chamber of Commerce and legal persons as well as strengthen law enforcement’s capacity to pursue money laundering and other financial crimes.
- Tax Transparency. Steps to increase tax information sharing and resolve issues related to the implementation of the OECD standards on the tax transparency and exchange of information are essential to improve international tax cooperation and tackle tax evasion.
14.Enhancing resilience to climate change is a priority to ensure sustainable growth. Aruba is a flat island and a substantial share of houses, primary infrastructure, and tourism assets are located near sea level. Therefore, the economy will be greatly affected by even a modest rise in the sea level. In this regard, the authorities are encouraged to develop a concrete action plan— under the auspices of the National Climate Resilience Council—to prioritize infrastructure investments that directly improve the physical resilience of low-lying areas. This should include identifying concrete financing sources for these projects and defining how they would fit within the overall medium-term fiscal framework. The ongoing climate risk profile assessment, the planned costing of climate change adaptation needs, and the development of a national climate resilience strategy are steps in the right direction.
The IMF team is grateful to the authorities and a broad range of public and private sector counterparts for their warm hospitality, cooperation, and constructive discussions
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