Netherlands: broad-based economic recovery surrounded by international uncertainties
The Dutch economy is clearly in recovery modus, with growth being driven by both exports and domestic demand. Public finances are expected to improve. Household debt levels are still relatively high. Efforts by Dutch banks to improve their capital position are successful.
Strengths (+) and weaknesses (-)
(+) Fiscal discipline
The Dutch government has been successful in reducing public deficit in a period of economic downturn. It has also implemented a number of key reforms that have improved long-term fiscal sustainability.
(+) Sizeable current account surplus
As a result of its competitiveness, and in recent years of low imports as well, the Netherlands has a sizeable current account surplus, which averaged around 8%-GDP over the past 10 years.
(+) Strong public institutions
Dutch infrastructure and communication networks are world-class. The education system is noted for its excellent quality.
(-) High household debt levels
Household debt levels are relatively high, which makes them vulnerable to negative wealth shocks.
1. Broad-based economic recovery
In 2015, the Dutch economy grew by 2% in real terms, which is twice as high as the year before. The relatively high economic growth was driven by a solid contribution of domestic demand, as well as exports (Figure 1). Over the next two years the economy is expected to sustain its 2015 growth rate, with private consumption and exports remaining the most important growth drivers. Labour market conditions are expected to improve further over the next couple of years, giving rise to a steady decline of the unemployment rate and resulting in upward pressure on wages. The housing market recovery is also expected to continue.
There are a number of risks to this economic outlook. The low interest rate threatens the financial position of pension funds, which makes it difficult for pension funds to compensate pension rights for increases in the general price level. This hampers growth through the worsened income position of pensioners, loss of purchasing power in pension rights of workers, and increased uncertainty. The influx of refugees is demanding substantial government funds and leads to incidental bouts of social unrest. As a result of the increased inflows of refugees, a number of Schengen countries have temporarily reinstated border controls. If the Schengen treaty would be abolished, this would have serious long-term negative economic implications for the Netherlands through reduced trade and economic growth. Likewise, refugee inflows and terrorist attacks have increased the possibility that the UK will leave the EU, which would also have a significant negative influence on Dutch exports as the UK is the third largest export market in terms of value added.
2. Improvement in government finances
Government finances are improving, with both the deficit and public debt-to-GDP ratio on a downward trajectory. The improving fiscal position of the Dutch government can be attributed to significant budget cuts, reforms that were implemented, and a growing tax base due to the recovery of employment and domestic demand.Despite considerable reforms over the past years, the government failed to get the political support last year for a tax reform bill in the Senate (First Chamber of parliament). Also, polls indicate that populist Party for Freedom (PVV) will become the largest party in the House of Representatives after next general elections in 2017. This would hamper the formation of a new government and may potentially lead to a reform backlash if the PVV would come into power. Despite the above risks, there is no structural problem in Dutch public finances, as the reforms that were taken over the past years have placed public finances on a more sustainable footing. Furthermore, several reforms such as an increase of the statutory retirement age and labour market reforms favour the productive capacity of the economy by encouraging labour supply.
3. Improved capital position Dutch banks
In the period leading up to 2008, banks became more leveraged and the duration of their liabilities became shorter. This made them vulnerable to financial market shocks. Over the past years, banks have made significant progress towards improving their capital position (Figure 2). According to the Dutch Central Bank, they are on schedule to comply with the Basel III rules in 2019. The deposit financing gap of banks has decreased steadily since 2009, though in an international perspective they remain relatively dependent on market financing. Over the past years, non-performing loans have remained very modest for household mortgages, despite the period of crisis and recession. Risks for the banking sector are also mitigated by the widespread coverage of the National Mortgage Guarantee (NHG) scheme.
4. Risks of household over-indebtedness have decreased
The issue of household debt overhang has become less pressing, but vulnerability to declines in house prices remains. In 2014, the gross debt-to-income ratio of households was around 215%, one of the highest in the eurozone. Though household debt is relatively high, it is counterbalanced by significant asset holdings. However, these assets holdings are unevenly distributed and most of the assets are in illiquid real estate and pension accounts. Tax incentives induce households to take up mortgage debt and make them vulnerable to negative wealth shocks. The government has taken measures to limit the risks of household over-indebtedness, such as less generous tax treatment of mortgage interest, more strict lending rules (both in loan-to-value and loan-to-income terms) and the limitation of mortgage interest deductibility to fully amortizing loans. As a result of these policy actions, household debt will ultimately decline substantially, though in the short term increased mortgage lending fueled by the recovery in housing transactions is pushing up private debt.
The Netherlands has an open economy that is highly developed and diversified. Infrastructure and communication networks are world-class. The Dutch economy is very competitive, taking the 5th position in the World Economic Forum 2015-2016 global competitiveness index. As a result, it has a sizeable current account surplus (8%-GDP on average over the past 10 years). Important export destinations are the Eurozone (particularly Germany), the United Kingdom and the United States. The Dutch government has pursued significant fiscal consolidation over the past years. The government budget balance has improved from -5.4% in 2009 to -1.8% in 2015. The debt-to-GDP ratio was 65.1%-GDP last year and is set to decline modestly over the next two years. Although fiscal consolidation is paying off in terms of improving fiscal metrics, it has come at a significant cost, as illustrated by the elevated unemployment rate. The long-term sustainability of government finances has improved considerably since 2010, when the first steps were taken to raise the statutory retirement age.