A special relationship with the Netherlands

Aruba – a former Dutch colony – is an autonomous and self-governing country within the Kingdom of the Netherlands. It seceded from the Netherlands Antilles in 1986 and has had “status aparte” since then. Aruba voluntarily halted the legal process to separate the island from the Kingdom of the Netherlands in 1990 and, as such, independence is unlikely in the medium term. That being said, relations with the Netherlands mainland have been under some strain in recent years. The public budget and migration-related issues are the main sources of friction.

Aruba holds general elections every 4 years. The last elections (2017) brought about a coalition government made up of Movimiento Electoral di Pueblo and the much smaller Pueblo Orguyoso y Respeta and Network of Electoral Democracy. This is the first coalition government in 16 years. Indeed, since 2001 the island had been led by consecutive majority governments. Furthermore, for the first time in Aruba’s history, the government is headed by a female prime minister, Evelyn Wever-Croes.

One of the most tourist-dependent countries in the world

Aruba is a small, open economy whose exchange rate is pegged to the USD (kept at USD 1.8 for the last 30 years). The island is heavily dependent on tourism: 87% of the economy depends directly or indirectly on tourism. Hence, the island is one of the most tourist-dependent countries in the world. Around 70% of tourists come from the US, making the island very sensitive to the US economic cycle. On the upside, the island is located outside the hurricane belt, which means tropical storms are a rare event and do not impact tourism revenues.

However, Aruba was not always so dependent on tourism. Before the last refinery was closed in 2012, oil refining was also a dominant sector in Aruba. A re-opening of the refinery would diversify the economy and give it a boost. Citgo Petroleum (the US subsidiary of Venezuelan state-owned oil firm PDVSA) signed an agreement on the reactivation of the refinery. However, the US sanctions and the ongoing deep economic crisis in Venezuela render a reopening unlikely in the foreseeable future.

Challenges for economic growth

The economy has witnessed several recessions since 2008. The global financial crisis and the end of oil refining have led to economic contractions. Since 2016, the island has been recovering gradually thanks to strong growth in tourism from the US. That being said, economic growth remains relatively sluggish. In 2019, a real GDP growth of 0.7% is expected while in the coming years it is forecast to increase only mildly to around 1%. The main reasons for these pessimistic growth forecasts are the slowing global – and especially US – economy and planned fiscal consolidation due to the dire state of public finances. Fierce competition from other tourist destinations in the Caribbean also hampers the possibility of strong growth in tourism revenues. In addition, an important downside risk is the ongoing economic crisis in Venezuela, which lies 30 kilometres away from Aruba. The risk of a sizeable influx of migrants (though the border is closed between the two countries) could have a significant negative impact on growth forecasts.

Public finances in a dire state

The island’s public finances are in a dire state. Weak economic activity and the government’s policy response after the global financial crisis have taken their toll. Public debt has more than doubled, from 41.7% of GDP in 2008 to 84.5% of GDP at the end of 2018, which is a high level. Since 2015, the government has tried to enact fiscal consolidation. As a consequence, the primary balance has turned positive since 2015. However, as the fiscal deficits have remained sizeable, public debt has not decreased to below the level of the end of 2015. In November 2018, the government proposed a new fiscal consolidation plan which spans 2019-2021. The agreement on fiscal consolidation was made together with the Netherlands, adding some credibility to the plan. Thanks to the fiscal consolidation plan, the fiscal deficit is expected to narrow to  0.8% of GDP in 2019 before further decreasing to -0.5% of GDP in the medium term. Consequently, public debt is expected to fall as well, to a still elevated 75% in the next 5 years. Nevertheless, the consolidation plan is very ambitious and it could be difficult to adhere to the agreement. First, in 2017 and 2018 fiscal targets were missed despite an agreement with the Netherlands being in place since 2015. Indeed, fiscal slippages led to an increase in public debt in 2017, which in turn led to strong tensions with the Netherlands. Second, compared to the historical experience of other countries, Aruba’s adjustment is large. Furthermore, the projected downward path of public debt remains vulnerable to weaker than expected economic growth. Last, protests are not unlikely and could derail consolidation efforts, especially in the light of the elections of 2021.

Oil prices and tourism revenues as main drivers of the current account balance

Tourism revenues are a vital source of export revenues, accounting for almost 80% of current account receipts. Food and offshore financial services are to a far lesser extent sources of export revenues. This small export base makes the current account balance of this small Caribbean island especially vulnerable to shocks related to the tourism industry. On the import side, oil is the main source of import expenditure. High oil prices partly pushed the current account deficit to a high level, notably in 2013 and 2014. In the past 4 years, however, the current account balance has been in positive territory thanks to higher tourism revenues and lower oil prices. The current account balance is expected to fall into negative territory again as of 2019. Indeed, high imports due to infrastructure projects are likely to keep the current account balance in a slight deficit at least until 2023. Thereafter, reduced oil imports thanks to the implementation of energy-saving technology, an expected increase in tourism and ongoing fiscal consolidation are expected to help the current account balance reach a surplus.

High external indebtedness

External debt has increased in recent years as fiscal deficits have been financed through a mix of domestic and external issuances. External debt stood at roughly 90% of GDP at the end of 2018 – a high level – while external debt service is rather elevated. External debt ratios will only increase moderately in the coming years due to the expected growth of tourism receipts and nominal GDP. Foreign exchange reserves stood at 4 months of imports in August 2019. This is generally a healthy level but to safeguard the peg with the USD over the medium term, nominal foreign exchange reserves should increase. That being said, fiscal consolidation and structural reforms are expected to support the accumulation of foreign exchange reserves in the coming years.

Downgrade of medium- to long-term political risk classification from 3/7 to 4/7

Past recessions, the dire state of public finances and high external indebtedness have negatively affected the macro-economic fundamentals of the Caribbean island. Lacklustre growth forecasts and enduring high external indebtedness are forecast in the medium to long term while the island is not likely to be able to diversify its small export base in the foreseeable future. In view of this, Credendo has downgraded the medium- to long-term political risk classification from 3/7 to 4/7.

Analyst: Jolyn Debuysscher – j.debuysscher@credendo.com