Island faces pressure from the Netherlands over the public finances

Curaçao is a relatively politically stable country though the government is coming under increased pressure in the run-up of the April 2021 elections. More specifically, governability is being hampered by the fragmentation of the political scene, corruption scandals, differences over the Venezuelan migrant crisis and influence of the Dutch government. Indeed, since the island became autonomous in 2010, the parliament of Curaçao has the responsibility for most local issues while the Netherlands retain the control of foreign and defense policies, some judicial functions and the supervision of public finances. Currently, Curaçao faces pressure from the Netherlands’ central government to impose harsher austerity measures. The public finances of Curaçao deteriorated after the Dutch government gave debt relief in 2010. Despite fiscal consolidation in recent years (leading to relatively small fiscal deficits of about -1% of GDP in the past 2 years) and projected austerity measures, fiscal deficits may persist in the coming years. Hence, government debt is likely to increase to more than 60 % of GDP in 2021, an elevated level but lower than most Caribbean peers. Curaçao is therefore at risk to lose its autonomy to draft its own budget as this responsibility could be reclaimed by the Netherlands. Though, if this scenario would likely lead to an improvement of the public finances, it would also raise the risk of political unrest in the country.

Venezuelan crisis is leaving strains on the economy

For already 4 years, Curaçao has been suffering from a protracted recession. In fact, since gaining autonomy in 2010, only in 2011 and 2015, Curaçao has experienced (small) positive real GDP growth. The fiscal consolidation of the past years and the economic crisis in nearby Venezuela (one of the country's main trading partners) have impacted the island through a sharp decline in tourism and trade. Furthermore, production at the Isla oil refinery, which is operated by the Venezuelan state-owned oil firm, Petróleos de Venezuela (PDVSA), has been declining for years, hampering the economy. The IMF expects the recession to deepen in 2020 to -4.5% based on the assumption that the oil refinery would close in the end of 2019 when the contract with PDVSA expires. However, the Switzerland-based firm, Klesch Group, agreed to take over the oil refinery in 2020, which could change the country´s fortunes.

Historically, the current account balance has always been very wide at around -23% of GDP in the past decade. On the import side, high oil imports and construction imports weighted on the current account balance. On the export side, the underutilisation of the oil refinery (one of Curacao’s main sources of current account receipts) and more recently the lower exports to Venezuela (historically accounting for a third of exports) and lower tourism revenues (accounting for around 40% of current account receipts) are the main reasons for these wide deficits. Also in 2020, the current account balance is expected to be in a large deficit of about -20% of GDP before gradually declining in the coming years. The improvement of the current account balance is expected to be driven by falling demand for construction materials and structural reforms designed to enhance the productivity of the tourism and financial services sectors (Curaçao has a large offshore financial sector). That being said, the agreement to take over the oil refinery by the Switzerland-based firm, Klesch Group, in 2020 could improve the current account balance faster than anticipated.

Risk of a balance-of-payments crisis is mitigated despite high debt levels

The current account balance has been mainly financed by FDI (a more stable source of financing) and portfolio inflows (a rather volatile source of financing which can quickly leave the country). In the past two years, the current account deficit has been more and more financed by external loans. Hence, external debt has been on the rise and stands at a high level. The external debt is expected to remain at a relatively high level compared to GDP and current account receipts in the coming years. High external debt in combination with wide current account deficits raises the risk of a balance-of-payments crisis. However, two main factors mitigate the risk for Curaçao. Firstly, debt service is estimated to be at a low level, compared to current account receipts and external debt. The reason is the concessional financing agreement with the Netherlands, which leads to relatively low interest payments. Secondly, the Netherlands subscribed to most of the external debt, which is denominated in local currency and with long maturity.

Currency peg is under stress

Curaçao has formed a monetary union with Sint Maarten since 2010. Their currency – the Netherlands Antilles Guilder – is pegged to the US dollar at ANG 1.79/USD 1. An adequate level of foreign exchange reserves at the level of the union is therefore important in order to keep a stable peg. However, the foreign exchange reserves of the union have decreased from the equivalent of more than five months of import cover in 2017 to about 4 months in December 2019. The negative impact of the Venezuelan crisis on Curaçao and the severe hurricane hit on Sint Maarten are the main reasons for the decline. The expected improvement of the current account balances on both islands and a re-opening of the oil refinery could boost foreign exchange reserves in the future. However, in case of a sharp drop of foreign exchange reserves (e.g. after another severe hurricane hit on Sint Maarten which is situated in the hurricane belt), a devaluation of the pegged currency could become necessary.

Oil refinery might be a game changer

For MLT political risk, Credendo has classified Curaçao in category 5/7, ever since it became an autonomous entity within the Kingdom of the Netherlands in 2010. This rating is largely explained by the wide current account deficits, the ongoing recession and high external debt but low external debt service. Looking forward, the future of the oil refinery, fiscal slippages, lower tourism revenues (due to the Venezuelan crisis or slower global economic growth) and possible large hurricane hits on Sint Maarten (affecting the foreign exchange reserves) are the main downside risks. As for ST political risk, Credendo has classified Curaçao in category 3/7. The decline of the foreign exchange reserves puts the liquidity under pressure despite the moderate short-term external debt levels. However, the expected improvement of the current account balance and the potential re-opening of the oil refinery are likely to improve the liquidity in the short term.

Analyst: Jolyn Debuysscher – J.Debuysscher@credendo.com