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Public financial woes and its impact on the economy

Public financingHow much impact may weak public finance have on an economy as a whole? This is one of the questions many managers in the private sector of Aruba may pose themselves these days. Their fear is that, while Aruba's economy is doing relatively well in general terms, government's financial struggles may have far reaching consequences. In what ways would the financial problems visible at present affect the economy?

Let us start with an assessment of Aruba's financial household at this time. During the last five years, tough times came along for government, caused both by the global financial and economic crisis of 2008/2009, and the shutdown of the Valero refinery, in 2009, and again in 2012.

Also, the newly installed government was obligated to deal with the worrisome situation of the public employees' pension fund (APFA), product of a too generous and unsustainable pension scheme built up through the years.

Pension age for public servants, including politicians in government and parliament, was reset at 60 years (was 55 years). However, in spite of leveling this age limit (60 years) with the general pension scheme (AOV), most experts are of the opinion that this would not be enough and that moving toward a higher retirement age (65 years) for all pension schemes would soon become imperative.

The years 2010, 2011 and 2012 presented a picture of growing budget deficits, caused by increasing expenditure and stagnant revenue, the latter also fueled by slashing the turnover tax from 3% to 1.5%, which was not compensated by significant economic growth. These deficits were financed primarily by recurring to the local and foreign market, issuing government bonds.
By end 2012, Aruba's public debt burden – according to the Central Bank of Aruba - is set at Afl. 3.062 billion (US$ 1.7 billion), which represents about 67% of GDP. At the start of the current government's term, debt was at approximately Afl. 2.226 billion, at that time 49.8% of GDP. Without a drastic turnaround in financial policy, budget deficits may further cause public debt/GDP ratio to climb past the 70% mark, on its way to 80%. In this situation, cutting expenses and increasing revenue may seem appropriate, both alternatives being unattractive. Cutting costs too abruptly, may lead to great loss of purchasing power, leading to less consumption, affecting retail and services. Revenue increase for government will also come at a cost for businesses and individual citizens, as they have to pay these tax increases. Let us start looking at the expenses side.

First and foremost, it may seem logical that government should attack those items that weigh more on its budget. This would undoubtedly be the personnel related items, which in 2012 totaled Afl. 684 million, compared to Afl 602 million in 2010. A solid 13.6% increase in only two years. Together with other expenses related to the apparatus (goods and services), these total apparatus related costs represented in 2012 a total of Afl. 927 million, more than Total Tax Revenue (Afl. 915 million) for the same year. On its turn, tax revenue represents about 90% of total revenue. As it will be very difficult to dodge other financial commitments, such as interest payments and government's contribution to the general healthcare scheme (AZV), cutting back on personnel expenses, either through decreasing the number of personnel, or by slashing salaries across the board, seems to become unavoidable. An attempt to weather out the situation, based on attrition only, will not reel in enough result to cure the problem.

Other debts
Until now we have been referring only to the direct commitments considered 'public debt', which are the bonds and treasury bills issued by government. But there are other commitments that represent a major threat to public finance. Those are primarily the payment arrears with the public servants' pension fund – APFA - of about Afl. 650 million. According to a recent agreement between the fund and government, these arrears are to be paid over a 15 year period, on top of current premium commitments, thus adding considerably to the budget in the coming years.

Next, the private capital to be invested in PPP projects, and which in due time must be repaid with a reasonable Return on Investment. The sheer size of the commitments - Afl. 1.4 billion, of which a major part will be private capital – will create a significant burden in repayments on the government budget for decades, as none of these projects are profit based.
Furthermore, some stormy weather may be expected in the near future from the aging phenomenon, among other things its effect on both medical and pension schemes. The AOV reserve fund is expected to be depleted in the latter part of this year, or early 2014, thus bringing along a considerable commitment for government to compensate for the AOV deficit. The measures agreed upon in the Social Dialogue – among them the flex pension program - did not turn out to be sufficient, taking into account also the rapid increase of eligible persons (60 years and over) during the last years. Demographic projections predict an even more rapid increase of persons eligible for pension toward 2020, from about 17.000 at end 2012, to 27.000 in 2020. In the case of medical insurance, substantially higher expenses for elderly will have an autonomous effect on medical costs, even when other factors are held equal, creating considerably higher medical bills to be paid.

Solutions
From the above we may derive that, in light of the considerable increase of expenditure to be expected in the coming years, suddenly the recent discussion about a ‘balanced budget’ does not seem to be the first priority anymore. The most important issue at this time seems to be how to prevent government budget deficit from mushrooming to an even higher level, thus leading to a completely unsustainable financial situation. From a deficit of close to Afl. 400 million on a Afl. 1.4 billion budget, we may face a situation where this deficit may become over Afl. 500 million, with a revenue side hardly growing. Unless… government recurs to hefty taxation in order to beef up revenue. It becomes imperative to know what road this country needs to go in the upcoming years, as further taxation will mean cutting back profits, and subsequently investments. As these increases will be passed on to the customer, this will fuel inflation on its turn, and add to the loss of competitiveness of Aruba’s economy. It is about time to look for other alternatives, like the limitation of benefits of healthcare and pension schemes, in order to have social security and healthcare systems that are more according to the carrying capacity of our economy, as we cannot go on adding more premiums to the already high employers’ contributions. A cold hard look should also be taken at our productivity and fiscal regime, in order to increase Aruba’s attractiveness for investors, and to determine a more feasible road to economic growth, and hence more sustainable public finance.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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