Author: Rendell de Kort, Economist
Aruba has wrestled with economic woes before: The disappearance of Natalee Holloway, the global financial crises and the closure of the oil refinery various times.
But this time it’s different, requiring policymakers to step up to mitigate the economic impact of an unusually challenging crisis. In this post, we look at the current state of our external environment, domestic vulnerabilities, and potential implications for Aruba when facing a crisis of a magnitude the island has not seen since obtaining its independence within the Dutch Kingdom in 1986.
Although the current level of disruption might seem manageable in the absence of local cases in Aruba, the COVID-19 outbreak has hit at a time of much greater economic vulnerability for both the external environment and for Aruba than during the previous shocks.
About 87 percent of the economy depends directly or indirectly on tourism, making Aruba one of the most tourism-concentrated countries in the world. The focus on the tourism industry as export-led growth strategy in hind-side served the island well, as the industry proved markedly consistent and resilient and drove strong economic growth.
This is not to say there weren’t hick ups along the way. With U.S. tourists accounting for almost 70 percent of stay-over tourism, the economy has been particularly sensitive to the U.S. business cycle. This was particularly evident after the global financial crisis and the disappearance of Natalee Holloway.
Indeed, there is a recurring call to diversify the economy and to diversify tourism source markets to mitigate risks. I would argue that neither would have been particularly helpful for a black-swan like event like COVID-19. A feature of COVID-19 is that it has already spilled over to other sectors and the global economy. The world economy was weak, and getting weaker, when COVID-19 struck. Should the oil refinery have remained active up to the Corona virus, it would have faced a plunge in oil prices and oil price forecasts at $30 per barrel for the third quarter and $29 per barrel over the fourth quarter of 2020.
There is just no way to count on the refining industry to maintain economic activity in such an environment and even if small islands like Aruba (despite natural disadvantages) were successful in nurturing other industries, it’s hard to imagine them escaping a global recession.
Diversifying tourism source markets also appears as a dubious proposition, given the current struggles of the largest source markets following the U.S. (Venezuela, Canada, Colombia, the Netherlands). Except for Venezuela, all of them have confirmed cases of COVID-19. With a global recession in the first half of 2020 looking almost but certain, the implications for a small island tourism destination is that there is just no diversifying away from it.
The domestic environment has its own set of challenges
UNWTO has revised its 2020 prospects for international tourist arrivals to a negative growth of 1% to 3%, translating into an estimated loss of US$ 30 to 50 billion in international tourism receipts. Prior to the COVID-19 outbreak, UNWTO predicted a growth of 3% to 4% for this year. In the end, the epidemiologists will have the final word on the endgame for COVID-19 and given the rapidly evolving situation, its obviously impossible to say with certainty how many potential tourists will stay home during an outbreak to avoid getting sick rather than travelling to Aruba. But it’s clear that export earnings will come under significant pressure as hotel occupancy levels have already been dropping in the first two months of 2020 and cancellations/travel restrictions become more common.
Spillovers
In turn, attention is to be placed on the spillovers on foreign exchange earnings and the international reserves, imports and the fiscal situation of the government.
Lower export earnings lead to less foreign exchange. It’s most crucially what enables import dependent islands to sustain their insatiable appetite to purchase practically everything from abroad, most notably food. The latest published information on the official reserves of the Centrale Bank van Aruba (CBA) tells us that it stood at Afl. 1,822.2 million at the end of September 2019. However, the question begs to be asked, to what extent will this level of reserves provide cushion to weather the eminent shock?
While traditionally the CBA reported the “import coverage ratio”, meaning the number of months it would hypothetically take for our import-appetite to completely deplete the reserves in the absence of export earnings, the answer remains elusive.
The CBA’s 2018 operational report notes:
“The level of international reserves remained adequate throughout 2018, when bench-marked against the CBA’s traditional critical norms. However, when compared to International Monetary Fund (IMF) requirements, Aruba does not meet the recommended optimal level.”
Important to note here is that there is no direct mention of what exactly the “adequate” level is according to the Central Bank of Aruba. But the IMF warned in its 2019 assessment against downward pressure and recommended Aruba to accumulate additional international reserves to maintain sufficient buffer. At the end of the day, whether Aruba can weather shocks like the COVID-19 depends crucially on its ability to hold enough dollars to pay for imports and the diminishing international reserve level should be viewed as a significant concern.
Prior to the COVID-19 outbreak the Centrale Bank van Aruba already projected real GDP growth to grow at a tamely meager 0.8 percent for 2020, underscoring weak fundamentals prior to COVID-19. Apart from the direct economic slowdown, this will also impact the ability of the Government of Aruba to generate income as lagging economic activity will likely result in lower tax revenues. Although the proposed 2020 GOA budget has yet to pass parliament, the projected surplus included in the budget assumes an economic growth of nominal 1.0%. Given the recent circumstances, this will now likely face a significant downward adjustment, which means the budgeted government income for 2020 (and subsequently the envisaged surplus) could likely quickly turn into liquidity constraints and a significant deficit.
If it’s of any comfort at all, debt levels have recently soared globally as well, including in the United States and the Netherlands. However, this also limits the scope for big fiscal stimulus if the world economy needs one. In Aruba, deficits have been the norm and the dynamics between the GOA and the independent council of financial supervision (CAFT) will be challenging should the former opt to further increase public debt to stimulate the local economy.
Some options to consider moving forward
There is little doubt that COVID-19 will have a significant impact. But the scale of impact will ultimately be determined by how the virus spreads and evolves, as well as how the government is able to coordinate a response to mitigate.
We need an immediate contingency plan, that considers the fiscal, monetary and real sector economic challenges ahead. Here are some options to consider moving forward:
Fiscal policy
- There is little choice but to abandon fiscal prudence in the face of an external shock of such magnitude. This may entail curtailing plans for additional taxation measures and updated fiscal priorities may need to be addressed at the Kingdom level.
- A fiscal stimulus package should focus on food security (SDG 2) to reduce imports and the pressure on foreign exchange outflows.
Monetary policy
- Should be well-coordinated with the fiscal policy.
- Transparency and timely information on the Balance of payments and the international reserve position will be crucial for any response.
- Additional capital control measures may need to be considered
- Consistent with the advice of the IMF, the Central bank should be ready to provide ample liquidity to banks and non-bank finance companies, particularly to those lending to small- and medium-sized enterprises, which may be less prepared to withstand a sharp disruption.
Real Sector
- Tourism promotion and marketing fund allocation should be revised to avoid being tonally off-base.
- The agricultural sector needs to be the beneficiary of stimulus to ramp up local food production in the short run.
As with many other developing states we are in a little boat that’s going to get pounded by high waves. I do not envy local policy makers; I wish them wisdom and courage to keep it afloat.
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