Netherlands: Dull budget in anticipation of new government

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1 ECONOMIC RESEARCH DEPARTMENT Netherlands: Dull budget in anticipation of new government Activity picked up strongly in 217, supported by household consumption, private investment and exports. Thanks to the favourable economic climate, the surplus of the 217 Budget reached.6% of GDP. The 218 Budget was presented by the care-taker government. Hardly any new measures were introduced. The budget surplus could reach.8% of GDP. Coalition negotiations are ongoing between the liberals - conservative and social - and Christian democrats. They could be concluded before the end of October. The new government is expected to continue the prudent fiscal policies of the outgoing coalition. Growth is expected to remain strong in the coming quarters, in particular supported by domestic demand. However, increasing labour and capacity shortages might hamper production. Strong growth in 217 Activity in the Netherlands picked up strongly recently. In the first half of 217, GDP was 3.2% higher from a year earlier. The main contributors to this performance were household spending, investment and foreign trade, each accounting for about 1 percentage point to GDP growth (chart 1). Household spending was boosted by a substantial increase in real disposable income. In the first half of 217, total wages were 3.3% higher from a year earlier. This is in the first place related to strong job creation. During this period, the labour volume of employees was 2.5% higher from a year earlier, implying a wage increase of around.8%. This is well below the collective agreed wage increase (1.6%). This is partly due to the replacement of relatively well-paid workers on retirement by lower-paid younger employees. Moreover, it could be an indication that most of the newly created jobs were not well paid. The second pillar was investment. In the period January-June 217, capital spending by households and business was 7.5% higher from a year earlier, thus contributing 1 percentage point to GDP growth. The construction sector played an important role, its value added being almost 6% higher from a year earlier. In particular housing investment continued to grow strongly after the sharp decline in the wake of the Great Recession, underpinned by favourable financing conditions Netherlands: Economic forecasts Components of growth Broad-based growth Contribution to growth of the components of GDP, y/y, percentage points Household consumption Public consumption Investment Foreign trade GDP growth Chart (1) 218 (1) 219 (1) Total GDP Private consumption Fixed investment Exports Imports Savings ratio (% ) Inflation & labour HICP Employment Unemployment rate (% ) External and public sector (% of GDP) Current account General govt. budget Gross govt. debt (end period) Footnotes: (1) forecast or preliminary data Source: BNP Paribas Figures are year-on-year percentage changes unless otherwise indicated Source: Statistics Netherlands economic-research.bnpparibas.com Raymond Van der Putten 5 October 217 1

2 real wage (%, y/y) and rapidly rising house prices (chart 2). In the first half of 217, investment in dwellings was 15% higher from a year earlier. Also favourable weather conditions contributed to this result. The construction of other buildings is also improving, but at a much lower speed. In the first of half of 217, it was only 2.5% higher from a year earlier. This is related to the difficulties in commercial real estate, in particular outside the Randstad, the megalopolis formed by the cities Amsterdam, Rotterdam, The Hague and Utrecht. The vacancy rate of offices declined to 15.9% by end 216, compared with 17.1% by end 215, partly because of withdrawals of office space. The Dutch association of realtors NVM reported that, even though the supply of retail space was declining, 16.8% of vacant shops were empty for more than three years, compared with 15.7% in 215. In the first half of 217, the construction sector contributed.4 percentage point to GDP year-on-year growth, slightly lower than in the preceding 6-month period. Investment in machinery and equipment is also showing signs of picking up. According to the bi-annual investment survey, manufacturers intend to step up their capital spending by 15% in 217 compared with only 4% in 216. In the large chemical industry, investment may even rise by 5%. The increase is partly motivated by the lack of capacity. At July 217, capacity utilisation had increased to 83.1%, a highest since July 28 (chart 3). Moreover, a record number of firms reported that production was hampered by a lack of labour and equipment. The third pillar is external demand. The contribution of net trade increased to 1 percentage point of GDP growth in the first half of 217. This confirms reports that Dutch industry has become very competitive on export markets, both within the EU and outside the EU. Manufacturing output even rose by more than 3% in January-June from a year earlier. Nevertheless, the contribution of this sector to GDP growth was limited to only.5 percentage point, as much of the sector s inputs are imported. The largest contribution to growth in the first half of 217 came from the trade sector and professional services - in particular temp and travel agencies - which each contributed.9 point to growth. Thanks to the increase in activity, the labour market continues to tighten. The unemployment rate (ILO definition) declined to only 4.8% in July, 6% according to the national definition, which also counts as unemployed those that have worked between 1 and 12 hours. The good results in the labour market are partly related to the widespread use of part-time work. In 216, Dutch employees worked on average 136 hours per year, one of the lowest in the OECD. Only German employees worked less 1298 hours. Wages are only slowly responding to the decline in unemployment rate (chart 4). In Q2 217, contract wages were 1.6% higher from a year earlier and wages were.9% higher. The reason is that employers and employees often conclude multi-annual wage contracts. Moreover, the tightening of the labour market is not uniform. Unemployment is mainly concentrated among low skilled workers. Against this backdrop, it is not surprising that consumer price inflation remains historically low. In August, overall inflation stood at 1.5% (harmonised) and core inflation was only.8%. Although consumer price inflation remains quite benign, real estate prices are increasing rapidly since mid-214. In Q2 217, house prices were on average 7.7% higher from a year earlier. Nevertheless, they are still around 8% below their peak reached in Q3 28. However, there are large differences. Construction boosted by rising house prices Building permits for owner-occupied homes (, RHS) Average sale price, existing homes ( EUR) 12-month moving average Chart 2 Source: Statistics Netherlands Investment driven by capacity shortages Investment in machinery and equipment (%, y/y) Capacity utilisation ratio (RHS) Chart 3 Sources: Statistics Netherlands, European Commission Labour shortages are pushing up real wages Q1 2 Q2 217 Real wages are nominal wages deflated by core inflation. The unemployment rate is lagged by 6 months Chart 4 Q unemployment rate (%) Source: Statistics Netherlands economic-research.bnpparibas.com Raymond Van der Putten 5 October 217 2

3 In the four largest cities, house prices are currently rising in double digits. In Amsterdam, they are even more than 2% higher than before the financial crisis. The housing boom is good news for heavily indebted households. The share of underwater mortgages, i.e. loans with a higher balance than the market value of the home, amounted to 2% by end 216, compared with almost 4% in 213. In Amsterdam, this share declined even to only 1% of mortgages, 3 percentage points lower than 3 years earlier. The Dutch central bank denies that the house price boom is credit driven. In fact, mortgage lending is only expanding by around.2% per annum. This is partly related to population ageing, as the share of elderly homeowners, who borrow less than the younger generations, is rising. Almost 2% of homeowners are older than 55, compared with less than 1% a decade earlier. Also stricter lending conditions, such as lower maximum LTV ratios and limiting mortgage interest relief to annuity or linear repayment loans, have dampened household lending. 218 Budget: ever-growing surpluses After the general election in March, the outgoing coalition between VVD (conservative liberals) and PvdA (Labour), the Rutte II government, lost the majority in parliament. Until a new coalition government has been formed, the outgoing coalition entered care-taking status, implying that it deals only with current affairs. As the coalition talks are only progressing slowly, the 218 Budget was still prepared by the Rutte II government. As expected, Finance Minister Dijsselbloem proudly announced a much higher surplus for 217 than projected -.6% of GDP compared with a.5% deficit presented in September thanks to the better-than-expected economic performance. As a caretaker government cannot initiate new policies, the 218 Budget only contained some small changes with the blessing of the parties that are currently involved in the coalition negotiations: EUR 27 million to increase salaries for primary school teachers, EUR 435 million more for nursing homes and EUR 425 million to support purchasing power of pensioners and benefit receivers. The collective burden, i.e. taxes and social security contributions, will remain at around 39% of GDP. According to the Netherlands Bureau for Economic Policy Analysis (CPB), the purchasing power of the average household will increase by.6% in 218. Employed persons may expect an increase by just over 1% thanks to a substantial rise in contract wages. Next year s gains for pensioners and benefit receivers are close to.5%. The government announced that the surplus would increase to.8% of GDP. Moreover, in the absence of new measures, it would further increase to 1.6% of GDP by 221. This is unlikely to happen. Once the new team is in place, the 218 Budget and the multi-annual projections will be amended. A complicated government formation The formation of a new government is rather complicated as it involves many parties with sometimes contrasting ideas. After the March election, the VVD, as the largest political formation, took the initiative in forming a new government. The intention is to form a new coalition between VVD, CDA (Christian Democrats) and D66 (social-liberals). As this group only occupies 71 of the 15 seats in the second chamber of parliament, a fourth partner is needed. The PvdA ruled out Parliament of the Netherlands Second Intended coalition Chamber Senat VVD Conservative liberals CDA Christian democrats D66 Social liberals 19 1 CU Protestants 5 3 Total intended coalition Opposition parties PVV Populist right 2 9 GROENLINKS Environmental protection 14 4 SP Radical left 14 9 PvdA Labour 9 8 PvdD Animal rights 5 2 Other 12 5 Total seats Sources: Kiesraad, BNP Paribas participation after the drubbing at the ballot boxes. The party is left with only 9 seats, compared with 38 seats before the election. Negotiations with GreenLeft stranded, officially on migration policies. The three parties are now trying to form a government with the CU, a small protestant party with 5 seats in parliament. These four parties are likely to agree on fiscal policies. They want to continue the prudent fiscal policies of the outgoing coalition. Nevertheless, negotiations are progressing only slowly, as the CU is very much opposed to a further liberalisation of euthanasia, a legislative proposal supported by D66. By contrast, these two parties agree on stricter environmental regulations and more generous migration policies, but their proposals go too far for VVD and CDA. Differences also exist on labour market flexibility. The VVD would like to increase the number and duration of temporary contracts that can be given, while D66 would like to see one type of contract with guarantees increasing with its duration. The Christian Democrats would like to see restrictions of the use of self-employed without employees (zzp). These workers should be obliged to take out disability insurance. VVD and D66 would only like facilitating these workers joining pension schemes. Labour market flexibility is not only a sensitive point for the prospective coalition parties, but also for trade-unions and employers organisations. Recently, negotiations on labour market reform between the social partners in the Social and Economic Council failed. Nevertheless, talks between them on pension reform continue. The outcome will also affect the coalition negotiations, as pension reform will be high on the agenda for the next government. All four parties are in favour of a more individualised pension system with collective risk sharing. The first act of the new government will be to change the 218 Budget with an eye on the municipal elections, which are to be held in March. The coalition parties would like to present a package of measures to please the voters. It is likely to include income tax reduction targeted at medium-income earners. The Christian Democrats - CDA and CU - aim at improving the tax economic-research.bnpparibas.com Raymond Van der Putten 5 October 217 3

4 treatment of single-earner married couples. In addition, the next government is likely to invest in care, education, security and environmental protection. The measures already taken in the 218 budget are far from sufficient. The budgets for defence and environmental protection have not been increased at all. However, time is running out for the negotiators. In order to change fundamentally the 218 Budget, they should reach quickly an agreement, as some measures are automatically activated. Parliament already froze the own risk in the health insurance at EUR 385. If nothing had been done, it would have automatically increased to EUR 4. The Christian Democrats and all the opposition partners would like to reduce it in the coming years. In addition, the absence of a fully operational government is a serious disadvantage for the Netherlands internationally. As Brexit approaches, multinationals might move their headquarters from the UK to Europe. These firms would like to have certainty about the tax treatment and other advantages. Moreover, the Netherlands may be left of the sideline in EU discussions on deeper integration. The negotiations are at a decisive stage. A new government could be in place before the end of October. In the meantime, the outgoing Rutte II coalition has become the longest serving government since the World War II. Outlook The outlook remains well oriented thanks to strong domestic and external demand. We project the economy to grow by around 2% in both 218 and 219, in particular driven by robust domestic demand. Tax reductions and generous wage settlements are likely to stimulate private consumption. Initially, investment should remain strong, as capacity utilisation is at record high levels. Moreover, construction activity remains underpinned by favourable financing conditions, strong housing demand, and lower vacancy rates in commercial real estate. However, bottlenecks have surfaced. Residential construction is held back by the lack of building plots. Moreover, as unemployment continues to decline, tensions in the labour market are increasing. Many employers already complain that it is hard to find sufficiently skilled workers. As a result, trade unions have already increased their wage demands for the upcoming collective agreements to 3%. More generous wage increases may affect competitiveness and reduce profit margins. Firms might be tempted to offshore some of their activities. In the short-term, these developments may weigh on capital spending and exports. The contribution to GDP growth from external trade is likely to diminish and the substantial current account surplus is projected to decline. Moreover, the increase in wage demand will also push up consumer prices. Inflation is expected to reach 2% in the coming quarters. Once a new government is in place, the fiscal stance is expected to become more accommodative due to the reduction of the tax burden. Nevertheless, the government budget is likely to remain in surplus in the coming quarters, allowing the public sector debt to decline further. Raymond Van der Putten raymond.vanderputten@bnpparibas.com economic-research.bnpparibas.com Raymond Van der Putten 5 October 217 4

5 Group Economic Research ADVANCED ECONOMIES AND STATISTICS BANKING ECONOMICS EMERGING ECONOMIES AND COUNTRY RISK economic-research.bnpparibas.com Raymond Van der Putten 5 October 217 5

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