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# 52014SC0087

**COMMISSION STAFF WORKING DOCUMENT Macroeconomic Imbalances – The Netherlands 2014 /\* SWD/2014/087 final \*/**

  

Results of in-depth reviews under
Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic
imbalances

The Netherlands continues to experience macroeconomic imbalances,
which require monitoring and policy action. In particular, macroeconomic
developments regarding private sector debt and ongoing deleveraging, coupled
with remaining inefficiencies in the housing market, deserve attention.
Although the large current account surplus does not raise risks similar to large
deficits, and is partly linked to the need for deleveraging, the Commission
will follow the developments of the current account in the Netherlands in the
context of the European Semester.

More specifically,
rigidities and distorted incentives have built up over decades to shape house
financing and sectorial savings patterns. Balance sheets of financial
institutions became heavily geared towards housing finance, as households
leveraged up against housing wealth. In parallel, since the mid-1990s, non-financial
corporates moved into a structural savings surplus. This has resulted in a
substantial and persistent current account surplus going hand-in-hand with a
high level of both gross household debt and household net assets. In recent
years, subdued domestic demand in the wake of the global crisis has further
pushed up the external surplus. Over the past years there have been
improvements in this regard with policies implemented to curb
mortgage-financing. Deleveraging will continue to weigh on economic activity
but a stabilising housing market and a significantly positive net asset
position of households limit the risks. As regards public finances, the
Netherlands is forecast to miss its headline deficit target in 2014, the year
in which the excessive deficit should be corrected, although it is expected to
have adopted the structural measures of the recommended size in 2013-14.

Excerpt of country-specific findings on The Netherlands, COM(2014) 150
final, 5.3.2014

Executive Summary and Conclusions 7

1.       Introduction  9

2.       Macroeconomic
Developments 11

2.1.     The
macroeconomic situation in perspective  11

2.2.     Short-term
outlook  13

2.3.     Long-term
effects of selected reforms 15

3.       Imbalances
and Risks 19

3.1.     Current
Account 19

3.1.1.  Trade Linkages 21

3.1.2.  Domestic
Savings and Investments 24

3.2.     Housing
market developments and household debt 34

4.       Specific
Topics 39

4.1.     Household
debt 40

4.2.     The
financial sector 44

4.2.1.  Pension funds
and insurers 44

4.2.2.  Banks 46

5.       Policy
Challenges 51

References 56

LIST OF Tables

2.1.     Key
economic, financial and social indicators - the Netherlands 17

3.1.     Housing and
Mortgage Markets: Main Indicators 34

LIST OF Graphs

2.1.     Evolution
of House Price Index and MFI Loans for House Purchase  12

2.2.     Decomposition
of Credit Flows (consolidated) 14

2.3.     Non-cyclical
current account 14

2.4.     Labour
market developments (in percentage) 15

2.5.     Poverty and
inclusion indicators (in percentage) 15

2.6.     Private
debt in % of GDP (scenario) 16

3.1.     Decomposition
of external position (current and capital accounts) 19

3.2.     Current
account, gross components 19

3.3.     Exports by
broad economic category  20

3.4.     Imports by
broad economic category  20

3.5.     Imports of
goods (market share) 21

3.6.     Exports of
goods (market share) 21

3.7.     Exports of
services (market share) 22

3.8.     Imports of
services (market share) 22

3.9.     Export
Market Share - contribution  22

3.10.   Price and
cost competitiveness indicators - Deflator: HICP  22

3.11.   Price and
cost competitiveness indicators - Deflator: nominal ULC total economy  23

3.12.   Price and
cost competitiveness indicators - Deflator: nominal ULC manufacturing  23

3.13.   Price and
cost competitiveness indicators - Deflator: GDP, market prices 23

3.14.   Decomposition
of rate of change of ULC, rate of change of ULC in (EA/EU) 24

3.15.   Savings and
Investment by Sector 24

3.16.   Net lending
position of Households (in % of GDP) 24

3.17.   Net lending
position of non financial corporations (in % of GDP) 25

3.18.   Balance
Sheet, Non-Financial Corporations 25

3.19.   Gross Capital
Formation by type  26

3.20.   Profit
margins, non-financial corporations 26

3.21.   Labour income
share  27

3.22.   Coefficient
of variation of average hourly wages across different sectors 28

3.23.   Coefficient
of variation of average hourly wages across different sub-sectors 28

3.24.   Coefficient
of variation of wage agreements across subsectors 29

3.25.   Average
yearly increase in gross value added, net operating surplus and average yearly
wage increase of wage agreements in main sectors (average over 2001-2013) 29

3.26.   Average
yearly increase in gross value added, net operating surplus and average yearly
wage increase of wage agreements (manufacturing) 30

3.27.   Wage
increases agreed in wage agreements 31

3.28.   Economic
growth, nominal ULC and contribution of incidental payments in wage agreements 31

3.29.   Job-to-job
mobility in science and technology (2012) 31

3.30.   Valuation
effects 33

3.31.   Gross
valuation effects (assets) 33

3.32.   Gross
valuation effects (liabilities) 33

3.33.   NIIP per
sector 34

3.34.   Decomposition
of y-o-y changes in debt-to-GDP ratios, households 34

3.35.   Total
Mortgages and House price index  37

4.1.     Sectoral
contribution to the Dutch external net lending or borrowing (million EUR) 39

4.2.     Balance
sheet by instrument, households 40

4.3.     Percentage
of households holding debt 40

4.4.     Composition
of real assets 41

4.5.     Composition
of financial assets 41

4.6.     Financial
assets of households (in % of GDP, year-end 2010) 41

4.7.     Households'
financial burden indicators 41

4.8.     Interest
burden, households 42

4.9.     Median debt
service to income ratio, all indebted households 42

4.10.   Negative home
equity mainly found in younger households 43

4.11.   Interest
charges by age category (% of homeowner's household income as at 1/1/2011) 43

4.12.   Debt to
income ratio, all indebted households 43

4.13.   Cumulative
distribution of fixed interest rate period and remaining fixed interest rate
term in years (% of total number mortgages) 44

4.14.   Non-performing
loans 44

4.15.   Pension funds'
balance sheet (billion EUR) 45

4.16.   Insurance
companies' balance sheet (billion EUR) 45

4.17.   Balance
Sheet, financial corporations 47

4.18.   Development
of the deposit funding gap (billion EUR) 47

4.19.   Savings,
mortgage debt and securitisation of mortgages since 1970 (billion EUR) 48

LIST OF Boxes

3.1.     Housing
market-related measures 36

4.1.     The National
Mortgage Institute  49

5.1.     A Current
Account norm for the Netherlands 53

LIST OF Maps

No table of contents
entries found.

In April 2013, the Commission concluded
that the Netherlands was experiencing macroeconomic imbalances, in particular
as regards developments related to the current account surplus, external
competitiveness and public and private indebtedness. In the Alert Mechanism
Report (AMR) published on 13 November 2013, the Commission found it useful,
also taking into account the identification of imbalances in April, to examine
further the persistence of imbalances or their unwinding. To this end this
In-Depth Review (IDR) provides an economic analysis of the Dutch economy in
line with the scope of the surveillance under the Macroeconomic Imbalance
Procedure (MIP). The main observations and findings of this analysis are:

• The Netherlands' current account has
been persistently in surplus for over three decades. Rigidities and policy
incentives have built up over time to shape house financing, sectoral savings
and leverage patterns. Households leveraged up against housing wealth and
reduced the pool of domestic savings not earmarked for pension savings.
Disposable household income registered relatively muted gains, partly through
increases in social security contributions, taxes and contributions to pension
schemes, and came under pressure in the aftermath of the crisis. Household
savings fell markedly since the mid-1990s. In parallel, nonfinancial
corporations moved into a structural and large savings surplus. This has
contributed to the emergence of a substantial and persistent current account
surplus going hand in hand with a high level of both gross household debt and
gross household assets. The net international investment position improved,
also driven by valuation effects in the wake of the crisis.

• The Dutch current account surplus
reflects a combination of cyclical factors, alongside structural determinants
of savings-investment balances across sectors. Net energy exports have an
upward impact on the balance, mainly mirroring exports of natural gas. The role
of international capital flows, partly related to the operations of
multinational companies, along with statistical discrepancies related to the
measurement of cross-border flows seem also to account for part of the
structural surplus. In recent years, weak economic activity and deleveraging
pressures combined to push up the surplus.

• The competitiveness and export
performance of the Dutch economy appears to be benign overall. The loss of
global market share for exports of goods and services is limited in comparison
with most other mature Western European economies. This loss does not appear to
be rooted in unfavourable domestic price and cost developments, as the
indicators for these have been growing broadly in line with the country's main
trading partners and the real effective exchange rate has not shown any
particular trend.

• The funding patterns of Dutch assets
and liabilities have made the Dutch economy sensitive to fluctuations in
international capital markets. At the aggregate level, financial flows show
large simultaneous capital outflows and net borrowing from abroad, with an
uneven distribution across sectors. This increases the sensitivity of balance
sheets of some sectors of the economy to portfolio shifts and
flight-to-quality. Domestic bank balance sheets have become tilted towards
mortgages. Coupled with the comparatively low level of household savings
flowing into deposits, this has left banks with a sizeable funding gap.

• Notwithstanding mitigating
circumstances, the high level of private-sector debt, in particular household
indebtedness, warrants attention. Long-standing tax incentives and
financial sector developments have encouraged households to become highly
indebted in mortgage debt, and also had a particularly stark impact on housing
prices. Recent adjustments in the housing market, along with policy and
supervisory measures to reduce the incentives for households to take up housing
debt and lower loan to value ratios, should ultimately lead to reduce
housing-related debt and leverage ratios.  However, it will take a long time
for these adjustments to feed through. The overhang of gross household debt
remains a source of vulnerability and points to continued deleveraging
pressures in the near term, though mitigated by broadly commensurate increases
in net household assets. Substantial financial buffers with corporations also
provide cushion.

• The leveraging of household balance
sheets implies risks for both mortgage borrowers and lenders. Financing
trends have heightened the sensitivity of the Dutch economy, and especially of
leveraged households, to negative shocks, such as a fall in house prices, weak
economic growth or a real interest rate shock. Financial institutions are still
readjusting to altered market conditions and changes in regulations; the global
economic and financial crisis hampered the ability of Dutch banks to borrow in
wholesale markets. Given the importance of securitised funding, this pushed up
domestic lending rates especially for housing finance. New EU banking
regulations underscore the importance of larger buffers to absorb losses and to
restore confidence and secure market access. After almost five years of house
price falls, the Dutch housing market seems to be recovering slowly. House
price falls are decelerating. Property transactions seem to be recovering,
albeit modestly. On the rental market, rent increases have become more
pronounced than in recent years. Surcharges are being used to encourage tenants
with high incomes, remaining in the regulated rental segment, to move into
private rental or owner-occupied homes.

• In addition, current housing policies
have implications for public finances, notably in terms of foregone tax
revenues and of the implicit liabilities stemming from housing-related
guarantees.

The IDR also discusses some policy
challenges stemming from these developments and possible ways forward. A number
of elements could be considered:

• Recent sluggish productivity increases
and the low value added of re-exports underline the importance of focusing on fostering
innovation and competitiveness. Cyclical effects, finance bottlenecks,
continuing uncertainty and the impact of (expected) balance sheet adjustments
all seem to play a role in the relatively low domestic rate of capital
formation, yet there may also be a structural element at play. For firms, the
challenge is about rethinking the balance between home and foreign investments.
A balanced adjustment of saving, expenditure and investment patterns across the
Dutch economy would have a beneficial effect on the domestic investment climate
and growth potential, hence improving economic prospects in the long term.

• Making use of the existing room in the
institutional framework to allow for more differentiated wage increases could
help support household income. The depth and the protracted nature of the
slump since the crisis imply that more robust income developments in households
could support the recovery and rebalancing of the economy. Naturally, such an
approach would have to take due account of the situation of firms as regards
productivity, profitability and prevailing buffers so as not to weaken their
viability or competitiveness. Reversing trends in social security
contributions, taxes and pension premiums, which seem to have played an
important role in dampening disposable household income in recent years, would
also help.

• The overhang of gross household debt
remains a source of vulnerability, though mitigated by broadly commensurate
increases in net household assets. Ongoing policy and supervisory measures
to reduce the incentives for households to take up housing debt and lower loan
to value ratios should ultimately lead to reduced housing-related debt and
leverage ratios. However, existing debt overhangs may require a long adjustment
period. The regulatory measures, in particular the limitation of mortgage
interest deductibility, are strongly back-loaded and discriminate new versus
existing mortgage loans.

• Not all rigidities in the housing
market have been corrected, including those that have prevented the emergence
of a functioning private rental market of appropriate size. The private
rental market is still not functioning fully and there are still inefficiencies
concerning the allocation of social housing to dwellers in need. It is
important to keep up and advance the pace of reforms of the housing market by
improving the functioning of this segment and reducing inefficiencies and
dead-weight losses associated with the operations of social housing
corporations.

On 13 November 2013, the European
Commission presented its second Alert Mechanism Report (AMR), prepared in
accordance with Article 3 of Regulation (EU) No. 1176/2011 on the prevention
and correction of macroeconomic imbalances. The AMR serves as an initial
screening device, which helps to identify Member States that warrant further in
depth analysis to determine whether imbalances exist or risk emerging.
According to Article 5 of Regulation No. 1176/2011, these country-specific
“in-depth reviews” (IDR) should examine the nature, origin and severity of
macroeconomic developments in the Member State concerned, which constitute, or
could lead to, imbalances. On the basis of this analysis, the Commission will
establish whether it considers that an imbalance exists and what type of
follow-up it will recommend to the Council.

For the Netherlands, the AMR suggested a
need to look more closely at whether the country is exhibiting macroeconomic
imbalances of an external and internal nature. On the external side, the AMR
highlighted a long series of large current account surpluses, which coincided
with a loss in market shares in recent years. On the internal side, the high
level of private debt was identified as a potential concern, mainly since
household indebtedness had built up in the context of past increases in house
prices. Recent years have witnessed falling house prices, with an impact on the
real economy through negative wealth and confidence effects. Despite signs of
stabilisation, household indebtedness remains very high. This IDR provides an
economic analysis of the Dutch economy in line with the scope of surveillance
under the Macroeconomic Imbalance Procedure (MIP).

Against this background, Section 2 of this
in-depth review looks into macroeconomic developments. Section 3 focuses
specifically on the imbalances and risks. Section 4 discusses specific topics.
Section 5 concludes with policy considerations.

2.1.      The
macroeconomic situation in perspective

At the current juncture, the Netherlands is
expected to gradually emerge from a protracted recession, largely due to feeble
domestic demand. According to the Commission Winter 2014 forecast real GDP
growth is expected to be positive in 2014, at 1%, from -0.8% in 2013 and to
strengthen further in 2015. The current state of the Dutch economy and its
outlook are shaped by the mutual interaction of structural and institutional
settings which define its adjustment trajectory. This section starts with a
brief introduction to some important structural features of the Dutch economy
that determines some of the outcomes (such as sectoral debt trends and the
external accounts that are the focus of the investigation into potential
imbalances).  The household sector plays a key role in accounting for trends in
sectoral and national savings, expenditure and financial flows, hence the
choice to begin with a brief sketch of some of its main characteristics. Also
interactions with sectors such as nonfinancial corporations and financial
institutions, which are briefly touched upon subsequently, determine the
macroeconomic situation. The section ends with a brief summary of the short
term macroeconomic outlook for the Netherlands.

Household Sector

For the household sector, income flows,
wealth accumulation and saving-and-expenditure decisions are to a large extent
shaped by the institutional environment. A feature
is the long-standing tradition of institutionalised dialogue between social
partners, reflected in several entities where social partners interact with
politics, exercising formal responsibilities and having a great influence in
areas such as the labour market, including wage determination, social security,
and the pension system. Prevailing institutional arrangements often find their
origin in the period of reconstruction right after the second World War or even
earlier (notably the 1930s). The institutional set-up defines important
regulatory parameters but is partly also mirrored in behavioural patterns of
economic agents.

The Netherlands has a three pillar
pension system with a large second (occupational) pillar([1]), which resulted in a strong gross and net asset position of Dutch
households. A large number of dedicated pension
funds manage pension savings of almost 150% of GDP, with a large degree of
international diversification of financial assets. Premia to the second-pillar
pension funds are an important item in the household accounts and depend on the
coverage ratio of assets to liabilities. Thus, they tend to respond to
(cyclical) conditions in financial markets and due to their procyclicality they
also have an important influence on household disposable income and thus the
cycle.

Next to pension savings, housing wealth
forms a substantial part of household balance sheets. Home ownership has been stimulated through several policies; in
particular mortgage interest deductibility (MID) which had its origin in the
1890s and until recently was not capped. There is also a public mortgage
guarantee scheme (NHG). The way the banking sector leveraged financial
incentives in the housing market led to high loan-to-value (LTV) ratios. MID
and associated financial products gave people the incentive to take on large
interest-only mortgages, which has resulted in long balance sheets of
households, domestic bank lending portfolios skewed towards domestic mortgages,
and a high gross debt level of households. Recently, policies have been enacted
to mitigate these leveraging incentives (see section 3 for an elaboration).
Other institutional characteristics, notably spatial regulation and governance
in the rental market also have a large impact on the housing market. Due to
spatial restrictions, partly reflecting geographical features of the
Netherlands, the supply of new houses could only weakly respond to increasing
demand in the run-up of the crisis, translating increasing borrowing capacity
into a long period of steadily increasing house prices (Graph 2.1), which only
did reverse with the financial crisis, although not resulting in similarly
sharp drops as experienced in other countries.

Home ownership is also indirectly
supported by a malfunctioning rental market. The
rental market is dominated by a large social housing segment which in effect
crowds out the private rental market. Even though a third of all dwellings are
owned by social housing corporations, long waiting lists still exist due to
misallocation of houses, reflecting prevailing regulations. In particular,
housing corporations have limited options to enforce mobility of their tenants
in function of changing incomes. These features of the rental market provide a
strong incentive for people into buying their own property. Labour mobility is
restrained by the way social houses are allocated. This impedes an efficient
allocation of human capital and negatively impacts employment, especially of
the lower-skilled.

Financial and corporate sectors

A large financial sector and the
presence of many multinationals shape the economy, the current account and
financial flows going through the Netherlands.

The Netherlands has one of the largest
financial sectors in the EU In terms of its balance sheet relative to the GDP. Two of the four largest banks are currently state-owned and a third
one received government support. Restructuring of the sector, also in light of
new regulations, is ongoing and capital bases are strengthened. This is needed
to improve the resilience of the financial sector. The financial sector has
been deleveraging for a few years in light of financial and economic trends and
new financial regulations. Changes to the housing market in particular are
expected to positively influence the composition of banks' balance sheets in
terms of reducing mismatches. The financial sector is not only highly exposed
to domestic mortgages, but also to a sizeable funding gap, due to fiscal
disincentives to save and a pension system that collects substantial savings
outside the banking sector (see section 4).

Additionally, the Netherlands has been
home to multinationals and has actively welcomed foreign companies to set up
their global headquarters in the country.
Multinationals are attracted by a favourable legal framework and a beneficial
tax treatment([2]) of
repatriated foreign income, which partly seems to determine the size and
direction of associated financial flows. The absence of withholding tax on
outbound royalties and interest payments and the fact that the Dutch tax
administration gives clarity in advance on the tax consequences for such
activities has contributed to companies being registered in the Netherlands,
even without having a substantial physical presence there. This generates gross
financial flows which are channelled through the Netherlands via special
purpose entities. The associated gross financial flows currently amount to more
than three times the GDP of the Netherlands.

These headquarters do not only serve as
a transit point for international capital flows to other jurisdictions, but
also generate profits that are far above the EU average. As Foreign Direct Investment (FDI) outflows have increased,
investment earnings in the form of profit remittances received from foreign
operations have also grown substantially.

Employment and labour costs

Exports remain strong on the back of a
fundamentally competitive economy. A favourable
geographical position, a long tradition of integration in global trade and an
increasing importance of re-exports (reflecting the integration of the Dutch economy
in global value chains) support exports. Although the direct relation between
export performance and wage developments is weak at best, the Netherlands has
had for decades a strong and institutionalised tradition of supporting
competitiveness through wage moderation. Since the beginning of the crisis the
decreasing purchasing power of households resulted in decreasing private
consumption, as simultaneous deleveraging pressures started to be felt. Apart
from employment trends the recent muted development of household disposable
income partly reflected increases in taxation and pension premia, negative
wealth effects and partly subdued wage developments.

A broad welfare system and favourable
labour market developments in the decades before the global financial crisis
have had a positive impact on social indicators.
This broadly holds, even though the labour market situation has worsened since
the beginning of the crisis. The unemployment rate was 5.3% in 2012 and has
risen further to 6.7% in 2013, mainly on the back of weak internal demand.
Poverty and social inclusion indicators also still show strong readings in
comparison to most other Member States. Important reasons for the relatively
low level of unemployment are good education that matches the needs of the
labour market, an efficient system of private employment services, a widespread
use of flexible labour contracts and the availability of part time work
(including child care facilities). Some of these features have become under
pressure recently, e.g. by planned measures to reduce the flexibility of
flexible contracts, which is intended to increase job security of people with a
flexible contract, but, in times of rising unemployment, could also lead to an
increasing number of dismissals.

2.2.      Short-term
outlook

The institutional setup of the
Netherlands as sketched above, in combination with adjustment dynamics, policy
choices and deleveraging needs (mainly of households, banks and the government)
are important forces behind the weak near-term economic outlook. Following a contraction in real GDP in 2013 of 0.8%, an increase of
1% is expected for 2014 with economic growth accelerating to 1.3% in 2015. The
fragile transition towards positive growth in 2013 was chiefly supported by net
exports. By contrast, domestic demand remained a drag on activity, despite
gross fixed capital formation rebounding in line with an improved business
outlook, and is projected to remain sluggish in 2014. Private consumption will
be still held back by the unfavourable development of employment and the
incurred negative wealth effects over the past years. In 2014 domestic demand
is expected to gradually move towards positive territory and to overtake net
exports as the main growth driver. In particular, investments are picking up,
especially in the private sector. Investment is forecast to veer up on the back
of a recovery in production and profitability. The recent rises in the capacity
utilisation rate, coupled with improved producer confidence, support this
outlook. Existing cash buffers at large companies, but also to some degree at
SMEs, should enable firms to finance investments even in an environment of bank
deleveraging. Additionally, larger companies increasingly tap the capital
market directly to finance investments. So, overall financing constrains do not
appear to be a major factor in holding back a recovery in economic activity.

The positive effects of a recovering
housing market would not suffice to offset the still weak real disposable
income and adverse labour market trends in the near term. Even though the total net asset position of the household sector
is getting even stronger, mismatches in its composition and distributional
effects still imply an overall drag on macro-economic activity. Negative and
decreasing housing equity has encouraged households to deleverage. With
previous LTV ratios often markedly exceeding one and given decreasing house
prices, in particular younger households try to avoid negative housing equity.
This implies an incentive to pay back debt, a development supported by low
interest rates and comparatively high tax rates on savings.

Deleveraging is gaining pace with credit
flows to the private sector (excluding the government) having come to a
standstill. Credit flows have been decreasing
strongly compared to pre-crisis years but flows have virtually dried out in
2012 if the government is excluded (Graph 2.2). With a lagged effect this will
strongly influence the gross debt position of the private sector. Weak internal
demand and deleveraging of households and other sectors explain a current
account surplus that is forecast to reach around 9% of GDP in 2014 and 10% of
GDP in 2015.

Part of the current account surplus is
explained by the cyclical position of the Dutch economy, especially weak
domestic demand. The cyclically-adjusted current
account surplus is estimated to be 6.4% in 2013 (Graph 2.3). In the medium term
the surplus is expected to decrease on the back of increasing consumption and
investment expenditure. But due to deleveraging pressure that will persist for
years to come, this decrease will be decelerated by the deleveraging that is
happening in the household and government sectors. As long as households, the
financial sector and the government are proceeding with the necessary
deleveraging, the current account surplus will remain artificially high.

Access to finance remains a challenge,
in particular for SMEs, but overall its negative impact seems limited. According to the most recent ECB survey([3]), 20% of SMEs name access to finance as their most pressing
problem, one of the highest percentages in the EU. For the moment the negative
impact on an aggregate scale of this situation appears to be limited due to the
fact that many SMEs are currently not in need of external financing, a
situation that can be expected to change if the economy stays as weak as
projected. To what extent this worsened situation is the result of a weaker
economic environment or rather of deleveraging of banks is difficult to tell
but has a strong influence on the prospects for economic recovery. However, as
banks are mainly deleveraging through retained profits, selling assets and the
issuance liabilities that count for some equity ratios and the fact that many
SMEs recently had to change bank - and usually applied at different banks for
loans - with a resulting push in rejection rates, the overall supply of credit
does not seem to be a major constraint to a recovery as such. Furthermore,
large corporations and dynamic SMEs still have enough sources of funding to
sustain an increase in investment. Additionally, the virtual disappearance of
interest-only mortgages from the mortgage market and the resulting shrinkage of
the mortgage portfolio of banks should, in the medium term, free up assets and
capital to provide credit for more productive sectors of the economy.  However,
the overhang from existing financing structures will take some considerable
time to adjust.

The unemployment rate is expected to
increase and the government budget deficit to stay around 3% of GDP. The unemployment rate is expected to increase from 6.7% in 2013 to
7.4% in 2014 and 7.2% in 2015. With weak internal demand, rising unemployment
and positive developments mainly coming from (relatively tax-poor) exports, the
general government deficit is expected to come out at 3.1% of GDP in 2013 and
3.2% in 2014. In 2015, the deficit is forecast to fall to 2.9% of GDP on
unchanged policies. Youth and long-term unemployment follow a similar pattern:
9.5% of the youth was unemployed in 2012 and this has risen to 11.5% in the
third quarter of 2013 (Graph 2.4). Nevertheless, the Not in Education,
Employment, or Training (NEET)-rate (6.2% in 2012) remains one of the lowest in
Europe. Although the long-term unemployment rate (1.8% in 2012) is less than
half of the EU-average (4.7%), it has been increasing with a higher magnitude
in the first two quarters of 2013.

The ratio of people at risk of poverty
and social exclusion to the whole population has been decreasing since 2005, stabilised since 2008 (Graph 2.5) and is well below the EU-average
(24.8%). Likewise, severe material deprivation for the total population remains
at very low levels (2.3% in 2012) but has somewhat increased since the onset of
the crisis. The decreasing ratio of average incomes of the last and first
quintile of the income distribution does not show any increase in income
inequality due to the weak economic situation.

Risks to this short-term outlook are
slightly on the downside. Uncertainties on the
policy side regarding the implementation and effects of foreseen measures in
areas such as pensions or the decentralisation of competencies to
municipalities may hamper the recovery of domestic demand. However, a faster
stabilisation of the housing market could provide an additional boost.

2.3.      Long-term
effects of selected reforms

Since the beginning of 2013, interest
payments on new mortgages are only tax-deductible in the case of annuity or
linear mortgages. The full effect of this measure
will only be seen gradually, given the large outstanding stock of existing
mortgages. This notwithstanding, in the medium to long run, changes to the
fiscal treatment of housing loans will not only have a positive effect on the
government's budget but will also reduce the funding gap of banks and could
facilitate the renewed use of securitisation as a financing instrument going
forward. As instalments for new mortgages include the repayment of principal,
this measures will also positively influence the gross debt position of households
and help contribute to shortening their balance sheets.

Under plausible assumptions about future
economic growth, house prices, etc., scenarios can be sketched of how the
private sector debt ratio (as % of GDP) is likely to develop under the new tax
regime.([4]) Graph 2.6 summarises the results of this scenario analysis.
Historical data are used until 2012 (highlighted by a vertical line) with two
alternative subsequent scenarios after 2012. The first scenario is the
no-policy-change benchmark. In this (hypothetical) case, private debt would
continue to rise and stabilise around 260% of GDP. The second scenario is one
which takes into account the recently implemented changes to the fiscal regime
governing housing loans (but not the recent decline in credit flows as
discussed above, this is assumed to be mainly cyclical). In this case the
private debt ratio is expected to initially increase further before steadily
decreasing to around 140% of GDP in 2060. In the short term, old and small
mortgages are replaced by larger mortgages (even though house prices recently
decreased, they are still much higher in nominal terms than 30 years ago),
resulting in a short-term increase of the debt-to-GDP ratio. In the medium
term, the “annuity effect” dominates and the private debt ratio (in % of GDP)
decreases significantly.

Under the policy change scenario,
private sector debt is expected to be more than 120 pp of GDP lower in 2060
than under a no policy change scenario. This
long-term deleveraging of the private sector will impact inter alia internal
demand, economic growth, financial stability and the current account position.

This chapter focuses on the two main areas
relevant to the identification of potential imbalances: the current account
surplus, and the level of private (in particular household) debt, also with
reference to the MIP scoreboard. The approach followed for the analysis of the
current account balance stresses underlying determinants in terms of sectoral
savings patterns and characteristics of income formation in the household
sector, with special reference to labour market institutions. These
collectively are underlying determinants of the current account balance (and of
leverage patterns), and for this reason any structural issues, bottlenecks or
risks originating there are relevant in discussing the Dutch surplus. As
regards determinants of private sector debt, the housing market and housing
debt of households plays a central role. Associated vulnerabilities and risks
are also discussed.

3.1.      Current
Account

The Netherlands has recorded persistent
current account surpluses for over three decades and currently has one of the
highest in the euro area. The surplus on the
current account, which had averaged around 5% of GDP during the 1990s,
increased to some 6% of GDP during the 2000s, and reached a record of 9.5% of
GDP in 2011. According to the MIP scoreboard headline indicators, the 3 year
average of current account balances over 2010 – 2012 was 8.8% for the
Netherlands. The Commission services Winter 2014 Forecast indicates a slight
decrease of the current account surplus in 2014, followed by an increase to
just around 10% of GDP in 2015.

The current account surplus has mainly
been driven by a large positive goods trade balance, with the contribution of other components being relatively small (Graphs
3.1 and 3.2).

The positive trade balance in goods has
increasingly mirrored the contribution of re-exports([5]), which have grown spectacularly due to a combination of the
on-going globalisation and the rise of 'global production chains'. In 2013
re-exports accounted for roughly one half of the Dutch goods balance compared
to one third in 1995. They contributed some 2 percentage points to the total
current account surplus.

The geographical location of the
Netherlands (with the port of Rotterdam being a trade gateway to Germany) and a
competitive transport and logistics sector accentuate the shifts towards
re-exports (Netherlands Bureau for Economic Policy Analysis, 2007). The
relative underperformance of domestically-produced exports can partly be
explained by differences in product mix. Domestically-produced exports are
dominated by agricultural products, foodstuffs, chemical products, rubber and
plastics, machinery and transport equipment. By contrast, computers and
electronic equipment account for nearly half of re-exports while re-exports
account for around two thirds of the total exports of machinery and transport
equipment. Since global demand for agricultural products and foodstuffs tends
to grow less rapidly than the world markets for electronic and
telecommunications equipment, the percentage share of Dutch
domestically-produced exports in world trade is falling.

Net exports of natural gas constitute
another, albeit limited, structural factor adding to the surplus, accounting for about 1 to 2.5 pp of GDP. This contribution mainly
reflects the combined net exports of domestically-produced gas and the
associated reduced need for energy imports. Additionally, the Netherlands has
become an important node in the intra-European gas trade. The importance of the
natural gas production to the Dutch economy is bound to gradually fade as
domestic reserves are being depleted. In early 2014 production ceilings were
put in place in order to mitigate the sensitivity to gas production-related
earthquakes in the northern province of Groningen.

Since 2004 the income and services
balances have to a large extent driven changes in the current account balance. The services balance had been negative for several years before
turning positive in 2004. Moreover, the dividend policy of Dutch multinationals
appears to have created an upward bias on the current account([6]). In addition, investment income in the form of profit remittances([7]) has become an increasingly important contributor to the surplus
due to increases in profits repatriated by foreign subsidiaries of Dutch
enterprises. Such repatriated profits increased from 1.1% of GDP in 2004 to
4.7% of GDP in 2011. A large share of total cross-border profits are earned by
listed multinational companies. Dividend payments by these companies to foreign
investors, which reduce the balance on the income account, have remained broadly
constant since 2007 (around 0.8% of GDP). Data limitations, partly linked to
statistical confidentiality, limit the extent to which more light can be shed
on the role of multinationals and possible associated upward biases to the
measured current account balance.

3.1.1.   Trade
Linkages

The Netherlands has been strengthening
its position as an international trading hub for goods flowing into the
European markets. Graphs 3.3 and 3.4 show the
increasing trade in intermediate goods, underlining the increased importance of
global value chains for the Dutch economy. Graph 3.5 shows that imports from
outside the EU account for almost half of total gross imports, whereas roughly
three quarters of gross exports are directed towards the EU.

The most important trading partners are
traditional ones such as Germany, Belgium and the United Kingdom. An increasing share of imports stems from emerging markets such as
the People’s Republic of China and Russia, underlining the increased importance
of global value chains and the Dutch role therein. EU Member States which
acceded since 2004 have an import share of below 5%. The combined import share
of southern EU countries (Spain, Italy, Portugal, and Greece) is also
comparatively small, at slightly above 4%.

Goods exports are strongly geared
towards Germany, with a share of almost 25% (Graph
3.6). The share of emerging markets in direct gross exports is still very
small: only 1.8% of all exports goes to China and 1.6% to Russia.

Gross imports and exports of services
show a slightly different geographical orientation (Graphs 3.7 and 3.8). Around half of all registered direct imports of services come from
other EU Member States, mainly the United Kingdom, Germany and France. The main
import markets from outside the EU are the USA and the British Overseas
Territory Bermuda and Switzerland. The combined share of services imports from
southern European countries (Spain, Italy, Portugal, Greece) accounts for only
6.3% of the total. Services exports are more strongly tilted towards the EU, with
Ireland, Germany and the United Kingdom being the main export markets.

The
Netherlands has been using its position as a trade hub for goods to secure a
share of profits from trading these goods. Apparently, the Netherlands is
able to extract added value from this trade that goes beyond pure transit. This
partly also accounts for the increasing positive contribution of the trade in
services to the surplus. However, the gross trade flows do not allow to trace
the ultimate origin and destination of goods or services trade. For that, and
to fully assess the linkages via global value chains, one would have to take
into account the input-output structure of the economy. Moreover, the data
available do not distinguish domestically produced exports and re-exports.

Export market shares have been under
pressure in recent years (Graph 3.9) but this
development is in line with other developed economies that lose market share to
developing economies.

Trends in competitiveness

Price and cost competitiveness
indicators show some deterioration in competitiveness from 1997 to 2002, and
point to stabilisation since. Standard indicators
do not reveal any strong tendency of competitiveness measures in the last
decade or so (Graphs 3.10 to 3.13).

Until the early 1980s, unit labour costs in
the Netherlands had increased at a faster pace than in its main competitor
countries. This had led to a deterioration in profitability and competitiveness
which was followed by a prolonged period of wage moderation. During the period
1980 to 1999 unit labour costs rose only by around 26% in the Netherlands vs.
67% in Belgium, 42% in Germany and 78% in France. From 2000 to 2010, unit
labour costs rose by around 24% overall in the Netherlands, which is somewhat
above the 22.5% increases in France and Belgium, but markedly above the 4%
increase in Germany over the same period. Since 2011, nominal unit labour cost
increases have been moderate, as has real compensation per employee (graph
3.14).

3.1.2.   Domestic
Savings and Investments

The current account balance ultimately
reflects the outcome of saving and investment decisions of domestic sectors. The most striking development in the sectoral breakdown of the
Dutch current account balanced (Graph 3.15) is the switch from a significant
savings surplus emanating from households towards a savings surplus of non-financial
corporations from the late 1990s onwards. One important explanatory factor for
this shift is the increase in financial leverage of households, largely
reflecting trends in housing and mortgage markets. On aggregate, the corporate
sector currently accounts for the lion's share of the savings/investments
balances at sectoral level that determine the current account surplus.

Households

For many decades Dutch households
recorded a sizeable saving surplus (Graph 3.16).
Traditionally, virtually all of household net saving took place through the
pension funds which manage the assets accumulated in the second pillar
(occupational) pension scheme. However, increasing household leverage and debt
service, mainly related to housing debt, led to a shift in this pattern. This
led to a trend decline in the savings surplus. Since 2002, total savings of
Dutch households have been below the euro area average([8]). From 2005 onwards, the household net lending position even turned
into a deficit, before turning into slight surplus again since 2011. Since the
onset of the crisis increases in pension premia, taxes and social
contributions, coupled with muted wage increases, held back net disposable
household income.

Non-financial corporations

Non-financial corporations have shown a
persistent savings surplus (Graph 3.17). The excess
of gross corporate saving over fixed investment widened since the late 1990s,
mirroring a roughly equivalent rise in gross saving and a fall in gross fixed
capital formation. Since 1998 the non-financial corporate sector has run an
increasing savings surplus which is the main factor behind the overall current
account surplus. Corporate savings have been higher than in other surplus
countries while domestic investments have been at a broadly similar level and
have been decreasing in recent years, chiefly in construction. Residential
investment has dropped to particularly low levels as the housing market turned.

Sluggish capital formation may partly
reflect a capital saving bias in fixed investment related to new technologies. Cyclical weakness also accounts for part of the aenemic business
investment observed in recent years. To some extent a substitution of domestic
capital formation with outward foreign direct and portfolio investment may have
been at play. Non-financial corporations have used direct investments to
penetrate new markets or to achieve efficiency gains through redirecting value
chains. However, it is unlikely that this was a full offset.

It is not clear to what extent foreign
capital flows represent “round-tripping”. Indeed,
FDI data are affected by specific transactions generally take place via
intra-company channels. Such inter-company transfers often lead to profit
shifts between countries. Against this background, part of gross FDI flows are
likely to mirror the strong presence of multinational companies residing in the
Netherland. The net measured impact on the balance of payments of
outward FDI results from subtracting the FDI outflow from all the positive
flows associated with the outflow, mainly repatriated profits, dividends and
interest (on the income account), and net receipts of royalties and license
payments (on the services account).

Strong corporate savings reflect
increasing profit shares, and likely have been partly related to higher profits
received from foreign operations. Dutch
multinational companies make a large contribution to the Dutch current account
surplus as registered in the official data because part of their earnings are
retained and reinvested, rather than being paid out as income to foreign
portfolio investors, thus driving measured corporate savings. Profit
remittances (both distributed and non-distributed profits or reinvested
earnings) realised abroad through foreign subsidiaries are accounted for as
income attributed to the Netherlands.([9])

It is possible that this implies some
upward impact on the registered current account balance. The exact size of such impact is difficult-to-assess, however.
Graph 3.20 shows that the profits generated by Dutch (multinational) companies
are far above the EU average, especially those that are retained. The
Netherlands is relatively sensitive to this effect (Dutch shares in foreign
hands amounted to 55% of GDP in 2011 compared to only 20% in Germany and 15% in
the United States). Dutch pension funds, by far taking the lion's share of
Dutch shareholders' interests in foreign companies, counterbalance this upward
effect to a limited extent only, since distributed dividends are attributed as
revenue to the Netherlands.([10])

Labour market arrangements

Wage developments and wage setting
institutions are an important determinant of household income. Households use their income to spend, pay taxes and/or social
security contributions, deleverage and/or change the share of savings dedicated
to pensions. This contribution can only offer an initial assessment of the of
wage and income developments in the household sector and their possible wider
ramifications for competitiveness, sectoral balance sheet position and growth
determinants. It should be stressed at the outset that it is very difficult to
provide quantitative or normative benchmarks for what constitutes a balanced
and optimal path for labour remuneration, taxes and profits. Feedback effects
from the cycle, considerations of dynamic efficiency, global determinants of
competitiveness, and technological innovations all play a role in determining
the outcome.

Historically, social partners have been
fully in charge of wage agreements and guiding sector-specific agreements from
a central level. The process of agreeing to the
around 700 wage agreements is very formalised and starts at a centralised
level. Social partners meet at the Stichting van de Arbeid (“Labour
Foundation”) to come to a central agreement that provides general guidelines
for the sectoral negotiations. The outcomes of these can then be declared
binding for an entire sector or industry.

The Netherlands embarked on a wage
moderation strategy in the early 1980s, following
the Wassenaar agreement, reached in 1982 between employers' organizations and
trade unions. The agreement implied restrained wage growth in return for the
adoption of policies to combat unemployment and inflation, such as reductions
in working hours and the expansion of part-time employment.

Wage developments in recent years have
had different driving forces, but there may be some institutionally embedded
tendencies to yield aggregate wage moderation. Weak
cyclical conditions in the aftermath of the crisis implied moderate wage
increases which, coupled with rising unemployment, translated into muted gains
in the contribution of wages to household income. Multiannual nominal wage
freezes in the public sector added to this. This was compounded by procyclical
increases in taxes and pension premiums, which led to real wages falling.

The wedge between labour costs and labour
income

The labour income share of GDP([11]) has been roughly constant since the mid-1980s despite cyclical fluctuations (Graph 3.21), at first sight
indicating that wage developments have been broadly in line with productivity
in the aggregate. As noted above, this is confirmed an assessment on the basis
of standard price and cost competitiveness indicators.

Nevertheless, the share of household
disposable income in GDP decreased substantially in the last twenty years. Whereas, in 1992, disposable income still accounted for more than
54% of GDP, that share has dropped to somewhat below 45% in 2012([12]). Growth of disposable household income in the Netherlands has been
lagging behind growth of the GDP for two decades. To an extent this is an
opposite movement as witnessed for non-financial corporations, which registered
significant increases in its income share. If part of corporate surpluses had
been distributed as dividends in full, disposable income of households and other
shareholders could have been higher.

An increasing part of the income earned
in the country accrues to households in a different way. Higher pension contributions played a role, although they, of
course, ultimately will benefit households. The government also has a larger
income share than twenty years ago, which is mainly being spent on higher
individual government consumption. The goods and services in question, for
instance education and healthcare, are financed collectively. Whereas
individual government consumption accounted for some 12.5% of GDP in 1992, this
had increased to 17.5% of GDP by 2012. This is mainly due to the sharp increase
in collective healthcare spending after the turn of the century.([13]) The pension contributions paid by employers and employees doubled
(from 3 to 6% GDP) in fifteen years’ time.

Since the crisis, gains in disposable
income for households have come under pressure, weighing on purchasing power. Partly this was due to rises in the burden of taxes, social and
pension premia, partly to moderate wage developments. Social security payments
(by employers and employees) accounted for slightly above 45% of total gross
household income in 2009 but have increased to almost 50% in 2012.([14]) Falling income of self-employed, rising unemployment, increasing
energy prices, and negative wealth effects have added to the already existing
pressures. Going forward, deleveraging pressures on household balance sheets
may continue to burden household disposable income in the near term.

Patterns in wage differentiation

Overall, wage costs have developed
broadly proportionally to gross value added and wage differentiation has
increased slightly since the mid-1980s. The
coefficient of variation of average hourly wages across different main industries
of the economy (standardised by the economy-wide average hourly wage) has
increased since around 1987, when it had reached its lowest level since 1969
(Graph 3.22). However, the overall degree of wage dispersion appears to have
remained fairly low. This is a crude measure of wage dispersion as hourly wages
are influenced by, for example, wage agreements, industry structure the skill
composition and incidence of part-time work, and changes in the share of
self-employed. The modest tendency towards more dispersion seems to have abated
since the onset of the global financial crisis.

There is not much wage dispersion across
subsectors. The coefficient of variation across
subsectors within the main branches of industry has remained fairly stable
since 1987 (see Graph 3.23([15]). This
indicates that, as the variation of average wages within subsectors appears to
have remained broadly constant, the variation between main industries has been
the driving force behind the overall still modest increase in the wage
differentiation as depicted in Graph 3.23.

It is striking that wage increases do not
vary much across subsectors. Even though in the existing institutional
framework social partners have a lot of freedom in negotiating collective
agreements, it seems that they do not fully use the room they have to negotiate
wage increases that differentiate more according to productivity and
profitability differentials across subsectors (industries defined at lower
aggregation level) or even large firms. Changes in hourly wages are to a large
extent determined by the currently around 700 collective wage agreements that
cover approximately 80% of the workforce. These collective agreements often are
legally binding within the industries for which they are concluded. The
standardised variation of wage increases across subsectors has experienced some
peaks in recent years but has the tendency to return to a level that seems to
have remained relatively stable since the beginning of the century (Graph
3.24).

The prevailing low degree of variation
of wage agreements contrasts with observed substantial differential
productivity developments across industries. Graph
3.25 shows that the average agreed yearly wage increases were around 2% in all
industries([16]), despite
substantial differences in the increase in gross value added and net operating
surplus. This observation holds when examining the relationship over time.
Graph 3.26 shows the same variables for manufacturing since 2001. Statutory wage
increases closely followed the overall increases agreed to across industries
and appear to respond fairly weakly to the cyclical position of the economy,
given customary lags.

One reason for the strong correlation of
collectively agreed wages across industries is that under prevailing
arrangements wage changes within sectors or industries are often evened
out by the binding nature of collective wage agreements. This reduces the scope for wage differentiation across companies
within sectors. Currently around 13% of all employees are subject to a
mandatory sector-wide wage agreement, even though their company is not directly
involved in the bargaining process among social partners. This percentage is
substantially higher for people outside the government and government-related
sectors, such as education and health care. For example, the share is 28.7% in
the agricultural, 26.1% in the construction, 22.5% in the transport and
communication and 19.7% in the for-profit services industries.([17])

A larger differentiation of wage
increases across firms and industries, with a closer alignment to productivity
increases, might provide a stronger incentive for reallocation of production
factors, increasing the overall efficiency of production. Moreover, exploiting wage differentiation opportunities while
aligning to productivity more fully might allow a more differentiated support
to the purchasing power of households without jeopardising the viability or
competitiveness of firms. Naturally, such an approach would have to take due
account of the situation of firms as regards profitability and prevailing
buffers, implying a truly decentralised approach. Possibly, in the Netherlands
the deeply engrained and institutionally embedded tendency towards wage
moderation has yielded an unintended aggregate outcome in the aftermath of the
crisis, in which households did receive less support from employment income
than otherwise could have been the case. Given the prevailing deleveraging
overhang, this does not mean that private consumption would have been much
higher. This also does not imply that there is no cyclical sensitivity of
labour costs to the cycle. There is (see below). An undifferentiated wage
impulse could negatively affect employment and weaken the viability of firms in
vulnerable industries. Yet more robust income developments for households could
help support domestic demand in an environment of protracted economic downturn.

At the aggregate level, labour
remuneration is responsive to the cycle. Flexible
elements of remuneration increase the degree of wage differentiation somewhat.
Wage agreements often include so-called 'incidental' or discretionary payments,
sometimes connected to collective or individual performance. In 2012, around
30% of all wage agreements included such payments. Most of these also included
additional or non-recurring payments linked to individual (or somewhat
collective) performance. Around 15% of all employees are subject to such
schemes. All in all, economy-wide agreed wage increases are quite responsive to
the cycle, in spite of a low degree of dispersion, as can be seen from Graph
3.27. Incidental payments account for around 10% of the total wage increases.
The figures suggest a procyclical correlation with aggregate wage increases,
but a fairly small overall effect of incidental components.

The incidence of incidental payments
correlates somewhat with nominal unit labour costs
(Graph 3.28). When unit labour costs increase, incidental payments are usually
higher as well. This reflects the fact that incidental payments are usually
agreed to be between 5 and 10% of the agreed wage increase. Since 2001 the
importance of incidental payments has been stable.

More difficult to pinpoint is whether
increased differentiation in wage setting might also increase the overall
productivity of the Dutch economy through a faster reallocation of human
capital towards more productive sectors. Currently,
labour mobility of highly-skilled people in science and technology in the Netherlands
is only around the EU15 average (Graph 3.29).

Medium-term outlook

Since the onset of the crisis, cyclical
factors have pushed up the current account surplus.
The weakness of domestic demand has been a particular feature of the Dutch
economy which had an upward impact on the headline current account surplus.
This effect should fade as a recovery sets in. Consistent with this, the
cyclically-adjusted current account surplus is estimated to be much lower than
the actually observed value (see Graph 2.3 in section 2).

Deleveraging pressures hinder an
adjustment of the current account balance. Ongoing
and simultaneous deleveraging in the financial and non-financial sectors and of
households, coupled with fiscal retrenchment, in the near term puts pressure on
internal demand and pushes up savings in the course of the adjustment process.
In light of the size of the sector and the impact of new regulations, banks are
currently deleveraging partly to meet the strengthened capital requirements.
Government deleveraging strategies aim at ensuring fiscal sustainability.
Already for a few years, non-financial corporations have been deleveraging,
mainly by reducing domestic investments. The balance sheet of these companies
has been showing a strengthening of the financial assets position in recent
decades, mainly through increases in the holding of shares and other equity
(Graph 3.18).

In the medium to long term, the
normalisation of the cyclical position of the economy, demographic changes,
easing deleveraging pressure and dwindling stocks of natural gas are expected
to lead to a significantly lower surplus on the current account. Given ongoing demographic changes, including ageing, pension funds
are likely to see a trend towards larger net pay-outs, likely to result in a
lower rate of asset accumulation. In view of the large share of international
assets in the portfolios of Dutch pension funds, this is likely to reduce the
current account surplus. From this perspective, the Dutch current account
surplus is partly an attempt to increase welfare intertemporally through the
operations of pension funds. Decreasing net exports of natural gas should also
support an adjustment of the current account in the longer term.

All this notwithstanding, the
Netherlands is very likely to maintain a sizeable current account surplus in
the coming years. For a part this should help
prepare for the demographic changes the country is currently undergoing. Moreover,
the fact that households are actively reducing their gross debt position is a
welcome development. Direct macro-financial stability risks are unlikely to
result from the surplus.

Adjustments in institutional
determinants of savings and expenditure could support a reduction in the
structural part of the surplus. For instance,
mobilising savings could support spending. Improving the scope for wage
differentiation may be another option. While overall labour costs do not appear
to have been out of line with fundamentals and did not seem to have led to a
marked change in the overall competitiveness of the Dutch economy, a higher
degree of wage differentiation could help reduce the corporate savings surplus
and support human capital formation and to some extent also improve the
purchasing power of households. To the extent that institutional changes may
help to reallocate capital to more dynamic sectors, this could also improve the
growth potential of the Dutch economy.

Net International Investment Position

Despite persistent current account
surpluses, the Dutch net international investment position (NIIP) has for a
long time remained relatively weak, also due to valuation effects. The development of the NIIP is strongly influenced by the structure
of the portfolio structure. The Netherlands has a strongly positive net
position in direct investments and a strongly negative position in portfolio
investments/ debt securities. The valuations of these types of assets have a
different sensitivity to the cycle and they have also moved in different
directions since the onset of the crisis, on balance resulting in an additional
strengthening of the NIIP in the recent years over and above the external
surpluses generated.

Swings in asset prices influence the
valuation of both assets and liabilities (see
Graphs 3.30, 3.31 and 3.32). The impact of valuation effects has become
increasingly important because the gross stocks of assets and liabilities have
been increasing relative to GDP in the last decades. Outward foreign direct
investments in particular seem to show stronger negative valuation effects than
inward direct investments.

The apparent high net stock of
international direct investments is partly the result of intra-company tax
optimisation. The engagement of firms in
international direct investments is offset by a negative net position of other
forms of investment (e.g. portfolio investments). Domestic equity and bonds are
owned to a large degree by international investors.

The NIIP across sectors is very diverse (Graph 3.33). The internationally-oriented banking sector has a
strongly negative NIIP, reflecting the international orientation of its balance
sheet. The Dutch central bank on the other hand has been involved in operations
supporting the functioning of financial markets and as a result has built up
assets, positively contributing to the international asset position. With a
debt stock that has increased substantially in the last years, the general
government adds negatively to the NIIP. The domestic private sector has a
strong and increasing positive net international asset position, chiefly on
account of strong balance sheets of households, while non-financial
corporations have a negative NIIP.

The pension system has resulted in a
strong net asset position of Dutch households and
influences financial flows and the external balance. As mentioned above,
pension assets currently amount to almost 150% of GDP. As over 80% of these
assets are invested abroad, significant international financial flows are the
result. The institutional features that constitute the foundation of the
current portfolio of international assets and liabilities are creating
financial flows that also influence the current account.

3.2.      Housing
market developments and household debt

The total mortgage debt of Dutch households
is high. However, since 2012 leverage ratios have
started to decrease slightly, despite economic contraction. This is due to a
decrease in nominal household debt, partly due to increased repayment of
mortgages. As economic growth is expected to turn positive from 2014 onwards, a
more marked decline in the household debt ratio can be expected.

Several factors contributed to the
build-up of household debt in the past decades.
First, the incentive to take out higher loans in order to take full advantage
of uncapped mortgage interest relief. Second, the rise of financial products to
maximise the fiscal benefits. Banks designed instruments to allow borrowers to
benefit to the maximum extent from mortgage interest deductibility such as
bullet-type mortgage loans which kept deductible interest high until maturity.
This allowed borrowers to postpone paying off the principal until the loan
matured. The importance of interest-only mortgages and the like soared in the
1990s. Third, the relaxation of lending standards. In the course of the 1990s
in particular, banks started taking second incomes into account to assess
borrowing capacity. In addition, high loan-to-value (LTV) ratios in excess of
100% became possible. In 2010 the vast majority (92%) of outstanding mortgages
thus consisted of non-amortising loans. Fourth, rigidities in housing supply,
partly linked to spatial and zoning regulations. Fifth, the existence of the
National Mortgage Guarantee (NHG) acting as a further incentive for households
to maintain high mortgage debt levels, as the risk of default is largely
transferred to the guarantee scheme at a relatively low premium for the
coverage. Moreover, the transfer of credit risk gave banks an incentive to
apply relatively relaxed acceptance criteria within the NHG for (the part of)
mortgages up to the threshold. The lower capital requirements for NHG-backed
loans further reduced the funding costs for banks. Lastly, the prolonged
uptrend in house prices and mortgage debt between the mid-1980s and 2008 also
reflected a combination of changing household behaviour patterns, increased participation
rates in the labour market, and changes in financing conditions – notably
increases in affordability due to lower interest rates.

An adjustment in the housing market is
underway. This is partly the result of policy
measures (see box 3.1). House prices have been falling since end 2008. By the
end of 2013, nominal house prices have fallen from their peak reached in August
2008 by some 20%. In the purchase segment transactions appear to have bottomed
out in the course of 2013, with a muted increase in the number of transactions
evident in the latter part of the year. Overall, house prices stabilised in
2013, even though in some parts of the country, in particular urban areas in
the west, the recovery seems to have started.

Household mortgage debt ratios appear to
have peaked. Due to falling house prices and lower
transaction volumes, the growth in mortgage lending flattened in the wake of
the crisis and turned negative from the third quarter of 2012 onwards. This
reflects a number of developments. On the one hand, the size of total mortgage
debt continued to rise (Graph 3.35) even as the housing market turned. Due to
past price increases many first-time buyers still need to take out a higher
loans than those repaid by previous cohorts. Also the amount of repayments on
existing mortgage loans is rising. Furthermore, trends in interest rates
provided an incentive for some to refinance housing loans. On the other hand,
households' borrowing capacity has been put under pressure, due to weak
disposable income and adverse labour market prospects. Also, there is evidence
that the lending policies of banks have become more restrictive since the
crisis, partly since market funding has become significantly more expensive for
banks. In addition, other measures have been taken to moderate mortgage
lending, such as the Code of Conduct for mortgage financing (GHF) and a
stricter interpretation of the former code. Finally, maximum LTV values are
being lowered.

The Dutch government has enacted various
legislations that are reshaping the Dutch mortgage market substantially. Since April 2012 various policy initiatives have been enacted,
mostly affecting the purchase segment. The most important recent legislative
change relates to the eligibility for mortgage interest deductibility (or MID).
New mortgages initiated from 2013 onwards must take an annuity or linear form
in order for interest to be tax deductible and to qualify for an NHG guarantee.
Also, interest can only be deducted for mortgages amortised over a maximum of
30 years. The former adjustment in the fiscal treatment of mortgages eliminates
the tax incentives to take out non-amortising mortgage loans which virtually
completely disappeared from the market. Since interest payments automatically
decline over time in amortising structures, the absolute size of the associated
tax advantage will also decline. Limiting the mortgage interest tax relief to
bring it in line with full annuity repayment does not fully remove distortions
in housing taxation, but it does reduce them. It may also gradually reduce
fiscal deductions and relieve the Dutch banking sector’s dependency on market
funding, thus reducing the vulnerability and leverage of both Dutch households
and banks.

The phasing in of the limitation of
mortgage interest deductibility is in effect strongly back-loaded due to the
gradual phase-in for existing mortgages. The
possibility to grandfather full mortgage interest deductibility for existing
loans when refinancing or moving home implies a substantial back-loading of the
actual impact on the existing stock of mortgages. Therefore, given the size of
the outstanding stock of existing mortgages (which for the majority consists of
interest-only loans in various guises) the measures will only gradually reduce
interest deductions. On the other hand, the incentive to repay mortgages has
clearly increased.

Since the full effect will be phased in
only very gradually, the current plans imply a difference in the fiscal
treatment between new and existing mortgages. The
latter will face a more favourable treatment, partly due to grandfathering
provisions. Indeed, the old tax regime is portable until a maximum of 30 years
after taking out the original mortgage loan, even in the case of refinancing.

A further aspect of the change in the
tax treatment of housing finance relates to the gradual reduction in the
deductible rate from 52% to 38%. From 2014 onwards,
the maximum deduction rate of 52% (for the highest income tax bracket) will
fall to 38% in steps of half a percentage point per year. This reform will be
applicable to new as well as existing mortgage loans, but the impact will only
be felt very gradually because of slow phasing in and grandfathering clauses
which allow tax advantages to persist on refinancing or relocation of an
existing housing loan. So the current plan to phase in this measure over a
period of 28 years is unlikely to have a significant impact on amortising
behaviour in the near term. For the first 20 years only those with taxable
income in the highest income tax bracket of 52% will be affected, while as a
result of the gradual reduction of the general tax credit, taxpayers in the 42%
tax bracket will get an effective deduction rate of 44% in 2014. Of course the
signalling impact of the changes may well be greater.

First-time home buyers bear the brunt of
more restrictive bank lending conditions, including the stepwise reduction over
five years in the maximum loan-to-value (LTV) ratio to 100%. Reducing the maximum LTV ratio translates into a limitation of the
borrowing capacity of more liquidity-constrained home buyers and thus
accentuates further the existing slump in the housing market, due to the
interaction with restrictions on mortgage interest deductibility for new
housing loans. On the other hand, lower house prices and interest rates have a
positive effect on the affordability of housing, in particular of first-time
home buyers.

The adjustment in the housing market,
coupled with policy initiatives, brought deleveraging pressures to the fore and
have increased vulnerabilities among homeowners.
Declining house prices have led to a deterioration in the net wealth position
of Dutch households, and even pushed a substantial number of households into
negative equity. The impact is differential across age groups, with especially
young first-time buyers finding themselves with negative equity.

The adjustment in the housing market has
revealed bottlenecks in the funding model of banks.
With mortgage loans forming a substantial part of Dutch bank balance sheets
(almost 30%), associated credit risk has come under attention. With falling
house prices default risk increased, even if the default rate still is quite
low, certainly by international standards. Moreover, with Dutch banks heavily
reliant on wholesale funding and securitisation in the run-up to the crisis a
‘deposit financing gap’ opened up.

Furthermore, there is indirect fiscal
risk through guarantees. Such risks explicitly
apply to the National Mortgage Guarantee (NHG), via the safety-net role that
the government plays in the Homeownership Guarantee Fund (WEW). Through this
fund, the government acts as a second-tier guarantor for over EUR 140 billion
worth (around 24% of GDP) of mortgages. However, the WEW only has EUR 730
million of capital to absorb direct losses. In the event of a serious stress
scenario, the government may have to step in.

An important characteristic of the Dutch
economy is the extent to which substantial financing flows exist both between
domestic sectors and with the rest of the world, translating into leveraged
balance sheets across a number of dimensions. The
particular financing structure of the Dutch economy reflects institutional
factors, including the pension system, the existence of a highly developed
financial sector (with large banks, large pension and insurance funds, but also
large "special financial institutions"), fiscal arrangements and
incentives, as well as a high degree of international integration (with an
important role for large multi-national companies and cross-border financial
institutions). Owing to its geographical location, historical ties, and a traditionally
strong competitive position and institutional setting, the Netherlands has
become a hub for international trade and capital flows.

With reference to indicators in the MIP
scoreboard on the current account and private debt, the determinants of balance
sheet positions are of particular interest for the assessment of potential
imbalances. Moreover, across sectors the crisis
instilled strong adjustment dynamics associated with the respective balance
sheet positions and financing dynamics, revealing some particular risks or
vulnerabilities. These are the focus of this chapter, with some special
reference to the central role the household sector plays in determining the
accumulation of private debt and wealth. In the Netherlands, persistent current
account surpluses have gone hand in hand with the accumulation of significant
external assets in the private sector, in particular by pension funds and
insurance companies, followed by investment companies and 'other financial
institutions'([18]). This is
reflected in the sectoral contributions to external net lending (Graph 4.1)([19]). Pension funds account for substantial holdings of foreign assets.
Households' leveraged balance sheets are reflected in modest net savings, apart
from pensions. By contrast, the strong international linkages of the banking
and non-financial corporate sectors are mirrored in a net borrowing position
vis-à-vis the rest of the world.

The Netherlands has accumulated a large
amount of pension wealth of approximately 165% of GDP, the bulk of which is
invested outside the Netherlands.([20]) In the wake of the global financial
crisis the net returns of these institutional investors have been disappointing
and their buffers significantly decreased since 2008. Solvency requirements in
pension funds required higher pension premia, lower pension pay-outs or a
combination of the two. These, in combination with negative wealth effects from
the housing market, weighed on consumer confidence and private consumption.

Along with substantial pension savings,
Dutch households for a long time considered it attractive to finance a home
with a relatively large debt, often not repayable until maturity. This in turn, confronted the banks with funding mismatches, thereby
increasing vulnerability to developments in the financial markets and also
increasing the volatility of lending in the Netherlands.

The crisis revealed the vulnerability of
the funding model of banks. The combination of
securitised funding drying up as a source of funding, changes in the
debt-to-asset position of Dutch households, and (expected) changes in
regulation and fiscal incentives have highlighted the exposure of banks to
longer-term mismatches on their balance sheets. This resulted in deposit
funding gaps, also reflecting the relatively high level of external leverage in
the banking sector. With the domestic banking system highly exposed to real
estate, needing to rely less on wholesale funding, and needing to fulfil
changing regulatory requirements, the adjustment of bank balance sheets is
underway.

4.1.      Household
debt

Household debt reached an all-time high
of 128.5% of GDP, or 266% of disposable income, in 2010 (Graph 4.2). Mortgage debt accounts for the largest part of
household debt. The rise in house prices and residential mortgage debt has
lengthened households’ balance sheets in the run-up to the crisis, increasing
the sensitivity to valuation changes.

The percentage of households holding
debt is high in the Netherlands, at 65.7%. Of All
households, 44.7% have mortgage debt, while 37% have non-mortgage debt (Graph
4.3).

From a balance sheet perspective, the
strong overall wealth position of Dutch households mitigates risks. Much of the build-up in mortgage debt has been mirrored by even
steeper increases in total household wealth. Households have capitalised on
rising house prices in the expansionary phase: the total value of the
owner-occupied housing stock was estimated at some 192% of GDP in 2011.([21]) The share of housing in total household wealth rose from 31% in
1993 to 39% in 2011. The recent fall in house prices obviously led to a
deterioration in the market value of housing and a shift in the asset
composition. For several households this led to a negative net equity position
(see below), with a strong differentiation between age groups. Apart from home
ownership, which has become the most important real asset in household
portfolios (Graph 4.4), pension wealth constitutes the principal financial
asset, reflecting the large holdings of second pillar pension assets. In this
respect, the Netherlands differs considerably from most other countries (Graph
4.5). In 2011, gross financial assets of households roughly equalled 300% of
GDP.

Moreover, Dutch households have a
relatively low ratio of risky to non-risky assets,
thanks to relatively high currency and deposits positions, and relatively low
asset positions in shares and other equity.

Nevertheless, the liquid assets buffer
for absorbing direct income or asset shocks of Dutch households is relatively
modest (Graph 4.6)([22]). Home-owning households usually have invested a large fraction of
their wealth in real estate, which is relatively illiquid and
non-diversifiable. Potential problems with debt servicing are therefore harder
to mitigate by selling liquid assets. Pension fund and life insurance assets
are tied up and not marketable without significant penalty, also in view of
their fiscal treatment. Still, relatively few households face acute financial
problems, in view of rising unemployment and a relatively steep 20.3% fall in
house prices from the peak in 2008. Even so, household balance sheets are now
arguably more vulnerable than during earlier recessions (Graph 4.7).

Negative equity

In recent years, low or even negative
returns on pension assets and declining house prices have led to a
deterioration in the net wealth position of Dutch households. This trend affected homeowners in differential ways, owing to the
differences in starting positions. Homeowners who bought their dwellings long
ago accumulated considerable home equity. On the other hand, given the fall in
house prices since 2008, a number of first-time buyers, concentrated in the
25-35 age group, have not yet realised any excess value on their housing
purchase, and now face a negative home equity position. It is estimated that
for around 25-30% of housing loans -the equivalent of 1.3 million mortgages-
the market value of the house is currently below that of the outstanding
mortgage debt([23]). The
incidence of decreasing house prices leading to negative equity reflects the
fact that LTV ratios well above 100 were the norm.

Even without further falls in house
prices, rising interest rates would negatively impact disposable income. As real and nominal interest rates have declined, the rise in
household indebtedness has been associated with relatively limited increases in
the debt service burden. A trend decline in mortgage rates has made it possible
for households to service a growing debt stock without allocating a larger
share of their budgets to debt servicing, from 2000 to 2005. However, total
interest expenditure as a share of disposable income did rise fairly sharply
from 2005 onwards (Graph 4.8). Still, according to ECB survey results,
vis-à-vis other EU countries, the Netherlands still occupies a median position
in terms of debt service to income ratio (Graph 4.9).

The group of younger first-time buyers
mostly account for households with negative net equity (Graph 4.10). They have taken out high mortgages relative to their
income, savings and the value of their home, which declined in the aftermath of
the crisis. Young people also spend a higher percentage of their gross income on
interest charges (Graph 4.11). These factors expose them to heightened risks,
stemming in particular from unemployment.

Compared to other EU countries, many
households spend a high proportion of their income on mortgage commitments
(Graph 4.12). On the other hand, households are accelerating their mortgage repayment
schedule. According to a survey with the four
largest mortgage lenders, homeowners significantly increased their mortgage
repayments in 2013, compared to 2012. One bank received more than 60% extra
repayments by end of October. Factors at play are the low interest rate on
savings accounts, the uncertainty on the housing market and negative equity.

The current distribution of refinancing
profiles still provides protection against the pass-through of increases in
mortgage interest rates. In 2009, about half of all
mortgages had a remaining fixed interest period of 4 years or less, while
one-fifth had a remaining fixed interest period of less than one year (Graph
4.13). Looking further ahead, households in negative equity may not have
sufficient buffer to repay their mortgage debt once the maximum interest relief
period expires.

Repayments arrears have however remained
very low by international standards so far.
Similarly, the rate of household defaults on housing debt is still very much
contained and much lower than the EU average (Graph 4.14). This is not only due
to strong creditors' rights, but also to the existence of an extensive social
security system. Another important factor is the significant rise in house
prices from the 1980s until 2008, which means the collateral value for older
mortgage loans is mostly sufficient. Moreover, mortgage debt has mainly been
incurred by those with higher incomes. A full 60% of all mortgages are held by
the highest-earning fifth of households, whereas the lowest-earning fifth only
hold about 3% of total debt. High-income earners usually face a lower risk of
unemployment and income shocks and should thus be more able to take on debt.
Problems concerning forced sales are therefore mostly the result of unexpected
life events, such as long-term unemployment, disability, death, and most
importantly divorce.

4.2.      The
financial sector

The financial system comprises three
main sectors—banking, pensions, and insurance.
Banks, with assets equal to almost 400 percent of GDP, account for the largest
part of the financial sector. Pension funds are the second most important
subsector, with assets under management equal to approximately 150 percent of
GDP. Although there are 545 registered pension schemes in the Netherlands, the
two largest and ten largest funds manage 44 and 78 percent of scheme assets,
respectively. The insurance sector holds assets of approximately 75 percent of
GDP, with life insurance representing the bulk (89 percent) of this.

4.2.1.   Pension
funds and insurers

The Netherlands has a pension and
insurance system, which is second only to the banking sector in size and
potential systemic importance. Total assets of the
Dutch pension and insurance sector amounted to almost EUR 1.350 billion (225%
of GDP) in 2012 (Graphs 4.15 and 4.16). Only in France and Germany is the
pension and insurance sector larger than the Netherlands.

Over the past seven years, the
liabilities of Dutch pension funds have grown more than twice as fast as their
assets. Consequently the coverage ratios of the
assets of funds to pension commitments fell from 130% to around 100% on average
at end-2010, below the 105% minimum required by the regulator.([24]) The coverage ratio of several funds dropped even below the
required value.

This fall in coverage ratios is due to a
combination of rising life expectancy, falling interest rates and low
investment returns in the wake of the crisis. Dutch
pension funds have an internationally diversified portfolio. The financial
crisis resulted in a combination of falls in equity prices and low interest
rates which proved to have very adverse effects on coverage ratios, given the
size of the shock. Pension funds have been attempting to restore their coverage
ratios through a combination of contribution increases, adjusted indexation,
and, as a last resort, renegotiations or unilateral adjustment of existing
arrangements leading to a decrease in pension pay-outs. Overall, this has led
to a pro-cyclical burden on the disposable income of households, one of the
factors accounting for sluggish private consumption in the Netherlands in
recent years. The issue of long-term sustainability of the current Dutch
pension system, with its guaranteed benefits, has been brought to the fore at a
relatively early stage because of the high level of transparency in accounting
and disclosure practices.

Several changes were introduced in the
September 2013 "pension package" to ensure sustainability and
mitigate the pro-cyclicality of the pension system.
First, the introduction of a so-called ultimate forward rate (UFR), allowing
for a more stable yield curve used for accounting over long maturities. This
yielded a more stable valuation of future commitments. Second, more flexibility
for pension funds to gradually adjust pension contributions in response to
coverage ratios falling under the statutory minimum. The third measure concerns
the ability to spread any reductions in pension entitlements over time and to
limit them to a decrease of no more than 7% per year in 2013 and 2014. The
pension package entailed further measures, including providing for a faster
increase in the statutory retirement age to 67, the automatic inclusion of any
further life expectancy increases in the calculation of existing pension
entitlements, and deferral of indexation until the coverage ratio of a pension
fund has reached at least 110%.

A protracted period of low long-term
interest rates could negatively affect pension funds and insurance companies on
both the asset and the liability sides of their balance sheet. Defined benefit pension funds and life insurers have a long funded
balance sheet structure, and, unless they are hedged, a negative duration gap
(the duration of liabilities typically exceeding the duration of assets). The
extent of the associated reinvestment risk depends on the extent of the
duration mismatch. The longer the maturity of the liabilities the larger any
negative impact of protracted low interest rates on defined benefit pension
funds and insurers. The commitment of these institutions to policyholders and
members are often very long-lasting and therefore quickly rise in value when
interest rates fall. The investments held against these long-term,
interest-rate-sensitive liabilities often have a shorter term to maturity and
therefore tend to rise less. Such effects become immediately visible as balance
sheets are valued at market value. In recent years, life insurance companies
have significantly reduced their exposure to equity and real estate markets,
but remain sensitive to interest rate risk.

The exact impact of duration gaps on net
pension and insurance obligations depends on the asset and maturity mix. In general, pension funds have lower allocations to bonds, and
higher allocations to equities, relative to life insurance companies. Insurers
and pension funds have sought to increase the duration of their assets in order
to reduce mismatches. Dutch pension funds are increasingly engaging in
maturity-matching and interest-risk-hedging activities by increasing their
allocation to low-risk long-term assets, such as government bonds, and by
increasing the duration of their investment portfolios. These liability-driven
investment strategies create potential further downward pressure on bond yields
with possible implications for solvency ratios.

The issue of the sustainability of the
current Dutch pension system, with its conditionally guaranteed benefits, has
been brought to the fore by the crisis, given the pro-cyclical feedbacks to the
financial sector and the real economy. The
relatively high level of transparency in accounting and disclosure practices
also increased the profile of the issue in public debate. The pension agreement
that the Dutch government reached with social partners offers a starting point
for a modernised pension system. The agreement incorporates elements such as
the linking of the retirement age to life expectancy, a focus on less
pro-cyclicality, and increased transparency in terms of pension benefits and as
regards the division of risks among stakeholders. Negotiations between social
partners on the details of risk sharing and risk transfer in pension contracts
are underway. The implications for intergenerational transfers and risk sharing
warrant closer investigation. Reforms may also be pursued along other
dimensions.

4.2.2.   Banks

The Dutch banking sector is large from an
EU perspective, with the total value of bank balance sheets equivalent to
almost 5 times GDP, lower than the banking sector in the UK (650% of GDP), but
much higher than that in France and Germany. Moreover, there is a high degree
of concentration, with three major players (Rabobank, ABN Amro and ING). Dutch
banks have a relatively large share of mortgage loans on their balance sheets
(Graph 4.17).

Funding: the key challenge

The domestic Dutch banking sector faces
a deposit funding gap reflecting the large size of mortgage portfolios relative
to the domestic deposit base. Banks are lending
approximately twice as much to Dutch households and businesses as they are
receiving in the form of savings deposits. The current total funding gap of
Dutch banks is estimated to amount to some 75% of GDP. This is larger than
elsewhere in the EU, despite the national savings surplus.

The loan-to-deposit (LTD) ratio rose to
more than 200% before the crisis – high by international standards. In 2011 only Ireland had a higher ratio than the Netherlands
within the euro area. In the predominantly bank-based European financial
sector, institutional investors such as insurers and pension funds largely
finance businesses and households in Europe indirectly by purchasing bank
bonds.

The high level of mortgage debt is an
important factor accounting for the size of the funding gap. Dutch banks hold relatively large domestic mortgage portfolios
compared to other EU countries, amounting to around 90% of GDP, double the
average in the euro area. In the ten years preceding the credit crisis, the
Dutch LTD ratio rose from 161% to 205%. That period coincided with an ongoing,
protracted rise in house prices, leading to a marked increase in mortgage debt.
As pension capital is not accrued in banks but rather in pension funds this has
limited domestic funding sources. Moreover, consumers have traditionally used
life insurers to save for the redemption of part of their mortgage principal.
As in the expansionary phase new mortgage loans were generally much higher than
expiring ones, which gradually disappeared from banks’ balance sheets as they
were repaid, the inherent dynamic tended to exacerbate the funding gap.

Since 2008, the funding gap has slightly
decreased, along with a rise in deposits (Graph
4.18). The narrowing of the funding gap is the combined result of a slowdown in
lending due to the economic downturn, a weak housing market and more
restrictive credit policies. Furthermore, the introduction of bank savings
products ("banksparen") has enabled banks to raise extra deposits
since 2008 in a market that was previously the preserve of insurers.

The Dutch banking system remains
relatively dependent on wholesale funding and savings from abroad. In the aftermath of the crisis, Dutch banks have been attempting to
find alternatives to wholesale funding, securitisation in particular (Graph
4.19).([25]) Still,
about two-thirds of the consolidated balance sheet of the Dutch banking system
is funded in financial markets. Existing securitisations may overall be
regarded as less creditworthy, reducing their value as collateral. The issuance
of RMBS fell back after 2008 when it had reached EUR 49 billion.

The fall in interest rates in recent
years reduced funding costs. As interest rates are
falling, the costs of raising finance tend to fall faster than the interest
rates on existing loans, thus supporting profits. However, going forward a rise
in interest rates could have an adverse impact on bank profitability via the
existing bond and mortgage portfolio while only a part of the risk usually is
hedged through interest rate derivatives. A rise in interest rates without
economic recovery would pose a particular vulnerability through the associated
rise in credit risk.

The dependence on market funding leaves
Dutch banks vulnerable to developments in financial markets. The relatively high LTD ratio and the orientation towards housing
finance are relevant in this regard. Mortgage financing is generally issued
with long maturity. As financing via financial markets is geared towards short
maturities, this leaves banks with higher refinancing risks compared to deposit
funding.

Towards a better balance

Rebalancing the structure of funding
could help reduce the deposit funding gap and mitigate deleveraging pressures. This rebalancing can take several forms and have broader
ramifications for the sectoral distribution of asset holdings and financial
flows between (sub)sectors. As regards the mortgage market, the prevailing
system of public guarantees of mortgages through the NHG is complex and
discourages international investors to buy Dutch securitisations. Also,
individual banks can only securitise and sell their own mortgage portfolio,
resulting in diseconomies of scale. An infrastructure that allows more
standardisation and transparency of securitisations, increased bundling, and a
different approach to guarantees could increase the willingness of foreign
investors in particular to invest. Initiatives towards creating a National
Mortgage Institute (see Box 4.1) could be seen as a step in this direction.
With regard to the new rules on securitisations, since 2011, and following the
introduction of Art. 122a in the Capital Requirements Directive II (CRD II),
rules are in place to oblige the originator to retain at least 5% of the
securitisations and to provide additional information about the portfolio at
loan level and an obligation for investors to undertake adequate due diligence.
Furthermore, progress with banking union could help increase the deposit base
from which Dutch mortgages are funded e.g. by facilitating cross-border deposit
taking.

A larger role for Dutch pension funds
and insurers in the mortgage market could also help in rebalancing. Mortgages are long-term investments that generally carry a fixed
interest rate, making them relatively suitable for covering long-term
commitments, such as those of pension funds. Life insurers have already become
more active on the Dutch mortgage market; their mortgage portfolio has grown by
28% over the last two years. To make it attractive for private Dutch pension
funds to step in more, it will be important to ensure that adequate incentives
to invest are in place in terms of the risk-return trade-off.

There may also be some scope for covered
bonds to help improve the funding profile. However,
in the near term the additional scope may be limited as the resulting asset
encumbrance can affect the credit risk exposure of other lenders, including
depositors. There is a trade-off between the security for holders of covered
bonds and the implications for unsecured creditors. This balance depends, inter
alia, on the extent to which banks pledge more assets as collateral than they
receive in funding (overcollateralisation). Since the Dutch residential
mortgage market is characterised by high loan-to-value ratios with
traditionally a large share of interest-only mortgage loans, this
overcollateralisation generally reaches more than 25% for Dutch covered bonds
(a high margin in international perspective). Moreover, asset encumbrance also
increases the interconnectedness and pro-cyclicality in the financial system.
An adequate degree of overcollateralisation and transparency and adequate
pricing of the encumbrance could impose discipline on banks, foster appropriate
risk assessment by investors, and contribute to increased market confidence.

Ultimately, banks need to structure
their balance sheets in such a way that domestic assets and liabilities are
more in balance, with lower leverage and less maturity transformation. Banks have not yet sufficiently strengthened their capital position
as provided for under Basel III. However, building up buffers to the required
level is a lengthy process since the losses suffered must first be made good,
which in the current bleak and uncertain level of economic growth is an
obstacle to profitability. A worrying development is that the initially rapid
strengthening of capital ratios in 2008 and 2009 is now levelling off. There
was actually a slight decline in banks’ solvency last year. Banks need to
improve their liquidity position as well. In this context, Basel III sets
standards both for short-term liquidity and for longer-term funding. The
challenges for the Dutch banking industry lie mainly in the latter area.
Despite their high risk-weighted capital ratio, Dutch banks continue to have
relatively high leverage form an international perspective. Due to the lowering
of this leverage by shrinking the balance sheet, however, credit to households
and businesses has been under pressure. Finally, banks need to be sufficiently
transparent about exposures on the asset side of their balance sheets.

All in all, efforts to improve the funding
of banks, coupled with efforts to reduce vulnerabilities in household balance
sheets, and broader initiative to mobilise 'locked up' capital in other parts
of the economy, may have an important bearing on the development of
intersectoral balance sheet positions and financing flows. This may help
mitigate potential imbalances in the Dutch economy and reduce the vulnerability
to financial and cyclical shocks. However, any rebalancing will take time.

The analysis in this IDR indicates that
macroeconomic developments regarding private sector debt and deleveraging
pressures, coupled with remaining inefficiencies in the housing market, continue
to be a challenge in the Netherlands. It is worth recalling that a relevant
policy recommendation on the housing market was already part of the
country-specific recommendations issued to the Netherlands in 2012 and 2013.
The full assessment of progress in the implementation of this recommendation
will take place in the context of the assessment of the Dutch National Reform
Programme and Stability Programme under the 2014 European Semester. While the
large current account surplus does not raise immediate stability risks, the
development of the current account also deserves attention. The surplus mirrors
cyclical influences, but it also appears to reflect more deeply embedded
structural issues, for instance as regards the determinants of cross-sectoral
financing and savings-investment patterns and the functioning of labour market
institutions.

Several avenues could be envisaged to
address the challenges identified in this IDR.

The Netherlands has to a large extent
been tapping financial flows from abroad in an original, yet potentially risky
way which could merit reorientation. Dutch
household savings primarily end up with pension funds and insurance vehicles,
which channel the bulk of these savings abroad. In recent years the net returns
of these institutional investors have been disappointing and their buffers to
be able to cope with financial setbacks have significantly decreased since
2008. Along with large pension savings, Dutch households took on substantial
gross housing debt, in turn shaping the funding patterns of the financial
sector. At the same time, profits received from foreign affiliates have spurred
registered non-financial corporation's savings, creating a net savings surplus.
Owing to its geographical location, historical ties, a traditionally strong
competitive position and sound and credible institutional setting, the Netherlands has become a hub for international trade and capital flows. This allowed
non-financial corporations (mostly multinationals) to channel FDI and
"route" income flows, via entities in the Netherlands, between a
company in one country and subsidiaries or affiliates in other countries. A
partial and gradual reorientation of overall savings and funding flows towards
more balanced patterns across sectors could help mitigate risks.

Profitable segments of the economy with
a strong competitive edge can help to underpin domestic demand. Making use of the existing room in the institutional framework to
allow for more differentiated wage increases could help support household
income. Naturally, such an approach would have to take due account of the
situation of firms as regards productivity, profitability and prevailing
buffers so as not to weaken their viability or competitiveness. The depth and
the protracted nature of the slump since the crisis imply that more robust
income developments in households could support the recovery and rebalancing of
the economy.

Productivity increases in the most
recent period have been sluggish and the value added of re-exports, the most
buoyant segment of exports, low. Cyclical effects,
finance bottlenecks, continuing uncertainty and the impact of (expected)
balance sheet adjustments all seem to play a role in the relatively low
domestic rate of capital formation, yet there may also be a structural element
at play. For firms, a balance has not always been struck between home and
foreign investments. A balanced adjustment of saving and investment patterns
across the Dutch economy would have a beneficial impact on the investment
climate and growth potential, including economic prospects in the long term.

Ongoing policy and supervisory measures
to reduce the incentives for households to take up housing debt and lower loan
to value ratios should ultimately lead to reduced housing-related debt and
leverage ratios. However, existing debt overhangs
may require a long adjustment period. The regulatory measures, in particular
the limitation of mortgage interest deductibility, are in effect strongly
back-loaded and discriminate new versus existing mortgage loans.

Although measures have been taken to correct
the rigidities in the housing market, the private rental market is still not
functioning fully. Moreover, inefficiencies and the
risks of dead-weight losses associated with the operations of social housing
corporations continue to exist. Reform steps in this area would need to protect
the segment of dwellers in need of social housing, and factor in positive
externalities of prevailing spatial regulation.

The imminent policy challenge is to
contain balance sheet adjustments and harness growth potential while
simultaneously stabilising public finances. Given
the depth and protracted nature of the downturn following the global financial
crisis, deleveraging pressures are likely to pose risks and a drag to the
recovery for some time to come. Against this backdrop it is important to find
an appropriate balance between adjustment needs and supporting near-term
activity. Long-run gains of reforms could even be larger if, after successful
fiscal stabilisation, part of the budgetary savings were to be channelled back
into the economy by tax relief aimed at reducing the costs of labour, promoting
investment, or a combination of such measures.

(Continued on the next page)

Box (continued)

(Continued on the next page)

Box (continued)

De Nederlandsche Bank (2014),
Differentiated wage development does justice to sectoral differences,
DNBulletin, 7 February 2014.

De Nederlandsche Bank (2013a), Overview of
Financial Stability in the Netherlands, No.18, October 2013.

De Nederlandsche Bank (2013b), Less money
in household purses, DNBulletin, 23 July 2013.

De Nederlandsche Bank (2013c), Sensitivity
of Dutch current account surplus to dividend payments, DNBulletin, 12 February
2013.

European Central Bank (2013), Survey on the
access to finance of small and medium-sized enterprises in the euro area,
November 2013.

European Commission (2012), Current account
surpluses in the EU, European Economy, Vol. 9, December 2012.

European Commission (2013), Macroeconomic
Imbalances - The Netherlands, Occasional Papers, No. 140, April 2013.

International Monetary Fund (2013),
External Balance Assessment (EBA) Methodology: Technical Background, IMF,
Washington D.C.

Ministerie van Sociale Zaken en
Werkgelegenheid (2013). CAO-Afspraken 2102. Den Haag.

Netherlands Bureau for Economic Policy
Analysis (2013), Macro Economische Verkenning. The
Hague.

Netherlands Bureau for Economic Policy
Analysis (2013), CPB Financial Stability Report 2013.

Salto & Turrini (2010), Comparing
alternative methodologies for real exchange rate assessment, European Economy –
Economic Papers, No. 427.

Vandevyvere, W. (2012), The Dutch current
account balance and net international investment position, European Economy –
Economic Papers No. 465, Brussels.

Vandevyvere, W. & Zenthöfer, A. (2012),
The Housing market in the Netherlands, European Economy – Economic Papers No.
457, Brussels.

([1])  All residents above 65 are entitled to a flat-rate public pension
that is financed through a pay-as-you-go (PAYG) scheme. An estimated 90% of the
labour force is furthermore covered by supplementary occupational pensions. The
third pillar of the Dutch pension system comprises individual, voluntary
pension plans.

([2])  Traditionally, the participation exemption on cross-border
intra-firm dividend payments (as well as capital gains) from subsidiary
companies abroad has been a major attractor of companies to the Netherlands. It
implies that when transnational companies repatriate affiliate income, or in
other words, pay themselves dividends from abroad, the tax treatment of this
income is not subject to domestic taxation. Although this system is applied in
most EU countries, with the exception of Greece, Ireland, Spain and the United
Kingdom, the extent to which income is fully or partially exempted varies
across countries and is affected by the provisions of bilateral tax treaties.
Other factors that make the Netherlands fiscally attractive are the the large
Dutch Double Taxation Treaty (DTT) network and the "advance tax
ruling" system.

([3])  Source: www.ecb.int/stats/money/surveys/sme/html/index.en.html

([4])  Both scenarios assume constant nominal GDP growth, constant
ratios of private household debt (non-mortgages) to GDP, a constant number of
transactions (average 1995-2011), a constant LTV ratio of 1 and house prices
that develop in line with nominal GDP. Repaid mortgages are approximated by
historical house prices. Both scenarios are very insensitive to changes in
these assumptions.

([5])  Re-exports are defined as goods
owned by a Dutch resident at
some point and subsequently by a foreign resident. If there is no transfer of
ownership at any stage, the goods are deemed to be in transit. Goods are
counted as domestically-produced exports if they
undergo processing. Other important re-exporting countries include Singapore,
Belgium and Germany.

([6])  De Nederlandsche Bank (2013c) estimates the net effect of both
directions at approximately 2% of GDP in the years 2006 to 2008, afterwards
reversing to -0.5% of GDP.

([7])  Profit remittances
on FDI not only cover payments of direct investment income, which consist of
income on equity dividends, branch profits, and reinvested earnings, but also
income on intercompany debt (interest). Some of
the profit remittances relate to, for example, royalties on intellectual
property, which can fairly easily be shifted to other tax jurisdictions.

([8])  In 2011 the households' gross savings rate in the Netherlands was
11.6% vs. 16.5% in Germany, 13.1% in the euro area and 11.0% in the EU27.

([9])  Profit remittances
on FDI not only cover payments of direct investment income, which consist of
income on equity dividends, branch profits, and reinvested earnings, but also
income on the intercompany debt (interest). Some
of these profits do not derive from physical goods, but from, for example,
royalties on intellectual property, which makes it easier to shift them to a
tax haven.

([10]) De Nederlandsche Bank (2013c).

([11]) Defined as compensation of employees (wages, salaries and
employers' social contributions) over gross value added at basic prices.

([12]) De Nederlandsche Bank (2013b).

([13]) De Nederlandsche Bank (2013b).

([14]) Centraal Planbureau (2013).

([15]) The shown subsectors entail around 60% of the total labour force.

([16]) Q: Health and social work activities,
D: Electricity and gas supply, K: Financial institutions, G: Wholesale and
retail trade, A: Agriculture, forestry and fishing, H: Transportation and
storage, L: Renting, buying, selling real estate, C: Manufacturing, R-U:
Culture, recreation, other services, F: Construction, I: Accommodation and food
serving.

([17]) Ministerie van Sociale Zaken en Werkgelegenheid
(2013).

([18]) Including a.o. investment funds, financial
holding companies, special purpose vehicles (SPVs) and special financial
institutions (SFIs).

([19]) The data on
pension funds were included into the 'other/households' category until 2002;
from 2003 on they are registered apart in a 'pension funds and insurances'
category, explaining the break in continuity between 2002 and 2003.

([20]) De Nederlandsche Bank (2013a).

([21]) Also important are holdings in insurance
companies and retirement savings in pension funds of EUR 1117 billion in 2011.
Other financial assets include deposits in banks and savings accounts (EUR 332
billion in 2011). Households also possess bonds and equities to the tune of EUR
200 billion. Total household assets (including housing, financial and other
assets, but not holdings in insurance companies and pension funds) reached EUR
1952 billion in 2011, or 324% of GDP (including pension funds: EUR 3068 billion
or 510% of GDP) – Statistics Netherlands.

([22]) If the value of the both owner-occupied
housing stock and holdings in insurance companies and pension funds is
excluded, households have a liquid assets position (including currency and
deposits, shares and other equity, and securities) of 117% of GDP in 2011.

([23]) In order to
partly address
this issue, from 2014 onwards the interest payment on residual debt will still
be tax deductible
for a maximum of 5 years (up to
10 years for residual debt originating between 29 October 2012 and 31 December
2017). Nevertheless, actual costs for these homeowners will still rise substantially if
they sell their properties, as banks will require the remaining debt to be
reimbursed over a period of 10 years. Moreover, although these measures may
contribute to an orderly adjustment of the housing market in the medium run, their short-term
stimulus effect is far less certain.

([24]) The Financial Assessment Framework, which is
part of the new Pension Act for second
pillar pension, sets out the statutory requirements. These include thresholds for the coverage ratio (i.e. the
relationship between assets and liabilities) and equity buffers.
The pension fund’s investment results as well as the liabilities are valued at
market price.

([25]) Roughly one third of Dutch mortgages are
bundled and issued as residential mortgage-backed securities (RMBS). Large
institutional investors, such as pension funds, buy these RMBS as part of their
investment portfolio. The 'packaging' of residential mortgage loans and other
credits to be sold on to companies specially carried out to create financial
manoeuvring room, are called 'special purpose vehicles' or SPVs. Dutch SPVs account for a rather high share (20% DNB, Statistical Bulletin
June 2008) of European securitisations.

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