Netherlands: Economy Resilient but Fiscal Deficit to Widen in the Medium Term

The Dutch economy has slowed. Scope Ratings is forecasting 2023 growth of just 0.8% (see Figure 1) and 1.1% in 2024. Both figures are below average medium-run potential of around 1.4%. The present slowdown reflects elevated inflation, tighter funding conditions and sluggish external trading conditions. However, we see household demand staying comparatively resilient and the government budget stance remaining accommodative in the medium term.

The slowdown comes after exceptionally resilient growth of 4.5% in 2022, above our estimate of 3% at the start of last year. This robust performance, reflecting avoidance of technical recession in the second half of the year, outperformed expectations. Growth has been resilient despite ramifications of Russia’s full-scale war in Ukraine.

Significant forced savings from the pandemic crisis, tight labour markets and government support have cushioned some of the effects of soaring prices for households. Furthermore, households have benefited from energy price ceilings and direct budget transfers, at an aggregate cost to the government of 2.4% of GDP (net of offsetting revenue measures) this year, according to a recent IMF estimate.

Figure 1: Gradual recovery from economic slowdown expected during this year
Real growth %, 2023-24

Significant Fiscal Pressures From Expenditure Programmes

However, State support measures add substantive pressure to budgetary dynamics. The headline government deficit of the Netherlands is expected to widen to 1.4% of GDP this year, after an estimated 0.5% general government surplus last year – the latter anchored by strong nominal economic growth and labour markets alongside a budget boost from natural gas revenues.

In the medium term, we expect the headline budget balance to remain durably weaker than that of similarly-rated peer countries (see Figure 2). This reflects a general government deficit averaging 2.8% of GDP between 2024 and 2027, potentially the weakest among Scope Ratings’ AAA-rated sovereigns.

Figure 2: Dutch government seen returning to wider deficits in coming years
General government balance, % of GDP

This partly reflects measures adopted in the context of today’s energy crisis, which has a structural impact on the general government budget. Specifically, a 10% revaluation of the minimum wage from January 2023 has effects on pension and welfare benefits payments. Our expectation of wider deficits reflects a shift in the government’s aggregate fiscal stance since a 2021 coalition agreement, which adopted an ambitious capital expenditure programme for roll-out across this next decade.

The coalition government displays strong ambitions with respect to combatting climate change. This will be achieved by a climate and transition fund (EUR 35bn in funding by end-2030, or 3.7% of 2022 GDP) and a nitrogen fund (EUR 25bn by end-2035, 2.7% of 2022 GDP). Such funds will advance the development of green infrastructure and transition for the agricultural sector.

Projects to be financed via such funds include the construction of two nuclear power plants by 2035, at an estimated cost of EUR 5bn. Additionally, several investments have been announced to enhance the quality of the Dutch education system (at an annual price tag of around EUR 1bn), and support research and development efforts (EUR 5bn to be invested over a decade).

Government Debt Returning to a Modest Rising Trend Medium Term

As a result, we expect general government debt to GDP to return to a gentle rising trajectory from 2025, concluding a forecast horizon in 2027 at around 50.1% (up a benign 1.5pps from end-2019 levels). The debt ratio edged below pre-pandemic levels last year to about 48.4% and we see it declining further this year to 46.7%. The slope of the debt trajectory near term will be helped by comparatively robust anticipated nominal economic growth and still-moderate financing costs by historical standards. These factors will partially offset the effects of persistent headline deficits.

The roll-out of the investment programmes, under a context of higher borrowing costs and still-tight labour markets, will be monitored closely for assessing whether it weighs on government debt sustainability or risks overheating the economy. Nevertheless, if carefully implemented, such investments have the potential to support transition to a more sustainable economic growth model, constituting an appropriate use of available fiscal space.

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Dennis Shen is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Brian Marly, Analyst at Scope, contributed to writing this commentary.