The Netherlands

Research guide to European Monetary Union

A special report prepared by ABN AMRO

It is an appropriate location not just because the Netherlands itself is clearly committed to monetary union in Europe, but also because the performance of its economy over recent years has demonstrated that adapting to the convergence criteria and maintaining high levels of growth and employment need not be mutually exclusive.

The Dutch miracle

Over the course of the last year the management of the Dutch economy has repeatedly won the praise of many of its neighbours and has come to be seen as presenting an example worth emulating. The so-called "Dutch miracle" stems from the fact that the Netherlands has demonstrated that structurally reducing the public sector deficit and maintaining a hard currency can lead to favourable trends in employment creation and in the economy as a whole. The Netherlands has been outperforming most other European economies in this regard over the last two years and has even received generous plaudits from commentators in Germany.

The key to this success has been strict wage moderation. Since 1983 the rise in Dutch unit wage costs has lagged other EU member states by more than 40%, which has resulted in a clear improvement in the Netherlands' competitiveness in Europe, with very positive knock-on consequences for employment, economic growth, the exchange rate and interest rates. According to the World Economic Forum, in 1996 the Netherlands was the EU's fifth most competitive economy, behind Luxembourg, Denmark, Finland and the UK, but comfortably ahead of Germany, France and neighbouring Belgium.

Additionally, the Dutch consensus model has allowed for broad-based support for wage growth moderation, as well as sufficient support for a sharp reduction in public spending, even when this reduction is extended to social security benefits. This has allowed deficit reduction to go hand in hand with substantial debt burden relief.

The obvious consequence of this broad-based support for Dutch economic policy has been that the Emu convergence criteria laid down by the Maastricht Treaty has not necessitated many of the more painful restructuring measures which have been experienced in a number of other EU economies - often with negative social ramifications. In contrast, no western country loses fewer days in strikes and other industrial actions than the Netherlands. Over the course of the 1980s and early 1990s only Japan was less affected by industrial action than the Netherlands.

The Dutch economy in 1996

1996 was a very good year for the Dutch economy, with GDP year expanding by 2.7% ­ well above the European average. This strength was for the most part fuelled by rising exports, consumption and investment levels. In the third quarter of 1996 alone, for example, Dutch exports soared by some 10% year-on-year.

Most important, perhaps, was that over the course of 1996 wage growth remained modest, paving the way for a substantial rise in employment creation which underpinned consumer confidence and hence personal spending levels. Together with low mortgage rates and rising rents this induced a booming demand for houses - with almost 550,000 new mortgages issued during the year - as well as for durable goods. Consumer spending in 1996 rose by 3.1%, with consumer credit expanding over the year by more than 14%, the strongest growth in 10 years.

The Netherlands' booming housing market is initiating a virtuous circle for the expansion of the economy. The Central Planning Bureau (CPB) has estimated that some 10% of the additional wealth which has been created as a result of the housing boom will lead to an increase in consumer spending. On an annual basis, this would translate into approximately Fls5 billion, or 1.25% of total private consumption.

The obvious downside for the Dutch economy is that this strength in consumer demand has led to some inevitable inflationary pressures, with the inflation differential vis-à-vis Germany rising from 0.5% at the start of 1996 to 1.1% by the end of the year, although this declined again to 0.8% in January 1997 and to 0.5% in February. Measured by Euro-standardised inflation statistics, however, the spread is a much lower 0.1%. Compared to most other EU member states, however, inflation in the Netherlands remains low at 1.5% in 1996 - only Luxembourg, Finland and Sweden posted lower rates last year.

Unemployment

Over the last 15 years the Netherlands has enjoyed a spectacular growth in employment levels. Over this period the number of people in work in the Netherlands has increased by 16%, compared to just 3% in Germany and 4% across the 15 members of the EU. Because of this vigorous employment growth, the Dutch dependency ratio has improved considerably. In 1984 there were still 83 benefit recipients for every 100 people in work. By 1997 this figure has fallen to just over 78. This indicates that the economic base has improved steadily, with fewer people depending on benefit and more people generating the benefits.

The Dutch labour market has continued to develop favourably over the last year, with the volume of temporary working hours in 1996 exceeding 300 million. This is the equivalent of some 146,000 full time jobs, or 2.5% of the total labour volume. The CPB expects unemployment to fall still further this year and next by a total of 15% against the 1996 average.

The Dutch economy in 1997

Estimates leaked from the Dutch Central Planning Bureau (CPB) in February showed an upward revision in the 1997 growth forecast from 2.75% to 3%. In 1998, the CBP also expects growth to be sustained at around 3%. This would mean that the Dutch economy will continue to grow at a faster rate than the EU average. Inflation, however, is also expected to rise to over 2% in 1997, in reflection of the strength of this growth and the continued boom in consumer spending which will accompany it.

The Dutch guilder and monetary policy

For the past 15 years Dutch exchange rate policy has been focused on maintaining a stable bilateral nominal exchange rate between the Dutch guilder and the Deutschmark, and in broad terms the policy has been highly successful.

In keeping with this policy the central guilder-Deutschmark cross rate was set at Fls1.1267/Dm in March 1983, since when it has never been adjusted. Furthermore, the guilder has been the only ERM currency which has been able consistently to maintain a narrow fluctuation band (of 2.25%) with the Deutschmark. As a result, the financial markets have seen virtually no exchange rate risk between Germany and the Netherlands, so that interest rate differentials between the two countries have disappeared, meaning that de facto convergence between the two economies has been the order of the day for several years. For some time now, Dutch interest rates have been kept below German levels.

In the first three months of 1997 the guilder came under sustained pressure relative to the Deutschmark. In the first week of March the Deutschmark rose to Fls112.5/Dm, a level not seen since March 1994, and subsequently to Fls112.6/Dm - its highest rate since August 1993. The reasons cited for the relative weakness of the Dutch currency included sustained lower Dutch yields at the long end of the yield curve leading to substantial switches by investors from Dutch government bonds (DSLs) into German Bunds. Another factor which may have influenced the weakening of the guilder in the first quarter of 1997 was the outperformance of the Dutch equity market relative to other European bourses, which prompted a bout of profit-taking .

The Dutch central bank responded quickly to this development: in February, the weakening of the Dutch guilder against the Deutschmark prompted De Nederlandsche Bank to tighten monetary policy and increase local interest rates. In spite of this interest rate rise, which had in any case been widely discounted by the market, the guilder continued to weaken against the German currency over the early part of March, which led the central bank to hike the voorschotrente (advances rates) by a further 50bp to 2.5%, which closed the gap between the Dutch rate and the German discount rate.

Following the second Dutch rate hike, the guilder gained some ground on the Deutschmark, although thereafter uncertainty about the starting date for Emu caused by contradictory statements by German government and Bundesbank officials led again to a slightly higher Dm/Fls rate. In view of the almost identical interest rates which are now prevailing in Germany and the Netherlands, there seems to be little reason why there should be any further dramatic changes in the Dm/Fls exchange rate, although economists do not rule out the possibility of Dutch interest rates ultimately rising above German rates.

The Netherlands and the Maastricht criteria

In terms of its macroeconomic fundamental indicators, the Netherlands is in the forefront of those EU economies most suitably equipped for Emu in accordance with the convergence criteria predetermined in the Maastricht Treaty, which the Dutch government ratified in 1992.

Although the Dutch budget deficit climbed in 1995 from 3.4% to 4%, in 1996 this weighed in at 2.3% of GDP, with the CBP expecting this to have declined to 1.3% by 1998 - comfortably within the Maastricht threshold of 3%, and also well below the EU average for 1996 of 4.4%.

The debt ratio has also been reduced in recent years, falling from 79.7% of GDP in 1995 to 78.5% in 1996 and an anticipated 74.5% in 1997. This would put the Netherlands broadly in line with the EU's average debt ratio figure of 73.7% in 1997. This is also in line with the Emu criterion stipulating that the debt ratio should be "diminishing sufficiently and approaching the 60% of GDP reference value at a satisfactory pace."

The other criteria determining an economy's suitability for Emu convergence - inflation, interest rates and exchange rate stability - have all been met by the Netherlands for some time now. As a result, early Emu qualification for the Netherlands appears to be a formality. Looking to the future, however, the focus on further reductions in the debt ratio will restrict the government's budgetary scope for public sector investments in infrastructure and for reducing the tax burden over the coming years.

The Dutch economy under Emu

It is generally anticipated that the Netherlands' economy would be a substantial beneficiary of the advent of a single European currency. In broad terms, the Dutch government supports the view that Emu would eliminate exchange rate movements and the uncertainty and volatility which go with them, promote trade and investment, optimise the choice of business locations, further improve scale benefits, reduce costs and make European business more competitive. Specifically with regard to the economy of the Netherlands, the CBP announced in its spring Economic Outlook that an Emu go-ahead would cause Dutch economic growth in 1998 to exceed its forecast of 3.25%, given that consumer and producer confidence would both receive an additional stimulus.

The Dutch pension system: one step ahead of the game

Thanks to demographic trends which are leading to a rapid ageing of the population in Europe - especially in Italy and Germany, where it is projected that between 50% and 60% of the population will be over the age of 65 by 2050 - most European countries now have higher public debts and future pension commitments than the average industrialised country.

In sharp contrast to several other European economies which are now weighing up the implications of drafting long overdue laws on the development of private pension funds, the Netherlands has historically boasted one of the world's most efficient and well-developed pension fund industries. At the end of 1994, on the basis of a narrow definition which only takes into account of funded public and private pension schemes, the total assets of Dutch pension funds amounted to $285 billion, or 85% of GDP. This is a higher figure than in any other developed economy, including those of the US and the UK which are also well regarded for the efficiency of their pension fund industries, and where the figures were 54% and 73% respectively. In EU countries such as Italy, France and Germany, meanwhile, the comparative figures are very low at 6%, 5% and 7% respectively. On the basis of a broader definition which includes the general reserves of life insurance companies, the total stock of Dutch assets at the end of 1994 stood at 129% of GDP, second only to the UK (144%), but comfortably ahead of Germany (29%), France (32%) and Italy (14%).

The Dutch government bond market

The front end of the Dutch yield curve has not changed much as a result of the change in monetary policy which was forced upon the Dutch central bank as a result of the weakening of the guilder in the first quarter of 1997, primarily because this was widely discounted by the market long before the rate hike. In the two and three-year area of the curve, yield spreads against Germany have been fluctuating between 10bp and 20bp, while further out along the curve the spreads vanish altogether and in maturities beyond 2004 yields trade significantly below those of Germany. Without medium term confidence in the strength of the guilder and the solid reputation of the Dutch central bank these spreads would not have been maintained.

The spreads on Dutch bonds versus Germany are not expected to change significantly over the near to medium term. One main source of support for DSLs will be the supply outlook, with the Dutch government having announced in January that its funding requirements in 1997 would be Fls14.35 billion lower than had previously been anticipated. In January the Dutch treasury launched a new 10-year benchmark 5.75% DSL, which raised Fls7.5 billion in three days.

Total bond issuance is expected to be in the neighbourhood of Fls19 billion for 1997 as a whole although Fls13.5 billion of this total requirement was successfully raised in the first quarter of the year, leaving the remaining financing requirement very limited, apart from the repayments of private loans and early redemptions due to the prevailing low yield levels.

While European bond markets will be subject to continuing volatility in the run up first to this year's Amsterdam summit in June - and subsequently to the planned starting date of Emu on January 1 1999 - the Dutch market is unlikely to be influenced sharply one way or the other by the threat of a postponement to monetary union. This is because the Netherlands, like France, enjoys economic fundamentals which justify yields close to German levels. In the event of a delay, however, it is to be expected that the peripheral bond markets of Europe would be negatively affected, with substantial flows of capital moving from these markets to the perceived safe haven of the core economies such as Germany and, to a lesser extent, the Netherlands. As a result, both the Deutschmark and the guilder - which already enjoy de facto convergence with one another - could expect to strengthen dramatically. Given the exposure of Dutch industry to revenues denominated in US dollars, this would have a harmful impact on the longer term stability of the Dutch economy.

Dutch equities and Emu

The resilience of the Dutch economy in 1996, twinned with strong exports and a benign interest rate environment had a positive effect on Dutch equities, with the Dutch stockmarket the second best performing European bourse in 1996.

For the Dutch equity market as a whole, Emu is expected to be beneficial. This is chiefly because for quoted Dutch companies which through their exports have an unusually high exposure to the dollar, an important consequence of Emu going ahead on January 1 1999 as planned will be the likely strength of the US currency relative to the euro. A stronger dollar can be expected to bolster export earnings at the leading blue chip companies.

While Dutch companies are ahead of many of their European competitors in terms of corporate restructuring and the creation of shareholder value - as epitomised in the recent decision of DSM to announce a share buyback programme - there are other structural reasons why Dutch equities can be expected to benefit from closer European monetary integration. For example, quoted Dutch companies have historically been artificially protected against hostile takeovers through a wide range of defence mechanisms which in an integrated European economy would need to be dismantled. This would have the effect of injecting the potential for some speculative appeal into the market where none has previously existed.

The growth of institutional support for equities in Europe is probably neutral for Dutch equities relative to other markets under the Emu scenario. On the one hand, Dutch pension funds have a stated aim of increasing their exposure to equities to 40% of total assets under management, which is largely positive. On the other, much of this allocation has already been made, while other European markets in which local pension funds play a far more marginal role in the equity market will, over the course of the next decade, need to catch up with their Dutch counterparts. In relative terms, therefore, more institutional cash will be channelled into equities over the longer term in markets such as France, Germany and Italy than in the Netherlands.

The role of the Dutch guilder in capital markets under Emu

It has been apparent from activity in the international capital market in the early months of 1997 that the Dutch guilder is already being recognised by investors as a currency which will be at the heart of Emu. Alongside the Deutschmark and the French franc, the guilder has played an important role in the succession of parallel and euro-fungible bonds which have been launched so far this year.

The first of the euro-fungible issues in January included a groundbreaking issue by the European Investment Bank (EIB), which launched a Fls1 billion 10-year bond led by ABN AMRO which incorporated clauses allowing the issuer to redenominate the the bonds into euros after January 1 1999 as well as to consolidate the bonds with any other EIB issues carrying identical terms and conditions. This issue was priced at 12.5bp over the 5.75% February 2007 DSL.

ABN AMRO was also a joint bookrunner for the EIB's Dm1 billion 10 year issue launched in March, which can be redenominated in euros after the third stage of Emu to become fungible with the bank's outstanding issues of Fls1 billion, Ffr3 billion and Esc20 billion.

Another groundbreaking euro-fungible issue in which ABN AMRO played a key role was the 10 year three-tranche bond launched by the German engineering giant, Siemens, which returned to the public debt market for the first time in 25 years with a bond which incorporated tranches in Deutschmarks, French francs and Dutch guilders. ABN AMRO acted as a joint bookrunner for the Dutch guilder component of this blow-out transaction, a Fls500 million tranche which was priced at 20bp over DSLs and which quickly tightened to 19bp over the government curve.

ABN AMRO in the international capital market

Over the last few years, ABN AMRO has positioned itself to be at the centre of Europe's capital market, and to be prepared to maintain and expand that position under the new market conditions which will prevail following the introduction of Emu. In 1996, ABN AMRO was the eleventh largest bookrunner of all international bonds, leading 134 issues worth just over $23 billion, to give a market share of 3.41%. In the Eurobond market, meanwhile, the bank climbed from eighth position in 1995 to sixth in 1996, leading 114 issues worth $20 billion.

Not surprisingly, the bank maintained its dominance in the Dutch guilder market in 1996, leading 39 issues in 1996 worth Fls16.175 billion, which equates to a market share of almost 45%. Aside from its presence in the guilder market, however, ABN AMRO also made a very strong advance as a bookrunner of Deutschmark-denominated bonds, rising from fifteenth in 1995's Euro-Deutschmark league table to tenth in 1996, and leading 28 issues valued at Dm6.45 billion.

Over the first few weeks of 1997, ABN AMRO has continued to demonstrate its commitment to developing its expertise in other European currencies, co-leading a Dm1 billion Pfandbrief issue in April, for example, for Hypothekenbank in Essen. The bank has also been stepping up its involvement in the Ecu market, leading an Ecu100 million seven-year bond for Bayerische Hypo Bank in January and an Ecu200 million subordinated debt issue on behalf of ABN AMRO Bank itself in February.