Dutch Update: Problem Unresolved, Pressure Mounts
The Dutch government nearly collapsed yesterday as efforts to find more savings to reach its deficit targets is causing near unbearable strains on the fragile coalition. However, highly secretive negotiations are resuming today as there is little alternative shy of new elections.
Recall the sequence of events. A key government agency warned of a budget overshoot for 2013 early in March. Rather than reach the EU-mandated deficit target of 3% of GDP, it now looks like 4.6%. This forced the coalition to begin negotiating a solution.
The Liberal PM Rutte seems eager to deliver new savings. Several areas of reforms have been suggested. In housing, there are some wanting to limit the deductibility of mortgage interest payments. The tax incentives help explain why the Netherlands has the highest level of mortgage debt in the euro zone.
There are also proposals to increase the co-payment on health services. Other proposal involve the reduction of unemployment insurance from the current maximum of more than three years.
The problem is that Rutte’s coalition partner, Geert Wilders Party for Freedom is loathe make social spending cuts, that would hurt the party members. His constituents are more sympathetic to cutting foreign aid, which stands near 0.7% of GDP and is a point of national pride.
Last week a MP in the Party for Freedom quit the part and left the government without a majority, though the MP says he will continue to support the government.
We first brought these issues to your attention on March 6. Since then the Dutch bonds under-performed German bunds, leading to a modest widening of the spread from about 45 bp to about 60 bp. Another measure of the pressure that can be found in the credit default swap market. The price of insuring Dutch sovereign exposure has risen more than 20% to 121.5 bp (5-year).
Pressure on the government will increase if the economic data warn of a deeper economic downturn this year. Next week features the March CPI. Base effects point to a drop in the year-over year rate which was 2.9% in February. In recent months, Dutch inflation has appeared a bit stickier than in Germany. Real sector data are not out until the following week, with industrial output, retail sales, consumer spending and trade figures.
One of our thematic points for Q2 is the increased importance of political factors for the investment climate. Dutch developments are consistent with this and the risk that the government collapses is rising.