Fitch Affirms Aruba's IDR at 'BBB-'; Revises Outlook to Negative

NEW YORK - Fitch Ratings has affirmed Aruba's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB-'. The Rating Outlook has been revised to Negative from Stable. The Negative Outlook reflects substantial deviation from previously established fiscal deficit targets, which has resulted in higher government debt levels and increased the challenges Aruba faces in achieving sustained fiscal consolidation. In addition, Fitch expects growth to underperform relative to previous expectations and rating peers, partly due to the delay in the St. Nicolas oil refinery conversion project.

A fiscal consolidation plan agreement with the Dutch government (Aruba is part of the Kingdom of the Netherlands with separate status), and negotiated by the previous administration, is off-track and undermines fiscal policy credibility. Because of the indefinite suspension of plans to reactivate the oil refinery, and previous over-reliance on one-off factors to meet earlier targets, revenues fell short in 2017 and the 2018 fiscal surplus target of 0.5% of GDP under the LAFT financial supervision agreement is out of reach.

Based on conservative economic assumptions, the budget deficit should reach 3% of GDP in 2018, similar to 2017 results. Public debt is rising quicker than the 'BBB' median. Gross general government debt reached 86.8% of GDP in 2017, and 72.6% of GDP on a consolidated basis (including the holdings of the social security and civil service pension funds), a 10pp rise in the latter ratio since 2014 and higher than the 'BBB' median at 41.1% of GDP.

The new coalition government that took office in November 2017 is seeking to extend the financial supervision arrangement with the Dutch authorities. They are working on a revised fiscal consolidation plan to balance the budget by 2020. Fitch expects Aruba to retain support from the Netherlands for its budgets and external borrowing plans; however, execution risks remain, particularly concerning the part of the consolidation plan that relies on trimming spending and boosting tax revenue via greater efficiency. Slow growth increases risks to tax performance.

Parameters are set for the 2018 budget, which will be submitted to parliament by the end of April. As an immediate consolidation measure, sales taxes (the BBO and the BAZV 'health tax') will be raised on July 1 by 2.5 percentage points, for a total of 6%, alongside measures to compensate lower-income groups. However, further structural tax or expenditure adjustment measures could be necessary to sustain the fiscal consolidation in 2019, according to Fitch.

A delay to the St. Nicolas oil refinery conversion project alters the near-term outlook for the economy and public finances. The project to convert the refinery into an "upgrader" for Venezuelan heavy crude oil fell behind schedule in 2017 and obtaining financing became more difficult after the imposition of U.S. sanctions on Venezuela. Previously, Fitch expected the investment to help drive growth to 2% in 2017 and 3% in 2018, and for the investment to create up to 600 jobs while generating significant tax revenue. Citgo has recently expressed interest in continuing the project but there is no firm restart date.

Underlying the negative outlook and performance of public finances is a pattern of low growth averaging around 1% over the past five years, well below the 'BBB' median. Fitch estimates real GDP growth at 1% in 2017, and tax increases will weigh further on consumption and growth in 2018-2019. Real output is lower than in 2007. However, tourism, the mainstay of the economy, is performing well. Current account revenues from tourism exports increased 3%, held back only by a sharp fall in visitors from Venezuela, while the core U.S. market remained strong. Tourism is set for another good year in 2018, based on year-to-date performance.

The rating level also reflects the following factors:

--The current account balance is expected to have recorded a small surplus in 2017, on strong tourism performance. Reserves fell slightly but coverage of the exchange rate peg is adequate. Aruba's high dependence on tourism revenues, an estimated 64% of CXR in 2017, combined with the island's small size makes it vulnerable to external shocks. Tourism's share of CXR averaged 21% during 2004-2009, when the refinery was consistently operational.

--Aruba's ratings are supported by strengths including high per capita income, long-standing macroeconomic stability, and membership of the Kingdom of the Netherlands with separate status. These are balanced by weaknesses including relatively high and growing public debt, a narrow economic base, small size and low economic growth.