S&P Supplementary Analysis Government of Aruba

Supplementary Analysis:

Aruba Primary Credit Analyst: Richard A Francis, New York (1) 212-438-7348; richard.francis@standardandpoors.com Secondary Contact: Kelli A Bissett-Tom, New York (1) 212-438-7573; kelli.bissett-tom@standardandpoors.com

Table Of Contents Rationale Outlook Summary Statistics Governance And Institutional Effectiveness: Benefits From Support From The Netherlands And Is Focused On Reducing Expenditures Economic Analysis: Tourism Should Continue To Support Economic Growth External Analysis: The Loss Of Oil Exports Will Continue To Pose A Weakness Fiscal Analysis: The Deficit Has Eased, But Remains High Monetary Policy Analysis: Constrained By A Fixed Exchange Rate And A Relatively Small Financial System Local Currency Rating And T&C Assessment Related Criteria And Research

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Supplementary Analysis:

Aruba This report supplements our research update "Aruba 'BBB+/A-2' Ratings Affirmed; Outlook Remains Stable," published on June 16, 2014. To provide the most current information, we may cite more recent data than that stated in the previous publication. These differences have been determined not to be sufficiently significant to affect the rating and our main conclusions.

Rationale Aruba's stable parliamentary system of government and the fact that the country

Sovereign Credit Rating

is a member of the Kingdom of the Netherlands (along with Curacao, St.

BBB+/Stable/A-2

Maarten, and the Netherlands), as well as its $24,000 per capita GDP, anchor its creditworthiness. The economy grew by 3.9% in 2013, largely because of the continued strong performance of its tourism industry. We expect the economy to grow by 2.7% in 2014. However, the closure of the Valero oil refinery in 2012 left the Aruban economy even more dependent on the tourism industry, accounting for (directly and indirectly) 84% of the overall economy.

The closure of the refinery also weakened the country's external indicators. Narrow net external debt rose to 25% of current account receipts in 2013 from 8% in 2012. The ratio of gross external financing needs to current account receipts and usable reserves, an indicator of external liquidity, also deteriorated, to 118% from 100% in 2012. Despite the continued robust performance of tourism, we do not expect these ratios to improve significantly over the next three years.

The government reduced its general government fiscal deficit to 5% of GDP in 2013 from 6.8% in 2012 largely through increases in government revenues. The government has pledged to reduce expenditures in 2014 and then freeze them over the next three years. Furthermore, the government passed major pension reform for its general pension system (AOV), which increased contributions and raises the retirement age to 65 over the next 10 years. The government is expected to pass a similar reform for its public-sector worker program (APFA) in the coming weeks as well. These reforms will strengthen the pension funds' finances over the coming decade. As a result, we expect the general government deficit to fall to 3% of GDP in 2014, where it will remain over the next three years. Based on this, the gross general government debt burden is expected to stabilize at nearly 60% of GDP. A fixed exchange rate and a moderately sized financial system constrain the central bank's ability to conduct monetary policy. Also, the central bank's monetary policy instruments are limited mainly to reserve requirement on bank deposits.

Outlook The stable outlook balances the recent deterioration in the government's fiscal and debt positions as well as the

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country's external indicators with the expectation that the government is taking adequate measures to reduce its fiscal deficits and the continued strength of the country's tourism industry.

The government has stated that its key focus for the second term is fiscal consolidation, largely by reducing expenditures in 2014 and then freezing them over the next three years. If successful, the government's fiscal deficits in terms of GDP would greatly diminish and the debt burden would begin to fall. A better fiscal position combined with improved external liquidity (through improvements in the country's balance of payments and international reserve position) could lead to an upgrade. On the other hand, a deterioration in the country's external liquidity position due to a significant increase in net external debt or a fall in international reserves could lead to a downgrade.

Summary Statistics Table 1

Aruba--Selected Indicators 2007 Nominal GDP (bil. US$)

2008

2009

2010

2011

2012

2013

2014e

2015f

2016f

2017f

2.6

2.7

2.5

2.4

2.5

2.5

2.6

2.7

2.8

3.0

3.1

GDP per capita (US$)

26,125

27,208

24,595

23,459

24,827

24,350

24,423

25,026

26,065

27,147

28,273

Real GDP growth (%)

2.0

0.2

(11.0)

(3.2)

3.7

(1.3)

3.9

2.7

3.2

3.2

3.2

Real GDP per capita growth (%)

1.3

(0.6)

(11.7)

(3.5)

2.9

(2.8)

2.2

1.5

2.0

2.0

2.0

Change in general government debt/GDP (%)

2.1

(0.4)

2.9

2.7

6.6

6.6

5.0

3.1

2.9

2.4

2.5

General government balance/GDP (%)

1.6

3.8

2.4

(0.1)

(5.8)

(6.8)

(5.0)

(3.0)

(3.1)

(3.1)

(2.9)

General government debt/GDP (%)

34.0

32.0

38.1

42.5

46.5

53.2

57.2

58.3

58.2

57.6

57.2

Net general government debt/GDP (%)

5.2

0.6

0.8

(0.4)

7.2

14.6

19.9

22.8

24.5

25.5

26.4

General government interest expenditure/revenues (%)

6.1

7.1

6.0

6.6

8.0

8.2

8.5

8.9

8.9

8.9

8.9

Other dc claims on resident nongovernment sector/GDP (%)

53.0

52.5

57.1

60.4

58.2

60.4

62.5

62.5

64.4

65.9

67.7

CPI growth (%)

5.4

9.0

(2.2)

2.1

4.4

0.6

(2.8)

1.0

2.2

2.2

2.2

Gross external financing needs/CARs plus usable reserves (%)

99.7

102.9

98.6

131.1

106.5

100.9

118.4

119.4

117.4

118.8

118.6

Current account balance/GDP (%)

10.0

0.8

8.3

(17.6)

(8.6)

4.8

(7.0)

(6.9)

(6.5)

(6.1)

(5.9)

Current account balance/CARs (%)

3.8

0.3

5.8

(21.7)

(3.1)

3.7

(7.8)

(7.7)

(7.4)

(7.0)

(6.9)

Narrow net external debt/CARs (%)

5.4

1.2

0.2

6.8

1.2

8.5

25.1

29.3

31.0

32.2

33.8

52.5

54.5

98.6

192.5

60.7

84.0

141.8

145.7

150.0

153.8

158.0

Net external liabilities/CARs (%)

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Table 1

Aruba--Selected Indicators (cont.)

Note: Other depository corporations (dc) are financial corporations (other than the central bank) whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private-sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. The data and ratios above result from Standard & Poor’s own calculations, drawing on national as well as international sources, reflecting Standard & Poor’s independent view on the timeliness, coverage, accuracy, credibility, and usability of available information. CARs--Current account receipts. e-Estimate. f-Forecast.

Governance And Institutional Effectiveness: Benefits From Support From The Netherlands And Is Focused On Reducing Expenditures • Aruba's stable parliamentary system of government and the fact that the country is a member of the Kingdom of the Netherlands (along with Curacao, St. Maarten and the Netherlands) help anchor its creditworthiness.

• The government's stated key focus for the second term is fiscal consolidation--namely reducing the government's expenditures.

Aruba has a stable parliamentary system of government and is a member of the Kingdom of the Netherlands, which support its creditworthiness. The government of the Netherlands is directly responsible for Aruba's foreign affairs and security. The highest court also lies at the Hague. Aruba's connections with the Netherlands, which support political and institutional stability, extend well beyond the constitutional and legal anchor that it receives as a member of the Kingdom of Netherlands. For example, the Central Bank of Aruba periodically hosts staff from the Dutch central bank on assignment to help strengthen its legal, regulatory, and institutional capacity. Such connections with the Netherlands help strengthen Aruba's public institutions and sustain investor confidence.

Since 1986 when Aruba gained status aparte (becoming a separate country) within the Kingdom, the government of Aruba has alternated between majorities led by the AVP party (Aruban People's Party) and the MEP (People's Electoral Movement) party. The current government of the AVP, which is akin to the "Christian Democratic" parties of Europe, came to power in 2009, led by Prime Minister Mike Eman. The AVP won reelection in September 2013, winning 13 out of 21 seats in Parliament (up from 12 in prior election). The opposition MEP won seven seats, and the Democracy Real won one seat. During the government's first term in office during 2010-2013, it sought to implement an ambitious infrastructure program, reduce the business turnover (or BBO) sales tax by half, focus on green energy, and tackle the problems in the country's public pension and health care systems.

Social dialogue with unions and employers is a key component of the government's political strategy to come to consensus on difficult political issues, such as public pensions, health care, safety, and quality of life. A number of key reforms, such as raising the retirement age gradually to 65 from 60 (over 10 years) and raising contribution rates for the public sector pension systems, were discussed and brokered through the forum. Going forward, the dialogue is likely to contribute to new legislation with a variety of minor tax changes that should contribute modestly to enhancing revenues as well as ongoing reforms to the public-sector health and pension systems that will reduce costs over the next decade. Effective implementation of measures in these areas would address an important source of fiscal slippage and spending pressure, as well as strengthen the pension plan's actuarial position.

The government has also embraced renewable energy and has ambitious plans to change the island's pattern of energy use, auguring well for cost savings and GDP growth. Key investments by WEB, the state-owned water and electricity utility company, have significantly lowered its reliance on expensive heavy oil imports, allowing it to reduce water and

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electricity tariffs (as well as aiding the country's balance of payments position). Additionally, an ambitious investment program to improve the country's infrastructure and make Aruba more attractive to tourists is underway.

The government's stated key focus for the second term is fiscal consolidation. It has pledged to reduce expenditures in 2014 and then freeze them over the next three years. If successful, the government's fiscal deficits in terms of GDP would greatly diminish and the debt burden would begin to fall. The next parliamentary elections are due in September 2017.

Economic Analysis: Tourism Should Continue To Support Economic Growth • Aruba's per capita income is more than $24,000, and it has several of the same issues as many developed countries, such as in the pension and health care areas as a result of age-related issues.

• GDP is likely to grow by 2.7% in 2014, on the back of solid growth in the tourism industry.

• Recent government initiatives could help sustain long-term growth through lower energy costs, better infrastructure, and new capacity in hotel rooms and condos.

Aruba's economy is heavily concentrated in tourism, representing directly and indirectly an estimated 84% of the total economy. The economy became more concentrated after the 2012 closure of the Valero refinery, which represented an estimated 12% of the total at the time. The U.S. tourism market (mainly from the Northeast, including the New York region and Boston) remains the most important for Aruba, representing nearly 70%. Venezuela is the second-biggest market, accounting for 20%. As such, the weakness of the Venezuelan economy creates significant risks for Aruba.

We expect the Aruban economy to grow by 2.7% in 2014 due to continued strong growth in the sector, following growth of 3.6% in 2013. The tourism sector has performed well over the past three years. In 2013, stay-over tourism grew by nearly 8% (versus 1% for the rest of the Caribbean and 5% worldwide), tourism receipts increased by 5%, and hotel occupancy averaged 76%. In addition, cruise ship arrivals were up sharply in 2013 (18%), largely because of success in attracting cruise ships in the off-season.

The government created the Aruba Tourism Authority (ATA) in 2010, seeking to professionalize the agency with an independent budget. The agency's key strategy is to improve the quality of tourism and attract more affluent travelers that spend more. Additionally, the ATA seeks to diversify its tourism markets, with a heavy focus on Latin America, especially Colombia, Brazil, and Chile. And for the U.S., it intends to diversify to regions outside the Northeast, such as California, Florida, and the Midwest. The ATA's efforts to expand airlift have been successful; new flights are coming from SouthWest, JetBlue, and USAir, and Copa is expected to add flights.

WEB has made significant investments (nearly $90 million) aimed at lowering its production costs and improving efficiencies that have aided the overall economy significantly over the past eight years. These have included installing new technology, a wind park, and adding biofuel electricity generators. The efficiencies and renewable focus enabled the company to reduce oil consumption by more than 40%, helping significantly reduce oil imports as well as water and electricity tariffs, one of the key costs of doing business in the country. Energy costs are now 22 cents/kilowatt-hour--far below most of the Caribbean. An additional wind park and expansion of a biofuel plant are in the investment pipeline, which will require investments of $70 million over the next three years. These investments would further reduce dependence on oil over the next three years. The company expects to reach 40% of renewable energy by 2018 from 17% at year-end 2013.

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Private-sector investment is likely to expand the number of hotel rooms over the next four years. The Ritz Carlton came online in late 2013. The Westin hotel closed in 2013 to renovate rooms, which are expected to come back on stream in 2015. Furthermore, we expect the number of condo units to increase sharply in 2015. New Web sites and the Venezuelan market are driving growth of non-hotel stay-over tourism. Additionally, a new Hard Rock Café hotel could be completed by 2017.

The government's ambitious public investment program should sustain economic activity in the coming couple of years.

Work on some projects has already finished, such as a downtown tram circuit in the capital city of Oranjestad and a park connecting the city to the airport. Other projects to renovate and expand the island's hospital and major road projects are also in the works. Additionally, the Aruba Port Authority is moving the cargo port to Barcadeira, freeing up valuable land. The cruise ship terminal will gain one berth when the container port facility is moved as well.

There is some upside to economic growth if the refinery starts operating again or if natural gas is found offshore.Repsol is currently doing offshore exploration for gas. The size and age of the refinery make it difficult to find a buyer, and significant investment would be needed to make it viable.

Table 2

Aruba--Economic Indicators

Nominal GDP (bil. AWG) Nominal GDP (bil. US$)

2007

2008

2009

2010

2011

2012

2013

2014e

2015f

2016f

2017f

4.7

4.9

4.5

4.3

4.6

4.5

4.6

4.8

5.1

5.3

5.6

2.6

2.7

2.5

2.4

2.5

2.5

2.6

2.7

2.8

3.0

3.1

GDP per capita (US$)

26,125

27,208

24,595

23,459

24,827

24,350

24,423

25,026

26,065

27,147

28,273

Real GDP growth (%)

2.0

0.2

(11.0)

(3.2)

3.7

(1.3)

3.9

2.7

3.2

3.2

3.2

Real GDP per capita growth (%)

1.3

(0.6)

(11.7)

(3.5)

2.9

(2.8)

2.2

1.5

2.0

2.0

2.0

Real investment growth (%)

(3.6)

2.0

(16.6)

(10.8)

4.5

(8.4)

(12.1)

14.2

3.0

3.0

3.0

Gross domestic investment/GDP (%)

32.5

33.3

30.3

28.9

28.5

26.6

22.9

25.5

25.4

25.4

25.3

Gross domestic savings/GDP (%)

42.5

34.0

38.6

11.3

19.9

31.4

15.9

18.5

18.9

19.2

19.4

3.8

1.7

(12.5)

(10.5)

4.6

(5.8)

5.9

3.4

4.7

4.7

4.7

Real exports growth (%)

Note: Savings is defined as investment plus the current account surplus (deficit). Investment is defined as expenditure on capital goods, including plant, equipment, and housing, plus the change in inventories. The data and ratios above result from Standard & Poor’s own calculations, drawing on national as well as international sources, reflecting Standard & Poor’s independent view on the timeliness, coverage, accuracy, credibility and usability of available information. e-Estimate. f-Forecast.

External Analysis: The Loss Of Oil Exports Will Continue To Pose A Weakness • The current account balance deteriorated as a result of the closure of Valero's refinery operations.

• Foreign exchange reserves are likely to remain stable in the coming two years as foreign direct investment (FDI) and external borrowing of the government cover current account deficits.

The current account balance will suffer in the coming years from the loss of net oil exports from the Valero refinery in 2012. After posting a current account surplus in 2012 on the sale of the remaining stock of oil, the current account balance was a deficit of 7% of GDP. As a small, open economy depending on tourism, Aruba typically runs large trade deficits since it imports most goods for both investment and consumption (the deficit was more than 40% of GDP in 2013). Similarly, it enjoys a large surplus in services (also nearly 40% of GDP in 2013). The tourism industry, however, is doing well. The Ritz Carlton hotel opened in November 2013, which we expect to further propel the tourism industry

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in 2014-2015, which could help gradually reduce the current account deficit. The government's fiscal consolidation is key to maintaining a healthy balance of payments by reducing imports. The government's push to renewable energy also is considered key due to Aruba's dependence on oil imports. Investments at WEB have helped reduce fuel imports over the past five years.

The central bank's rule that 60% of assets must be held locally limits the banking sector and private-sector net exposure to external debt. However, public-sector external debt has been increasing, leading to deterioration overall. (The public-sector pension funds have large external assets.) As a result, we expect narrow net external debt to rise over the next four years, to 30% in 2014 from less than 10% of current account receipts in 2012. Similarly, Aruba's external liquidity has deteriorated as current account receipts have fallen due to the closure of Valero. However, the country's international reserves have held steady, partly because of the government's international issuance. The gross external financing gap to current account receipts plus usable reserves deteriorated to about 120% in 2013 from 100% in 2012.

We expect the ratio to remain at nearly 120% over the next three years. Tourism is likely to continue experiencing strong growth, at 4% in 2014.

The combination of FDI (mainly related to tourism) and external debt issuance by the government is likely to largely fund the current account deficit this year, resulting in steady foreign exchange reserves. We expect Aruba's current account deficit to gradually improve toward 5% of GDP over the next three years--given better prospects for tourism earnings and some improvement in oil imports as a result of the country's move toward renewable energy. Foreign exchange reserves are likely to remain stable in the coming two years as small current account deficits are offset with FDI and external borrowing by the government. Net increases in public-sector external debt as well as direct and portfolio investment inflows are expected to fully cover the country's current account deficit.

Table 3

Aruba--External Indicators 2007

2008

2009

2010

2011

2012

2013

2014e

2015f

2016f

2017f

5.4

1.2

0.2

6.8

1.2

8.5

25.1

29.3

31.0

32.2

33.8

Gross external financing needs/CARs plus usable reserves (%)

99.7

102.9

98.6

131.1

106.5

100.9

118.4

119.4

117.4

118.8

118.6

Net external liabilities/CARs (%)

52.5

54.5

98.6

192.5

60.7

84.0

141.8

145.7

150.0

153.8

158.0

Current account balance/GDP (%)

10.0

0.8

8.3

(17.6)

(8.6)

4.8

(7.0)

(6.9)

(6.5)

(6.1)

(5.9)

Current account balance/CARs (%)

3.8

0.3

5.8

(21.7)

(3.1)

3.7

(7.8)

(7.7)

(7.4)

(7.0)

(6.9)

Narrow net external debt/CARs (%)

Trade balance/GDP (%)

3.0

(19.9)

(19.6)

(46.6)

(27.9)

(25.7)

(41.7)

(41.6)

(40.8)

(39.8)

(38.5)

(19.5)

0.6

(0.5)

7.7

19.0

(12.9)

6.1

4.4

5.1

4.8

4.6

Net portfolio equity inflow/GDP (%)

1.7

2.2

(0.1)

0.3

0.5

5.7

2.5

0.0

1.4

1.3

1.2

Short-term external debt by remaining maturity/CARs (%)

5.1

5.2

10.3

18.0

4.9

12.4

19.2

16.9

15.5

18.7

20.3

Reserves/CAPs (months)

0.2

0.2

0.8

0.7

0.2

1.0

0.8

0.5

0.5

0.7

0.8

Net FDI/GDP (%)

Note: Other depository corporations (dc) are financial corporations (other than the central bank) whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private-sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. The data and ratios above result from Standard & Poor’s own calculations, drawing on national as well as international sources, reflecting Standard & Poor’s independent view on the timeliness, coverage, accuracy, credibility, and usability of available information. CARs--Current account receipts. e-Estimate. f-Forecast.

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Fiscal Analysis: The Deficit Has Eased, But Remains High • Recent efforts to address long-term fiscal challenges in pensions and health care should strengthen public finances over the long term, but more work is necessary to stabilize the recent growth in the debt burden.

• The government's medium-term fiscal plan is to reduce the deficit through targeting maximum expenditures from 2014-2017 of Aruban florin (AWG) 1.350 billion.

• Better coordination between the Ministry of Finance and the Central Bank of Aruba could improve the budget process.

Fiscal performance and flexibility The central government deficit reached an estimated 7.2% of GDP in 2013 (compared with an original target of 6.5%), down from 9.8% of GDP, largely because of a solid increase in tax revenues and some cuts in capital expenditures. (The government calculates its deficit excluding the civil service pension fund and other social welfare funds.) The general government deficit, a better measure of the underlying fiscal stance, reached an estimated 5% of GDP in 2013 from 6.8% in 2012 (when cash surpluses in the APFA pension fund of public-sector workers are taken into account).

The central government's fiscal deficit could decline toward 4%-5% of GDP in 2014, but much depends on the government's ability to implement spending cuts. This expectation is based on the government's announced multiyear plan to reduce spending to AWG1.350 billion in 2014 (from AWG1.432 million in 2013) and hold expenditures steady in 2015-2017. In the near term, the government has limited room for raising added revenues, mainly through minor revenue measures. The government continues to discuss various fiscal measures in its social dialogue with unions, employers, and others. It is likely to present several tax proposals to Parliament later this year for the 2015 budget, modestly contributing to higher revenues in the coming years. These measures could include changes in the manner of calculating various taxes, elimination of some deductibles, and a financial transaction tax. The government is likely to curtail some current spending and potentially delay some capital spending as well. The government is expected to fund its 2014 financing needs mainly through external issuance. (Most of the issuance in 2015 and 2016 is likely to be internal debt as very little external debt comes due, roughly $30 million each year.)

Ahead of the 2015 budget, the government is studying changes in the tax system to widen the base and simplify the system while lowering tax rates. Currently, the highest tax rate is 59.5%, but the effective rate is much lower. The government is also discussing revenue measures, such as a financial transaction tax, value-added tax (VAT), and fuel tax. The government is also discussing a fiscal responsibility rule that seeks to balance the budget with the creation of an Aruba Fiscal Council for oversight. The government's fiscal adjustment strategy is important given that spending pressures are likely to rise by 2016 as public private partnerships' lease payments come into the budget, the interest payments continue to increase because of higher debt levels, and wage pressures build.

Over the past four years, the government has made a number of reforms to tackle the growing challenges of an aging society. One of the most important was a reform to the public social security system (AOV), which raised the retirement age to 65 from 60 over a phased-in 10-year period as well as increased the contribution rates. The reform should bring the system into balance by 2015 and to post surpluses beginning in 2016. (The losses in 2014-2015 would be covered by its reserves.) The pension system for public-sector workers (APFA) similarly is expected to raise the retirement age to 65 from 60. Further, reforms in the national health care system (AZV) are being discussed, as well as the introduction of co-payments and a further increase in the premiums. The bank and APFA are working on a long-term plan to build up reserves and increase their coverage level to more than 100% of future payments. (Reserves now are about 78%.) Shortfalls in the health care agency, whose obligations the government must legally meet, and structural weaknesses in APFA have contributed to fiscal slippage in recent years.

Public-sector companies are largely well-run and profitable, with the exception of the bus company. However, WEB's

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primary focus is not profit making, but rather keeping water and electricity costs low. As noted, the company's plan to increase efficiency and reduce dependency on oil has helped lower water and electricity costs.

Debt burden Gross general government debt (which excludes public-sector agencies' holdings of central government debt) reached 57% of GDP in 2013 but will likely fall after 2015 if the government is successful in implementing its fiscal adjustment plan over the medium term. However, net general government debt remained modest, at nearly 20% of GDP in 2013, thanks to assets held in the public-sector pension funds. (We count assets other than holdings of central government debt, including investments held by APFA, as general government assets.) Gross central government debt reached nearly 75% of GDP in 2013.

Just over half of the government's gross debt is in local currency, mainly in bearer bonds held mostly by local financial institutions (private and civil service pension funds, old age security funds, and insurance companies). Despite the small size of the domestic financial market (there is no local exchange and hence very little trading), it has some absorptive capacity thanks to the financial institutions with funds to invest. The average interest rate on domestic debt is about 6%, and average maturities typically have been 10 years or slightly longer since 2007. On average, external debt maturities are eight to 10 years.

The level of contingent liabilities is likely limited (estimated at less than 5% of GDP), given Aruba's healthy banking system and generally profitable government-owned corporations. Public-sector debt is less than 5% of GDP, mostly at AAA and WEB. Table 4

Aruba--Fiscal Indicators 2007

2008

2009

2010

2011

2012

2013

2014e

2015f

2016f

2017f

Change in general government debt/GDP (%)

2.1

(0.4)

2.9

2.7

6.6

6.6

5.0

3.1

2.9

2.4

2.5

General government balance/GDP (%)

1.6

3.8

2.4

(0.1)

(5.8)

(6.8)

(5.0)

(3.0)

(3.1)

(3.1)

(2.9)

General government primary balance/GDP (%)

3.9

6.6

5.0

2.8

(2.8)

(3.5)

(1.4)

0.7

0.8

0.8

1.0

General government revenue/GDP (%)

37.4

39.9

43.5

44.7

37.5

40.3

41.9

42.6

42.9

43.1

43.3

General government expenditures/GDP (%)

35.7

36.2

41.1

44.8

43.3

47.1

46.9

45.7

45.9

46.2

46.2

6.1

7.1

6.0

6.6

8.0

8.2

8.5

8.9

8.9

8.9

8.9

General government debt/GDP (%)

34.0

32.0

38.1

42.5

46.5

53.2

57.2

58.3

58.2

57.6

57.2

Net general government debt/GDP (%)

5.2

0.6

0.8

(0.4)

7.2

14.6

19.9

22.8

24.5

25.5

26.4

28.8

31.4

37.2

42.9

39.2

38.6

37.3

35.5

33.7

32.1

30.8

General government interest expenditure/revenues (%)

General government liquid assets/GDP (%)

Note: The data and ratios above result from Standard & Poor’s own calculations, drawing on national as well as international sources, reflecting Standard & Poor’s independent view on the timeliness, coverage, accuracy, credibility, and usability of available information. e-Estimate. f-Forecast.

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Supplementary Analysis: Aruba

Monetary Policy Analysis: Constrained By A Fixed Exchange Rate And A Relatively Small Financial System • The fixed exchange rate anchors confidence in the Aruban economy but also limits its monetary flexibility. • Inflation is likely to rise by just 0.5% in 2013 because of declines in electricity and water tariffs, before rising to its historical average of 3% in the coming years.

A fixed exchange rate and a moderately sized financial system constrain the central bank's ability to conduct monetary policy. Monetary policy remains geared toward managing domestic credit conditions and maintaining an adequate net external asset position for the central bank and the commercial banks, sustaining confidence in the fixed exchange rate system. The central bank abolished credit ceilings for the banking system in 2010 and replaced them with a reserve requirement of 11% on deposits (unremunerated), which has remained unchanged since January 2010. The central bank will continue to rely on direct policy tools because there is no interbank market. Domestic credit to the private and nonfinancial public sectors is about 60% of GDP. There was deflation of 2.4% in 2013, largely the result of declines in water and electricity tariffs. However, there was little inflation in other areas of the consumer price index (largely near zero). We expect inflation to remain low in 2014, at just 0.5%, because of the residual effects of the water and price cuts.

Aruba has four commercial banks, but three of them dominate the financial sector. These three are Royal Bank of Trinidad & Tobago, now fully owned by Royal Bank of Canada; Aruba Bank, fully owned by a group in the Netherland Antilles; and Caribbean Mercantile Bank, also owned by a bank in Curacao and affiliated with Scotiabank of Canada.

Regulated financial institutions (such as pension funds and insurance companies) must allocate a minimum share of their investments to the local market based on a 40/60 rule (a sliding scale that permits a greater share for external investment for each increment in the total funds that are invested). The policy has created a stable domestic market for sovereign debt, helped by a long track record of low inflation, a fixed exchange rate, and macroeconomic stability. As pension fund assets increase in the coming years, so will the capacity to buy sovereign domestic debt. Aruba's banking system remains in a net foreign asset position. The banks are funded locally, via retail deposits, as well as deposits from the utility company, pension funds, and insurance companies. Bank loans equal slightly less than 70% of deposits.

The bulk of bank lending goes to retail credits since large hotel projects raise money abroad. Banks hold very little government debt (pension funds hold more).

Credit growth was 2% in 2013, mainly because of consumer credit (credit cards). Banks have been building capital buffers since 2010 when nonperforming loans (NPLs) began to increase significantly as a result of the deep recession.

NPLs were 7% of total loans as of year-end 2013, down from more than 10% in 2010. Furthermore, provisioning has increased. Banks' reluctance to quickly write off bad loans and a number of sizable nonperforming loans largely explain the continued relatively high NPL ratio, though NPLs have fallen because of credit growth and work-outs. The central bank is moving to Basel II standards by 2016. Depository insurance is being discussed, and AWG$10,000 is likely to be covered. The banks are highly profitable, with the return on equity above 20%. Foreclosures are difficult and slow, in part because of a lack of demand. Housing prices have remained largely unchanged, though real estate is staying on the market longer. Mortgages are typically 20-30 years at fixed rates with standard loan-to-value ratios of 80%. Banks' exposure to government debt is low, at less than 4% of total assets (mostly Treasury bills).

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Supplementary Analysis: Aruba

Table 5

Aruba--Monetary Indicators 2007

2008

2009

CPI growth (%)

5.4

9.0

GDP deflator growth (%)

5.7

4.8

Other dc claims on resident nongovernment sector growth (%)

4.1

53.0

Other dc claims on resident nongovernment sector/GDP (%)

2010

2011

2012

2013

2014e

2015f

2016f

2017f

(2.2)

2.1

4.4

0.6

(2.8)

1.0

2.2

2.2

2.2

2.3

(1.2)

2.9

0.9

(1.9)

1.0

2.1

2.1

2.1

4.0

(0.9)

1.1

2.8

3.4

5.4

3.8

8.5

7.9

8.3

52.5

57.1

60.4

58.2

60.4

62.5

62.5

64.4

65.9

67.7

Note: Other depository corporations (dc) are financial corporations (other than the central bank) whose liabilities are included in the national definition of broad money. The data and ratios above result from Standard & Poor’s own calculations, drawing on national as well as international sources, reflecting Standard & Poor’s independent view on the timeliness, coverage, accuracy, credibility, and usability of available information. e--Estimate. f--Forecast.

Local Currency Rating And T&C Assessment The local currency rating on Aruba is 'BBB+', reflecting the limited flexibility of the country's monetary policy. The transfer and convertibility (T&C) assessment is 'BBB+', the same as the foreign currency sovereign rating. This reflects Standard & Poor's opinion that the likelihood of the sovereign restricting access to foreign exchange that Aruban-based nonsovereign issuers need for debt service is the same as the likelihood of the sovereign defaulting on its foreign currency obligations. This is based on Aruba's fairly restrictive fixed foreign-exchange regime.

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Supplementary Analysis: Aruba

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Supplementary Analysis: Aruba

Chart 11

Related Criteria And Research Related Criteria Sovereign Government Rating Methodology And Assumptions, June 24, 2013 Ratings Detail (As Of June 26, 2014) Aruba Sovereign Credit Rating

BBB+/Stable/A-2

Transfer & Convertibility Assessment

BBB+

Senior Unsecured

BBB+

Sovereign Credit Ratings History 14-Jun-2013

BBB+/Stable/A-2

24-Aug-2012

A-/Negative/A-2

17-Nov-2011

A-/Stable/A-2

02-Nov-2010

A-/Negative/A-2

*Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor's credit ratings on the global scale are comparable across countries. Standard & Poor's credit ratings on a national scale are relative to obligors or obligations within that specific country.

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Supplementary Analysis: Aruba

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