CPB June forecast: Historic contraction of Dutch economy

But consumers are also spending appreciably less than last year. The sharp fall in output is accompanied inevitably by a stong rise in unemployment. In the current forecast the unemployment rate will average 5½% in 2009 and will then rise rapidly to 9½%. The government will be deep in the red this year and next year, posting budget deficits of 4.1% and 6.7% of GDP respectively.
These are the main estimates from what is known informally as the "Queen's Economic Forecast" (KMEV), which is published annually in June as input for the government's budget preparation. These projections have been published today in the June issue of the CPB Newsletter. In this Newsletter, the Netherlands Bureau for Economic Policy Analysis (CPB) presents its forecasts for the Dutch economy for the years 2009 and 2010.

Deep global recession
Since March, the turmoil on the financial markets - triggered by the collapse of the US investment bank Lehman Brothers - has eased thanks to the exceptional measures taken by central banks and governments. Market players no longer take into account a total collapse of the financial system. But the situation is far from normal again. Many submarkets are still only barely functioning, estimates for the bank losses were revised further upwards recently, and house prices in the United States and many euro zone countries continue to fall.

Over the year as a whole, 2009 will show a historical output fall. In the euro zone, GDP is expected to contract by no less than 5%. Because of the expansive macro-economic policies and the assumed improvement on the financial markets, euro zone GDP is expected to decrease by much less in 2010, around ½%. The recession is holding down inflation. But unemployment and budget deficits will not yet turn for the better next year. World trade will expand again in 2010, albeit only fractionally.

Major uncertainties remaining
The turmoil on the financial markets has eased, but a full normalisation during this projection period is by no means guaranteed. In light of the precarious situation, new problems in the financial sector are a real possibility. Moreover, many businesses and households find themselves in trouble because of the deep recession and tighter borrowing conditions. Hence, the credit crisis and the global recession may well continue for longer than expected in the presented projection. There is also a risk of falling prices and wages (deflation) owing to the very deep recession. Against this, it is possible that the robust measures by the authorities may prove more effective than assumed, so that the economic recovery may prove somewhat stronger.

Record contraction of Dutch economy
The Dutch economy has been shrinking since the second quarter of 2008. The low point in terms of quarter-to-quarter growth is expected to fall in the first quarter of 2009. From then on the economy should develop less dramatically, but it will still shrink both this year and next year. For this year, the estimated contraction will be 4¾%. Next year, the decline in output growth will be more modest, around ½%.

Experiences from countries which have faced a banking crisis in the past show that the difference between the peak and the trough averages 9% and that it takes nearly two years to reach the trough. Compared with this scenario, the consequences of the crisis according to the current forecast are actually not as dire. However, without the credit crisis the Dutch economy would probably have expanded "normally" after 2008, so that GDP in 2010 will now be around 10% lower compared with the old trend. Although there are major differences between countries, it can be said that on average a substantial part of the lost growth is structural, that is to say, long-term and perhaps even permanent. This is the case when, for instance, unemployment remains at a higher level, or when investments in capital and innovation develop less favourably.

Exports hit hard
Relevant world trade, which is very important for an exporting country like the Netherlands, is expected to plummet by 15¼% this year, a post-1945 negative record. It should therefore not come as a surprise that Dutch exports are tumbling. Total goods exports will decline by one-sixth this year. Exports of domestically produced goods are performing slightly worse than reexports.
Export market growth should improve somewhat next year, expanding by a modest 1¾%. This will lead to a similar pattern for Dutch exports: they should broadly stabilise at this year's low level.

Households starting to save
After incurring painful wealth losses in 2008, households have decided to tighten their belts. Consumer spending is also hampered by the fear of job losses, a sharp fall in dividend payments and somewhat falling house prices. For the whole of 2009, the projection forecasts a fall in consumption of 2¾%. Disposable pay and benefit income will still increase this year, because the expected average contractual pay increase of 3% is well above the rate of inflation. Consequently, purchasing power will increase this year, by 1¾% on average. On balance, these developments will result in an individual savings ratio of 2½%, that is to say, Dutch households will on average save 2½% of their incomes. Next year, private consumption is expected to decline somewhat further, by 1%.

Investment plummeting
As things stand at the moment, output in the market sector is likely to shrink by 6¾% this year. The capacity utilisation rate is falling sharply. Businesses will therefore have little need for expansion investments for some time to come. Moreover, labour productivity will fall appreciably this year, because businesses tend to cut jobs in response to cuts in production with a certain time lag. This means that profitability will come under pressure, a trend which will also make investing less attractive. And finally, the acceptance criteria for borrowing are tighter than they were a year ago. The upshot of all this is a slump in estimated total business investment, by 14¾%. This sharp downward trend is likely to continue next year, with investment falling by a further 13%.

Unemployment sharply up
With all these very poor output figures in the recent past and in the offing, the labour market will also be hit hard. The number of job vacancies has been falling sharply since the last quarter of last year, and unemployment is already clearly above the 3.8% level recorded for the third quarter of 2008. The part-time unemployment benefit scheme introduced by the government is keeping unemployment in bounds to some extent this year, but it will not prevent an average of 5½% of the labour force being out of work in 2009. The projection shows the unemployment rate rising to an average of 9½% next year, close to the levels of 1983 and 1984.

Inflation appreciably down
The oil price has been falling rapidly since July 2008. This downswing is reflected in lower fuel prices, and thus has a major knock-on effect on inflation. Gas and electricity prices will be cut significantly with effect from July 2009, so that inflation will end up clearly below the annual average in the second half year. On an annual basis the general price level is expected to increase by 1% in 2009 and by 1¼% in 2010. Underlying inflation, that is, excluding the effect of changes in indirect taxes and energy prices, will remain relatively stable in the projection, between 1½-2%. This is because producers have only limited scope to cut their prices, since margins are under pressure owing to rising unit labour costs.

Substantial budget deficit
In 2008, the budget was in surplus for the third consecutive year. This had not happened since 1961. The turnaround has been abrupt, however. This year, the budget is expected to be in deficit by the equivalent of 4.1% of GDP. And in 2010, the deficit will widen further, to 6.7% of GDP. The lion's share of the deterioration in the EMU government budget balance is due to the automatic stabilisers, which are performing as expected: revenues from taxes and national insurance contributions are falling, while outlays on unemployment benefits are rising sharply. On top of that, there are the costs of the stimulation package, falling natural gas revenues and widening local authority deficits. The EMU debt will increase to 66.3% of GDP in 2010, and will thus be more than 20 percentage points higher than in 2007.

The surge in the public debt as a result of the credit crisis poses a substantial challenge for the public finances. The crisis is causing problems for the budget in other ways as well. For instance through wealth losses by households and pension funds; but "lost" economic growth also has implications for the public finances over the medium and long term. An exact quantification is not possible at this stage, but on the basis of those elements which can be quantified, the public finances will come out ½-1½ percentage points of GDP worse than assumed at the start of this term of government.