Sovereigns

www.fitchratings.com 31 July 2014

Latin America & Caribbean

Aruba Full Rating Report

Key Rating Drivers

Deteriorating Creditworthiness: Aruba’s creditworthiness has deteriorated since 2009 due to

the negative impact of recurrent suspensions of the Valero refinery operations on growth,

investment and foreign reserves. The island has a narrow economic structure and is vulnerable

to external shocks. The focus of the fiscal stimulus response on tax cuts, government payroll

and future commitments on infrastructure projects have accentuated budgetary rigidities and

increased the challenges to reduce large fiscal imbalances and a rising public debt burden.

Outlook Revised to Stable. The revision of the Outlook to Stable reflects Fitch's expectation

that economic growth will gain pace and Dutch oversight should result in adherence to stricter

deficit reduction and debt sustainability standards in 2014-2016. A comprehensive package of

entitlement reforms has mitigated the risk of unfunded pension liabilities and reduced the

burden of the universal healthcare system on public finances.

Fiscal Deterioration Continued: The budget deficit averaged 6.8% of GDP in 2010-2013,

resulting in a jump in public debt to 60%, well above the 39% ‘BBB’ median, from 40% of GDP.

Reduced fiscal credibility and uncertainty over the medium-term fiscal consolidation path has

meant that the Governor of Aruba has requested the Secretariat of the Council of Financial

Supervision of Curacao and Saint Maarten (CFT) to evaluate the fiscal position of Aruba before

signing the 2014 budget and approving additional external financing operations.

Growth Underperformance: Aruba's five-year average growth was negative 1.7% in 2009-

2013, while the 'BBB' median grew 3.1%. High dependence on cyclical tourism receipts,

demographic challenges, labour market rigidities, lengthy legal disputes and structural

impediments to start new businesses hinder domestic investment and economic diversification.

External Vulnerability Increased: The current account balance (CAB) deteriorated sharply to

a deficit of 9.9% of GDP in 2013 from a surplus of 4.1% in 2012, following the halt of fuel

exports at the Valero refinery. International reserves fell 15% to USD654 million or 3.1 months

of current external payments in 2013. Aruba is increasing its dependence on foreign exchange

liquidity restrictions and external debt to maintain an adequate reserve position.

Positive Tourism, Energy Prospects: Fitch forecasts that growth will average 2.6% in 2014-

2016, supported by tourism, construction and infrastructure prospects. The CAD could narrow

to 7.3% of GDP in 2014-2016, reflecting a tighter fiscal stance and fuel imports substitution.

Investment-Grade Anchors: Aruba's investment-grade rating is underpinned by its higher per

capita income than peers, track record of consensual structural reforms and membership of the

Kingdom of the Netherlands, which has provided access to technical cooperation, development

funds and emergency assistance during episodes of financial distress.

Rating Sensitivities

Faster Growth, Fiscal Consolidation: The ratings could be positively affected by successful

consolidation that results in decreasing budget deficits and public debt burden; and higher

infrastructure execution and private investment leading to a sustained faster growth trajectory.

Fiscal Slippage, Reserves Erosion: Material fiscal deterioration leading to a further

escalation in government indebtedness; material reductions in international reserves and

emergence of financing constraints; and deterioration in the institutional relationship between

Aruba and the Netherlands could put downward pressure on the ratings.

Ratings

Foreign Currency

Long-Term IDR BBB− Short-Term IDR F3

Local Currency Long-Term IDR BBB−

Country Ceiling BBB

Outlooks

Foreign-Currency Long-Term IDR Stable Local-Currency Long-Term IDR Stable

Financial Data

Aruba

(USDm) 2013

GDP 2,589.4 GDP per head (USD 000) 24.2 Population (m) 0.1 International reserves 653.5 Net external debt (% GDP) -12.9 Central government total debt (% GDP)

73.7

CG foreign-currency debt 667.6 CG domestically issued debt (AWGm)

2,218.9

Related Research

Global Economic Outlook (June 2014)

2014 Latin American Government Financing Needs (February 2014)

2014 Outlook: Latin American Sovereigns (December 2013)

Aruba (August 2013)

Fiscal Rigidity: The Achilles Heel of LatAm Sovereigns (June 2013)

Analysts

Cesar Arias +1 212 908 0358 cesar.arias@fitchratings.com

Erich Arispe +1 212 908 9165 erich.arispe@fitchratings.com

Sovereigns

Aruba

July 2014 2

Peer Comparison

Current Account Balance

% of GDP

-25

-20

-15

-10

-5

0

5

10

15

20

04

20

05

20

06

20

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20

08

20

09

20

10

20

11

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12

20

13

20

14

f

20

15

f

20

16

f

Aruba Medians

-25-20-15-10-505

10152025

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14f

20

15f

20

16f

Net External Debt % of GDP

0

10

20

30

40

50

60

70

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014f

2015f

2016f

General Government Debt % of GDP

-10

-8

-6

-4

-2

0

2

4

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014f

2015f

2016f

General Government Balance % of GDP

0 50 100 150 200 250

Bahrain (BBB)

Panama (BBB)

Median (BB)

Median (BBB)

Aruba (BBB-)

Uruguay (BBB-)

International Liquidity Ratio, 2014 %

0 20 40 60

Median (BB)

Panama (BBB)

Median (BBB)

Uruguay (BBB-)

Aruba (BBB-)

Bahrain (BBB)

GDP per capita Income, 2013e

At market exchange rates, USA=100

Related Criteria

Sovereign Rating Criteria (August 2012)

Country Ceilings (August 2013)

Sovereigns

Aruba

July 2014 3

Rating Factors

Summary: Strengths and Weaknesses

Rating factor Macroeconomic Public finances External finances Structural issues

Status Neutral Weakness Weakness Strength Trend Stable Stable Stable Stable

Note: Relative to ‘BBB’ category/sovereigns rated ‘BBB+’, ‘BBB’ and ‘BBB−’ Source Fitch

Strengths Aruba’s creditworthiness is supported by its higher per capita income than peers, strong

rule of law and long track record of political and social stability. A high degree of consensus among policymakers and key stakeholders has facilitated the passage of structural reforms to improve fiscal sustainability.

Aruba’s links with the Kingdom of the Netherlands presently provides active fiscal oversight and in the past has facilitated access to development funds and emergency assistance in the event of acute balance of payments pressures and financial distress.

Aruba has an impeccable repayment record. A captive domestic investor base and continued access to international capital markets have provided the sovereign with sufficient fiscal financing flexibility.

External solvency ratios are stronger than those of peers. Adequate external liquidity, low financial dollarisation, a well-capitalised banking system with strict capital flight controls and potential access to balance of payments support from the Netherlands underpin confidence in the stability of the exchange rate peg.

Weaknesses Aruba’s budget deficit is 3x higher than the ‘BBB’ median. Persistent and material

deviations from approved budget targets in 2010-2013 increased the challenges for the authorities to achieve sustained fiscal consolidation.

Structural weaknesses in the fiscal accounts include a narrow and volatile revenue base and high expenditure rigidities stemming from a large public sector wage bill, a heavy interest burden and generous universal healthcare and pension benefits.

Government debt, measured in gross and net terms, is significantly higher than the ‘BBB’ median. Debt and interest payments as a percentage of fiscal revenue could deteriorate further relative to peers without a comprehensive tax reform.

Aruba’s five-year average growth was negative 1.7% in 2009-2013, while the ‘BBB’ median grew 3.1% during the same period. A narrow economic base and low domestic savings limit the country’s potential growth. Volatility of output has increased in recent years due to repeated suspensions of operations at the Valero refinery.

As a small open economy, Aruba has limited capacity to absorb external shocks and implement counter-cyclical policies. Demographic challenges, labour market rigidities, lengthy legal disputes and structural impediments to start new businesses hinder domestic investment and economic diversification.

Local Currency Rating

The Long-Term Local Currency IDR is at the same level as the Long-Term Foreign Currency

IDR. This reflects the country’s limited monetary policy flexibility due to the combination of a

fixed exchange rate regime and weak public finances. The domestic capital market is relatively

liquid but underdeveloped and partially dependent on foreign investors from Curacao.

Country Ceiling

Aruba’s Country Ceiling is one notch above the Long-Term Foreign Currency IDR. The Aruban

economy is open to international trade and capital, as shown by the large presence of foreign

financial institutions and tourism corporations in the island. However, the country maintains

restrictions on the holdings of foreign currency and convertibility controls for commercial banks,

collects taxes on foreign exchange payments to non-residents and sets limits on residents’

investments abroad to protect the fixed exchange regime.

Peer Group Rating Country

BBB Bahrain Brazil Colombia Iceland Panama Russia South Africa BBB- Aruba Azerbaijan Bulgaria India Indonesia Morocco Namibia Philippines Romania Turkey Uruguay BB+ Costa Rica Croatia Hungary Macedonia Portugal

Rating History

Date

Long-Term Foreign Currency

Long-Term Local Currency

23 Apr 14 BBB- BBB- 29 Apr 02 BBB BBB

Sovereigns

Aruba

July 2014 4

Figure 1 Strengths and Weaknesses: Comparative Analysis

2013

Aruba

BBB-

BBB

Mediana

BB

Mediana

Bahrain

BBB

Panama

BBB

Uruguay

BBB-

Macroeconomic performance and policies Real GDP (5yr average % change) -1.7 3.1 3.7 3.5 8.3 5.2 Volatility of GDP (10yr rolling SD) 5.1 2.9 2.3 2.2 2.4 2.5 Consumer prices (5yr average) 0.5 4.1 5.0 2.1 4.3 7.7 Volatility of CPI (10yr rolling SD) 3.4 1.9 2.8 1.1 2.4 1.3 Unemployment rate (%) 7.6 7.3 12.6 3.6 4.1 6.5 Type of exchange rate regime Peg n.a. n.a. Peg Dollarised Managed float Dollarisation ratio (% of bank deposits) 17.5 29.0 40.4 19.7 100.0 73.7 REER volatility (10yr rolling SD) 2.4 5.3 5.8 4.9 2.2 5.4 Structural features GDP per capita (USD, mkt. exchange rates) 24,246 10,801 4,434 25,499 10,432 17,488 GNI per capita (PPP, USD, latest) n.a. 15,820 7,780 31,820 15,700 15,570 Human development index (percentile, latest) n.a. 63.4 46.7 74.7 68.2 73.1 Governance indicator (percentile, latest)

b 86.7 54.6 50.4 52.7 54.5 75.0

Broad money (% GDP) 71.1 68.6 47.5 74.3 79.8 44.2 Default record (year cured)

c None n.a. n.a. None 1996 2003

Ease of doing business (percentile, latest) n.a. 69.1 45.7 75.6 70.7 53.3 Trade openness (CXR and CXP % GDP) 93.9 44.2 53.1 75.1 81.2 27.5 Gross domestic savings (% GDP) 8.4 21.3 17.7 47.7 30.2 18.2 Gross domestic investment (% GDP) 22.9 22.3 21.1 20.4 29.0 22.2 Private credit (% GDP) 62.5 66.3 43.2 95.3 82.3 24.9 Bank systemic risk indicators -/1 n.a. n.a. bbb/1 bbb/1 bb/1 Bank system capital ratio (% assets)

d 22.7 16.0 15.0 19.2 15.7 16.0

Foreign bank ownership (% assets) 100.0 38.0 32.1 33.0 49.0 54.9 Public bank ownership (% assets) 0 16.8 18.6 13.0 14.8 45.0 External finances Current account balance + net FDI (% GDP) -4.8 0.5 -0.4 9.9 -1.1 -0.8 Current account balance (% GDP) -9.9 -1.5 -3.4 10.1 -11.9 -5.5 Net external debt (% GDP) -12.9 8.6 15.9 -101.3 19.9 -14.8 Gross external debt ( % CXR) 64.3 122.8 110.1 442.0 228.0 195.4 Gross sovereign external debt (% GXD) 61.8 35.7 50.9 5.5 17.2 65.3 Sovereign net financial assets (% GDP) -10.1 0.2 -0.2 -4.2 -17.4 -1.1 Ext. interest service ratio (% CXR) 5.1 4.8 2.9 6.1 6.4 5.0 Ext. debt service ratio (% CXR) 13.3 13.8 8.9 10.2 18.3 12.8 Foreign exchange reserves (months of CXP) 3.1 4.8 4.3 2.9 1.2 11.4 Liquidity ratio (latest)

e 187.6 145.0 142.2 86.5 112.6 212.3

Reserve currency status 0 n.a. n.a. 0 0 0 Commodity export dependence (% CXR, latest) 34.4 33.5 18.7 62.8 55.5 54.5 Sovereign net foreign currency debt (% GDP) 0.6 -7.8 -1.2 2.7 -8.5 -8.4 Public finances

f

Budget balance (% GDP) -7.2 -2.6 -2.7 -5.7 -3.5 -2.1 Primary balance (% GDP) -2.5 -0.6 -1.1 -4.2 -1.4 0.4 Gross debt (% revenue) 244.4 150.2 159.2 182.6 158.3 154.4 Gross debt (% GDP) 59.9 39.8 41.2 43.6 38.9 46.1 Net debt (% GDP) 54.7 33.0 31.4 25.2 19.7 41.3 Foreign currency debt (% total debt) 43.1 31.9 53.7 45.0 0.0 44.0 Interest payments (% revenue) 14.5 7.9 6.6 6.5 8.3 8.4 Revenues and grants (% GDP) 24.5 32.9 27.2 23.9 24.6 29.8 Volatility of revenues/GDP ratio 10.6 5.4 6.0 9.9 7.6 1.0 Central govt. debt maturities (% GDP) 7.1 5.6 4.0 10.9 3.0 1.2 a Medians based on three-year centred averages

b Composite of four World Bank governance indicators used in the Sovereign Rating Model: government effectiveness, rule of law, control of corruption and voice &

accountability c Modern (ie. since 1980) rescheduling history

d Bank systemic indicator, which equates to a weighted average viability rating; and macro prudential indicator, with 1 ‘low’ systemic risk through to 3 ‘high’

e Ratio of liquid external assets, defined as the stock of official FX reserves including gold at the end of the previous calendar year plus banks‘ liquid external assets, to liquid

external liabilities, defined as scheduled external debt service in the current year, plus the stock of short-term external debt and all non-resident holdings of marketable medium- and long-term local-currency debt at the end of the previous calendar year f General government unless stated Note: Acronyms used: Consumer price inflation (CPI), gross domestic product (GDP), current external receipts (CXR), current external payments (CXP), gross national income (GNI), purchasing power parity (PPP), standard deviation (SD), foreign direct investment (FDI) Source: Fitch

Sovereigns

Aruba

July 2014 5

Key Credit Developments

Second-Term Government to Rebuild Prudent Fiscal Policy Credentials

The global financial crisis, intermittent operations at the Valero refinery, rising current spending,

burdensome entitlement benefits and selective tax cuts weakened Aruba’s public finances

during the first term of Mike Eman’s administration1. The budget deficit averaged 6.8% of GDP

in 2010-2013. This led to a jump in the government debt burden to 60% of GDP from 40%

during the same period. Persistent and material deviations from the official fiscal targets, which

called for a gradual reduction of the deficit to 3% of GDP by 2013 and a balanced budget by

2016, reduced confidence in the authorities’ commitment to fiscal consolidation.

The fiscal deficit moderated to 7.2% of GDP in 2013, but exceeded the 5% of GDP prescribed

in the budget and the additional 1.6% of GDP authorised in a supplementary bill in 4Q13. The

relaxation of budget controls in the run-up to the September 2013 elections led to cost

overruns. The government granted temporary contracts to laid-off workers from the Valero

refinery and accelerated public works and procurement. Extraordinary revenue from the sale of

the public hospital and dividends from the airport authority offset a 1.7% of GDP shortfall in

projected tax collection, preventing a weaker fiscal outturn.

The new elected cabinet intends to reduce the fiscal deficit to 1.4% of GDP and stabilise the

consolidated debt burden at 63% of GDP by the end of 2017. The strategy sets a fixed annual

spending ceiling of AWG1350m and a revenue floor of AWG1150m that will grow in line with

the pace of the economy in 2014-2017. Expenditure rationalisation is the primary focus of the

consolidation efforts, although a technical commission has been set up to study the reform of

the current income, profit and indirect tax systems. The 2014 budget seeks to front-load 40% of

the fiscal adjustment through drastic reductions in infrastructure investment, purchases of

goods and services and the number of public servants under temporary contracts.

Fitch forecasts that the deficit could average 5% of GDP in 2014-2016, a more modest and

gradual consolidation trajectory than official estimates. Preliminary results point to a widening

of the deficit to 1.6% of GDP in 1Q14 from 0.6% in 1Q13. Expenditure expanded by 3.7% in

1Q14, driven by interest payments, personnel and goods and services, reflecting delays in the

execution of spending cuts. Non-recurrent revenue halved and tax collection grew by 2.1% in

1Q14, below projected nominal growth of 3% and half the budget target of 4.3% for 2014.

Reduced fiscal credibility and uncertainty over the medium-term fiscal consolidation path has

meant that the Governor of Aruba has requested the Secretariat of the Council of Financial

Supervision of Curacao and Saint Maarten (CFT) to evaluate the fiscal position of Aruba before

signing the 2014 budget and approving additional external financing operations. Dutch

oversight could be positive for policymaking should it result in adherence to stricter budgetary

and debt sustainability standards in 2014-2016.

Entitlements Reforms Mitigate Contingent Liabilities and Yield Fiscal Savings

The Social Dialogue, regular negotiations between the government, labour unions and the

business sector, have proven to be an effective mechanism to advance reforms to lessen the

burden of the universal pension and healthcare systems on fiscal accounts.

An overhaul of the general pay-as-you-go scheme (AOV) will reverse its deficit position and

make it self-sustainable beyond 2030. The agreement gradually increases the pension age to

65 from 60 in 2015-2025 and raises the premium paid by workers and employers by 1% in

2014 and 1% in 2015. Without these changes, AOV would have depleted its cash reserves in

2014 and required annual government transfers of 1.5% of GDP per year in 2014-2016.

1 In 2010, the government halved the turn-over tax rate to 1.5% from 3% to stimulate the economy,

exempted Valero from taxes on oil exports after a AWG212m (4.9% of GDP) settlement in 2010 and moved tourism levies off-budget to guarantee the sustainability of the Aruba Tourism Authority (ATA).

Figure 2

Figure 3 Budget Rigidities, 2013

Central government (AWGm)

(%) of total exp.

(%) of

GDP

Current expenditure

1,353 94.5 29.2

Personnel 696 48.7 15.0 Goods & services

250 17.5 5.4

Interest 165 11.5 3.6 Other 122 8.5 2.6 AZV transfers

120 8.4 2.6

Capital expenditure

12.7 21.8 3.0

Source: Ministry of Finance, Fitch

Figure 4

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(%)

Original targets

Fitch's forecasts

Revised targets

Source: Ministry of Finance, Fitch

Fiscal Targets DeviationsFiscal deficit (% of GDP)

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-8

-6

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0

2

4

20

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f

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16

f

(%)

Aruba BBB median

Source: Fitch

Comparative Fiscal StanceFiscal deficit (% of GDP)

Sovereigns

Aruba

July 2014 6

Reforms to the defined-benefit pension regime for civil servants (APFA) could yield 0.6% of

GDP in annual savings beginning in January 2014. Retroactive increases in the retirement age

to 65 and adjustments in the salary base and the accrual rate to compute benefits could reduce

the public sector pension premium to 17% from 36% of the wage bill2. The government also

committed to inject approximately AWG200m into APFA to bring its gross coverage ratio closer

in line with the regulatory requirement of 100% by end-2014. The authorities plan to borrow the

funds to recapitalise APFA from the pension fund itself.

The Social Dialogue reached an agreement to introduce a 1% mark-up in the turn-over tax to

ease the pressure that medical costs and a rapidly aging population are imposing on the

universal healthcare system (AZV). The “health tax”, expected to be rolled out in 4Q14, could

rise up to 1.3% of GDP a year, half of the total government contribution to AZV in 2013.

Deteriorating Debt Dynamics Despite Fiscal Adjustment

Public debt continues on an upward trajectory despite the economic recovery, fiscal tightening

and reforms to contain healthcare and pension liabilities. Aruba’s debt burden could reach 63%

of GDP in 2014 and 65% by 2016, well above the 39% median of the ‘BBB’ category3.

Aruba’s capacity to maintain higher debt levels is constrained by its weak tax-rising capacity,

rigid budget expenditure, narrow economic base and high vulnerability to external shocks.

Interest payments to revenue are expected to climb to 17% in 2014, double the ‘BBB’ median

of 8%. Support from the Netherlands to borrow at lower rates is tied to strict pre-conditions. It

could require a reduction of the fiscal deficit to 3% of GDP, the introduction of a balanced

budget rule in the Aruban Constitution and the creation of an independent oversight council4.

Fitch expects financing needs to average at 9.6% of GDP in 2014-2016. The treasury intends

to increase its reliance on the local market after issuing USD558m (21% of 2014 GDP) in

international private placements to finance large deficits and external amortisation humps in

2012-2014. Local insurers and pension funds have absorption capacity due to restrictions

capping their asset holdings abroad and few alternative investments in the island. Non-resident

investors, mostly from neighbouring Curacao, hold 22% of domestic debt, and also support the

demand for local-currency instruments at favourable interest costs and long tenors5.

Current Account Deficits Put Pressure on International Reserves

The current account balance deteriorated sharply to a deficit of 9.9% of GDP in 2013 from a

surplus of 4.1% of GDP in 2012, following the permanent halt of fuel exports at Valero. Tourism

receipts grew strongly but were not enough to offset the deterioration in the trade balance,

interest payments, profit repatriations and remittances outflows in 2013. International reserves

fell 15% to USD654m or 25% of GDP in 2013. Nearly 60% of the decline came from a negative

result in the balance of payments and 40% from valuation losses in gold reserves.

The CBA revised the methodology for calculating the maximum foreign exchange allowance for

commercial banks to restrict their potential recourse to international reserves. Banks will have a

lower net foreign asset position quota and are obliged to sell their excess reserves to the CBA

at an earlier stage than before the adjustment. The authorities could increase reserve

requirements (at 11% since January 2010), foreign exchange taxes, excise levies and import

2 Some public sector unions did not sign on the APFA agreements. Retroactive reforms and changes

affecting fundamental rights and pension benefits might be subject to legal challenges. 3 Fitch’s general government debt ratio nets out the holdings of treasury bonds and loans by public

pension funds. Intra-public sector debt could increase to 18% of GDP after APFA extends the AWG200m (4.2% of GDP) recapitalisation loan to the government in 2H14.

4 In March 2013, Aruba signed a protocol that would allow it to borrow at rates applicable for the Netherlands (rated AAA/Stable) and use the interest savings to reduce the public debt burden. Aruba requires previous consent from the Council of the Ministers of the Kingdom of the Netherlands to issue debt and conduct liability management exercises in international markets.

5 Aruba maintains a nearly balanced split between domestic and external debt. It issued AWG184m (4% of GDP) locally in 2013 at an average maturity of 14 years and an average coupon of 5.5%.

Figure 5

Figure 6

Figure 7

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f(%)

Aruba consolidated

Aruba non-consolidated

BBB median

Source: Fitch

Rising Government DebtGG debt (% of GDP)

0 4 8 12 16 20 24

BBB median

Colombia

Mexico

Italy

South Africa

Ireland

Philippines

Brazil

Aruba

India

(%)Source: Fitch

Interest to Revenue RatioLargest burdens in the BBB category

0

5

10

15

20

25

30

35

-20

-10

0

10

20

20

07

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f

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f

20

16

f

(%)

Non-oil (LHS)

Oil (LHS)

Foreign reserves (RHS)

Source: Central Bank of Aruba, Fitch

Current Account Deficit(% of GDP)

Sovereigns

Aruba

July 2014 7

duties to defend the stability of the currency peg to the US dollar. There is precedent of balance

of payments support. The Netherlands extended AWG100m (13% of GDP) in stabilisation

loans to the Aruban government after the closure of the Exxon refinery in 1985.

The CAD could narrow at an average 7.3% of GDP in 2014-2016, reflecting a tighter fiscal

stance and a gradual substitution of fuel imports. Oil consumption fell 40% since 2007 and

could decline 25% by 2016 due to technological enhancements, greater reliance on wind power

and biogas and the construction of waste-to-energy plants. FDI, mostly into hotel developments

and real state, is expected to cover 80% of the CAD in 2014-2016.

Aruba is increasing its dependence on external debt to maintain an adequate reserve position.

Fitch forecasts that foreign reserves will stabilise in 2014, but could fall to USD614m or 21% of

GDP, as the government shifts issuance to the domestic market. Aruba’s reserve coverage at

3.1 months of current external payments compares unfavourably with the ‘BBB’ median of 4.8

months. However, external solvency indicators remain stronger than peers, thanks to the

positive net foreign asset positions of the international tourism corporations and commercial

banks operating in the island. The sovereign maintains market access and all its external

liabilities are long-term, mitigating liquidity and refinancing risks.

Tourism Fuels Economic Recovery, Investment to Sustain It

The Aruban economy recovered in 2013 after contracting by a cumulative 12% in 2008-2012

due to the global financial crisis and two prolonged suspensions of refining operations at

Valero6. Real GDP rebounded 3.9% in 2013 driven by the strong performance of tourism

7.

Higher employment in the hospitality industry and the public sector, deflation resulting from

lower utility tariffs and transfers to low-income earners propped up private consumption8.

Fitch forecasts that growth will average 2.6% in 2014-2016, above the country’s estimated

potential of 1.8% but lower than the expected ‘BBB’ median of 3%. The Aruba Tourism

Authority (ATA) estimates that stay-over visitors and tourism receipts will grow 2.5% and 4% in

2014, respectively, down from a record 8.3% and 7.1% in 2013. Tourism prospects are

supported by the recovery in the US, source of 57% of visitors in 2013, increased airlift and

room capacity and advertising campaigns targeting more affluent travellers. The ATA’s

projections factor in a deceleration in arrivals due to fewer flight frequencies and stricter foreign

exchange quotas for Venezuelan tourists, nearly 20% of total visitors to the island in 2013.

Risks to economic performance will depend on the pace of private investment. Aruba’s

domestic investment rate declined to 23% of GDP in 2013 from 29% in 2008. The government

only completed 13% of its ambitious AWG1.7bn (36% of GDP) stimulus infrastructure

investment plan in 2010-2013. Institutional capacity constraints, prolonged legal disputes over

land rights and bidding procedures, and labour shortages postponed the implementation of the

largest public-private partnership projects to 2014-2017.

Construction could accelerate in 2014-2017. The ATA expects room inventory to increase 16%

(1500 units) by 2017. Hard Rock is expected to develop a large hotel and casino and non-

resident demand for real estate is driving activity in the condominium market. After three years

of preparations, two private contractors were awarded long-term concessions for the renovation

of the island’s hospital and the relocation of the cargo port. The two projects involve AWG400m

(9% of GDP) in investments and are scheduled to be operational in 2016-2017.

6 At full production capacity, Valero accounted for 12% of GDP and 90% of merchandise exports.

The company invested USD600m (23% of GDP) after acquiring the plant in 2004 and directly and indirectly employed about 5% of the national work force.

7 The World Travel and Tourism Council estimated that tourism accounted for 84% of GDP and 86% of total employment in 2013, the third-largest tourism dependence in a survey of 189 countries.

8 Inflation fell to negative 2.4% in 2014 from 0.6% in 2013. Water tariffs decrease 30% for households and 26% for companies in August 2012. Electricity tariffs decreased an average of 10% for households and 6% for companies in November 2012.

Figure 8

Figure 9

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Figure 11

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Fuel consumption (LHS)

Fuel price (RHS)

Source: Aruba's Utilities Company (WEB)

Fuel Imports Substitution

(x000 Bbl/day) (USD/Bbl)

1.0

1.5

2.0

2.5

3.0

400

600

800

1,000

1,200

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

f

Stay-over visitors (LHS)

Cruise visitors (LHS)

Tourism receipts (RHS)

Source: Central Bank of Aruba, ATA

Solid Tourism Results

(x000) (AFLbn)

-15

-10

-5

0

5

10

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

(%)

Net exports Investment

Consumption Real GDP

Source: Central Bank of Aruba

GDP Growth Contributions

-3-2-10123456

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

f

20

15

f

20

16

f

(%)

Aruba BBB Median

Source: Fitch

Growth UnderperformanceReal GDP growth (5-year avg.)

Sovereigns

Aruba

July 2014 8

Public Debt Dynamics

Fitch forecasts that the public debt burden will peak at 66% of GDP in 2018. The main risks to

sustainability would be growth underperformance and failure to shift the primary fiscal deficit to

a surplus through cost-containment and revenue-enhancing measures. A balanced currency

composition, long maturities and a high share of fixed-rate instruments in the sovereign debt

portfolio make the projections less sensitive to foreign exchange and interest rate shocks.

Debt Dynamics – Fitch’s Baseline Assumptions

2012 2013 2014 2015 2016 2017 2018

Gross general government debt (% GDP) 59.9 63.3 64.6 65.4 66.0 66.1 65.0 Primary balance (% of GDP) -2.5 -0.9 -0.5 -0.3 1.4 1.9 2.3 Real GDP growth (%) 3.9 2.7 2.8 2.8 2.5 2.3 1.8 Avg. nominal effective interest rate (%) 8.4 8.1 8.0 7.9 7.8 7.7 7.6 Local currency/USD (annual avg.) 1.8 1.8 1.8 1.8 1.8 1.8 1.8 GDP deflator (%) -1.9 -0.4 1.6 1.8 2.2 2.2 2.5

Debt Sensitivity Analysis: Fitch’s Scenario Assumptions

Growth Real GDP grow average 0.5% (1.3% below potential) Interest rate Marginal interest rate 200bp higher Fiscal No change in primary balance from 2015 level Exchange rate 15% devaluation at end-2014

55

60

65

70

75

80

85

90

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

(% of GDP)Baseline Growth Interest rate Fiscal Exchange rate

Sensitivity AnalysisGross general government debt

Source: Fitch estimates, national sources, IMF

Forecast Summary

2010 2011 2012 2013 2014f 2015f 2016f

Macroeconomic indicators and policy Real GDP growth (%) -3.3 3.5 -1.3 3.9 2.7 2.8 2.8 Unemployment (%) 10.6 8.9 9.6 7.6 8.5 8.0 8.0 Consumer prices (annual average % change) 2.1 4.4 0.6 -2.4 0.5 1.6 1.8 Short-term interest rate (bank policy annual avg.) (%) 1.0 1.0 1.0 1.0 1.0 1.3 1.5 General government balance (% of GDP) -3.6 -7.8 -8.7 -7.2 -5.5 -4.9 -4.5 General government debt (% of GDP) 45.6 48.6 55.4 59.9 63.3 64.6 65.4 AWG per USD (annual average) 1.79 1.79 1.79 1.79 1.79 1.79 1.79 Real effective exchange rate (2000 = 100) 109.6 110.9 109.3 105.2 103.8 103.4 103.2 Real private sector credit growth (%) 1.3 -1.0 -1.5 2.9 8.0 3.5 1.4 External finance Current account balance (% of GDP) -19.2 -10.2 4.1 -9.9 -8.8 -6.9 -6.3 Current account balance plus net FDI (% of GDP) -19.3 -2.2 7.5 -4.8 -3.0 -1.1 -0.6 Net external debt (% of GDP) -5.8 -13.0 -18.7 -12.9 -7.9 -4.4 -1.3 Net external debt (% of CXR) -7.1 -4.7 -14.5 -14.5 -8.9 -5.0 -1.5 Official international reserves including gold (USDm ) 709.9 694.1 768.5 653.5 673.9 640.2 614.0 Official international reserves (months of CXP cover) 3.5 1.2 2.9 3.1 3.1 2.9 2.7 External interest service (% of CXR) 5.2 1.4 3.0 5.1 5.2 5.2 5.1 Gross external financing requirement (% int. reserves) 81.9 49.4 5.9 57.9 57.5 42.1 40.5 Real GDP growth (%) US 2.5 1.9 2.8 1.9 2.0 3.1 3.0 China 10.4 9.3 7.7 7.7 7.3 7.0 6.7 Eurozone 1.9 1.5 -0.6 -0.4 1.1 1.4 1.6 World 3.9 3.2 2.6 2.4 2.9 3.2 3.1 Oil (USD/barrel) 79.6 111.0 112.0 108.8 108.0 100.0 95.0

Source: Fitch

Fitch uses stylised projections for a

sovereign’s gross general government

debt/GDP ratio to illustrate the

sustainability of its debt burden and its

sensitivity to economic growth, the cost of

borrowing, fiscal policy and the exchange

rate.

Sovereigns

Aruba

July 2014 9

Figure 12 Fiscal Accounts Summary (% of GDP) 2011 2012 2013 2014f 2015f 2016f

General government Revenue 21.4 22.4 24.5 23.7 23.2 23.1 Expenditure 28.0 31.0 30.6 28.9 27.7 27.3 O/w interest payments 3.0 3.3 3.5 4.0 4.0 3.8 Primary balance (cash concept) -3.5 -5.3 -2.5 -0.9 -0.5 -0.3 Overall cash balance (cash concept) -7.0 -9.2 -6.9 -5.5 -4.9 -4.5 Change in unmet financing needs 0.8 -0.5 0.3 0 0 0 Overall balance (accrual concept) -7.8 -8.7 -7.2 -5.5 -4.9 -4.5 General government debt (consolidated)

a 48.6 55.4 59.9 63.3 64.6 65.4

% of general government revenue 226.9 247.8 244.4 267.1 278.1 283.0 General government deposits 7.5 4.5 5.3 5.3 5.2 5.1 Net general government debt 41.1 50.9 54.7 58.0 59.4 60.3 Central government Revenue 21.4 22.4 24.5 23.7 23.2 23.1 O/w grants 0 0 0.5 0 0 0 Expenditure and net lending 28.0 31.0 30.6 28.9 27.7 27.3 O/w current expenditure and transfers 26.3 28.7 28.1 28.0 26.6 26.0 - Interest 3.0 3.3 3.5 4.0 4.0 3.8 O/w capital expenditure 1.2 1.7 1.7 0.6 0.7 0.9 Current balance -7.5 -8.6 -7.8 -7.3 -6.0 -5.5 Primary balance (cash balance) -3.5 -5.3 -2.5 -0.9 -0.5 -0.3 Overall balance (cash balance) -7.0 -9.2 -6.9 -5.5 -4.9 -4.5 Central government debt (Non-consolidated) 61.1 67.6 73.7 81.7 83.1 83.9 % of central government revenues 285.2 302.0 300.3 344.7 357.8 363.1 Central government debt (non-consolidated AWGm) 2,790.5 3,072.6 3,413.9 3,871.8 4,115.7 4,350.9 By residency of holder Domestic 1,628.9 1,611.1 1,624.6 2,001.6 2,137.7 2,228.3 Foreign 1,161.6 1,461.5 1,789.3 1,870.2 1,978.0 2,122.6 By currency denomination Local currency 2,034.3 2,015.1 2,218.9 2,595.9 2,732.0 2,822.6 Foreign currency 755.2 1,057.4 1,195.0 1,275.9 1,383.7 1,528.3 In USD equivalent (eop exchange rate) 421.9 590.7 667.6 712.8 773.0 853.8 Average maturity (years) 10.2 9.3 8.5 7.6 7.6 7.6 Memo Nominal GDP (AWGm) 4,566.8 4,547.0 4,635.0 4,741.9 4,952.7 5,183.0 a Consolidated general government debt excludes the holdings of central government debt by APFA and AOV. Non-consolidated debt includes the debt holdings of these

social security agencies Source: Ministry of Finance and Fitch estimates and forecasts

Sovereigns

Aruba

July 2014 10

Figure 13 External Debt and Assets (USDm) 2008 2009 2010 2011 2012 2013

Gross external debt 1,408.3 1,378.0 1,290.2 1,305.7 1,476.2 1,479.9 % of GDP 51.3 55.1 54.0 51.2 58.1 57.2 % of CXR 19.6 38.1 66.5 18.7 45.2 64.3 By maturity Medium- and long-term 1,067.0 1061.5 982.8 1,015.7 1,168.7 1,171.7 Short -term 341.3 316.5 307.5 290.1 307.5 308.3 % of total debt 24.2 23.0 23.8 22.2 20.8 20.8 By debtor Sovereign 595.8 603.1 625.9 656.5 817.5 915.3 Monetary authorities 4.2 1.7 0.7 0.5 2.1 2.1 General government 591.6 601.4 625.3 656.1 815.5 913.2 O/w central government 597.2 607.4 629.4 648.9 816.5 999.6 Banks 325.6 302.6 298.2 279.9 295.0 300.9 Other sectors 486.9 472.3 366.1 369.3 363.7 263.8 Gross external assets (non-equity) 1,460.2 1,668.9 1,428.7 1,636.9 1,950.7 1,814.3 International reserves, incl. gold 691.1 687.8 709.9 694.1 768.5 653.5 Other sovereign assets nes 9.9 13.3 14.5 17.8 19.0 10 Deposit money banks' foreign assets 426.3 484.3 397.1 402.8 381.2 360.9 Other sector foreign assets 332.9 483.5 307.2 522.1 782.1 789.9 Net external debt -51.9 -290.9 -138.5 -331.1 -474.5 -334.4 % of GDP -1.9 -11.6 -5.8 -13.0 -18.7 -12.9 Net sovereign external debt -105.2 -97.9 -98.5 -55.4 30.1 261.8 Net bank external debt -100.7 -181.7 -98.9 -122.9 -86.3 -70.1 Net other external debt 154.0 -11.2 58.9 -152.9 -418.4 -526.1 Net international investment position -3,584.6 -3,209.7 -3,346.3 -3,645.4 -3,593.9 n.a. % of GDP -130.6 -128.5 -140.0 -142.9 -141.5 n.a. Sovereign net foreign assets 105.2 97.9 98.5 55.4 -30.1 -261.8 % of GDP 3.8 3.9 4.1 2.2 -1.2 -10.1 Debt service (principal & interest) 244.9 188.4 205.8 183.8 241.9 305.3 Debt service (% of CXR) 3.4 5.2 10.6 2.6 7.4 13.3 Interest (% of CXR) 1.7 3.0 5.2 1.4 3.0 5.1 Liquidity ratio (%) 139.8 211.0 224.4 225.3 206.2 187.6 Net sovereign FX debt (% of GDP) -7.0 -8.5 -11.2 -10.7 -6.9 0.6 Memo Nominal GDP 2,745.4 2,498.7 2,390.6 2,551.3 2,540.2 2,589.4

Source: NBP, IMF, World Bank and Fitch estimates and forecasts

Sovereigns

Aruba

July 2014 11

Figure 14 External Debt Service Schedule on Medium- and Long-Term Debt at June 2014 (USDm) 2013 2014 2015 2016 2017 2018 2019

Sovereign: Total debt service 173.4 140.5 95.5 81.7 96.5 136.6 114.7 Amortisation 129.3 84.2 34.8 22.6 42.1 84.3 62.5 Official bilateral 3.7 3.7 3.8 3.8 3.8 3.9 1.5 Multilateral 0 0 0 0 0 0 0 O/w IMF 0 0 0 0 0 0 0 Other (development banks) 3.0 3.1 3.2 2.9 2.4 1.9 1.4 Commercial banks and bonds 122.6 77.4 27.8 15.9 35.9 78.5 59.6 Interest 44.0 56.3 60.8 59.1 54.3 52.3 52.2

Source: Ministry of Finance, Central Bank and Fitch

Figure 15 Balance of Payments (USDm) 2011 2012 2013 2014f 2015f 2016f

Current account balance -261.1 103.3 -256.3 -233.6 -190.2 -181.2 % of GDP -10.2 4.1 -9.9 -8.8 -6.9 -6.3 % of CXR -3.7 3.2 -11.1 -10.0 -7.8 -7.1 Trade balance -736.6 -651.9 -1,079.7 -1,102.1 -1,120.2 -1152.3 Exports, fob 5,180.1 1,389.0 284.3 279.6 285.8 290.7 Imports, fob 5,916.8 2,040.9 1,364.0 1,381.7 1,406.0 1,443.1 Services, net 837.4 941.9 1,043.0 1,074.5 1,135.9 1,184.5 Services, credit 1,680.8 1,760.5 1,883.1 1,933.5 2,013.6 2,092.8 Services, debit 843.4 818.6 840.1 859.0 877.8 908.3 Income, net -246.0 -110.9 -163.9 -138.5 -136.0 -136.7 Income, credit 40.1 36.1 34.2 55.7 65.2 71.7 Income, debit 286.1 147.0 198.2 194.2 201.2 208.4 O/w: Interest payments 94.3 97.5 116.8 121.5 127.8 128.2 Current transfers, net -115.9 -75.8 -55.7 -67.5 -69.9 -76.6 Capital and finance accounts Non-debt-creating inflows (net) 218.2 232.0 132.8 154.4 158.9 163.5 O/w equity FDI 204.4 86.3 132.8 154.4 158.9 163.5 O/w portfolio equity 13.7 145.7 0.0 0.0 0.0 0.0 O/w other flows 3.3 2.8 5.3 6.5 5.7 5.1 Change in reserves 12.9 -0.9 88.0 -10.0 33.7 26.1 Gross external financing requirement 350.6 41.1 444.8 375.8 283.4 259.4 Stock of international reserves, incl. gold 694.1 768.5 653.5 673.9 640.2 614.0

Source: IMF and Fitch estimates and forecasts

Sovereigns

Aruba

July 2014 12

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