UNCLAS SECTION 01 OF 05 THE HAGUE 002750

SIPDIS

STATE FOR EUR/UBI SHERRI HOLLIDAY

USDOC FOR 4212/USFCS/MAC/QEURA/FALCO
TREASURY FOR IMI/OASIA/VIMAL ATUKARALA
PARIS ALSO FOR OECD
FRANKFURT FOR TREASURY/WALLAR
STATE PASS FEDERAL RESERVE FOR MICHAEL ACCORNERO

E.O. 12356: N/A
TAGS: ECON EFIN PREL EINV ELAB PGOV MCAP NL
SUBJECT: DUTCH 2004 BUDGET: TOUGH DEFICIT REDUCTION PACKAGE
KEEPS DEFICIT WITHIN STABILITY PACT CRITERIA

REF: THE HAGUE 1697

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SUMMARY
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1. THE DUTCH PARLIAMENT HAS APPROVED A TOUGH DEFICIT
REDUCTION PACKAGE AIMED AT LIMITING THE 2004 BUDGET DEFICIT
TO 2.3 PERCENT OF GDP, WELL UNDER THE THREE PERCENT
STABILITY AND GROWTH PACT (SGP) CEILING. ON OCTOBER 1, THE
PARLIAMENT APPROVED A CY 2004 BUDGET THAT COMBINES SHARP
SPENDING REDUCTIONS WITH CUTS IN TRANSFER PAYMENTS INTO AN
UNPRECEDENTED PACKAGE OF RETRENCHMENTS WORTH 16.7 BILLION
EURO (ROUGHLY $ 19 BILLION) OVER FOUR YEARS. THE TIGHT 2004
BUDGET IS A RESPONSE TO THE MOST DISAPPOINTING ECONOMIC
PERFORMANCE IN A DECADE, WHICH WOULD HAVE DRIVEN NEXT YEAR'S
DEFICIT TO 3.8 PERCENT OF GDP IN THE ABSENCE OF CORRECTIVE
MEASURES.


2. THE GOVERNMENT HAS SO FAR SUCCESSFULLY DEFENDED THESE
BUDGET PLANS AS NECESSARY TO REMAIN WITHIN SGP LIMITS,
PROMOTE COMPETITIVENESS, TRIM THE DUTCH WELFARE STATE, AND
INCREASE WORK INCENTIVES. IN DOING SO, IT IS FACING THE IRE
OF MANY PROMINENT ECONOMISTS WHO ARGUE AGAINST FISCAL
RETRENCHMENT DURING A RECESSION AND THE LEFT-WING OPPOSITION
PARTIES AND LABOR UNIONS WHO WANT TO PRESERVE WELFARE STATE
BENEFITS. THE GONL, WARY OF RUNNING UP DEBT IN VIEW OF THE
AGING DUTCH POPULATION, BELIEVES THAT DEMAND STIMULUS IN A
SMALL OPEN ECONOMY SUCH AS THE NETHERLANDS' IS INEFFECTIVE.
THE DEBATE OVER THIS BUDGET IS LIKELY TO BE REPEATED IN
SUBSEQUENT YEARS, AS WITHOUT ADDITIONAL DEFICIT-REDUCTION
MEASURES, THE FISCAL DEFICIT WILL CONTINUE TO BUMP UP
AGAINST THE SGP'S 3 PERCENT DEFICIT CRITERION. THIS WILL BE
A TEST FOR FINANCE MINISTER ZALM, WHO HAS STAKED MUCH OF HIS
INTERNATIONAL REPUTATION ON PROMOTING STRICT ADEHERENCE TO

GSP CRITERIA (REFTEL). END SUMMARY.

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A BUDGET GRAPPLING WITH FISCAL STABILITY
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3. AMIDST ECONOMIC RECESSION AND RESULTING REVENUE
SHORTFALLS, THE CENTER-RIGHT COALITION GOVERNMENT PRESENTED
THE DRAFT 2004 BUDGET TO PARLIAMENT SEPTEMBER 16. FOLLOWING
POLITICAL AND FINANCIAL DEBATES THE LOWER HOUSE AGREED TO
THE OVERALL BUDGET PARAMETERS WITH ONLY MINOR AMENDMENTS
OCTOBER 1. PARLIAMENTARY DEBATE ON THE PARTICULAR ELEMENTS
OF EACH MINISTRY'S BUDGET WILL CONTINUE THROUGH NOVEMBER BUT
THE OVERALL BUDGET AND ITS ALLOCATION AMONG MINISTRIES IS
NOW FIXED. DURING CY 2004, MINISTRIES MAY BE ABLE TO
REPROGRAM FUNDS WITHIN THEIR INDIVIDUAL BUDGET ALLOCATIONS
BUT A TRANSFER OF FUNDS BETWEEN ONE MINISTRY AND ANOTHER IS
NOT FEASIBLE. DUE CHIEFLY TO STAGNATING ECONOMIC GROWTH AND
FALLING REVENUES, PUBLIC FINANCES HAVE COME UNDER PRESSURE,
PUTTING THE BUDGET ON A PATH TO OVERSHOOT THE EMU'S GROWTH
AND STABILITY PACT (GSP) DEFICIT AND DEBT CRITERIA WITHOUT
FISCAL RETRENCHMENT. ACCORDING TO THE NEW BUDGET, WHICH IS
BASED ON PROJECTED 2004 GROWTH OF TWO PERCENT AND CONTINUED
RESTRAINT IN PUBLIC SECTOR WAGES, CENTRAL GOVERNMENT
SPENDING WILL RISE SLIGHTLY (LESS THAN THREE PERCENT) TO
118.8 BILLION EURO ($136.6 BILLION) IN 2004, WITH REVENUES
TOTALING 106.5 BILLION EURO ($122.5 BILLION), RESULTING IN A
BASIC BUDGET DEFICIT OF 12.3 BILLION EURO ($14.1 BILLION),
OR 2.6 PERCENT OF GDP. WITH TOTAL SPENDING OF 134.4 BILLION
EURO ($154.6 BILLION) AND REVENUES OF 123.7 BILLION EURO
($142.2 BILLION), THE PUBLIC SECTOR BALANCE FOR EMU PURPOSES
(CENTRAL GOVERNMENT, LOCAL GOVERNMENT AND SOCIAL SECURITY
FUNDS BUDGETS COMBINED) WILL BE MOVING INTO A DEFICIT OF
10.7 BILLION EURO ($ 12.3 BILLION), OR 2.3 PERCENT OF GDP.
THIS COMPARES WITH A SIMILAR DEFICIT OF 2.3 PERCENT OF GDP
PROJECTED FOR 2003 AND FOLLOWS THE SURPLUS OF 2.2 PERCENT
RECORDED IN 2000.


TABLE 1: THE 2004 BUDGET (EUR BN)
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CENTRAL GOVT:
--SPENDING 118.8
--REVENUE 106.5
--DEFICIT 12.3
PUBLIC SECTOR:
--SPENDING 134.4
--REVENUE 123.7
--DEFICIT 10.7

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A CHOICE BETWEEN GROWTH AND FISCAL STABILITY
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4. TO PREVENT THE DEFICIT IN 2004 FROM EXCEEDING THE 3
PERCENT DEFICIT CRITERION IN THE SGP, THE 2004 BUDGET
SUPPLEMENTS A 5.2 BILLION EURO CONSOLIDATION PACKAGE
INHERITED FROM THE PREVIOUS "BALKENENDE I" GOVERNMENT (THAT
FELL IN EARLY 2003) WITH ADDITIONAL BUDGET MEASURES TO THE
TUNE OF 5.7 BILLION EURO. SUPPLEMENTAL RETRENCHMENTS RAISE
TOTAL SPENDING CUTS AND BURDEN INCREASES (I.E., INCREASES IN
TAXES AND FEES AND REDUCTIONS IN SUBSIDIES) IN 2004 TO 10.9
BILLION EURO ($ 12.5 BILLION). ROUGHLY HALF OF THE PACKAGE
IS AIMED AT IMPROVING MARKET FUNCTIONING AT THE MICRO LEVEL
(E.G., FOR HIGHER LABOR MARKET PARTICIPATION THROUGH TIGHTER
ENFORCEMENT OF DISABILITY BENEFIT RULES). THE OTHER HALF
(E.G., LOWER SPENDING ON ASYLUM PROGRAMS, ON DEVELOPMENT
AID, ON SUBSIDIES TO NGO'S, AND ON A HOST OF CARE PROGRAMS)
CONSISTS OF STRAIGHTFORWARD MONEY-SAVING MEASURES THAT
REFLECT THE COALITION'S DETERMINATION TO STRICTLY ADHERE TO
THE SGP DEFICIT AND DEBT CRITERIA AND TO REDUCE THE SIZE AND
SCOPE OF GOVERNMENT. THE BULK OF THESE MEASURES BEAR THE
UNMISTAKEN SIGNATURE OF FINANCE MINISTER ZALM'S LIBERAL
PARTY (VVD), THE MOST LIMITED-GOVERNMENT-ORIENTED PARTNER IN
THE CENTER-RIGHT COALITION.


5. BY FAR THE LARGEST PORTION OF THE PACKAGE OF SPENDING
CUTS (3.1 BILLION EURO ($3.6 BILLION) WILL BE IN MAJOR
SOCIAL SECURITY PROGRAMS (LABOR DISABILITY AND UNEMPLOYMENT
BENEFITS) WITH THE OBJECTIVE OF CREATING INCENTIVES FOR
HIGHER LABOR MARKET PARTICIPATION. THE REMAINING SAVINGS
WILL COME FROM FREEZING OF PUBLIC SECTOR WAGES AND PAY
CONDITIONS TO THE TUNE OF 1.3 BILLION EURO, A REDUCTION OF
PUBLIC SECTOR RED-TAPE OF 1 BILLION EURO, REDUCED FINANCING
OF NON-ODA ITEMS AND AID TO ASYLUM SEEKERS OF 800 MILLION
EURO, CURTAILING SEVERAL PUBLIC SUBSIDY PROGRAMS BY 1.9
BILLION EURO, REDUCING HEALTH CARE SUBSIDIES BY 1.7 BILLION
EURO, AND BY CURTAILING VARIOUS OTHER TAX INCENTIVES AND
SUBSIDIES BY 1.2 BILLION EURO. DURING THE COALITION'S FOUR-
YEAR TERM IN OFFICE, THE ACCUMULATED CONSOLIDATION PACKAGE
OF MEASURES WILL ADD UP TO 22.9 BILLION EURO, EQUAL TO FOUR
PERCENT OF GDP. THE GOVERNMENT PROJECTS THAT ITS MEASURES
WILL REDUCE THE CONSOLIDATED PUBLIC SECTOR DEFICIT FOR EMU
PURPOSES TO A PROJECTED 0.6 PERCENT OF GDP IN 2007, LOWERING
THE PUBLIC DEBT TO GDP RATIO IN THAT YEAR TO A LITTLE OVER
52 PERCENT.

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RAISING REVENUES AT THE EXPENSE OF TAX PAYERS
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6. IN THE WAKE OF BUDGET RETRENCHMENTS THE 2004 BUDGET ALSO
PROVIDES FOR MEASURES TO RAISE REVENUES AMOUNTING TO AN
ESTIMATED 1.2 BILLION EURO, GROWING AN TO ACCUMULATED 1.9
BILLION EURO IN 2007. THE HIGHER TAX BURDEN IN FISCAL YEAR
2004 IS THE BALANCE OF MEASURES AIMED AT RAISING TAX
REVENUES ON THE ONE HAND AND THE INTRODUCTION OF TAX
INCENTIVES AIMED AT STIMULATING THE COALITION`S LABOR MARKET
POLICIES ON THE OTHER. WIDENING THE GENERAL INCOME TAX BASE,
ABOLISHING TAX INCENTIVES FOR EARLY RETIREMENT, AND
CURTAILING THE DEDUCTABILITY OF MORTGAGE INTEREST WILL RAISE
REVENUES BY 500 MILLION EURO (OR A CUMULATIVE 4.1 BILLION
EURO FOR 2004-2007). REALLOCATING SPENDING ON HEALTH CARE
AND RAISING THE EXCISE TAX ON TOBACCO WILL RAISE REVENUES BY
1 BILLION EURO (AN ACCUMULATED BALANCE OF 200 MILLION).
INCREASING THE NUMBER OF TAX INCENTIVES CONTRIBUTING TO
LABOR MARKET DYNAMICS AND IMPROVEMENT OF EDUCATION AND
COMPENSATING FOR THE IMPACT OF HIGHER TAXES AND REDUCED
SPENDING ON INCOMES OF VULNERABLE INCOME CATEGORIES WILL
REDUCE REVENUES BY 300 MILLION EURO, OR A CUMULATIVE FOUR-
YEAR TOTAL OF 2.1 BILLION EURO.

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LITTLE MONEY LEFT FOR NEW POLICY SPENDING
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7. THE COALITION HAS EARMARKED A RELATIVELY SPARTAN 3.9
BILLION EURO IN 2004, GROWING TO AN ACCUMULATED 8.1 BILLION
EURO IN 2007, ON NEW POLICY SPENDING. THE BULK WILL GO TO
FINANCE MEASURES AIMED AT CONTROLLING COST IN PUBLIC HEALTH
INSURANCE, REMOVING STRUCTURAL BOTTLENECKS (CAPACITY AND
STAFFING) IN HEALTH CARE, AND STIMULATING DEREGULATION AND
PRIVATIZATION IN HEALTH CARE (1.3 BILLION EURO). ROUGHLY 1.2
BILLION EURO WILL GO TO FINANCE LABOR MARKET MEASURES
INTENDED TO BOOST EMPLOYMENT AND RAISE LABOR MARKET
PARTICIPATION BY REDUCING CLAIMS IN UNEMPLOYMENT AND LABOR
DISABILITY BENEFITS. THE REMAINING 1.5 BILLION EURO WILL GO
TO PAY FOR IMPROVEMENT OF THE KNOWLEDGE INFRASTRUCTURE AND
THE QUALITY OF R&D (0.5 BILLION), A REDUCTION IN OVERALL
CRIMINALITY BY IMPROVING THE LAW ENFORCEMENT CHAIN AND BY
MORE AGGRESSIVELY TACKLING YOUTH CRIMINALITY (0.5 BILLION),
AND IMPROVING MOBILITY BY UPGRADING THE TRANSPORT
INFRASTRUCTURE (0.5 BILLION).

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DEFENSE AND DEVELOPMENT AID BUDGETS RELATIVELY UNHURT
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8. DEFENSE WILL GET AN EXTRA 30 MILLION EURO ($34.5 MILLION)
(GROWING TO 100 MILLION EURO EQ $ 115 MILLION IN 2007) TO
FINANCE MEASURES TO STRENGTHEN THE DEPLOYMENT OF DUTCH ARMED
FORCES IN OPERATIONS RELATED TO CONTAINMENT OF REGIONAL
CRISES. EXTRA DEFENSE OUTLAYS WILL ONLY PARTLY COMPENSATE
FOR A 215 MILLION EURO ($ 247 MILLION) REDUCTION (OR A
CUMULATIVE 350 MILLION EURO FOR 2004-07) THAT IS INTENDED TO
RESULT IN DOWNSIZED BUT MORE EFFECTIVELY DEPLOYABLE ARMED
FORCES. INCLUDING SAVINGS ALREADY PROVIDED FOR IN THE
GOVERNMENT'S COALITION ACCORD, TOTAL CUTS IN DEFENSE
SPENDING WILL AMOUNT TO 470 MILLION EURO EQ $ 540 MILLION IN
2004, AND TO ACCUMULATED 730 MILLION EURO EQ $840 MILLION IN

2007. ON BALANCE, DEFENSE SPENDING IN 2004 WILL STILL SHOW
AN INCREASE OF 3 PERCENT TO 1.6 PERCENT OF GDP. ALTHOUGH
SUBJECT TO GEOGRAPHIC AND THEMATIC RELOCATION, THE SPENDING
TO GDP RATIO FOR OFFICIAL DEVELOPMENT ASSISTANCE (ODA)
CONTINUES AT A HIGH OF 0.8 PERCENT.OF GDP

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ADHERING TO THE STABILITY PACT IN A CYCLICAL DOWNTURN
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9. UNFAVORABLE CYCLICAL DEVELOPMENTS AND POOR PERFORMANCE OF
THE DUTCH ECONOMY SINCE 2001 HAVE GIVEN RISE TO A DRAMATIC
DETERIORATION OF PUBLIC FINANCES. AFTER MOVING INTO THE
FIRST SMALL (0.7 PERCENT OF GDP) FISCAL SURPLUS IN DECADES
IN 1999, THE FISCAL BALANCE MOVED BACK INTO A 1.6 PERCENT
DEFICIT IN 2002. DUE TO THE LOSS OF TAX REVENUES AND GROWING
SPENDING ON SOCIAL SECURITY AND UNEMPLOYMENT RESULTING FROM
THE SLUGGISH ECONOMY, THE PROJECTED FISCAL DEFICITS FOR 2004
AND 2005 WOULD HAVE OVERSHOT THE SGP'S 3 PERCENT DEFICIT
CRITERION IN THE ABSENCE OF DEFICIT-REDUCTION MEASURES, WITH
THE BASELINE 2004 DEFICIT PROJECTED AT 3.8 PERCENT OF GDP.
WITH ITS FOUR-YEAR, 16.9 BILLION EURO PACKAGE, THE THE
CENTER-RIGHT COALITION EXPECTS THE PUBLIC SECTOR DEFICIT TO
FALL FROM 2.3 PERCENT OF GDP IN 2004 TO 0.6 PERCENT BY 2007.
SHOULD THE DEFICIT BROACH A SELF-IMPOSED CEILING OF 2.5
PERCENT OF GDP DURING THAT PERIOD, ADDITIONAL BUDGET
RETRENCHMENTS WILL BE TRIGGERED. OVER THE SAME 2004-07
PERIOD, THE CYCLICALLY-ADJUSTED STRUCTURAL DEFICIT WILL
DECLINE SLIGHTLY, FROM 0.7 PERCENT IN 2004 TO 0.5 PERCENT IN

2007.


10. AS A RESULT OF SUCCESSIVE FISCAL DEFICTS, THE PUBLIC
DEBT TO GDP RATIO, WHICH HAS FALLEN ANNUALLY SINCE 1995,
WILL GROW TO 54.0 PERCENT OF GDP IN 2003 AND A PROJECTED
54.5 PERCENT IN 2004. THE GONL PROJECTS THAT ITS DEFICIT-
REDUCTION PROGRAM AND A REVIVAL IN GROWTH WILL CUT THE RATIO
TO 52.2 PERCENT OF GDP IN 2007.

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NEAR-TERM ECONOMIC OUTLOOK: CAUTIOUS
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11. THE DRAFT 2004 BUDGET WAS PRESENTED AT A TIME WHEN THE
DUTCH ECONOMY IS SLOWLY RECOVERING FROM THE LONGEST AND
DEEPEST RECESSION IT HAS SEEN SINCE THE EARLY 1990S.
FOLLOWING GDP GROWTH OF JUST 0.2 PERCENT IN 2002, THE
ECONOMY SLUMPED INTO (D0WNWARD REVISED) AVERAGE 0.7 PERCENT
NEGATIVE GROWTH DURING THE FIRST HALF OF 2003. IN THE
CURRENT CLIMATE OF SHARPLY LOWER PUBLIC SPENDING, EXPORTS
WILL BECOME AN IMPORTANT DETERMINANT OF ECONOMIC EXPANSION.
A RAPID RECOVERY OF ECONOMIC GROWTH IS NOT IMMINENT,
HOWEVER, AS A SERIOUS LOSS OF PRICE COMPETITIVENESS WILL
KEEP THE ECONOMY FROM FULLY BENEFITTING FROM A RECOVERY OF
WORLD TRADE GROWTH DURING THE SECOND HALF OF 2003. LAGGING
BEHIND WORLD TRADE GROWTH, EXPORTS ARE FORECAST TO EXPAND BY
1 PERCENT IN 2003, FOLLOWED BY 5.25 PERCENT IN 2004. EXPORT
GROWTH WILL BE GENERATED PREDOMINANTLY BY AN INCREASE IN THE
VOLUME OF RE-EXPORTS (UP 4 PERCENT AND 8.5 PERCENT IN 2003
AND 2004 RESPECTIVELY). GROWTH IN DOMESTICALLY PRODUCED
EXPORTS IS EXPECTED TO REMAIN STAGNANT (MINUS 1.5 PERCENT IN
2003 AND PLUS 2.75 PERCENT IN 2004). THE MODEST RECOVERY OF
FOREIGN DEMAND WILL NOT BE SUFFICIENT TO COMPENSATE FOR
WEAKER CONSUMER SPENDING AND FALLING INVESTMENT. LOSS OF
PURCHASING POWER, SLUMPING STOCK MARKETS AND GROWING
UNEMPLOYMENT WILL KEEP CONSUMER SPENDING MORE OR LESS
DORMANT (ZERO GROWTH FOLLOWED BY 0.75 EXPANSION IN 2003 AND
2004 RESPECTIVELY), WHILE SURPLUS CAPACITY, ERODING MARGINS
AND POOR PRODUCER CONFIDENCE WILL PUT A DAMPER ON NON-
RESIDENTIAL INVESTMENT (MINUS 3.75 PERCENT AND MINUS 0.75
PERCENT IN 2003 AND 2004 RESPECTIVELY). IN A CLIMATE OF
RELATIVELY WEAK DOMESTIC AND FOREIGN DEMAND, THE DUTCH
ECONOMY CONTINUES TO PERFORM WELL BELOW ITS 2.5 PERCENT
GROWTH POTENTIAL TO SHOW ZERO GROWTH IN 2003 AND JUST ONE
PERCENT GDP EXPANSION IN 2004. IN THE ABSENCE OF CLEAR SIGNS
OF IMPROVEMENTS, EVEN THESE MODEST GROWTH EXPECTATIONS MAY
PROVE TOO AMBITIOUS AND ERODE THE ECONOMIC BASIS OF THE 2004
BUDGET.


12. REFLECTING THE ECONOMIC DOWNTURN, THE OUTLOOK FOR THE
LABOR MARKET HAS CHANGED DRAMATICALLY. FOR THE FIRST TIME IN
EIGHT YEARS NEGATIVE EMPLOYMENT GROWTH, COMBINED WITH A
GROWING NUMBER OF REDUNDANCIES, HAS PUSHED THE LEVEL OF
UNEMPLOYMENT WELL BEYOND ITS EQUILIBRIUM. AS A CONSEQUENCE
UNEMPLOYMENT IS FORECAST TO INCREASE TO A LEVEL OF 5.5
PERCENT OF THE LABOR FORCE IN 2003 AND TO FURTHER EXPAND TO
7 PERCENT OF THE LABOR FORCE IN 2004. THE RESULTING HIKE IN
UNEMPLOYMENT BENEFITS IS AMONG THE FACTORS CONTRIBUTING TO
THE UNEXPECTED PUBLIC SPENDING INCREASE.


13. WITH CONSUMER PRICE INFLATION COMING DOWN TO 2 PERCENT
IN 2003 AND TO 1.5 PERCENT IN 2004, INFLATION THUS SEEMS THE
ONLY POSITIVE NOTE LINING ON AN OTHERWISE CLOUDY PICTURE. AN
INCREASE IN INDIRECT TAXES (HIGHER TOBACCO EXCISE AND ROAD
TAXES) AND BUSINESS SECTOR ATTEMPTS TO REPAIR ERODED GROSS
MARGINS BY INCREASING PRICES WILL PUT SOME UPWARD PRESSURE
ON CONSUMER PRICE INFLATION. IMPORTED INFLATION ON THE OTHER
HAND HAS EASED DUE TO THE STRENGTH OF THE EURO VIS-A-VIS THE
DOLLAR. SIMILARLY A COMBINATION OF MODERATE WAGE
DEVELOPMENTS AND ACCELERATING LABOR PRODUCTIVITY GROWTH HAS
SOFTENED THE IMPACT OF PER UNIT LABOR COSTS ON CONSUMER
PRICE INFLATION.

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MOTIVATIONS AND REACTIONS: ECONOMISTS CRITICAL
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14. IN A FIRST REACTION TO THE DRAFT 2004 BUDGET, THE
GOVERNMENT'S HIGHEST ADVISORY BODY, COUNCIL OF STATE (AN
OFFICIAL PANEL OF EMINENT PERSONS CHARTERED TO ADVISE THE
GOVERNMENT), AND A GROWING NUMBER OF ECONOMISTS HAVE
CRITICIZED THE MAGNITUDE AND THE TIMING OF THE PACKAGE OF
RETRENCHMENTS AND BURDEN INCREASES AS UNFORTUNATE. MANY
ECONOMISTS ARGUE THAT NEITHER THE GOVERNMENT'S CURRENT
FISCAL PROBLEMS NOR ITS DETERMINATION TO COMPLY WITH THE EMU
STABILITY AND GROWTH PACT JUSTIFY RETRENCHMENTS AND BURDEN
INCREASES AS MASSIVE AS THE ACCUMULATED 23 BILLION EURO
(EQUAL FOUR PERCENT OF GDP) ANNOUNCED IN THE DRAFT 2004
BUDGET. THEY CONSIDER THE COALITION'S RESPONSE TO CURRENT
BUDGET PROBLEMS AS AN ILL TIMED AND OVERDRAWN REACTION. THE
COUNCIL OF STATE HAS CRITICIZED THE COALITION'S PACKAGE OF
SPENDING CUTS AND BURDEN INCREASES UNNECESSARILY MASSIVE,
AND "PRO-CYCLICAL" IN A TIME OF RECESSION. BUDGET CUTS AND
BURDEN INCREASES ARE LIKELY TO DAMPEN PUBLIC AND CONSUMER
SPENDING AND HAVE A POTENTIAL OF SERVING AS A DRAG ON
ECONOMIC RECOVERY FORECAST FOR 2004.


15. BANKING ECONOMISTS ARGUE THAT IN THE ABSENCE OF EXTRA
MEASURES THE BUDGET WOULD MOVE INTO A DEFICIT OF 3.8 PERCENT
OF GDP IN 2004, WHILE THE STRUCTURAL DEFICIT WOULD BE
LIMITED TO ROUGHLY 2 PERCENT OF GDP. A CONSOLIDATION PACKAGE
OF BUDGET CUTS AND BURDEN INCREASES OF ROUGHLY 2 PERCENT OF
GDP WOULD HAVE BEEN SUFFICIENT TO ACHIEVE THE GOVERNMENT'S
FISCAL CONSOLIDATION TARGETS. AND ALTHOUGH THE STRUCTURAL
DEFICIT WOULD FALL SHORT OF THE SGP CRITERION OF "A NEAR
BALANCED BUDGET" IN 2007, GIVING UP EXTRA BUDGET MEASURES
WOULD ALLOW AUTOMATIC STABILISERS TO DAMPEN THE CYCLICAL
DOWNTURN.


16. WITH REGARD TO THE TIMING OF VARIOUS BUDGET MEASURES,
ECONOMISTS ARGUE THAT THE BULK OF SPENDING CUTS AND BURDEN
INCREASES WILL BE IMPLEMENTED IN 2004 AND 2005 WHEN CYCLICAL
CONDITIONS ARE STILL RELATIVELY FRAGILE. THE BALKENENDE II
GOVERNMENT HAS COME UNDER GROWING PRESSURE TO POSTPONE
PORTIONS OF ITS CONSOLIDATION PACKAGE UNTIL AFTER 2005. A
MUCH USED ARGUMENT IS THAT EVEN WITHOUT THE PACKAGE OF EXTRA
MEASURES, THE DEFICIT IN 2004 WOULD STILL BE NO MORE THAN
ROUGHLY HALF A PERCENTAGE POINT ABOVE OF THE 3 PERCENT
DEFICIT STANDARD. THE BALKENENDE II COALITION HAS ALSO BEEN
URGED TO HOLD LESS TO THE STABILITY AND GROWTH PACT DOCTRINE
AND TO GIVE HIGHER PRIORITY TO MEASURES AIMED AT STIMULATING
LONG-TERM ECONOMIC GROWTH POTENTIAL.

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GOVERNMENT FIRM ON LONG-TERM OBJECTIVES
--------------

17. THE GOVERNMENT HAS SUCCESSFULLY HELD TO ITS BUDGET
OBJECTIVES ARGUING THAT THE RETRENCHMENTS ARE KEY TO LONG-
TERM ECONOMIC STABILITY AND REFORM. ALLOWING EVEN LARGER
DEFICITS, THE GOVERNMEMT ARGUES, WOULD JEOPARDIZE IMPORTANT
ECONOMIC GOALS SUCH AS REDUCING THE OVERALL DEBT BURDEN TO
PROVIDE FOR THE NEEDS OF AN AGING POPULATION. THE
GOVERNMENT ALSO ARGUES THAT PUBLIC SECTOR INFLUENCE ON
CYCLICAL DEVELOPMENTS IN A RELATIVELY SMALL AND OPEN ECONOMY
SUCH AS THE NETHERLANDS IS VERY SMALL. THROUGH THIS BUDGET,
THE GOVERNMENT IS ALSO PROMOTING ITS PRIORITY SOCIAL
OBJECTIVES - "A LANDSLIDE SHIFT IN CULTURAL MINDSET",
ACCORDING TO PRIME MINISTER BALKENENDE - OF REDUCING THE
ROLE OF GOVERNMENT AND REQUIRING MORE INDIVIDUAL
RESPONSIBILITY.


18. THE GOVERNMENT HAS IDENTIFIED AS IMPORTANT POLICY
OBJECTIVES TO BE PURSUED THROUGH THIS BUDGET IMPROVING THE
SERIOUSLY ERODED PRICE COMPETITIVE POSITION OF THE DUTCH
BUSINESS SECTOR, INCREASING THE DUTCH ECONOMIC GROWTH
POTENTIAL, IMPROVING THE QUALITY OF PUBLIC SERVICES, AND
MOVING THE BUDGET INTO NEAR BALANCE CONDITIONS BY 2007 AS BY
FAR THE MOST IMPORTANT. TO MEET ITS POLICY TARGETS, THE
COALITION HAS PLACED REDUCING LABOR COSTS, INCREASING LABOR
MARKET PARTICIPATION, BOOSTING PRODUCTIVITY THRU INNOVATION,
AND COPING WITH THE FINANCIAL IMPLICATIONS OF A RAPIDLY
AGING POPULATION PROMINENTLY ON ITS AGENDA. AS A NOVELTY IN
DUTCH POLITICS, THE CENTER-RIGHT COALTION AGREED TO
BENCHMARK ITS PERFORMANCE AGAINST MAJOR SOCIO-ECONOMIC
POLICY TARGETS AGREED IN THE 2003 COALITION AGREEMENT AND
THE DRAFT 2004 BUDGET. MAJOR POLICY TARGETS TO BE MET BY
2007 HAVE BEEN LISTED AS FOLLOWS.
0 ECONOMIC GROWTH TO EXCEED THE EU-15 AVERAGE GROWTH RATE
0 THE STRUCTURAL DEFICIT TO BE REDUCED TO 0.5 PERCENT OF
GDP
0 THE DUTCH COMPETITIVE POSITION TO BE IMPROVED
SIGNIFICANTLY
0 PUBLIC RED TAPE TO BE REDUCED BY 25 PERCENT TO ALLOW
FOR INCREASED PRIVATE INITIATIVE
0 THE EFFICIENCY OF DUTCH UTILITIES SECTORS (GAS, POWER,
POST AND TELECOM) TO RANK AMONG THE EU'S TOP-FIVE PERFORMERS
0 THE QUALITY OF DUTCH CORPORATE GOVERNANCE TO IMPROVE TO
MATCH THE INTERNATIONAL TOP

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COMMENT
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19. PASSAGE OF ITS TOUGH, UNPOPULAR--BUT IN THE EYES OF THE
COALITION PARTNERS NECESSARY--BUDGET THROUGH PARLIAMENT
AMOUNTED TO AN IMPORTANT POLITICAL AFFIRMATION OF GOVERNMENT
POLICY. UPCOMING NEGOTIATIONS BETWEEN THE GOVERNMENT,
INDUSTRY AND TRADE UNIONS ON CONTRACT WAGES AND PAY
CONDITIONS FOR 2004 AND 2005 WILL BE ANOTHER KEY TEST.
TRADE UNIONS HAVE ALREADY SIGNALED THAT THEY REMAIN
SKEPTICAL OF THE SIGNIFICANT WAGE MODERATION THAT IS
IMPORTANT TO THE SUCCESS OF THE GOVERNMENT'S ECONOMIC
PROGRAM. THE GOVERNMENT UNDOUBTEDLY HOPES FOR A FASTER THAN
ANTICIPATED PICK UP IN WORLD ECONOMIC GROWTH THAT WILL
MITIGATE THE NEED FOR ADDITIONAL BIG SPENDING CUTS NEXT
YEAR. UNDER THESE CONDITIONS OF BUDGET AUSTERITY, WE
ANTICIPATE THAT THE DUTCH WILL BE RELUCTANT TO SPEND
SIGNIFICANT AMOUNTS OF NEW POLICY INITIATIVES AS THEY NEED
TO CUT BACK ON EXISTING ONES. (DRAFT:JERAZOUX-SCHULTZ).
SOBEL

SOBEL