Netherlands Loses Its AAA Credit Rating

The Netherlands has lost its triple A credit rating by Standard & Poor’s, leaving just Germany, Finland, and Luxembourg in the Eurozone at the highest level. The downgrade to AA+ is ironic, as it appears to be the result of an overdose of “responsible” budgetary policy. According to S&P, “The downgrade reflects our opinion that the Netherlands’ growth prospects are now weaker than we had previously anticipated, and the real GDP per capita trend growth rate is persistently lower than that of peers.”

The Dutch government, which has strongly urged Eurozone periphery countries to pursue stringent austerity programs despite their economies being in deep recession, enforced tough fiscal discipline at home in the face of the bursting of a housing bubble and subsequent heavy deleveraging by the household sector. As recently as October 11, a further 6-billion-euro round of belt-tightening was adopted just as the Dutch economy appeared to be recovering from recession. GDP was up 0.1% in the quarter but was still 0.6% below the GDP for the same period a year earlier.

Looking forward, the European Commission projects GDP growth for the Netherlands next year at only 0.2%. This would be well below the 1.1% growth for the Eurozone projected by the European Central Bank and the 1.6% growth that looks likely for neighboring Germany.

The underperformance of the Dutch economy is occurring despite the country’s many strengths, including a strong current account surplus and a sovereign debt level that, at 71% of GDP, is well below the average in the Eurozone. The Dutch population is committed to market-oriented economic reforms and fiscal responsibility. There should be no question about the country’s ability and willingness to pay its debts. Its 10-year bond rate, at 2.15, is close to that of Germany, 1.84, and about half those of Italy and Spain, both 4.17. Thus, the market was little moved by the anticipated downgrade.

The ratings downgrade can be criticized as backward-looking. It was issued just when leading economic data have started to look brighter. The Purchasing Managers’ Index for November hit a 31-month high. The improvement was broad-based. New orders, output, employment, and suppliers’ delivery times all indicated an improving Dutch economy. Both domestic and export demand are stronger. Consumer confidence is also picking up. The projections for 2014 may need to be boosted.

The Netherlands equity market has performed with surprising strength this year despite the weak economy. This is likely due to the healthy export performance of the Netherlands, which remains highly competitive. The MSCI index for the Netherlands is up 23.19% for the year to date, which is above the 22.31% gain for the German market. But that slight advantage has been reversed during the last three months, during which the German market’s gain of 8.05% was twice the 3.95% gain for the Netherlands. The difference came largely in the most recent month. The iShares ETF for the Netherlands, EWN, declined slightly, down -0.48%, while the iShares ETF for Germany gained 3.01%.

Going forward, the German and Dutch equity markets appear to offer very similar value. While the current economic growth projections for the Netherlands are not as encouraging as those for Germany, the economic policies and prospects for further economic reform are reassuring. Netherlands should benefit from an expected sizable improvement in world trade in 2014 and 2015. That will be beneficial for Germany as well.

However, we have, in contrast, some concerns about the direction German policies are taking under Germany’s new coalition government. Germany may be poised to reverse some valuable reforms. For example, it looks as though retirement ages for some categories of workers will be reduced at a time when most governments are recognizing the need to increase retirement ages as a critical element of pension reform. While changes like that will not have an immediate economic impact, international investors would likely curb their current attraction to the German equity market if they see such a trend developing.

BY Bill Witherell