Every year when the draft budget and Macroeconomic Outlook are presented to Dutch Parliament on Prinsjesdag, media attention zooms straight in on the household purchasing power forecasts. Newspaper columns are filled with analyses about ministries dealing with cutbacks or windfalls - and about the size of the national debt. The latter expressed either in billions of euros or as a percentage of the Gross Domestic Product (GDP).Not a lot of attention usually goes to investment or to financial markets generally. Indeed, it’s not easy, as most budgetary measures don’t really invite comment of this kind. Still, the government is a key player in the bond market, being the country’s largest issuer of bonds. And the government influences financial markets and the investment climate in other ways as well. Usually in indirect ways, when it comes to investment opportunities for investors. For instance, government measures can have consequences for corporate earnings, and thus for investor returns.
Government measures can have consequences for corporate earnings, and thus for investor returns.
Ben Steinebach Head of Investment Strategy
The feed-through of tax relief to financial markets
Let’s look at some of these indirect effects. The government has decided, for example, to raise the earned income tax credit for middle and higher incomes. The budgetary effect will amount to €500 million. This tax relief measure will free up more money for investing than the reduction of the tax rate in the lowest income tax bracket (involving €475 million). This is because the savings ratio is higher for higher income households, while lower-income households devote a larger portion of what they earn to consumption.
Another indirect effect is related to the sharp decline of capital market rates. Since year-end 2013, the interest rate on Dutch 10-year government bonds has dropped by over one percentage point to just 1.2%. Given the government’s borrowing requirement of €25 billion in 2014, that saves €250 million. This is not structural, of course, as interest charges will rise again when interest rates eventually start climbing. But the government could decide to use this amount to give the economy a one-off boost. In particular in the form of subsidies to innovative start-ups.
Encourage innovative start-ups
Subsidies for innovative start-ups would improve the structure of the Dutch economy and could contribute towards a more favourable investment climate. Young, innovative companies often supply new technology to more mature and established companies, including listed ones. Assuming that the government does not influence the market shares of companies in the longer term, this can in theory lead to higher corporate earnings via lower costs and higher productivity.
Sometimes, a combination of the two is possible, when innovative ideas and technologies structurally reduce cost levels. Well-crafted government measures to foster innovation can ultimately improve the profitability of listed companies, which helps to create a better investment climate. Although the National Budget was not written with investors in mind, a measure like this would do the Dutch investment climate a world of good.