Fitch to Rate Aruba's 2018 Notes 'BBB'.

NEW YORK -- Fitch Ratings has assigned a prospective 'BBB' rating with a Stable Outlook to Aruba's soon-to-be-issued USD notes due 2018. Aruba's sovereign ratings reflect its per-capita income well above the 'BBB' average; its market-friendly institutional environment; its social and political stability; and its strong links and implicit support from the 'AAA' rated Dutch government. Aruba's rating weaknesses include structural weaknesses in its public finances and its small, narrow economy that has grown more slowly than 'BBB' peers and is more vulnerable to external and domestic shocks.

Fitch revised the Outlook to Stable from Negative on June 8 of this year. According to Shelly Shetty, Fitch Senior Director and lead sovereign analyst for Aruba, "The government's efforts to consolidate public finances in 2005 and measures taken to strengthen the financial viability of the universal health scheme were the key factors behind the revision of the Rating Outlook." In 2005, the fiscal deficit declined to 3.8% of GDP (on an accrual basis) from 6.2% of GDP in 2004, and it could decline further to 1.7% this year. In 2006, the health care scheme (AZV) increased health premiums by two percentage points, which should help eliminate losses at the AZV, thereby reducing transfers to it from the government. The government has also reformed the public sector pension system for new employees, a move that should limit the increase in future pension liabilities. In terms of key solvency ratios, while the general government debt at 45% of GDP is higher than the 'BBB' median of 34%, both net external debt and net public external debt (expressed as a percentage of current external receipts or CXR) are in line with the 'BBB' median.

Structural weaknesses in public finances relative to other 'BBB' sovereigns include fiscal rigidity and inferior financial management capabilities that have caused delays in passing budgets in recent years. The government is currently preparing a tax reform involving the introduction of a consumption-based sales tax, which would increase the contribution of indirect taxes to total revenue. The reform is intended to increase tax collection by 2% of GDP even though it may include some reductions in income tax rates. If implemented, this reform could further boost the credibility of the government's plan to achieve a balanced budget by 2009, thereby increasing fiscal flexibility and improving public debt dynamics.

Aruba's narrow economy needs to be diversified to boost its growth potential as the island's growth performance is lagging that of most rating peers. Tourism receipts have declined in 1H06 compared to the same period of the previous year, further underscoring the need to diversify the economy. The government and the private sector appear to be in favor of moving towards higher-value-added tourism, and some hotels have already begun renovating their facilities to provide even more upscale services that will allow them to command a high premium on their rooms. Some other possible niches for diversification include healthcare and education, which would require lowering the higher marginal tax rates and making immigration laws more flexible. Fitch will closely monitor the government's strategy for attracting investment into new sectors. Higher growth is essential if Aruba is to improve its debt dynamics and the living standards of its residents.

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