Stress test municipality of The Hague
SEO Economic Research carried out a stress test for the finances of the municipalities Amsterdam, Rotterdam, The Hague and Eindhoven. The possible consequences of exogenous shocks for the financial position of a specific municipality are examined. The exogenous shocks are: a financial crisis (an increase in the interest rate and an increase in inflation), a social-economic crisis (economic contraction and an increase in the unemployment rate), a real estate crisis, and central government cuts. Extreme, but plausible scenarios are formulated.
To calculate the effects of these exogenous shocks, a model is build using the municipality’s financial statements. This model encompasses quantitative relations among the variables in which exogenous shocks take place and the various items in the financial statement of Amsterdam that are influences by the exogenous shocks. The model also contains a number of lower level variables that make it possible to further examine the variations of the exogenous shocks. The model is sufficiently flexible, such that the effects from both small and large exogenous shocks and the effects of various combinations of shocks can be calculated. The model is also suitable for future use since it is possible to replace the base year financial data with new information from income and expenditure statements.
The effects of various exogenous shocks on the finances of The Hague are calculated as deviations in million euros from the baseline scenario. A negative effect in a certain year should be interpreted as the amount by which the profit in the baseline deteriorates when the municipality does not change its policy in order to neutralize or mitigate the effects.
The negative effect of the interest shock is increasing from € 0,4 million in year 1 till € 12,6 million in year 5. The cumulative negative effect of the shock is € 32,5 million, which corresponds to a negative average annual effect of € 6,5 million as compared to the baseline. If this interest shock is accompanied by an increasing inflation and therefore does not affect the real interest rate, the negative effect of the interest shock is offset by a positive effect of the inflation shock. The positive effect of the inflation shock is driven by the decrease in the real value of depreciation and interest costs.
The cumulative negative effect of the exogenous shock of economic contraction is € 25,4 million, and that of the exogenous shock of rising unemployment € 124,9 million. Together the cumulative negative impact of a socio-economic crisis will hence be € 150,3 million compared to the baseline.
The municipality has indicated that during a real estate crisis projects are delayed or stopped, so there is a cost reduction. If 80 percent of the costs could be saved the cumulative negative effect of the exogenous shock will be € 70,0 million compared to the baseline. If no cost reduction takes place, the cumulative negative effect of the exogenous shock is € 243,2 million compared to the baseline.
The cumulative negative impact of the central government cut scenario is € 236,0 million compared to the baseline. Finally, the humanitarian disaster has a cumulative negative effect of € 63.5 million compared to the baseline.
Considering present circumstances, it is not unimaginable that a financial crisis, consisting of an increase in the interest rate, a social-economic crisis, a real estate crisis and a central government cut will occur simultaneously. In this case the cumulative negative effect amounts to € 488,8 million, which comes down to a negative average annual effect of € 97,8 million as compared to the baseline. This amount is calculated by stacking the effects of the various crises, without taking a possible interaction among the crises and their effects on municipality’s finances into account.
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