Luxembourg: Risk Assessment
Country Risk Rating
|A1||The political and economic situation is very good. A quality business environment has a positive influence on corporate payment behavior. Corporate default probability is very low on average.|
Business Climate Rating
|A2||The business environment is good. When available, corporate financial information is reliable. Debt collection is reasonably efficient. Institutions generally perform efficiently. Intercompany transactions usually run smoothly in the relatively stable environment rated A2.|
Continued vigorous growth
Growth should remain one of the strongest in the Eurozone in 2016, essentially driven by financial sector exports. Despite the higher VAT rate, up from 15 to 17% as of 1 January 2015, consumption is expected to remain at a satisfactory level, supported by the indexing of wages as of the first quarter of 2016. Whilst private investment is expected to remain flat, given the underutilization of production capacities, public investment will remain high as a result of the implementation of major equipment projects. The government’s diversification strategy is aimed at promoting the development of new industries (data processing centers, innovative companies) and will help improve employment opportunities for lower skilled workers (logistics). The country’s attractiveness could possibly suffer in the future as a result of the process of financial harmonization and transparency within the European Union and the OECD (Base Erosion and Profit Shifting project).
In terms of prices, the vitality of domestic demand and the relative stabilization of oil prices should see inflation moving upwards in 2016 and at a rate above the Eurozone average.
A financial services focused economy
In 2016, despite a growing deficit in investment income, the current account balance will remain in surplus, a reflection essentially of the scale of its exports of services. The Grand Duchy is Europe’s leading center for investment funds, the main private banking center in the Eurozone and home to a large number of reinsurance companies. The attractiveness of Luxembourg has also resulted in the six biggest Chinese banks setting up their European head offices there. Whilst financial services play a key role in its economy (over 30% of GDP), the process of harmonizing financial standards within the European Union and at the international level (automatic exchanging of tax data for individuals as of 1 January 2015 and the end of banking secrecy by 2017) could pose a short-term threat to the attractiveness and profitability of the Luxembourg financial sector. This process will necessitate the sector adapting to its new regulatory context (Banking Union, Basel III Agreement) which should, in the medium term, help increase the resilience of the sector. In addition, the open-ended investment company sector should remain healthy. The level of exposure to the property market among the banks positioned on the domestic market does however need to be monitored.
Strengthening the budget
After balancing in 2015, the public accounts are expected to produce a slight surplus in 2016. Firstly the 2 percentage point increase in VAT, as well as the introduction of an education contribution taken from household incomes, should offset the reforms to the European VAT system relating to online retail services which will continue to reduce tax receipts. Secondly, whilst public investment will continue to play a significant role in the government’s budget, spending is going to be limited by the multi-year budget consolidation measures introduced in the 2015 budget that should reach 1.5% of GDP in 2016. The public debt should remain one of the lowest in Europe. The main challenges facing the public finances remain the future increase (one of the largest in the Eurozone) in the cost of the aging population and cross border workers, as well as the measures for the harmonization of financial practices.
A stable tripartite governing coalition
After the fall of the government led by Jean-Claude Juncker in July 2013, with the departure of the Socialist party from the coalition, the early elections led to the formation of a new coalition including, for the first time, Liberals, Socialists and Greens, headed by the Liberal, Xavier Bettel. The ruling coalition was weakened by the absolute rejection on 7 June of the proposed constitutional changes in the three referendums in which the key issue was the granting of the right to vote in national elections to foreign nationals who have been resident in Luxembourg for more than 10 years. This did not undermine the stability of the political settlement but increased support for the opposition party (Christian-Social Party) and could hinder the implementation of future major political reforms such as the one on financial system which would require a consensual approach by the parties.