WEAK GROWTH IN AN ADVERSE ENVIRONMENT FOR THE FINANCIAL SECTOR

Luxembourg’s economy was resilient throughout the pandemic thanks to its specialization in financial services (27% of GDP), which has been generally strong. The country is the world’s second-largest investment fund center (EUR 5,800 billion in assets under management in Q2 2022) behind the US. The financial sector mainly comprises foreign banks (subsidiaries of European banks) - of the 130 banks surveyed in 2019, seven were commercial banks focused on the domestic market - and alternative investment funds. Despite its activities’ diversity and strong capitalization, the sector will be affected by global monetary tightening, geopolitical tensions, and the high level of uncertainty in the global economy, particularly the expectations of stagnation in the euro area. While inflation should continue its downward trend initiated at the end of 2022 and will be partially offset by support measures (reduction in VAT, cap on gas and electricity prices) and by wage increases (indexation planned in April 2023 in particular), households will limit their consumption, in an uncertain environment conducive to precautionary savings. Household investment in property will also decline as rising interest rates add to high prices in the sector due to a low housing supply. Furthermore, as the Grand Duchy imported 40% of its gas from Russia before the war in Ukraine and its gas market is integrated with Belgium, it appears to be as vulnerable as the rest of the region to an energy crisis. At the same time, activity will be supported by public investment, which will remain high (around 4% of GDP), aiming to improve the economy’s competitiveness and accelerate the ecological and digital transition.

PUBLIC ACCOUNTS BACK IN DEFICIT

The public deficit is expected to increase in 2023. The budgetary allocation of 3.3% of GDP to support households and businesses will continue to weigh on public spending. Most VAT rates are temporarily reduced by about one percentage point starting 1 January 2023. Significant public investments will also weigh on the deficit. These measures, together with the increase in the interest burden, will push up the public debt. However, it will remain one of the lowest in the Eurozone, below the 30% of GDP threshold, the political objective set by the 2018 coalition agreement.

The adverse economic situation of its main trading partners (France, Germany, and Belgium account for 54% of goods exports) will slow down exports. However, the current account will remain largely in surplus in 2023 thanks to a substantial services surplus (32% of GDP in 2022, mainly attributable to banking and financial services). Its trade balance is almost balanced (0.3% of GDP in 2022). This makes it possible to compensate for the large deficit in the proportion of income caused by cross-border transfers (16% of GDP) and by the repatriation of dividends from massive portfolio investments made in the country (13% of GDP). Luxembourg has consistently held more assets than liabilities vis-à-vis the rest of the world since 2013. It thus continues to have a solid favorable net international investment position (54% of GDP in 2021).

COALITION SET TO EMERGE STRONGER FROM THE 2023 LEGISLATIVE ELECTIONS

At the head of the country since 2013, Prime Minister Xavier Bettel of the Democratic Party (DP, center-right) remained in power following the 2018 legislative elections thanks to a coalition with the Socialist Party (LSAP) and Déi Gréng (green) as in the previous term. All 60 seats in the Chamber of Deputies will be voted on again in the parliamentary elections in October 2023. According to a poll conducted in November 2022, it should emerge stronger from these legislative elections, with voting intentions increasing for the LSAP, which is expected to win three more seats than in 2018, a whole number for the Prime Minister’s party, and a loss of one seat for their green partners. The Christian Social People’s Party (CSV), the main opposition party, which won 29% of the vote in 2018, would remain the country’s largest party but would see its weight in the opposition weakened by the loss of 6 seats to the benefit of the Piraten party, a direct democracy movement (+4 seats).