Public Information Notice: IMF Concludes Article IV Consultation with Luxembourg

May 16, 2000

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On May 8, 2000, the Executive Board concluded the Article IV consultation with Luxembourg.1


Luxembourg's growth performance has remained impressive: during 1998-99, real GDP grew at an annual rate of some 5 percent, while employment increased by some 4½ percent. Buoyant private sector services, particularly financial services, remained the main engine of growth and sheltered activity from the adverse effects of the global financial crisis. Moreover, strong labor demand was accommodated by a growing number of cross-border workers.

Price and wage pressures have been subdued, and external competitiveness has been maintained. Reflecting moderate wage increases and, until recently, declining commodity prices, CPI inflation remained at about 1 percent during 1998-99.

Fiscal policy has continued to follow a prudent course, aiming at restraining central government spending growth below projected nominal GDP growth. This has allowed for persistent and sizeable general government surpluses (2.3 percent of GDP in 1999). As a result, general government gross debt was a mere 6 percent of GDP in 1999, while the public sector's net financial assets totaled some 30 percent of GDP. The 2000 budget targets a surplus of some 2.5 percent of GDP.

The financial sector continued its expansion at a healthy pace, despite the removal of some regulatory advantages, such as the introduction of minimum reserve requirements following the advent of Stage 3 of European Economic and Monetary Union (EMU). In addition, the establishment of the Central Bank of Luxembourg, and new regulatory frameworks for mortgage banking, funded pension schemes, and Internet banking and E-commerce are expected to add to the growth potential of the financial sector.

Luxembourg's impressive growth experience since the early 1980s reflects a virtuous circle between sound policies, cooperative social partnership arrangements and, most of all, external economies based on regional specialization. The latter have underpinned the rapid expansion of Luxembourg's specialized cluster of service industries, particularly financial services. Short- to medium-term prospects are bright, and the staff projects real GDP growth during 2000-2003 to average about 5 percent. The longer term outlook for continued fast-paced growth is, however, much less assured: (i) experience elsewhere shows that the growth dividends from regional specialization accrue at the cost of increased vulnerability to largely idiosyncratic and unpredictable shocks; (ii) ongoing European integration is likely to eat into Luxembourg's remaining locational advantages, in particular those based on regulatory structures and taxation; and (iii) environmental and social constraints could eventually act as brakes to continued fast-paced growth.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They warmly commended Luxembourg's macroeconomic and fiscal performance: real activity had continued to expand vigorously; unemployment was low and stable; there were no underlying price or wage pressures; and Luxembourg's fiscal performance was unmatched among European Union (EU) countries. Directors commented that Luxembourg's impressive performance reflected a virtuous growth circle driven by sound domestic policies, social consensus, and economic specialization in a regional environment of high labor mobility.

Looking ahead, Directors generally thought that the economic prospects for the next few years were bright. At the same time, they noted that the long-term prospects for strong output growth were less assured. In this context, Directors noted that the scope for effectively counteracting by fiscal demand management any shocks that might occur would be limited in view of the openness and specialization of Luxembourg's small economy.

Against this background, Directors recommended a proactive policy approach, focused on institutional reforms, to strengthen the robustness of Luxembourg's economy and public finances. In this connection, they welcomed the authorities' progress in diversifying the services sector of the economy. Directors noted that the favorable fiscal outlook for the next few years would provide a wide window of opportunity for implementing reforms. They recommended that the authorities resist pressures to further expand the large-scale social security system, and that they build the needed social consensus to underpin a proactive reform agenda.

Directors noted that Luxembourg's public pension system was subject to longer-term challenges, particularly if population aging were to combine with an abrupt halt or reversal in cross-border worker flows. They felt that a shift to a more diversified multi-pillar pension system would be desirable, and observed that Luxembourg was exceptionally well placed to handle the difficult transition to a more diversified pension system.

Directors welcomed the Government's plans to implement a significant income tax reform by 2002--as a lower tax burden would boost competitiveness and a more neutral tax system would improve the overall functioning of the economy. They also urged the authorities to improve the management of the public sector's holdings of financial assets, and welcomed the authorities' plan to review present constraints on investment policies.

Directors observed that the exceptionally favorable economic performance in recent years appeared to have blunted the effects of Luxembourg's pervasive labor market rigidities. Nevertheless, they recommended that the authorities pursue greater labor market flexibility: such reforms could include promoting more flexible labor cost structures, especially at the lower end of the labor market, and tightening eligibility criteria for social benefits, particularly the early retirement scheme.

Directors noted that the Central Bank of Luxembourg, established in June 1998, had been quick and skillful in acquiring the necessary competencies to fulfill its tasks within the European System of Central Banks. They underscored that maintaining effective supervision and governance of the financial sector should remain a priority of public policy. Directors noted that the Financial Sector Surveillance Commission, which took over supervisory responsibilities from the central bank in 1998, appeared to be well equipped to meet the challenge of supervising Luxembourg's large, evolving, and mostly foreign-owned financial sector. Some Directors thought that full consolidation of financial sector supervision, by integrating insurance supervision, could be considered in due course. Directors welcomed the recent steps to strengthen anti-money laundering measures.

Directors welcomed the recent substantial increases in budgetary resources for addressing the remaining weaknesses in Luxembourg's economic statistics. In particular, they emphasized the need to close the remaining gaps in national accounts and balance of payments data. Directors also encouraged the authorities to take additional measures to allow Luxembourg's subscription to the Special Data Dissemination Standard.

Directors warmly welcomed Luxembourg's determination to live up to, and go well beyond, its commitments regarding official development assistance, noting in particular that, in 2000, Luxembourg was likely to join the exclusive circle of countries whose assistance met the United Nations' target.

It is expected that the next Article IV consultation with Luxembourg will be held on the 24-month cycle.

Luxembourg: Selected Economic Indicators

  1996 1997 1998 1999 2000 1/ 2001 1/

Real economy (change in percent)  
Real GDP 2/ 2.9 7.3 5.0 5.2 5.1 5.0
Domestic Demand 2/ 2.7 5.5 2.2 4.2 3.3 3.1
CPI (year average) 1.4 1.4 1.0 1.0 1.6 1.4
Unemployment rate (in percent) 3.3 3.3 3.3 2.9 2.7 2.3
Gross national saving (percent of GDP) 35.3 32.6 30.2 31.8 32.4 32.4
Gross capital formation (percent of GDP) 20.3 20.1 19.2 20.2 20.1 20.0
Public finance (percent of GDP)  
Central government balance 1.0 2.1 1.4 0.9 1.1 1.3
General government balance 2.7 3.6 3.2 2.4 2.6 3.4
General government gross debt 6.2 6.0 6.4 6.1 5.8 5.4
Money and interest rates  
M2 (end of year, percent change) 3/ -2.0 18.9 6.6 ... ... ...
Money market rate (in percent) 3.2 3.5 3.6 3.5 ... ...
Government bond yield (in percent) 6.3 5.6 4.7 4.7 ... ...
Balance of payments (in percent of GDP)  
Trade balance (percent of GDP) -9.5 -11.4 -10.8 -14.9 -14.6 -14.8
Current account (percent of GDP) 15.2 13.8 12.6 8.3 10.3 10.5
Official reserves (US$ million) 4/ 73.7 64.1 ... 77.1 ... ...
Exchange rates  
Exchange rate regime Member of euro area 5/ 
Nominal effective exchange rate (1995=100) 98.8 97.0 96.7 96.4 ... ...
Real effective exchange rate (1995=100) 98.2 96.1 95.7 95.4 ... ...

Sources: Data provided by the authorities; IMF, International Financial Statistics; and IMF staff estimates.

1/ Staff projections.
2/ 1999 figures are IMF staff estimates.
3/ Monetary aggregates are no longer calculated for Luxembourg following its joining the European Economic and Monetary Union in 1999.
4/ Excluding gold. From 1999, eurosystem definition.
5/While the Luxembourg franc to euro rate was irrevocably fixed on January 1, 1999, the external exchange Rate of the euro is market determined. The Luxembourg franc will remain in circulation until 2002, when euro Banknotes and coins will be issued.

1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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