Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with Luxembourg

May 8, 2006

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. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2006 Article IV consultation with Luxembourg is also available.

Public Information Notice (PIN) No. 06/52
May 8, 2006

On April, 26, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Luxembourg.1


Luxembourg's dominant financial sector has supported a steady rebound in economic activity in recent years and growth is projected to remain relatively strong in the near term. While headline inflation is high compared to the EU average, underlying inflation has remained subdued. The recovery notwithstanding, the fiscal deficit widened to 1.9 percent of GDP in 2005, driven primarily by social expenditure growth, while unemployment edged up to 4½ percent. The government plans to announce in May a comprehensive reform package to address fiscal and structural challenges.

Trend growth may decline as the financial services industry is maturing, following a successful shift into investment fund services. This shift stimulated growth, but the expansion is likely to decelerate over time given the lower value added of these new activities. The staff projects growth to slow down to about 3½ percent over the medium term; about 1 percentage point below the authorities' forecast.

The financial sector remains sound and resilient to potential adverse shocks. Supervision is adequate. Financial stability is underpinned by the close integration of foreign-owned financial subsidiaries with their parent companies, which tends to enhance asset quality and capital adequacy. Financial sector soundness is also helped by an increasing diversification of income sources, as the shift to investment fund services has boosted commission income.

The 2006 budget targets a moderate reduction of the deficit and the authorities intend to restore fiscal balance soon after 2008. Achieving this target requires cumulative expenditure measures equivalent to 2½ percentage points of GDP during 2006-08, which remain to be defined. Moreover, securing funding of the future liabilities of the public pension system would require additional measures.

There has been a steady increase in structural unemployment, largely owing to a labor supply shock triggered by benefit reforms in neighboring countries. A widening gap between the entitlements to resident and foreign job seekers has heightened competition in Luxembourg's regional labor market, pushing a growing number of resident workers into unemployment.

Executive Board Assessment

Directors noted that Luxembourg's near-term growth outlook remains positive, supported by the continued strong performance of the dominant financial sector. Directors welcomed the sector's successful shift from traditional banking activities into the investment fund industry and the authorities' initiatives to create an environment for future opportunities. Nevertheless, they noted that growth prospects could weaken over the medium term as the financial sector is maturing.

Against this background, Directors saw the need to adjust fiscal and social policies as Luxembourg's major policy challenge. They called on the authorities to address this challenge in a comprehensive manner in their forthcoming reform package. Directors attached particular importance to reining in expenditure growth and redesigning social policies with the aim of reversing structural unemployment.

Directors noted that the financial system appears sound and well supervised. They welcomed the banking sector's continued diversification of income sources, and resulting improvement in the quality of banks' earnings. Directors noted that the sector is well positioned to withstand various market risks, as well as potentially adverse developments in the real estate market. They encouraged the authorities to adjust stress tests in a timely manner to changing market conditions and to continue to closely monitor potential risks stemming from the rapid expansion of the investment fund industry. Directors welcomed continued progress in strengthening the Anti-Money Laundering/Combating the Financing of Terrorism regime.

Directors supported the authorities' policy of returning the fiscal accounts to balance over the medium term, noting that sound public finances have been critical to Luxembourg's success in attracting substantial foreign capital and labor—highly mobile factors. While commending the targeted reduction in expenditures over 2006-08, Directors looked forward to specific measures to underpin this target as part of the authorities' forthcoming reform package. In this context, Directors called for a strengthening of the 2006 budget and saw a need for curtailing social expenditures, including through enhanced targeting of benefits and means testing, and delinking social expenditures from wage developments.

Directors stressed the need for setting medium-term budget targets consistent with long-term sustainability requirements, including those arising from aging. They called therefore for sustaining a small general government surplus in the absence of deep-seated reforms, in particular in the benefit system.

Directors emphasized that the targeted slowdown in expenditure growth will require health care and pension reforms. In view of the projected emergence of a substantial future funding gap in the public pension system, Directors called for a benefits reform, including linking the statutory retirement age to life expectancy and the replacement rate to the contribution base. They called for pension reforms to be complemented by efforts to raise low returns on pension fund assets. Directors encouraged the authorities to gradually build up the assets of the pension fund to close any remaining funding gap and forestall harmful increases in contribution rates. To avoid deleterious increases in payroll taxes, Directors underscored the need to intensify health care reforms, including by raising co-payments.

Directors expressed concern over the steady increase in structural unemployment and stressed the need to raise labor force participation. Reservation wages in Luxembourg need to be aligned more closely with those in neighboring countries, so as to prevent wage competition from pushing resident job-seekers into long-term unemployment. To this effect, Directors urged a review of social benefits, especially unemployment benefits and the minimum guaranteed income. They also looked forward to a review of early retirement schemes to raise labor force participation.

Directors welcomed Luxembourg's high level of official development assistance and commended its leadership in this area.

Directors observed that Luxembourg's economic statistics are adequate for surveillance. Nonetheless, they encouraged further improvements, also to allow subscription to the Fund's Special Data Dissemination Standard.

Luxembourg: Selected Economic Indicators

  2002 2003 2004 2005

Real economy

(Change in percent unless otherwise indicated)

Real GDP

2.5 2.9 4.5 4.3

Real total domestic demand

-0.2 2.9 1.6 2.4

Unemployment (as percent of total labor force)

2.6 3.5 3.9 4.2

Resident employment

1.7 0.9 1.5 1.6

Total employment

3.2 1.9 2.5 3.2

Harmonized CPI index, p.a.

2.1 2.5 3.2 3.8

Gross fixed investment (in percent of GDP)

21.9 19.8 19.3 19.4

Public finances 1/

(Percent of GDP)

General government revenues

45.8 45.2 44.5 42.0

General government expenditures

43.7 45.0 45.6 43.9

General government balance

2.1 0.2 -1.2 -1.9

General government gross debt

6.8 6.7 6.6 6.0

Balance of payments

(Percent of GDP)

Current account balance

11.6 6.8 11.1 7.9

Balance of trade in goods and services

28.4 26.1 28.2 30.1

Factor income balance

-15.3 -17.0 -13.0 -18.9

Transfer balance

-1.5 -2.3 -4.1 -3.4

Exchange rate


Exchange rate regime

Member of the Euro area

US dollar per Euro

0.94 1.13 1.24 1.25

Nominal effective rate (1990=100)

99.5 100.8 101.1 100.8

Real effective rate (CPI based; 1990=100)

101.9 103.7 104.3 104.2

Sources: Data provided by the authorities; and IMF staff calculations and projections.

1/ 2005 ratios reflect revised GDP data.

1 Under 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.


Public Affairs    Media Relations
E-mail: E-mail:
Fax: 202-623-6220 Phone: 202-623-7100