Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Belgium: Concluding Statement of the 2013 Article IV MissionBrussels, March 27, 2013
The economy has entered a second year of near zero growth amid persistent vulnerabilities. While an improvement in external conditions, even if gradual, should support the recovery, the economy’s capacity to rebound and create jobs is constrained by structural rigidities and a loss of competitiveness. The financial sector has been transformed and downsized in the aftermath of the financial crisis, but vulnerabilities remain. Combined with the fragile situation of public finances, these vulnerabilities could, in an adverse environment, undermine macroeconomic stability. In the face of these challenges, the mission welcomes the efforts undertaken by the government to consolidate public finances, with a resulting improvement in market confidence. The mission encourages the authorities to use the window of opportunity that exists before the next elections to advance the structural reform agenda and lock in some durable growth-enhancing fiscal adjustment.
The views of the mission also reflect the findings of the Financial Sector Assessment Program (FSAP) Update, which was conducted by the IMF over the period November 2012-January 2013.1
I. Outlook and Risks
1. We project real GDP to grow by only 0.2 percent in 2013 and by just over 1 percent in 2014, with downside risks linked to the unsettled external environment and a loss of competitiveness. Under these conditions, employment creation will be insufficient to prevent a further increase of the unemployment rate. The forecast reflects weak external demand conditions, with average output growth in Belgium’s three main trading partners expected to be nearly flat in 2013. Additionally, since 2011, Belgium has fallen behind Germany, France, and the Netherlands in terms of export performance, as unit labor costs have grown faster than those of its neighbors, pushed by sticky inflation, wage indexation, and a loss of productivity relative to its partners. Reversing the trend decline in productivity growth is critical to sustaining real GDP and employment growth over the medium term.
2. Risks to macro-economic stability remain elevated on account of fiscal and financial vulnerabilities, which are related to public debt sustainability and the substantial cross-exposures between the government and the financial sector. In a context of renewed financial tensions or protracted slow growth in Europe, these domestic vulnerabilities could again be exposed and trigger a sharp increase in Belgian sovereign spreads, with adverse implications for the financial sector. Finally, failure to correct competitiveness losses constitutes further downside risk to the outlook.
3. The government undertook important efforts in 2012 to reduce fiscal risks, but continued fiscal consolidation needs to confront a number of rigidities. The growth of primary (non-interest) government spending continues to outpace GDP growth, with high structural pressures due to widespread indexation of public spending and the accelerating costs of ageing. At the level of Entity II, operational expenses and employment have also risen more rapidly than GDP. Fiscal consolidation is further complicated by the need to create fiscal space to reduce the tax burden on labor and to sustain pro-growth public spending in support of R&D, training, and infrastructure.
4. Ongoing financial sector repair has reduced risks to financial stability. Decisive policy actions have preserved financial stability and the banking system has become smaller, less leveraged, and less complex. A large and stable deposit base and the strategic re-orientation towards the domestic market helped to support credit supply, while non-performing loans have remained low so far. The capital positions remained strong, with aggregate Tier 1 ratio rising to 15.3 percent in September 2012.
5. Still, the financial sector remains vulnerable. Weak growth outlook and increased linkages with the sovereign are main sources of vulnerability. As firms refocus on the domestic market and core activities, profitability remains constrained by increased competition, low interest rates, and structurally high costs. FSAP Update stress tests found that while bank capital buffers are solid in aggregate, some banks would experience deterioration of profitability under stress and capital pressures could emerge in the medium term given Basel III capital requirements. Insurers’ meet the current solvency regime, but vulnerabilities are apparent when a more risk-based solvency framework is applied.
6. The strategic reorientation of banks onto the domestic market combined with high private sector savings creates new challenges. Domestic deposits funded Belgian banks’ cross-border expansion in the past. Many of these funds now face limited investment opportunities in a smaller and less buoyant market. This trend is exacerbated by a fragmentation of the euro area financial market in the absence of a complete banking union. International banks have adapted by transferring some group operations to Belgian subsidiaries, where they can put to use their liquidity margins. Supervisory vigilance is required in assessing the risks entailed by these operations.
7. The FSAP Update found that the new supervisory structure is functioning well, with few remaining gaps. Compliance with international standards for regulation and supervision of banks and insurers is generally high, and the National Bank of Belgium (NBB) made material progress in improving supervisory practices and acquired broader supervisory powers. The mission welcomes the new memorandum of understanding between the NBB and the Financial Services and Market Authority, which will over time strengthen the effectiveness of the new institutional setup.
II. Policy Challenges
8. Against this background, the government should capitalize on the current state of political stability to maintain the momentum of reform and fiscal adjustment ahead of the 2014 elections. Key priorities should be: (i) to realize meaningful progress toward the medium-term budget objectives; (ii) to restore competitiveness and boost the economy’s growth potential through structural reforms, which would, in the process, facilitate fiscal adjustment and bolster bank soundness; and (iii) to strengthen supervision and crisis management frameworks so as to ensure timely detection and resolution of financial sector problems. Unwinding the state support to the financial sector and reducing vulnerabilities will take time, and puts a premium on steady progress.
Sustaining Quality Fiscal Adjustment
9. In view of the significant risks created by the level of public debt, the mission recommends that the government lock in, before the elections, a cumulative reduction of the structural primary deficit of 1½ percentage points of GDP over 2013-14. This corresponds closely to the policy adjustment effort embedded in the 2012-15 Stability Program, which remains, in our view, a relevant guide to policy. Because of the high structural growth of public spending under unchanged policies, achieving this objective would require measures somewhat in excess of 1½ percent of GDP. Anchoring fiscal adjustment to a structural deficit target (without one-off measures and the impact of the economic cycle) would increase the predictability of policies and allow automatic stabilizers to operate in the event of higher or lower than anticipated growth. Under our current (lower) growth projections, this adjustment path would reduce the actual deficit to around 2 percent of GDP in 2014 and would place the debt ratio on a downward path in 2014.
10. The quality of budgetary adjustment has an important impact on the growth potential, and therefore the effort should be redirected to expenditure containment, rather than tax increases. Revenue measures might be necessary in the short term to accelerate adjustment, but reliance on stop gap revenue measures is second best to well-planned expenditure containment and reforms. The decision to launch a consultation on deeper pension reform is welcome. There is still a window of opportunity before the elections to further reform social transfer policies, and in particular pensions and other benefits, by linking real increases to economic developments. Reform priorities could also go to tightening controls on the growth of health spending, targeting a faster compression of public sector employment through attrition in Entity II, limiting access to subsidies that discourage work (such as the “credits temps” mechanism), and greater use of means-testing for government benefits and tax expenditures, including the tax credit on service vouchers.
11. A clearer rule-based multi-year fiscal policy framework is needed to increase policy efficiency, as well as to ensure adequate burden sharing across all levels of government and consistency with fiscal targets agreed at the European level. The requirements of European fiscal governance provide an opportunity to establish an internal stability mechanism to better coordinate the targets of the various levels of government and to provide for more automatic correction mechanisms. It would be desirable to reach agreement between all levels of government to assign unforeseen revenue gains to faster debt reduction. A clearer multi-year framework, based on conservative revenue projections, would also put greater emphasis on expenditure reform and avoid the risk of a repeated and inefficient ratcheting up of revenue measures in pursuit of annual deficit targets.
Reforming the Labor Market to Boost the Growth Potential
12. The structural reforms agenda should focus on raising growth by restoring cost competitiveness, raising labor market participation rates, and boosting productivity. Absent an acceleration of structural reforms, Belgium risks losing additional ground to peers that are engaged in significant structural reforms. Substantial productivity gains could be realized by reorienting labor market policies away from protecting specific jobs to making the labor force more adaptable to the requirements of a dynamic economic through skill development and job search support. These actions require close coordination across all levels of government given the divided competencies.
13. Wage and price indexation continue to create risks of cost misalignment and lost growth. Beyond the steps already taken on wage indexation, the ongoing discussion to reform the 1996 Law on the Promotion of Employment and the Preventing Safeguarding of Competitiveness is welcome. Reforms should provide for an automatic (and relatively rapid) adjustment mechanism for past deviations from the norm and from observed divergences in productivity. In addition, the forward-looking mechanism could be revised to create greater buffers against the risks of forecast errors in partners’ wage growth. A one-off improvement in cost competitiveness could be achieved by reducing further the high tax wedge on labor in a budget-neutral way, and in the framework of broader tax reform. More broadly, Belgium needs to confront the inherent structural weakness of maintaining wage indexation while its peers do not. Price indexation in the economy more generally should be restrained. To begin, the use of indexation in the pricing of government and market services could be phased out. In the current low inflation environment this would be of limited consequence.
14. Belgium’s target of raising the employment rate to 73.2 percent by 2020 calls for continued pension and labor market reforms before 2014, including activation and training. On pension reforms, additional parametric changes could be adopted to raise the effective age of retirement, ahead of deeper reforms that might be taken by the next government to better link retirement age to life expectancy. In addition, a number of tax incentives that reduce labor participation could be tightened. Ongoing efforts to incentivize and support job search are welcome and should be accompanied by stronger training programs to upgrade skills.
15. The cost of labor market rigidities adversely affects the economy’s competitiveness and employment creation. High statutory severance payments and lengthy notification periods raise the effective cost of labor, inducing enterprises to postpone restructuring rather than doing it preemptively, thus destroying rather than preserving value. The policy challenge of aligning the status of blue and white collar workers should be taken as an opportunity to re-examine more broadly labor market functioning, in order to make it more adaptable while promoting workers’ rights to training and other forms of support in case of layoffs.
Financial sector: from stability to sustainability
16. Important policy actions have helped to safeguard financial stability but the legacy of the crisis and euro area vulnerabilities require continued attention. The mission recommends continued vigilance on bank capital and liquidity and maintaining the momentum in strengthening domestic supervisory framework. Specifically:
- Requiring financial institutions to maintain capital and liquidity buffers is appropriate. Banks’ capital buffers should be further strengthened in line with forthcoming Basel III requirements. The current liquidity regime, which is closely aligned with the Basel III framework, should be maintained until the new liquidity rules are fully phased in at the European level in 2018.
- Continuing to improve supervisory practices remains important. The newly introduced clustering methodology will ensure more systematic coverage for smaller institutions, enhancements to risk oversight. A conduct of business regime for insurers and intermediaries, and additional attention to risks specific to financial conglomerates are needed.
- Strengthening the national crisis management and resolution framework is a priority. The framework for orderly bank resolution needs to be further improved. A comprehensive reform of the deposit insurance, including the establishment of a segregated fund, with a recalibrated target size and enhanced scope is needed. Shares issued by cooperative corporations should be excluded from deposit guarantee coverage.
- Review of vulnerabilities identified by the stress tests should be accompanied by supervisory follow-up. The NBB is encouraged to expand the ongoing review process of business models of supervised entities, focusing on asset quality, real estate related vulnerabilities, impact of further spread compression on earnings capacity, as well as intragroup transactions within conglomerates. This will help supervisory authorities to take actions aimed at further improving sustainability of financial institutions.
- The insurance sector warrants careful monitoring. Given the medium term financial pressures stemming from the protracted low interest rate environment and high legacy guaranteed rates of return on life insurance policies, increasing focus on consolidation of the sector over the medium term is needed.
- Continued vigilance is required in the process of dismantling the Dexia Group. The complex execution of the Dexia Group resolution plan requires intensive supervisory and government oversight and close coordination with the French authorities.
17. The evolving EU-wide landscape underscores the need for continuing domestic supervisory reforms. While supervision for most banks operating in Belgium will shift to the European Central Bank (ECB), operational responsibilities at a local level will likely remain important. Oversight of financial conglomerates will become more challenging, and close coordination with the ECB will be needed. Therefore, increasing supervisory resources and enhancing supervisory practices should remain priorities.
18. The crisis has highlighted the need for increased cross-border supervisory cooperation and potential benefits of a common resolution framework and deposit guarantee scheme in the euro area. Completing the banking union would yield long term benefits beyond improving supervision of international banks. In particular, improved resolvability of cross-border banks would reduce the financial fragmentation incentives for both national authorities and markets, helping efficient intermediation of savings and credit across the entire euro area.
In conclusion, the IMF mission team would like to thank the authorities for their generous hospitality and the open and constructive discussions.
1 Countries with financial sectors that are considered systemically important, such as Belgium, must undertake a mandatory stability assessment every five years