## 1. Improving Public Investment Management ## Source details **Canonical URL:** [1. Improving Public Investment Management](https://www.imf.org/-/media/files/publications/cr/2021/english/1luxea2021001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2021/english/1luxea2021001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2021/english/1luxea2021001.pdf.json) --- ### Context and pre-COVID landscape - Luxembourg managed the first COVID-19 wave in March-April 2020 with early public health response and large-scale testing including residents and cross-border workers. - Pre-COVID growth: about 3.5 percent annually on average during 2014–19. - Fiscal position pre-COVID: gross debt around 22 percent of GDP; accumulated substantial fiscal space. - Financial sector pre-COVID: - Banks well capitalized and liquid but profitability weakened. - Investment funds expanded rapidly; fund asset liquidity decreased over the past decade. ### Pandemic impact, containment, and recovery - Economic shock: - Q2 2020: -7.7 percent year-on-year (yoy); domestic demand fell by -13.7 percent (yoy). - Real GDP contracted by -1.3 percent in 2020; recovery supported by net exports but weak private domestic demand. - Labor market and inflation: - Unemployment peaked around 7 percent in April 2020 and receded to 6.1 percent in March 2021. - Employment grew driven by public sector, construction, and financial services. - Core and headline inflation fell in 2020; core inflation declined due to lower aggregate demand and free public transportation. - Second wave (late 2020): - Daily new cases almost four times higher than spring peak; intensive care patients up about 50 percent. - Stringency near first-wave peak by end-2020; relaxed since early-2021. - Policy support: - Two main packages totaled about 17 percent of 2020 GDP; actual fiscal impulse lower due to conservative needs assessment and partial repayments (about 4.6 percent of GDP in 2020). - Short-time work scheme scaled up; in April 2020 between 50 and 80 percent of workers in the hardest-hit sectors participated. ### Fiscal allocations and uptake (figures from 2021 Stability and Growth Programme; uptake as of end-March 2021) - Direct support: Allocated 7,620 million euros; Uptake 6,235 million euros; 11.9 percent of GDP allocated; 9.4 percent of GDP uptake. - Revenue measures: Allocated 4,590 million euros; Uptake 2,320 million euros; 7.2 percent of GDP allocated; 3.5 percent of GDP uptake. - Direct taxes (PIT/CIT): Allocated 1,290 million euros; Uptake 232 million euros; 2.0 percent of GDP allocated; 0.4 percent of GDP uptake. - Indirect taxes (VAT): Allocated 300 million euros; Uptake 204 million euros; 0.5 percent of GDP allocated; 0.3 percent of GDP uptake. - Social security contribution: Allocated 3,000 million euros; Uptake 1,780 million euros; 4.7 percent of GDP allocated; 0.3 percent of GDP uptake. - Expenditure measures: Allocated 3,030 million euros; Uptake 2,021 million euros; 4.7 percent of GDP allocated; 3.2 percent of GDP uptake. - Health crisis management: Allocated 240 million euros; Uptake 221 million euros; 0.4 percent of GDP allocated; 0.3 percent of GDP uptake. - Grants to firms: Allocated 540 million euros; Uptake 178 million euros; 0.8 percent of GDP allocated; 0.3 percent of GDP uptake. - Reimbursable advances to businesses: Allocated 400 million euros; Uptake 152 million euros; 0.6 percent of GDP allocated; 0.2 percent of GDP uptake. - Measures to support investment and green recovery: Allocated 500 million euros; Uptake 30 million euros; 0.1 percent of GDP allocated; 0.0 percent of GDP uptake. - Short-time work: Allocated 1,310 million euros; Uptake 995 million euros; 2.0 percent of GDP allocated; 1.6 percent of GDP uptake. - Leave for extraordinary/sick reasons: Allocated 410 million euros; Uptake 384 million euros; 0.6 percent of GDP allocated; 0.6 percent of GDP uptake. - Social support: Allocated 500 million euros; Uptake 41 million euros; 0.1 percent of GDP allocated; 0.1 percent of GDP uptake. - Other current spending: Allocated 300 million euros; Uptake 47 million euros; 0.0 percent of GDP allocated; 0.1 percent of GDP uptake. - Indirect support: Allocated 3,390 million euros; Uptake 2,530 million euros; 5.3 percent of GDP allocated; 4.0 percent of GDP uptake. - State-guarantee for new loans: Allocated 2,500 million euros; Uptake 1,490 million euros; 3.9 percent of GDP allocated; 2.4 percent of GDP uptake. - Other capital support/loan guarantee: Allocated 890 million euros; Uptake 1,040 million euros; 1.4 percent of GDP allocated; 1.6 percent of GDP uptake. - Total: Allocated 11,010 million euros; Uptake 8,884 million euros; 17.2 percent of GDP allocated; 13.9 percent of GDP uptake. ### Financial sector: banks and investment funds - Banks: - CET1 ratio at 23.5 percent on aggregate. - LCR ratio at 152 percent on aggregate. - NPLs about 0.9 percent; asset quality started to deteriorate with increases in stage 2 inflows. - Net profits declined significantly for domestically oriented banks (DOBs); net income before provisions and taxes remained rather stable in 2020. - About ¾ of new provisions in 2020 were made on performing loans. - Credit: growth to resident NFCs slowed to below 1 percent; household credit growth remained robust at more than 8 percent. - Investment funds: - March 2020 turmoil triggered stress; decisive global central bank actions aided recovery and large net inflows thereafter. - Post-stabilization rebalancing toward riskier assets (global equities, high-yield bonds). - Growth largely driven by equity funds and money market funds. ### External position and external sector assessment - Current account surplus edged down to 4.3 percent of GDP in 2020. - NIIP declined to 48 percent of GDP from 56 percent of GDP at end-2019. - EBA-lite results: - Current account gap of 0.5 percent of GDP (including a policy gap of 3.6 percent). - REER undervaluation of 0.4 percent (models indicate small undervaluation). ### Vaccination, outlook, and risk scenarios - Vaccination plan: government committed to purchase 1.3 million doses via EU procurement; free vaccines for residents and cross-border workers. - Baseline outlook: - Real GDP growth projected to rebound to about 4 percent in 2021. - Core and headline inflation set to increase in 2021 and stabilize just under 2 percent thereafter. - Over the medium term, real output forecast to remain slightly over 1 percent lower than its pre-COVID-19 trend by 2025. - Downside risks: - Prolonged pandemic, sharp rise in global risk premia, portfolio rebalancing affecting funds and bank profitability, accelerating deglobalization, Brexit-related disruptions, changes in international taxation. - Upside scenario: - Widespread effective vaccine and extensive immunization in advanced economies could accelerate recovery. ### Fiscal policy stance, projections, and recommendations - Baseline fiscal outlook: - Structural fiscal balance gradually improves from a 3.3 percent of GDP deficit in 2020 to broadly neutral by 2025. - Public debt stabilizes around 27.3 percent of GDP over the medium term. - Baseline assumes some uptake on support measures to mid-2021; full execution of 2021-24 spending plan; and some revenue loss from U.S. tax reform. - 2021 stance and measures: - Fiscal stance flexible in 2021; maintain high public investment at about 4.5 percent of GDP. - Headline and structural balances expected to improve by about 2 percent of GDP in 2021. - Policy recommendations: - Fiscal policy should remain supportive until firm recovery and focus on the most vulnerable. - Fiscal normalization should be state contingent and start only when output has broadly recovered to pre-COVID level. - Continue targeted measures (liquidity support to wholesale, retail, hospitality sectors). - Allow automatic stabilizers to operate fully while unwinding extraordinary measures. - Preserve comfortable buffers and diversify revenues (including environmental levies and housing taxation). ### Greening the economy and revenue diversification - 2021 green measures: - Carbon tax €20 per ton (equivalent to 5 cents per liter of fuel), set to increase over the medium term; accompanied by tax credit for lower-income households. - Reduction of subscription tax for sustainable investment funds. - Tax incentives for green investment and energy-efficient building modernization. - Revenue risks: - SPEs currently account for about 3 percent of GDP; changes in international taxation could reduce revenues. - Baseline assumes medium-term revenue impact from U.S. tax reform of 0.5 percent of GDP. - Fuel tax hikes could cause non-negligible revenue loss due to price-elastic non-resident fuel demand. - Revenue diversification options: - Increase taxation on private vehicles and one-off car registration fees. - Remove preferential VAT treatment of energy products while protecting the most vulnerable. - Modernize property valuation and incentivize municipal taxes on unused construction land. - Remove corporate net wealth tax and replace with an annual registration fee. ### Public investment management (PIM) gaps and recommendations (Box 1) - Findings on PIM shortcomings: - No medium-term expenditure plan (MTEF) and no performance-based budgeting. - Budget circular lacks firm overall ceilings for line ministries; ceilings can be modified without limits. - Fragmented project-by-project approach to public investment; risk of insufficient planning, sequencing, delays, and cost overruns. - Projects above €40 million subject to more in-depth analysis; no published list of projects with cost estimates and implementation status; no systematic ex-post evaluations. - Recommendations to strengthen budgetary framework: - Adopt an MTEF and multiannual expenditure strategy; authorities envisage implementing medium-term expenditure plans for individual expenditure items in the context of the 2022 budget. - Embed a spending review mechanism into the budgetary process. - Review carry-over rules for special funds to avoid inefficient resource buildup. - Measures to enhance planning and oversight: - Consider establishing an independent entity to coordinate cross-sectoral assessment, prioritization, sequencing, and performance monitoring of infrastructure projects. - Review the €40 million threshold to widen coverage of projects subject to in-depth analysis (example: Ireland’s €20 million threshold). - Conduct systematic ex-post evaluations and publish post-project reviews; empower the independent unit to carry out ex-post evaluations. - Examples of public investment units and roles: - France — General Commission for Investment (2010): check project consistency, coordinate reviews, oversee ex-ante and ex-post evaluations. - United Kingdom — National Infrastructure Commission (2015): impartial expert advice, National Infrastructure Assessment. - New Zealand — National Infrastructure Unit (2009): 20-year plan, cross-government appraisal frameworks. - South Korea — Public and Private Infrastructure Management Center (2005): preliminary feasibility studies and efficiency review. ### Macroprudential, housing, AML/CFT, and institutional priorities - Residential real estate: - Real house prices grew "16.7 percent yoy in nominal terms in Q4 2020". - Mortgages grew "11.6 percent in 2020". - Household debt about "190 percent of net disposable income in 2019" ( OECD data), "1.7 standard deviations above the euro area average (108 percent)". - Authorities introduced differentiated LTV limits starting "early-2021": general "80 percent" limit; first-time buyers up to "100 percent"; primary residences "90 percent" with lenders allowed 15 percent of new mortgages up to 100 percent. - Authorities estimate "14 percent of current mortgage loans would have not been granted by the top RRE banks under the new LTV limits. About a third of these loans have LTVs above 100 percent." - AML/CFT and UBO registries: - Easy and free access to UBO registries welcomed; additional measures needed to ensure accuracy of information at collection stage. - September 2020 national risk assessment indicates persisting threats from cross-border proceeds of corruption and tax evasion. - Investment fund sector macroprudential actions recommended: - Enhance system-wide surveillance and granular reporting; close data gaps; introduce a consistent measure of leverage; improve liquidity stress testing including second-round effects; lead in international fora on macroprudential toolkit for funds; issue guidance on liquidity management tools (LMTs). - Institutional and supervisory actions: - Strengthen supervision of intra-group exposures and waivers; harmonize LTV and DSTI reporting standards (CSSF circulars). - Continue engagement with parent supervisors for Less Significant Institutions and monitor structural vulnerabilities (custodian, private banking, intra-group maturity/currency transformation). ### Selected key macroeconomic projections and indicators (Table 1 highlights) - Real GDP (percent change): 2020: -1.3; 2021 (Est.): 4.1; 2022 (Proj.): 3.6; 2023: 3.0; 2024: 2.7; 2025: 2.5; 2026: 2.5. - Unemployment (percent of labor force): 2020: 6.3; 2021: 6.7; 2022: 6.4; 2023: 6.1; 2024: 5.9; 2025: 5.8; 2026: 5.7. - General government balance (percent of GDP): 2020: -4.1; 2021: -1.6; 2022: -0.6; 2023: -0.2; 2024: -0.1; 2025: -0.1; 2026: -0.1. - General government gross debt (percent of GDP): 2020: 24.9; 2021: 26.7; 2022: 27.3; 2023: 27.4; 2024–2026: 27.3. - GDP (billions of euro): 2020: 64.1; 2021: 69.0; 2022: 73.3; 2023: 77.0; 2024: 80.6; 2025: 84.2; 2026: 88.0. - GDP per head (memorandum): €101,446. - Population in 2019 (memorandum): 626,108. - Land area (memorandum): 2,586 sq. km. ### Risk Assessment Matrix — selected high-likelihood/high-impact risks and policy responses - Business model risk (High likelihood, High impact): Changes in EU and international taxation. - Policy responses: fiscal normalization when recovery solid; diversify fiscal revenue base; contingency plans; pension reform. - Global pandemic shifts (Medium likelihood Downside/Medium Upside, High impact): prolonged pandemic risk vs faster containment. - Policy responses (Downside): increase testing; targeted fiscal support; deepen surveillance of investment fund sector; temporary measures to alleviate bank capital/liquidity pressures; stand ready to provide liquidity support with ECB. - Accelerating de-globalization (Medium likelihood, High impact): policy responses include supporting multilateral trade rules, coordinated EU/global responses, diversify tax base, structural reforms. - Sharp rise in global risk premia (Medium likelihood, High impact): deepen surveillance of funds, monitor LMTs, international coordination on macroprudential toolkit. - Cyber-attacks (Medium likelihood, Medium impact): enhance cybersecurity, public-private coordination, contingency planning. _Source: INTERNATIONAL MONETARY FUND — content unit 1luxea2021001._ ### 1. Improving Public Investme nt Management _________________________________________________________ 38 ### 1. Improving Public Investme nt Management _________________________________________________________ 38 ### CONTEXT - Luxembourg managed the first wave of the COVID-19 epidemic during March-April 2020 with an early and vigorous public health response and a large-scale testing campaign that included both residents and cross-border workers. - Sizeable and flexible policy support to preserve jobs and firms, and a quick reopening of the economy, underpinned by large-scale testing, supported a rapid, albeit incomplete economic recovery in the second half of 2020. - As the pandemic progressed in Luxembourg, resulting in above average deaths to population ratio, the government launched a large-scale testing campaign, including both residents and cross-border workers. ### THE PRE-COVID LANDSCAPE - The economy expanded rapidly pre-COVID, growing by about 3.5 percent annually on average during 2014–19, translating into solid employment gains and a significant decline in unemployment; signs of moderation in activity and softening in the labor market had emerged. - Luxembourg accumulated substantial fiscal space due to a persistently prudent fiscal stance and buoyant tax revenues, including one-off factors (sizeable corporate income tax assessments for previous years); gross debt is around 22 percent of GDP. - Financial sector performance: - Banks remained well capitalized and liquid but profitability weakened because of increasing administrative costs and low interest rates. - Variation across bank segments: commission-based activities such as custodian banks fared better. - Investment funds expanded rapidly; search-for-yield in a low-yield environment led to build-up of liquidity and maturity mismatches. - Fund asset liquidity has continued to decrease during the past decade. ### PANDEMIC IMPACT AND POLICY RESPONSE - Economic impact and recovery - The economy adapted quickly to teleworking, supporting a rapid decline in infections after the first wave. - The decline in mobility during the first wave was comparable to countries with the most stringent lockdowns, reflecting high teleworkability and low share of contact-intensive sectors. - The economy entered an unprecedented recession in H1 2020: -7.7 percent year-on-year (yoy) in Q2 2020; domestic demand fell by -13.7 percent (yoy). - Real GDP contracted by 1.3 percent in 2020, driven by weak private domestic demand despite a positive contribution from net exports. - Labor market: - Unemployment rate peaked around 7 percent in April 2020 and receded to 6.1 percent in March 2021. - Employment continued to grow, driven by the public sector, construction, and financial services. - Inflation: - Core inflation declined due to a fall in aggregate demand and the introduction of free public transportation. - Headline inflation fell more sharply as food inflation declined and global energy prices slumped. - Economic sentiment recovered faster than in the euro area, reaching pre-COVID levels in early 2021. - Second wave and containment - Infections began rising in early October 2020, with daily new cases almost four times higher than during the spring peak and about a 50 percent increase in patients in intensive care. - The government tightened restrictions, reaching stringency levels close to the first-wave peak by end-2020 (including nighttime curfew and closures of non-essential businesses), relaxed since early-2021. - High telework capacity and relatively tight containment measures prevented a third infection wave so far. - Fiscal and policy measures - The government deployed timely, sizeable, and multi-pronged emergency measures in March-April 2020 focused on public health infrastructure and support to households and businesses; measures were broadened to include the short-time work scheme, grants, repayable advances, tax deferrals and rebates for H1 2020, loan guarantees, and moratoria. - In mid-May 2020, a new stimulus package targeted vulnerable sectors (hospitality and retail), included short-time work, grants to businesses, and fiscal incentives for green investment, including aid for energy efficiency projects. - The two packages totaled about 17 percent of 2020 GDP; actual fiscal impulse was significantly lower due to conservative assessment of financial needs, stronger-than-expected recovery, lower demand for assistance, and partial repayment of earlier support (about 4.6 percent of GDP in 2020). - Fiscal support impacts - The unprecedented fiscal support preserved employment, cushioned household income shortfalls, and relieved firms’ cash-flow pressures. - Short-time work scheme ("chômage partiel"): - Quickly scaled up to include all businesses with subdued activity. - In April 2020, between 50 and 80 percent of workers in the sectors most hit by the pandemic (hospitality, retail, construction) participated in the scheme. - Extraordinary support was slightly reduced in July 2020—except for tourism, hospitality, and sectors not allowed to resume activity—but remains generous and can, under certain conditions, allow for permanent layoffs based on firms’ job retention plans. - Support to firms’ cash flows included tax and social security deferrals, cash grants to SMEs and the self-employed, capital advances, and debt moratoria; bankruptcies hovered around pre-COVID levels. - Fiscal allocations and uptake (figures from 2021 Stability and Growth Programme; uptake as of end-March 2021) - Direct support: Allocated 7,620 million euros, Uptake 6,235 million euros, 11.9 percent of GDP allocated, 9.4 percent of GDP uptake. - Revenue measures: Allocated 4,590 million euros, Uptake 2,320 million euros, 7.2 percent of GDP allocated, 3.5 percent of GDP uptake. - Direct taxes (PIT/CIT): Allocated 1,290 million euros, Uptake 232 million euros, 2.0 percent of GDP allocated, 0.4 percent of GDP uptake. - Indirect taxes (VAT): Allocated 300 million euros, Uptake 204 million euros, 0.5 percent of GDP allocated, 0.3 percent of GDP uptake. - Social security contribution: Allocated 3,000 million euros, Uptake 1,780 million euros, 4.7 percent of GDP allocated, 0.3 percent of GDP uptake. - Expenditure measures: Allocated 3,030 million euros, Uptake 2,021 million euros, 4.7 percent of GDP allocated, 3.2 percent of GDP uptake. - Health crisis management: Allocated 240 million euros, Uptake 221 million euros, 0.4 percent of GDP allocated, 0.3 percent of GDP uptake. - Grants to firms: Allocated 540 million euros, Uptake 178 million euros, 0.8 percent of GDP allocated, 0.3 percent of GDP uptake. - Reimbursable advances to businesses: Allocated 400 million euros, Uptake 152 million euros, 0.6 percent of GDP allocated, 0.2 percent of GDP uptake. - Measures to support investment and green recovery: Allocated 500 million euros, Uptake 30 million euros, 0.1 percent of GDP allocated, 0.0 percent of GDP uptake. - Short-time work: Allocated 1,310 million euros, Uptake 995 million euros, 2.0 percent of GDP allocated, 1.6 percent of GDP uptake. - Leave for extraordinary/sick reasons: Allocated 410 million euros, Uptake 384 million euros, 0.6 percent of GDP allocated, 0.6 percent of GDP uptake. - Social support: Allocated 500 million euros, Uptake 41 million euros, 0.1 percent of GDP allocated, 0.1 percent of GDP uptake. - Other current spending: Allocated 300 million euros, Uptake 47 million euros, 0.0 percent of GDP allocated, 0.1 percent of GDP uptake. - Indirect support: Allocated 3,390 million euros, Uptake 2,530 million euros, 5.3 percent of GDP allocated, 4.0 percent of GDP uptake. - State-guarantee for new loans: Allocated 2,500 million euros, Uptake 1,490 million euros, 3.9 percent of GDP allocated, 2.4 percent of GDP uptake. - Other capital support/loan guarantee: Allocated 890 million euros, Uptake 1,040 million euros, 1.4 percent of GDP allocated, 1.6 percent of GDP uptake. - Total: Allocated 11,010 million euros, Uptake 8,884 million euros, 17.2 percent of GDP allocated, 13.9 percent of GDP uptake. *IMF staff compilation from Luxembourg: 2021 Stability and Growth Programme and IMF staff calculations.* ### 11. Thanks to the broad-based policy support, both domestic and global, the impact of ### 11. Thanks to the broad-based policy support, both domestic and global, the impact of the pandemic on the financial sector has been limited. ### Financial sector: banks - Capitalization and liquidity - CET1 ratio at 23.5 percent on aggregate. - LCR ratio at 152 percent on aggregate. - Asset quality and profitability - Non-performing loans (NPLs) broadly stable at about 0.9 percent. - Asset quality has started to deteriorate and inflows into stage 2 assets have increased. - Net profits declined significantly for the domestically oriented banks (DOBs) and overall, largely due to higher provisions for loan losses. - Bank net income (before provisions and taxes) remained rather stable in 2020. - CSSF data indicate that about ¾ of the new provisions in 2020 were made on performing loans. - Credit developments - Growth in credit to resident non-financial corporations slowed to below 1 percent (compared to above 10 percent on average since 2016), mostly reflecting weak demand. - Growth in household credit remained robust at more than 8 percent, mainly driven by mortgages. - Behavior during uncertainty - Luxembourg banks continued to increase their central bank deposits in this highly uncertain environment. ### Financial sector: investment funds - March 2020 turmoil and recovery - Luxembourg funds faced significant financial stress during the March 2020 turmoil, triggering heightened surveillance. - Decisive global policy action, including large liquidity provisions by the ECB and other major central banks, helped funds recover from valuation losses and experience large net inflows. - After market stabilization, funds rebalanced portfolios toward riskier assets (notably global equities and high-yield bonds) to increase returns. - Asset growth drivers - Funds’ net assets recovered since the March turmoil and consistently experienced large net inflows. - Growth in assets was largely driven by equity funds and money market funds. ### External position (2020) - Current account and NIIP - Current account surplus edged down to 4.3 percent of GDP, mainly driven by lower net goods exports and net transfers. - Net international investment position (NIIP) declined to 48 percent of GDP from 56 percent of GDP at end-2019, driven by both net direct and other investment and partly offset by the improvement in the net portfolio position. - EBA-lite model results - Current account gap of 0.5 percent of GDP—including a policy gap of 3.6 percent mostly reflecting a looser world average fiscal stance. - Real effective exchange rate (REER) undervaluation of 0.4 percent. ### Vaccination strategy and near-term risks - Vaccination plan - Government committed to purchase 1.3 million doses through the EU common procurement mechanism. - Free vaccines to be administered to residents and cross-border workers (on a voluntary basis) following a centralized approach. - Implementation risk - Vaccination has not progressed as planned due to supply shortfalls, posing downside risks to the baseline. ### Authorities’ views (policy response and outlook) - Authorities attributed Luxembourg’s relative success to: - Timely deployment of broad-based support measures. - Low share of contact-intensive sectors and high capacity to telework. - Accommodative global financial conditions benefiting financial services. - Policy calibration - Policies have been closely calibrated to pandemic dynamics and increasingly targeted to the most vulnerable sectors. - Lower-than-initially-budgeted uptake on key support measures attributed to the economy’s overall resilience and generous initial assessment of needs. - External position - Authorities agreed that Luxembourg’s external position is broadly in line with fundamentals. ### Outlook and risks - Baseline assumptions - No significant tightening of containment measures in the near term; no major impact on the economy. - Widespread availability of an effective vaccine or treatment towards end-2021. - Growth and inflation projections - Real GDP growth projected to rebound to about 4 percent in 2021, well above-potential growth. - Recovery supported by domestic and foreign demand amid accommodative global financial conditions. - Negative, albeit narrowing, output gap expected as aggregate demand trails supply-side recovery. - Core and headline inflation set to increase in 2021 and stabilize just under 2 percent thereafter. - Over the medium term, higher corporate balance sheet impairment and labor market scarring will weigh on output; real output forecast to remain slightly over 1 percent lower than its pre-COVID-19 trend by 2025. - Downside and other risks - Virus risk: prolonged pandemic could weaken recovery, increase financial market volatility, and undermine bank performance, tax revenues, and growth. - Upside scenario: widespread effective vaccine and extensive immunization in advanced economies could accelerate recovery. - Other risks: sharp rise in global risk premia, portfolio rebalancing affecting fund sector and bank profitability, accelerating deglobalization, Brexit-related disruptions (viewed as mitigated), and changes in international taxation posing notable revenue risks. ### Fiscal policy: supporting a strong, sustainable, and greener recovery - Baseline fiscal outlook and assumptions - Structural fiscal balance gradually improves from a 3.3 percent of GDP deficit in 2020 to a broadly neutral position by 2025, driven by unwinding COVID-related support. - Public debt would stabilize around 27.3 percent of GDP over the medium term and remain sustainable under stress scenarios. - Baseline assumes: some uptake on main support measures extended to mid-2021; steady economic improvement; full execution of the government’s 2021-24 multiyear spending plan; and some revenue loss from the U.S. tax reform. - 2021 stance and measures - Fiscal stance considered adequately flexible in 2021 with key supportive measures extended and targeted (short-time work, financial-aid schemes, cancellation of tax advances). - Extended measures mainly financed with unused funds from the 2020 stimulus packages. - High level of public investment maintained at about 4.5 percent of GDP. - Headline and structural balances expected to improve by about 2 percent of GDP in 2021 but remain lower than 2019 levels. - Policy recommendations - Fiscal policy should remain supportive until a firm recovery is underway and focused on the most vulnerable. - Fiscal normalization should be state contingent and start only when output has broadly recovered to its pre-COVID level. - Continue targeting subsequent measures (e.g., liquidity support to wholesale, retail, and hospitality sectors). - Allow automatic stabilizers to operate fully while unwinding extraordinary measures. ### Greening the economy and revenue diversification - Green policy measures in 2021 budget - Introduction of a carbon tax (€20 per ton, equivalent to 5 cents per liter of fuel), set to increase further over the medium term; accompanied by a tax credit to shelter lower income households. - Reduction of the subscription tax for sustainable investment funds. - Several tax incentives to support green investment and energy-efficient modernization of buildings. - Risks to revenues - Changes in international taxation could reduce tax revenues from Special Purpose Entities (SPEs), which currently account for about 3 percent of GDP. - The baseline assumes a medium-term revenue impact from U.S. tax reform of 0.5 percent of GDP; other international tax changes could have a significantly larger impact. - Climate mitigation: road transportation is the largest GHG emitter; non-resident fuel demand is likely price elastic, so fuel tax hikes may cause non-negligible revenue loss due to lower sales of fuel and complementary goods. - Revenue diversification and carbon footprint reduction options - Increase taxation on private vehicles and introduce one-off car registration fees, penalizing higher-emission vehicles. - Remove preferential VAT treatment of energy products while protecting the most vulnerable (e.g., replace preferential VAT rates benefiting high-income households with targeted cash transfers). - Modernize property valuation and incentivize municipal taxes on unused construction land. - Remove the distortionary corporate net wealth tax and replace it with an annual registration fee for companies to offset revenue loss. ### Public investment management and spending efficiency - Recommendations to improve investment efficiency - Introduce a medium-term expenditure framework (MTEF) and spending review mechanism to align investment expenditures with policy objectives. - Improve planning, selection, and ex-post assessment of major infrastructure projects to benefit from the move from project-by-project to an overall approach under the country’s long-term mobility plan. - Strengthen public procurement effectiveness, including COVID-related spending: collect and publish information on beneficial ownership of public tender winners and subject COVID-related contracts to independent ex-post audit. *Source: INTERNATIONAL MONETARY FUND — content unit 1luxea2021001.* ### 25. The authorities stand ready to deploy additional support as needed while remaining ### 25. The authorities stand ready to deploy additional support as needed while remaining committed to fiscal discipline ### Fiscal policy stance and priorities - Near-term focus: providing support for affected firms and individuals as needed, calibrated as the pandemic evolves to avoid increases in inequality. - Additional fiscal support should be temporary; future fiscal normalization should not be open-ended to mitigate moral hazard and facilitate efficient adjustment. - Safeguarding public resources: checks implemented to ensure financial aid is channeled to viable firms; importance of collecting and publishing information on public procurement contracts of tender winners. - Longer-term plans: beef up resources to further green and digitalize the economy while compensating the most vulnerable who may be disproportionately affected. - Preserving comfortable buffers to help withstand adverse shocks, including from changes in international taxation. - Existing budgetary and governance frameworks for public investment management achieve proper ex-ante analysis and budgeting but could be strengthened by enhancing sectoral coordination during budgeting and ex-post project oversight. ### Corporate sector: liquidity, solvency, and policy support - Strong pre-COVID equity levels contributed to resilience of Luxembourgish firms. - Staff estimate: without policy support the proportion of illiquid firms would have tripled to about 12 percent. - Sectors most exposed to the pandemic account for 22 percent of GDP. - Short-time work scheme and loan moratoria played an important role supporting liquidity and solvency. - Potentially costly vulnerabilities concentrated in wholesale and retail were warded off by continued credit access for larger companies. - Risk: illiquidity could turn into insolvency if state support is withdrawn prematurely or recovery is weak; while only a small proportion of firms would be at risk in an extreme scenario, the cost of insolvencies as percent of GDP may be large. - Policy implication: continue targeting support to the most affected sectors until a firm recovery is underway. ### Household sector: unemployment, mortgage default risk, and distributional concerns - A sustained economic slowdown with a spike in unemployment could weaken household debt repayment capacity, especially among the most vulnerable. - Mortgages represent the bulk of household debt service payments. - Staff estimate: overall probability of default on mortgages (within 5 years) conditional on job loss is around 3 percent, much lower than in neighboring countries (about 10 percent on average). - Moratoria can temporarily—albeit marginally—mitigate the risk of default. - Low- and middle-income households face a much higher risk of default (over 30 percent), more than ten-fold higher default risk than higher-income households. - Data note: lower-income households have higher debt-to-income and debt service-to-income ratios and hold less liquid assets. - Policy implication: maintain state support to those experiencing income shortfalls, especially lower-income households, until the recovery firms up to mitigate solvency risks and potential correction in the residential property market. ### Banking sector: asset quality, profitability, and resilience - Banks’ profitability relatively weak due to low-for-long interest rates: return on assets of about 0.5 percent, slightly below the EU average. - Banks’ exposure to sectors most affected by the pandemic accounted for about 90 percent of CET1 capital at end-2019. - Higher loan loss provisions or charge-offs from unprovisioned loan losses would weigh on banks’ profits; however, aggregate capital buffers support capacity to extend credit in the short term. - Risk: tightening lending standards amid higher credit risk perceptions and expectations of premature withdrawal of key support measures (set to expire by mid-2021) could intensify corporate insolvencies and increase credit losses. - Bank metrics and exposures: - CET1 buffers would decline by only 1.5 percentage points by end-2021 under the baseline macroeconomic projection (from 20.1 percent at end-2019). - Banks’ exposure to commercial real estate (CRE) represented about 3 percent of total loans and less than 12 percent of loans to NFCs at end-2020. - NPLs on CRE loans increased to 3.9 percent in 2020, up from 2.7 percent in 2019. - Coverage ratio of NPLs remained high at about 88 percent (including collateral). - Supervisory and data priorities: - Inclusion of household credit data in the ECB’s harmonized credit bureau initiative is essential to better assess household solvency risks. - Monitor structural vulnerabilities in other business lines (custodian, private banks), intra-group lending maturity/currency transformation, large cross-border exposures, and waivers to large exposure limits for intra-group transactions. - Maintain engagement with supervisors of parent groups of Luxembourg’s Less Significant Institutions located outside the euro area. ### Investment fund sector: vulnerabilities and macroprudential actions - The investment fund sector weathered the crisis but displayed vulnerabilities: - March 2020 market turmoil led funds to increase holdings of cash and liquid assets, producing procyclical selling; later trend resumed toward increasing liquidity, maturity, and currency mismatches driven by search for yield. - Open-ended funds remain prone to widespread outflows and procyclical selling of less liquid assets in a market downturn. - Recommended actions (consistent with 2017 FSAP recommendations): - Further enhance system-wide surveillance of the sector while coordinating at the EU and international levels. - Continue granular and frequent reporting requirements for a large sample of asset managers and close data gaps for system-wide vulnerability indicators (including CSSF risk dashboard and BCL market-based indicators). - Introduce a consistent measure of leverage in the context of ESMA’s forthcoming AIFM and UCITS reviews. - Improve internal methodologies for system-wide liquidity stress testing by incorporating second-round effects and expanding asset-class coverage. - Maintain high-level engagement with regulators in jurisdictions where delegated portfolio and risk management are prominent. - Take a lead role in international fora to design and calibrate a macroprudential toolkit for investment funds; continue active engagement in assessments of funds’ liquidity management frameworks and policy options for money-market funds. - Issue guidance to industry on the effectiveness of liquidity management tools (LMTs) in mitigating systemic liquidity risk. *Source: 1luxea2021001 - 25. The authorities stand ready to deploy additional support as needed while remaining* ### 32. Money laundering risks should continue to be monitored and mitigated and the Anti- ### 1luxea2021001 - 32. Money laundering risks should continue to be monitored and mitigated and the Anti- ### AML/CFT framework, UBO registries, and money laundering risks - Staff welcome the easy and free access to the information collected by the ultimate beneficial ownership (UBO) registries. - Greater transparency of legal entities would facilitate more effective due diligence by Luxembourg’s financial institutions and strengthen competent authorities’ capacity to identify and address major proceeds of crime. - The September 2020 update of the national risk assessment indicated persisting threats posed by cross-border proceeds of corruption and tax evasion. - While AML/CFT supervision of banks is conducted on a risk-sensitive basis: - Ensuring greater ongoing monitoring of cross-border flows could further enhance the understanding of money laundering risks, and support effective mitigation measures. - The UBO registries were launched relatively recently and include a process intended to improve the accuracy of information collected over time. - To increase their usefulness, additional measures to ensure the accuracy of information, including at the stage of data collection, should be implemented. ### Investment funds, liquidity management tools, and market stress observations - During the March 2020 market turmoil, Luxembourg funds benefited from CSSF’s active guidance on LMTs and used a variety of tools, especially swing pricing and anti-dilution levy. - Observed fund behavior during the pandemic included: - Increased holdings of securities with lower credit ratings (BBB/BB), indicating renewed search for yield. - High exposure to U.S.-dollar-denominated securities. - Liquidity management tools at the height of the pandemic (number of notifications by NAV date — daily) included: Borrowing, Deferred Redemption/Gating, Swing Pricing, Antidilution Levy, Redemption in Kind, and Others. ### Macroprudential stance and residential real estate (RRE) risks - Residential real estate prices grew at a double-digit rate: "16.7 percent yoy in nominal terms in Q4 2020". - Household indebtedness trends and mortgage growth: - Mortgages grew "11.6 percent in 2020, above its long-term trend". - According to OECD data, Luxembourg’s household debt stood at "about 190 percent of net disposable income in 2019", about "1.7 standard deviations above the euro area average (108 percent)". - Authorities’ macroprudential responses: - Introduction of LTV limits differentiated across various categories of borrowers starting "early-2021". - The general rule is an "80 percent limit on LTVs, but higher LTV limits applies for first-time home buyers (100 percent) and primary residences (90 percent, with lenders allowed to issue 15 percent of the new mortgages with an LTV ratio up to 100 percent)". - Authorities estimate that "14 percent of current mortgage loans would have not been granted by the top RRE banks under the new LTV limits. About a third of these loans have LTVs above 100 percent." - Staff assessment and recommendations: - While the differentiated LTV limits should help reduce tail credit risk in the new mortgage portfolio, their effectiveness in reducing households’ high indebtedness remains to be seen. - If household indebtedness continues to increase, the current LTV setup should be revisited and other tools provided in the legal framework for borrower-based measures explored. - The authorities appropriately kept the counter-cyclical buffer unchanged given the current credit cycle; some tightening of the macroprudential stance may help alleviate credit market pressures if they reemerge. ### Housing affordability and policy measures - Real house prices are estimated to be "about 18 percent in Q2 2020" above long-term equilibrium. - Government actions to improve affordable housing supply: - Pacte Logement 2.0 will link provision of financial support to municipalities to the number of affordable housing units built, and raise the requirement for minimum built surface dedicated to affordable housing from "10 to up to 30 percent". - 2021 budget measures to discourage speculation and support rental supply, including lowering the depreciation rate for rented properties. - Additional measures recommended: modernizing urban zoning, planning and administrative rules; amending communal development legislation to increase supply of land (e.g., by increasing taxes on unused land). ### Sustainable finance and diversification of the financial sector - Luxembourg’s positioning: - Hosts the lion’s share of Europe’s environmental sustainability funds. - Its stock exchange launched a green bond in 2007; in 2016 established the world’s first platform exclusively dedicated to green securities, which lists half of the world’s green bonds. - Government initiatives: - Adopted the first framework for sustainable bonds in Europe (in line with the EU Taxonomy Regulation) and issued its green bond ("1.5 billion euro at a negative rate"). - Launched Luxembourg Sustainable Finance Initiative, a public-private platform to design and implement the country’s strategy for sustainable finance. - Policy view: Steps will help diversify Luxembourg’s financial sector. ### Authorities’ views and monitoring stance - Authorities emphasized that the financial sector remains resilient and agreed on the need to remain vigilant given increased risks and vulnerabilities. - Agreed points: - Loan moratoria boosted firms’ liquidity and helped withstand the pandemic. - Slower growth in business credit mainly attributable to weaker demand. - Insolvency risks in the non-financial corporate sector need close monitoring given persistent uncertainty and large policy support measures. - Banking sector weakened profitability due to higher provisioning, mainly on performing loans and stressed banks remain resilient thanks to large capital and liquidity buffers. - Vulnerabilities in the investment fund sector have increased overall following the March 2020 market turmoil; authorities will continue to strengthen sector oversight and support work on macroprudential framework for the investment fund sector in collaboration with global securities regulators and international macro-prudential authorities. - Luxembourg complies with international regulations and transparency standards and is open to strengthening UBO registries further, following an EU approach. - On real estate: - Authorities monitor build-up of risk and stand ready to take further action as needed. - They concurred that differentiated LTV limits would reduce tail credit risks in new mortgages and enhance resilience of banks and households. - Agreed to continue monitoring households’ growing indebtedness and to revisit measures or explore other borrower-based instruments depending on evolution. - Broad agreement that current uncertainty does not warrant releasing the countercyclical capital buffer; its appropriateness will be continuously reevaluated. ### Outlook, fiscal stance, and medium-term priorities - Outlook: - Economy projected to rebound in 2021, with "GDP increasing around 4 percent" amid continuing targeted policy support and accommodative global financial conditions. - Over the medium term, output is forecast to remain below the pre-crisis trend due to impaired corporate balance sheets and scarring in the labor market. - Risks skewed to the downside, dominated by virus dynamics; other downside risks include tightening of financial conditions, acceleration of de-globalization, and potential revenue loss from changes in international taxation. Upside: quicker containment of the pandemic. - Fiscal policy recommendations: - Fiscal policy should remain supportive until a sustained recovery is underway and target the most vulnerable. - Fiscal normalization should be state contingent and start only when output has broadly recovered to its pre-COVID level. - Subsequent support should continue to be targeted to most impacted (lower-income households and firms in sectors most exposed), while allowing automatic stabilizers to fully operate. - Medium-term fiscal priorities: - Further greening the economy and closing infrastructure gaps, taking advantage of ample fiscal space. - Pursue transition to a data-driven economy, step up digitalization of public services, and incentivize business investment. - Maintain high public investment spending to close physical infrastructure gaps (e.g., transportation). - Preserve comfortable buffers, explore options to diversify revenues (including increasing environmental levies and housing taxation such as outdated property valuations), and improve public investment efficiency. - Collecting and publishing information on beneficial ownership of winners of public tenders and subjecting COVID-related contracts to an independent ex-post audit to strengthen public procurement effectiveness. _International Monetary Fund staff report excerpt._ ### 46. While firms and households were shielded by the unprecedented policy support in ### 1luxea2021001 - 46. While firms and households were shielded by the unprecedented policy support in ### Balance sheet risks and liquidity support - In 2020, unprecedented policy support shielded firms and households but the pandemic could weigh on their balance sheets. - Liquidity support—especially the short-time work scheme—together with favorable lending conditions helped alleviate potentially costly vulnerabilities concentrated in the most affected sectors (notably wholesale, retail, and hospitality). - Going forward, liquidity pressures could intensify and may turn into insolvencies should state support be withdrawn prematurely or the recovery delayed. - A sharp rise in unemployment due to a sustained economic slowdown could weigh on household debt repayment capacity, especially for lower-income households who would be more vulnerable to cliff-edge risks. - Policy signal: maintain targeted liquidity support while monitoring transition risks as fiscal support is wound down. ### Financial sector vulnerabilities and oversight - Rising risks and vulnerabilities in the financial sector, while manageable, should continue to be closely monitored and addressed in line with the 2017 FSAP recommendations. - The banking sector entered the crisis with large capital and liquidity buffers, which would remain adequate even under severe stress scenarios. - Continued vigilance is required as asset quality deterioration could weigh on DOBs already weak bank profitability, especially if the health crisis persists. - Luxembourg’s investment funds have weathered the crisis well thanks to decisive global policy action and robust oversight, but the pandemic illustrated growing vulnerabilities, especially liquidity mismatches. - Recommendations: - Continue to enhance internal methodologies for system-wide liquidity stress testing. - Remain proactive in international fora to push forward the macroprudential reform agenda. - Strengthen ongoing monitoring of cross-border flows to bolster AML/CFT supervision of banks. - Implement additional measures to ensure the accuracy of information on beneficial ownership to increase the usefulness of UBO registries. ### Macroprudential stance and real estate risks - Notwithstanding the pandemic, the authorities tightened the macroprudential stance as risks in the real estate market continued to rise. - The introduction of differentiated loan-to-value (LTV) limits aims to curb increasing household indebtedness amid fast-growing house prices and mortgages. - If household indebtedness continues to increase, the current LTV setup should be revisited, and other tools provided in the legal framework for borrower-based measures explored. - The authorities appropriately maintained the counter-cyclical capital buffer unchanged, given the current credit cycle position. - Policy option: as the recovery gains momentum and if credit market pressures reemerge, some tightening of the macroprudential stance may help alleviate these pressures. ### Labor market policies and reallocation - As the recovery firms up, policies should shift from preserving jobs to helping workers, especially among the most vulnerable groups, to facilitate labor reallocation. - Near-term: labor market policies should remain protective and target the most affected firms and sectors. - The extension of the short-time work scheme until mid-2021 is welcome as it will help prevent scarring and possible widening in inequalities. - As recovery firms, promote labor mobility within and across sectors through measures such as hiring subsidies for viable firms to facilitate reallocation from shrinking to expanding firms and sectors. - Continue support for training programs (building on initiatives such as Future Skills) to upgrade skills and promote reintegration of crisis-hit workers into the labor market. ### Housing supply and affordability - Steps taken in 2020 to improve housing supply are welcome and should be followed up with further actions to improve inclusiveness in the housing market. - Continued rapid growth in housing prices, mainly due to significant supply constraints, has continued to weigh on affordability in this challenging economic environment. - Building on recent steps to improve the supply of affordable housing available for sale, such as the Pacte Logement 2.0, the authorities should take further action to alleviate supply constraints, including by amending the law on communal development to discourage hoarding of land that can be used for development. *Source: 1luxea2021001 - 46.* ### 51. It is proposed that the next Article IV consultation with Luxembourg take place on the ### 1luxea2021001 - 51. It is proposed that the next Article IV consultation with Luxembourg take place on the ### Timing of Article IV consultation - It is proposed that the next Article IV consultation with Luxembourg take place on the standard 12-month cycle. ### Key macroeconomic projections and indicators (selected from Table 1) - Real GDP (percent change): 2016: 4.6; 2017: 1.8; 2018: 3.1; 2019: 2.3; 2020: -1.3; 2021 (Est.): 4.1; 2022 (Proj.): 3.6; 2023: 3.0; 2024: 2.7; 2025: 2.5; 2026: 2.5. - Domestic demand (percent change): 2016: 2.8; 2017: 2.1; 2018: 2.3; 2019: 3.3; 2020: -4.4; 2021: 4.4; 2022: 3.5; 2023: 2.9; 2024: 2.6; 2025: 2.5; 2026: 2.5. - Private consumption (percent change): 2016: 3.4; 2017: 2.1; 2018: 3.3; 2019: 2.8; 2020: -7.0; 2021: 6.6; 2022: 4.9; 2023: 3.6; 2024: 3.0; 2025: 2.5. - Unemployment (level, thousands): 2016: 16.9; 2017: 16.2; 2018: 15.3; 2019: 15.4; 2020: 18.7; 2021: 20.1; 2022: 19.7; 2023: 19.1; 2024: 18.9; 2025: 18.8; 2026: 19.2. (Percent of labor force): 2016: 6.2; 2017: 5.8; 2018: 5.1; 2019: 5.4; 2020: 6.3; 2021: 6.7; 2022: 6.4; 2023: 6.1; 2024: 5.9; 2025: 5.8; 2026: 5.7. - Resident employment (level, thousands): 2016: 250.4; 2017: 257.7; 2018: 265.0; 2019: 272.4; 2020: 277.0; 2021: 282.1; 2022: 288.6; 2023: 295.3; 2024: 301.5; 2025: 307.8; 2026: 314.1. - Cross border workers (net, thousands): 2016: 168.0; 2017: 175.0; 2018: 183.8; 2019: 192.7; 2020: 197.2; 2021: 199.8; 2022: 205.0; 2023: 210.3; 2024: 215.6; 2025: 221.3; 2026: 227.1. - GDP deflator (percent change): 2016: 0.8; 2017: 1.7; 2018: 2.5; 2019: 3.4; 2020: 2.3; 2021: 3.3; 2022: 2.5; 2023: 2.1; 2024: 1.9; 2025: 1.9; 2026: 1.9. - CPI (harmonized, percent change): 2016: 0.0; 2017: 2.1; 2018: 2.0; 2019: 1.7; 2020: 0.0; 2021: 0.9; 2022: 1.8; 2023: 1.9; 2024: 1.9; 2025: 1.9; 2026: 1.9. - General government balance (percent of GDP): 2016: 1.9; 2017: 1.3; 2018: 3.0; 2019: 2.4; 2020: -4.1; 2021: -1.6; 2022: -0.6; 2023: -0.2; 2024: -0.1; 2025: -0.1; 2026: -0.1. - General government gross debt (percent of GDP): 2016: 20.1; 2017: 22.3; 2018: 21.0; 2019: 22.0; 2020: 24.9; 2021: 26.7; 2022: 27.3; 2023: 27.4; 2024: 27.3; 2025: 27.3; 2026: 27.3. - Current account (percent of GDP): 2016: 4.9; 2017: 4.9; 2018: 4.8; 2019: 4.6; 2020: 4.3; 2021: 4.9; 2022: 4.9; 2023: 4.8; 2024: 4.7; 2025: 4.7; 2026: 4.6. - GDP (billions of euro): 2016: 54.9; 2017: 56.8; 2018: 60.1; 2019: 63.5; 2020: 64.1; 2021: 69.0; 2022: 73.3; 2023: 77.0; 2024: 80.6; 2025: 84.2; 2026: 88.0. - GDP per head (memorandum): €101,446. - Population in 2019 (memorandum): 626,108. - Land area (memorandum): 2,586 sq. km. ### Balance of payments highlights (selected from Table 2) - Current account (percent of GDP): 2016: 4.9; 2017: 4.9; 2018: 4.8; 2019: 4.6; 2020: 4.3; 2021: 4.9; 2022: 4.9; 2023: 4.8; 2024: 4.7; 2025: 4.7; 2026: 4.6. - Balance on goods and services (percent of GDP): 2016: 47.1; 2017: 44.1; 2018: 42.0; 2019: 38.7; 2020: 36.9; 2021: 37.3; 2022: 37.5; 2023: 37.3; 2024: 36.9; 2025: 36.8; 2026: 36.6. - Net factor income (percent of GDP): 2016: -43.8; 2017: -38.7; 2018: -37.3; 2019: -33.4; 2020: -31.1; 2021: -32.7; 2022: -32.9; 2023: -32.8; 2024: -32.5; 2025: -32.3; 2026: -32.3. - Financial account (percent of GDP): 2016: 4.7; 2017: 4.5; 2018: 5.7; 2019: 4.4; 2020: 6.9; 2021: 4.5; 2022: 4.6; 2023: 4.5; 2024: 4.4; 2025: 4.4; 2026: 4.3. - Direct investment, net (percent of GDP): 2016: -68.1; 2017: 218.6; 2018: 10.2; 2019: -30.9; 2020: -28.6; 2021: -25.7; 2022: -23.2; 2023: -20.8; 2024: -18.8; 2025: -16.9; 2026: -15.2. - Portfolio investment, net (percent of GDP): 2016: -209.5; 2017: -115.4; 2018: -163.5; 2019: -88.1; 2020: 66.9; 2021: 66.9; 2022: 66.9; 2023: 66.9; 2024: 66.9; 2025: 66.9; 2026: 66.9. ### Fiscal operations (selected from Table 3) - General government revenue (percent of GDP): 2016: 43.0; 2017: 43.6; 2018: 45.4; 2019: 44.7; 2020: 43.7; 2021: 43.2; 2022: 42.8; 2023: 42.6; 2024: 42.5; 2025: 42.5; 2026: 42.5. - General government expenditure (percent of GDP): 2016: 41.0; 2017: 42.3; 2018: 42.3; 2019: 42.3; 2020: 47.8; 2021: 44.8; 2022: 43.4; 2023: 42.8; 2024: 42.6; 2025: 42.6; 2026: 42.6. - Taxes (percent of GDP): 2016: 25.6; 2017: 26.4; 2018: 28.4; 2019: 27.8; 2020: 26.7; 2021: 26.8; 2022: 26.6; 2023: 26.6; 2024: 26.5; 2025: 26.5; 2026: 26.4. - Social contributions (percent of GDP): 2016: 11.8; 2017: 12.2; 2018: 12.2; 2019: 12.1; 2020: 12.7; 2021: 12.0; 2022: 11.8; 2023: 11.7; 2024: 11.6; 2025: 11.7; 2026: 11.7. - Public gross debt (Maastricht definition, percent of GDP): 2016: 20.1; 2017: 22.3; 2018: 21.0; 2019: 22.0; 2020: 24.9; 2021: 26.7; 2022: 27.3; 2023: 27.4; 2024: 27.3; 2025: 27.3; 2026: 27.3. - Structural balance (percent of GDP): 2016: 1.2; 2017: 0.7; 2018: 2.4; 2019: 2.1; 2020: -3.3; 2021: -1.3; 2022: -0.5; 2023: -0.1; 2024: -0.1; 2025: 0.0; 2026: 0.0. ### Financial soundness indicators (selected from Table 6) All Banks (2015–2020, selected) - Regulatory capital to risk weighted assets (percent): 2015: 22.0; 2016: 25.0; 2017: 25.9; 2018: 25.0; 2019: 22.0; 2020 (Prelim.): 24.3. - Return on assets (percent): 2015: 0.8; 2016: 0.8; 2017: 0.7; 2018: 0.6; 2019: 0.5; 2020 (Prelim.): 0.5. - Return on equity (percent): 2015: 11.0; 2016: 11.0; 2017: 8.1; 2018: 7.4; 2019: 7.4; 2020 (Prelim.): 6.2. - Household debt to GDP (percent): 2015: 57.0; 2016: 60.0; 2017: 60.0; 2018: 59.5; 2019: 64.3; 2020 (Prelim.): 69.7. - Customer deposits to total (non interbank) loans (percent): 2015: 129.0; 2016: 106.0; 2017: 102.9; 2018: 106.2; 2019: 107.7; 2020 (Prelim.): 109.0. Domestically Oriented Banks (selected) - Regulatory capital to risk weighted assets (percent): 2015: 22.6; 2016: 23.0; 2017: 23.0; 2018: 22.9; 2019: 22.5; 2020 (Prelim.): 22.9. - Return on assets (percent): 2015: 1.0; 2016: 1.0; 2017: 0.8; 2018: 0.8; 2019: 0.7; 2020 (Prelim.): 0.7. - Customer deposits to total (non interbank) loans (percent): 2015: 137.6; 2016: 124.0; 2017: 128.0; 2018: 112.0; 2019: 108.1; 2020 (Prelim.): 101.0. ### Risk Assessment Matrix — key risks, likelihood, impact, and policy responses (from Table 7) - Business model risk: Changes in EU and international taxation rules and transparency standards for cross-border activities. - Likelihood: High. - Expected impact: High — tax base erosion, reduction of budget revenues and activity. - Policy response: - Once the recovery is on firm ground, fiscal normalization would help maintain buffers to mitigate revenue loss. - Diversify fiscal revenue base, and develop contingency plans, and further pension reform. - Global risks: Unexpected shifts in the Covid-19 pandemic. - Likelihood: Downside: Medium; Upside: Medium. - Expected impact: High (Downside) / High (Upside). - Downside scenario summary: Prolonged pandemic weakens recovery, could undermine large financial sector performance, adversely affect fiscal revenues, corporate balance sheets, unemployment, and consumption. - Upside scenario summary: Faster containment boosts confidence and economic activity. - Policy response (Downside): - Further increase testing capacity; ensure hospitals adequately resourced. - Provide fiscal support in a targeted manner. - Deepen risk surveillance in the investment fund sector and spillovers. - Introduce transparent, targeted, and temporary measures to alleviate pressures on capital and liquidity of banks affected. - Stand ready to provide liquidity support to banks in collaboration with the ECB. - Accelerating de-globalization. - Likelihood: Medium. - Expected impact: High — reshoring and less trade could hurt exports, FDI inflows, financial sector profitability, and tax revenues. - Policy response: - Continue support for the multilateral rules-based trading system, advocate trade liberalization. - Participate in a coordinated policy response at European and global level. - Ensure robust contingency plans to diversify tax revenue base. - Advance structural reforms and infrastructure investments to boost competitiveness. - Sharp rise in global risk premia (widespread risk-off event). - Likelihood: Medium. - Expected impact: High — could weaken financial sector, trigger investor redemptions in investment funds, reduce banks’ profits and tax revenues, and impair economic activity. - Policy response: - Deepen surveillance of systemic risks in the investment fund sector. - Closely monitor liquidity management tools and act as needed. - Take a lead role in international discussion of macroprudential toolkit and regulation for investment funds. - Ensure robust contingency planning for operational risks from market volatility. - Cyber-attacks. - Likelihood: Medium. - Expected impact: Medium — potential disruptions to financial services and teleworking-dependent economy. - Policy response: - Enhance cybersecurity protection and coordination between public and private sectors. - Ensure robust contingency planning for operational risks and stand ready to provide liquidity support to banks in collaboration with the ECB. *Sources: Luxembourg authorities and IMF staff estimates.* ### Box 1. Improving Public Investment Management ### Box 1. Improving Public Investment Management ### Summary findings on public capital and PIM gaps - Luxembourg has one of the highest public capital stock-to-GDP ratios among EU countries but exhibits efficiency gaps in both quantity and quality of infrastructure when assessed against the global efficiency frontier. - Shortcomings in the public investment management (PIM) framework identified: - Budget processing: - The budget framework does not currently include a medium-term expenditure plan (MTEF) and does not follow a performance-based approach. - The budget circular does not include firm overall ceilings for line ministries; ceilings can be modified at the discretion of the government to allow for revisions in underlying macroeconomic assumptions or other unforeseen fallouts. - There are no limits on such adjustments (provided they are justified) and no systematic sensitivity analysis of the fiscal impact of deviations from key variables. - Strategic planning in public investment projects: - Luxembourg has adopted a fragmented project-by-project approach to public investment, which can lead to insufficient planning and sequencing, delays, and cost overruns. - The recent adoption of the national plan to accommodate mobility needs until 2035 is noted as a step to enhance intersectoral coordination, prioritization, and execution efficiency. - Public investment performance oversight: - Ex-ante cost-benefit analysis is generally applied during budget preparation and reviewed by the General Inspection Directorate of the Ministry of Finance. - Projects with capital value exceeding €40 million are subject to more in-depth analysis and are authorized by a special law. - The government does not publish a list of infrastructure projects with cost estimates, implementation status, possible delays, and performance targets, which undermines lesson-learning and transparency. - There are no systematic ex-post evaluations of large infrastructure projects, partly due to limited availability of information on cost overruns and delays. ### Policy recommendations to strengthen budgetary framework - Continue to enhance the budgetary framework in line with the 2012 OECD recommendations; this may require revisions in the existing legal framework. - Adopt a multiannual expenditure strategy: - Implementing multi-year budgeting was welcomed; further strengthening could come from incorporating an MTEF into the multi-year budget framework to better align sectoral expenditures with government priorities and long-term macroeconomic objectives. - The authorities envisage implementing medium-term expenditure plans for individual expenditure items in the context of the 2022 budget. - Capital expenditure ceilings should be based on medium-term forecasts reflecting, among others, maintenance cost profiles over the medium term to reduce the risk of resource over-commitments. - Implement a spending review into the budget process: - The Ministry of Finance conducted an ad-hoc spending review in 2014 focused on informing large-scale spending cuts and consolidation. - Going forward, a spending review mechanism should be embedded into the budgetary process once an MTEF is introduced; options include continuous and selective reviews or comprehensive reviews at regular intervals. - Review and assess existing carry-over rules for special funds: - The authorities abolished “extra-budgetary” special funds by converting them into budgetary ones, which helps monitoring of budget execution and reduces over-commitment risk. - They should review and assess carry-over rules to avoid inefficient buildup of resources. ### Measures to enhance planning and oversight of public investment - Strengthen governance arrangements for managing public investment in line with international good practices: - Consider establishing an entity with independent powers to ensure robust cross-sectoral coordination. - Such an independent body could coordinate assessment of infrastructure needs consistent with national long-term mobility objectives, contribute to project prioritization and sequencing, help remove bottlenecks in delivering major projects, and monitor performance. - Examples of countries with similar entities include France, the U.K., New Zealand, and South Korea (see examples summarized below). - Enhance investment project oversight: - The €40 million threshold for more in-depth analysis is relatively high by international standards; some countries use lower thresholds (example provided: Ireland’s €20 million). - The U.K. and the Netherlands require cost-benefit analysis to be applied to all projects with effort proportionate to project size. - Review the €40 million threshold with a view to widening coverage of projects subject to more in-depth analysis. - Conduct systematic ex-post evaluations and audits of major infrastructure projects to review experience and draw lessons; publish results of post-project reviews for transparency. - The proposed independent unit could be entitled to conduct ex-post evaluations. ### Examples of public investment units (roles and responsibilities) - France — General Commission for Investment (2010), reports to the Prime Minister: - Check project consistency with Government policies and strategy on future investment. - Coordinate processing of investment projects, the independent review process, and provide advice and recommendations. - Oversee ex-ante and ex-post evaluations of investment. - United Kingdom — National Infrastructure Commission (2015), executive agency reports to HM Treasury but operates at arm’s length: - Provide impartial, expert advice and independent recommendations on economic infrastructure. - Account for interactions between infrastructure recommendations and housing supply. - Prepare a National Infrastructure Assessment once in every Parliament setting out long-term infrastructure needs with recommendations for government action. - New Zealand — National Infrastructure Unit (2009), unit of the Treasury: - Formulate and monitor progress on the 20-year National Infrastructure Plan. - Establish cross-government frameworks for project appraisal and capital asset management and monitor their implementation. - South Korea — Public and Private Infrastructure Management Center (2005), independent think-tank: - Conduct preliminary feasibility studies for major projects based on general and sector-specific guidelines. - Examine efficiency and appropriateness of projects by reviewing economic and policy feasibility. *Prepared by Padma Hurree-Gobin (STA) and Moez Souissi (ICD).* ### Annex III. External Sector Assessment ### Annex III. External Sector Assessment ### Bottom-line assessment - Staff’s bottom line assessment: Luxembourg’s external position is broadly in line with fundamentals and desirable policy settings. - Assessment basis: EBA-lite quantitative models, review of balance of payments and net foreign asset position, and consideration of Luxembourg’s roles as a financial hub and center for intra-corporation cash pooling. - Caveats: EBA-lite models only partially capture Luxembourg specificities (large investment fund industry, very small open economy, large share of non-resident workers). Staff adjusted the EBA-lite explanatory variable “output per worker” to reflect that almost half of Luxembourg’s labor force is non-resident. ### Current account developments - Current account has been broadly unchanged around 5 percent of GDP since 2016. - 2020 outcome: - The current account surplus declined moderately to about 4¼ percent of GDP in 2020. - Decline driven by lower net goods exports and net transfers. - Persistent surplus mainly driven by strong net services exports (about 33 percent of GDP), partly offset by a deficit in net factor income. - Services surplus related to private banking, the investment fund industry, and corporate cash management entities; many of these are part of large international financial groups and multinational corporations operating cross-border. - Net factor income outflows are shared between investment income and compensation of employees. ### Net International Investment Position (NIIP) and investment positions - NIIP developments: - NIIP deteriorated but stayed positive. - NIIP fell to 48 percent of GDP in 2020 from 56 percent of GDP at end-2019. - Deterioration mainly due to decline in net other investment (256 percent of GDP) and net direct investment (133 percent of GDP). - Partially offset by improvement in net portfolio position (367 percent of GDP), driven by larger outward investment flows. - FDI trends: - Since 2017, both outward and inward FDI have been on a downward trend. - Gross positions in direct investment assets and liabilities have been trending downwards since 2017, partly reflecting the U.S. CIT reform; net direct investment position declined. - Baseline assumption: gradual decline of net FDI as a share of GDP. - SPEs and FDI composition (from related Annex IV context): - Luxembourg hosts around 45,000 special purpose entities (SPEs). - SPEs feature very large balance sheets and income flows, account for bulk of inbound and outbound FDI. - SPEs’ contribution to the economy: spending on salaries and business services representing only 3 percent of GDP; SPEs pay around 2¾ percent of GDP in tax revenue. ### Real Effective Exchange Rates (REER) - 2020 REER changes: - CPI-based REER appreciated by about 3 percent year-on-year compared to December 2019. - ULC-based REER appreciated by 5.8 percent over the same period. - Cross-country comparisons (Dec 2019 to Dec 2020): - CPI-based REER appreciation similar to France and Germany; smaller than Belgium. - ULC-based REER appreciated in Belgium and France (by 6.7 and 2.4 percent respectively) and depreciated in Germany (by 0.9 percent) compared to end-2019. - REER index charts (2015–2021 indexes shown in source): CPI-based and ULC-based REER indices for Luxembourg, Belgium, Germany, France. ### EBA-lite and REER model estimates for 2020 (in percent of GDP) - EBA-lite CA model and REER model summary (as presented in table): - CA-Actual: 4.3 - Cyclical contributions (from model): (-) -0.5 - COVID-19 adjustor: 1/ 0.2 - Additional temporary/statistical factors: 0.0 - Natural disasters and conflicts: (-) -0.1 - Adjusted CA: 5.2 - CA Norm (from model)2/: 10.6 - Adjustments to the norm (+): -6.0 - Adjusted CA Norm: 4.6 - CA Gap: 0.5 1.1 - o/w Relative policy gap: 3.6 - Elasticity: -1.37 - REER Gap (in percent): -0.4 -0.8 - Footnotes: - 2/ Cyclically adjusted, including multilateral consistency adjustments. - 1/ Additional cyclical adjustment to account for the temporary impact of the pandemic on oil trade balances (-0.7 percent of GDP) and on tourism (0.9 percent of GDP). - Staff conclusions from models: - EBA-lite CA model suggests external position broadly in line with fundamentals and desirable policies. Current account gap estimated at 0.5 percent of GDP and corresponding REER undervaluation at 0.4 percent. - The current account gap includes a policy gap of 3.6 percent of GDP, mostly reflecting a looser world average fiscal stance. - REER index model suggests some undervaluation; policy gap estimated at 2.8 percent, reflecting mainly a positive domestic private credit to GDP gap. *Source: Annex III. External Sector Assessment (extracted content).* ### Annex VI. Implementation of BEPS Actions/ATAD in Luxembourg ### Annex VI. Implementation of BEPS Actions/ATAD in Luxembourg ### Overview - Luxembourg has implemented measures across the BEPS Action Plan and the EU Anti-Tax Avoidance Directives (ATAD I and ATAD II) through national laws, transpositions of EU Directives, participation in OECD/G20 Inclusive Framework work, and ratification of the Multilateral Instrument (MLI). - Key implementation dates preserved from source: - May 31, 2019: international road map agreed to resolve tax challenges from digitalization. - January 2019: Inclusive Framework agreed to examine proposals in two pillars (Pillar One and Pillar Two). - October 2020: Inclusive Framework published Blueprints for Pillar One and Pillar Two. - Law of December 18, 2015: amendments to articles 147 and 166 of the Luxembourg Income Tax Law (LITL) transposing EU Directive 2014/86/EU. - Law of December 21, 2018: transposed whole ATAD I. - Law of December 20, 2019: transposed ATAD II, applicable since 1st of January 2020. - April 17, 2018: law introducing the new IP regime incorporating the nexus approach. - December 23, 2016: Budget Law introducing article 56bis LITL on transfer pricing and law on CbCR. - October 10, 2017: Council Directive (EU) 2017/1852 on tax dispute resolution mechanisms (transposed by law of 20 December 2019). - February 14, 2019: Luxembourg Parliament adopted ratification bill of the MLI. - April 9, 2019: instrument of ratification deposited with the OECD. - August 1, 2019: MLI entered into force. - January 1st, 2020: MLI provisions entered into effect for Luxembourg. - May 25, 2018: ECOFIN adopted Council Directive (EU) 2018/822 (DAC6). - Law dated 25 March 2020: Luxembourg transposed DAC6 into national legislation. ### Action 1 — Digital economy - Luxembourg participation and actions: - Members of the OECD/G20 Inclusive Framework agreed to review two key concepts of the international tax system in response to G20 mandate. - May 31, 2019 road map agreed; 129 members adopted the working program. - Pillar One: focused on nexus and profit allocation. - Pillar Two: focused on a global minimum tax to address remaining BEPS issues. - October 2020: Blueprints for Pillar One and Pillar Two published for public consultation. - Luxembourg actively participates in related working groups in the EU and OECD. ### Action 2 — Hybrid mismatches - Implementation details: - Luxembourg has regulations based on EU Directive 2014/86/EU (Parent-Subsidiary Directive amendment). - Law of December 18, 2015 amended articles 147 and 166 of LITL. - ATAD I transposed by law of December 21, 2018, including rules on hybrid mismatches. - ATAD II transposed by law of December 20, 2019 and applicable since 1st of January 2020. ### Action 3 — Controlled Foreign Corporation (CFC) rules - Implementation details: - ATAD I transposed by law of December 21, 2018, including Article 7 on CFC rules. ### Action 4 — Interest limitation - Implementation details: - ATAD I transposed by law of December 21, 2018, including introduction of specific interest limitation rules. ### Action 5 — Harmful tax practices / IP nexus - Implementation details: - Spontaneous exchange of certain information applies in Luxembourg based on tax treaties and the Convention on Mutual Administrative Assistance in Tax Matters (MAC). - Directive 2015/2376 (DAC 3) transposed by law of July 23, 2016 extends automatic exchange to advanced cross-border tax rulings. - April 17, 2018 law adopted a new IP regime comprising the nexus approach advocated in Action 5. ### Action 6 — Treaty abuse - Implementation details: - Measures implemented via the Multilateral Instrument (MLI). - MLI ratified by Parliament in February 2019; instrument of ratification deposited April 2019; entered into force August 2019. - MLI covers all Luxembourg’s tax treaties at time of signature; bilateral treaties with ratifying countries will be modified according to mutual provisions. - MLI provisions apply to taxes withheld at source where the event occurs on or after the first day of the next calendar year that begins on or after the latest of the dates on which the MLI enters into force for the two parties; these provisions entered into effect on January 1st, 2020 for Luxembourg. - 2016 update of Luxembourg’s model tax treaty aligned to Action 6 minimum standards; further adaptations made in Luxembourg’s final MLI position. ### Action 7 — Permanent establishment avoidance - Implementation details: - New definition of permanent establishment is part of the MLI. ### Actions 8–10 — Transfer pricing alignment with value creation - Implementation details: - Budget Law of December 23, 2016 introduced article 56bis into LITL incorporating the arm’s length principle based on OECD principles revised by Actions 8–10. - End of 2016: administrative circular issued referencing article 56bis LITL on transfer pricing framework for intra-group financing activities. ### Action 11 — Measuring and monitoring BEPS - Implementation details: - Luxembourg participates in the corresponding working party at the OECD. ### Action 12 — Mandatory disclosure (DAC6) - Implementation details: - ECOFIN adopted Directive (EU) 2018/822 (DAC6) on May 25, 2018. - Luxembourg transposed Directive into national legislation by law dated 25 March 2020. ### Action 13 — Transfer pricing documentation / CbCR - Implementation details: - December 23, 2016: Luxembourg Parliament passed law on CbCR, transposing EU Directive 2016/881 (amending Directive 2011/16/EU) on mandatory automatic exchange of information in taxation. ### Action 14 — Dispute resolution - Implementation details: - October 10, 2017: Council Directive (EU) 2017/1852 on tax dispute resolution adopted by Council of the EU. - Directive transposed into Luxembourg law by law of 20 December 2019. - Several provisions of Action 14 are being implemented into Luxembourg’s tax treaties via the MLI. - Luxembourg’s model tax treaty contains the minimum standard recommendation on dispute resolution in tax treaties. ### Action 15 — Multilateral instrument to modify bilateral tax treaties - Implementation details: - Luxembourg Parliament adopted MLI ratification bill on February 14, 2019; instrument of ratification deposited with OECD on April 9, 2019. - MLI entered into force on August 1, 2019 and covered all Luxembourg’s tax treaties at signature. - MLI provisions applicable for withheld taxes as described under Action 6; in Luxembourg these provisions entered into effect on January 1st, 2020. *Annex VI. Implementation of BEPS Actions/ATAD in Luxembourg* ### 10. Strengthen the institutional ### 10. Strengthen the institutional framework to increase the willingness to act, including by enshrining in the law the de facto leading role of the BCL. ### Overall authorities' view - MT: The authorities consider the current institutional framework to be adequate. ### Macro-financial risk transparency - MT: The CdRS has published the substance of the macro-financial risk analysis in 2019. ### Banking regulation and supervision - NT: Increase intensity of supervision over intra-group exposures; require banks to demonstrate continued eligibility for large exposure limit waivers. - Implementation and actions: - Ongoing monitoring by the CSSF has been strengthened, including quarterly review of intragroup exposures, and an escalation process to reevaluate eligibility for the waiver in case of ad hoc information in the context of annual SREP. - Since mid-2018, monitoring has been enhanced with the new EU monthly reporting on maturity mismatches. - Beginning 2019 an additional resource dedicated to reviewing existing waivers has been recruited. - The CSSF continues to weekly monitor the Rating and CDS of parent entities and to conduct its annual horizontal review of intra-group exposures and waivers, which serves as a basis for individual waiver reviews. - C: Continue monitoring ability of banks to absorb a real estate market price decline. - The CSSF conducts an annual stress test analysis based on bank individual LTV distributions, taking into account extreme price declines and high default rates in the Luxembourg residential real estate market, leading to capital losses and risk-weighted assets increases. - Results are incorporated within the annual CSSF-Solvency Stress Test and are discussed with supervisors and considered in ongoing supervision and in the SREP. - C: Increase frequency of on-site inspections of subsidiaries of SIs. - The SSM is implementing this recommendation. - The CSSF was requested to participate in a survey on the targeted engagement level from Central On-Site of the SSM (specifically, for significant subsidiaries of SSM banks) to be conducted in the course of 2020. - I: Harmonize data reporting standards for loan-to-value and debt-to-income ratios. - Harmonized definitions for the LTV and DSTI ratios and additional relevant indicators are included in CSSF circular N°18/703, following the ESRB’s recommendation ESRB/2016/14. The data requested under the CSSF circular is bi-annual. - Data reporting has been further harmonized through the issuance of CSSF circular N°20/737 (18/703 amended). - The first data under the new reporting requirements was received in April 2019, covering the period from the beginning of July to end-December 2018. The results are used to assess potential risks linked to the real estate market. ### Investment fund regulation and supervision - NT: Strengthen guidance on substance in the context of delegated activities and actively engage with regulators in jurisdictions where such activities are prominent. - The CSSF issued specific guidance on substance requirements in the context of delegated activities in CSSF Circular 18/698. - The CSSF has regular bilateral meetings with EU/third-party supervisory authorities (such as, France, Ireland, Germany, Switzerland, and Asian jurisdictions) as well as the U.S. securities regulator. - The CSSF initiated standardized information requests to regulators of jurisdictions where Luxembourg fund managers mostly delegate collective portfolio management activities. - NT: Issue guidance on the holdings of directorships of funds and their managers. - The CSSF has issued specific guidance on the holdings of directorships of funds and their managers in CSSF Circular 18/698 (published on August 23, 2018). - NT: Assess whether safeguards to ensure depositary independence are adequate. - The CSSF started revisiting this issue internally in 2018. Discussions with industry representatives within the CSSF UCI Committee started in early 2019. - The CSSF concluded that it is neither necessary nor appropriate to implement depositary independence requirements beyond the requirements outlined in the EU Directive 2014/91/EU (UCITS V Directive). ### Insurance regulation and supervision - NT: Implement revised early warning system under Solvency II regime. - The CAA has designed a risk-based early warning system based on a risk appetite level chosen by insurance and reinsurance undertakings. - The early warning system is based on the risk appetite which every insurance and reinsurance undertaking must define internally as part of its Own Risk and Solvency Assessment (ORSA) process. ### Contingency planning and financial safety nets - I: Develop policies on intragroup exposures and the transfer of custodian functions in recovery and resolution. - Recovery: - No formal policies in place to address transfer of custodian functions; CSSF determined custody service is generally substitutable due to presence of numerous depositary banks in Luxembourg, though transfer may be time consuming due to legal/contractual constraints and asset volumes. - Major custodian banks have qualified their custodian functions as critical for the local economy within their recovery plans; continuity should be ensured in recovery (and resolution). - CSSF verifies whether recovery plans include option of selling/transferring custodian functions; impact and credibility of each recovery option are assessed pursuant to provisions in the EBA Single Supervisory Handbook’s module on supervisory assessment of recovery plans. - Assessment of recovery plans includes credibility, completeness and quality including both intra-group exposures and transfer of custodian function, if applicable. - Resolution: - In the absence of an SRB formal policy regarding depositary banks, the CSSF has not put in place its own policy regarding use of transfer tools for transferring the depositary function. The SRB has elaborated guidance notes, including on the sale of business tool, and a resolution planning manual requiring IRTs to assess preconditions for effective use of a transfer strategy. - Resolution plans have been drafted and approved by the CSSF for banks with specialized business models and for banks providing custodian function next to other functions, covering all LSIs except a few (recent establishment or change of status). Preferred resolution strategy and assessment of transfer tools or winding up have been undertaken on a case-by-case basis; consistency throughout resolution plans has been ensured. Draft plans have been submitted to the SRB. - For intragroup exposures, the new point (h) of article 44(2) BRRD (as added by article 1, point (15)(a)(ii) of Directive (EU) 2019/879 (BRRD2)) provides mandatory exclusion from bail-in of certain intragroup exposures. This provision was transposed into national law in April 2021. ### Financial market infrastructure oversight - NT: Reduce CBL’s exposure to commercial banks vis-à-vis CSDs and central banks. - CBL’s dependencies on commercial banks have been reduced for most relevant currencies (i.e. EUR, GBP, USD) by having multiple CCBs, at least three, to reduce concentration risk. Additional CCBs will still have to be appointed for CHF and JPY. - Clearstream has defined contingency measures aiming at executing switchover from an appointed CCB to another defined CCB in case of unavailability of services of the first one. - Robust testing and communication plans have been defined for the USD currency. Similar contingency measures are planned to be implemented and tested for the other major currencies during the coming year to ensure CBL can switchover all payment flows of a CCB to another CCB within Clearstream RTO of 2 hours. - NT: Require establishment of third data center and conduct a full failover test. - Establishment of a third data centre: CBL has analysed the likelihood of unavailability of both data centres as extremely low. CBL is re-evaluating its data-centre strategy. No final decisions have been made; a proposal (including the proposed way forward as regards the third data centre) will be made to the CSSF in the coming months. - Conduct of a full failover test: CBL successfully performed a failover test on 29 January 2019, which covered all critical Clearstream functions based in Luxembourg. - Full failover tests are conducted every year as part of the Business Continuity testing framework via simulating the loss of CBL primary facilities in Luxembourg and/or its staff according to a yearly test plan. Test parameters and simulated scenarios change year to year to validate different dimensions of CBL recovery ability. ### AML/CFT - I: Ensure the 2016/2017 national risk assessment focuses adequately on TCSP risks. - Luxembourg finalized its first National Risk Assessment (NRA) in September 2018 based on data available as end 2017. The NRA covered TCSPs and assessed inherent risk and mitigating actions. From an AML/CFT perspective, risks inherent in TCSPs’ activities were assessed as “High”. - The update of the current NRA, covering 2018–19, adopted in September 2020 and published in2020, confirms the inherent risk linked to TCSP activity by financial and non-financial sectors as “High”. - The NRA assesses “legal entities and arrangements” with inherent risk allocated to this category as “High”. The national coordination committee decided to perform a vertical (more granular) risk assessment on this subject, currently being drafted. - The 2004 AML/CFT Law was adapted in 2020 and requires every professional providing TCSP activity to register with their respective authority/SRB, improving supervision at the national level. - The CSSF supervises professionals offering TCSP services in the financial sector which fall under its remit. CSSF published a sub-sectoral risk assessment in July 2020 to raise awareness and provide guidance/supervisory expectations to professionals supervised by it and performing TCSP activity. - CSSF AML/CFT questionnaires submitted annually by professionals include updated information on inherent risks and mitigation measures linked to TCSP activity and are taken into account for entity-level risk assessment. - As a result, all Luxembourg TCSPs will need a new obligatory authorization/registration process for their activity with the relevant authority or SRB (for example, notaries or lawyers) in charge of supervision for AML/CFT purposes. - The legal framework and institutional set-up have been regularly upgraded in line with higher international standards, including the draft bill of law 7467, fully transposing the AMLD V into the 2004 Law. ### Crisis roles and responsibilities - NT: Agree on the roles and responsibilities in dealing with a system-wide crisis. - This recommendation is being considered by the Ministry of Finance. *Source: 1luxea2021001 - 10. Strengthen the institutional (PDF chapter).* ### 25. Finalize the operational modalities ### 25. Finalize the operational modalities of emergency liquidity assistance provision. ### Operational modalities - Operational modalities are in the process of being finalized. - Time Frame: MT (medium term) = 3–5 years. - Agencies referenced: BCL = Banque centrale du Luxembourg; CAA = Commissariat aux Assurances; CBL = Clearstream Banking Luxembourg S.A.; CdRS = Comité du Risque Systémique; CSSF = Commission de Surveillance du Secteur Financier; ECB = European Central Bank; MoF = Ministry of Finance; MoJ = Ministry of Justice; SRB = Single Resolution Board; SREP = Supervisory Review and Evaluation Process. ### Macroeconomic outlook and projections - 2020 GDP contraction: -1.3%. - Authorities expect a V-shaped recovery and forecast GDP to exceed pre-crisis output levels in 2021: +4.0%. - Over the medium-term, output is forecast to remain slightly below pre-crisis trends. - Authorities broadly agree with staff that risks are mostly external, crisis-related, and subject to a high degree of uncertainty. ### Labor market - Employment continued to grow during the crisis months. - Employment projected to increase at an average annual rate of about 2% over the medium-term. - Unemployment returned to pre-crisis levels in early 2021; authorities monitor potential scarring effects that may materialize with a lag. - Policy response included a broadened COVID-19 short-time work scheme that limited job losses, especially in contact-intensive sectors. - Active labor market policies and initiatives such as the Future Skills initiative focus on re- and upskilling, including digital skills. ### Fiscal policy and public investment - Authorities unlocked a total of 18.6% of GDP in crisis response measures. - General government deficit in 2020: -4.1% of GDP. - Deficit expected to dissipate gradually and return to a balanced position by 2024. - Public investment has been maintained at around 4.0% of GDP in recent years. - Recovery and Resilience Plan envelope: EUR 183 million. - 61% of investments supporting a green transition. - 32% targeting the digital transformation. - These shares exceed the European Commission’s targets of 37% (green) and 20% (digital). - Authorities aim to preserve comfortable fiscal buffers once the recovery firms. - Luxembourg’s self-imposed debt-to-GDP ceiling: 30%. - Projected public debt in the medium-term: 27.6% by 2025. - Luxembourg experienced the smallest increase in public debt in the EU in 2020. - AAA rating by all major rating agencies; recent issuances showing negative yields. ### Tax policy - Luxembourg has aligned its tax framework with international and EU standards (including BEPS Action Plan and EU Anti-Tax Avoidance Directives). - Assessed to be compliant by both the OECD and the European Commission. - Authorities remain engaged in international fora and stand ready to address potential revenue risks. ### Financial sector resilience and policy measures - Financial sector proved resilient due to solid capital and liquidity positions, policy support, and supervisory action. - CET1 ratios have remained far above regulatory requirements; share of NPLs remains low. - Private sector loan moratoria peaked at about EUR 3.6 billion in June 2020. - Public guarantee loan scheme worth EUR 2.5 billion contributed to mitigating the crisis impact. - Investment funds recouped March 2020 losses and ended the year with positive net inflows. - Authorities acknowledge potential vulnerabilities in the investment fund sector and call for internationally coordinated macroprudential framework design. - Domestically-oriented banks expected to remain resilient; financial stability risks anticipated to remain manageable even under severe stress test scenarios. - Overall profitability affected by loan loss provisioning, low-for-long interest rates, and regulatory compliance costs. - Measures to mitigate household indebtedness risks include recently introduced LTV limits. - AML/CFT: Luxembourg fully transposed the 5th EU AML Directive in 2020, updated its National Risk Assessment, and established an open and freely accessible Ultimate Beneficial Owners Registry. - Authorities commit to implement 2017 FSAP recommendations and to continuously adjust national regulatory and supervisory frameworks. ### Structural policies and housing market - Pacte Logement 2.0, large-scale affordable housing projects, and targeted tax measures aim to alleviate pressure from rising real estate prices driven by insufficient supply and low interest rates. - Government focuses on tackling skills mismatches through re- and upskilling programs. ### Green and digital transition - Emission reduction target: 55% compared to 2005 by 2030. - Energy efficiency gain target: 40%. - Target for share of renewable energy sources: 23%. - Public investment in sustainable infrastructure, especially rail and tramway, has been at historic highs. - Since 2020, Luxembourg is the first country to make public transport free-of-charge nationwide. - Policies to switch to electric vehicles include tax incentives, subsidies, and a new carbon tax. - Sustainable finance initiatives: - World’s first stock exchange platform exclusively dedicated to green securities lists half of the world’s green bonds. - 2020: Luxembourg became the first European and first AAA-rated country to launch a sustainability bond framework fully in line with the EU’s taxonomy and issued a sustainability bond of 1.5bn EUR under the framework. - Digital agenda measures include: developing high-quality digital infrastructure; fostering digital skills for pupils and jobseekers; digitalizing public services; spearheading European initiatives such as EuroHPC. - Luxembourg House for Financial Technology established a digital innovation hub focused on payments, regulatory technology, and other areas. ### Data, statistics, and standards - Data provision is adequate for surveillance; macroeconomic data sometimes released with a lag and subject to substantial revisions. - Statec publishes a full range of economic and financial data and provides an advance release calendar. - Luxembourg reports monetary data to STA through the European Central Bank using standardized report forms (SRFs); data cover the depository corporations’ sub-sector. - Central Bank of Luxembourg compiles FSIs in line with the FSI Guide and reports quarterly to STA. - Luxembourg moved up from the Special Data Dissemination Standard (SDDS) to the SDDS Plus on November 18, 2019, becoming the 22nd country in the world—and 12th in the euro area—to adhere to the highest tier of the IMF Data Standards Initiatives. - Luxembourg uses SDDS flexibility options on the timeliness of the analytical accounts of the central bank. *Source: IMF staff report and informational annex (April 29, 2021) — Luxembourg: Staff Report for the 2021 Article IV Consultation; informational annex prepared by European Department, as of March 31, 2021.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1luxea2021001.pdf_