## 1. Impact of External Headwinds ## Source details **Canonical URL:** [1. Impact of External Headwinds](https://www.imf.org/-/media/files/publications/cr/2026/english/1luxea2026001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2026/english/1luxea2026001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2026/english/1luxea2026001.pdf.json) --- ### Context and structural assessment - Growth and composition - Luxembourg’s growth has stagnated since 2022 and is below its long-term trend after a strong post-pandemic recovery in 2021. - Recent growth increasingly driven by the public sector, masking weakness in private activity. - Cyclical headwinds - Construction sector downturn, post‑pandemic adjustments in ICT, subdued external demand. - Structural constraints - Subdued productivity and weak investment by nonfinancial corporates; elevated housing prices; rising labor cost. - Real estate sector - Tentative signs of recovery supported by easing financial conditions and policy measures, but persisting vulnerabilities. - Fiscal and financial buffers - Low public debt and a resilient financial sector; healthy household balance sheets support private consumption. - Policy context - Pension reform enacted; individual taxation reform planned to boost labor supply; significant skill mismatches and predominance of public-sector employment create labor demand uncertainty. ### Recent developments - Growth and demand - Real GDP: 0.4 percent in 2024; 0.6 percent in 2025. - Luxembourg’s 10-year average growth: 1.9 percent. - Domestic demand supported by expansionary fiscal policy and real income gains; external demand weighed on growth. - Investment rebounded strongly in late-2025 due to large government purchases and a lower drag from construction (new dwellings activity turned positive). - Sectoral trends: elevated volatility in ICT and non-financial services, reflecting emerging competitiveness concerns. - Labor market - Employment gains in 2025 concentrated in the public sector (accounting for ¾ of the increase); private sector employment remained subdued. - Labor force expansion outpaced employment growth. - Unemployment rate: 6.1 percent at end-2025; 6.3 percent in Q1 2026. - Productivity growth weak and below historical levels; unit labor costs elevated. - Inflation - Headline inflation: 2.1 percent in 2024; 2.3 percent in 2025. - Core inflation eased to 1.8 percent in 2025 despite automatic wage indexation in May. - Early 2026: headline inflation eased to 1.3 percent after a new electricity grid subsidy introduced in January, then surged to 3.1 percent in April driven by a spike in fuel prices. - Fiscal outcomes - Spending bill increased by +8.8 percent y-o-y in 2025, driven by higher-than-budgeted capital spending, increase in public wages (beyond automatic indexation), and rising social benefits. - Revenue growth slowed to 2.5 percent y-o-y in 2025 from around 10 percent in 2024 due to reduced CIT windfalls and lower PIT after a tax‑bracket adjustment and labor market softening. - General government fiscal balance: surplus of around 1 percent of GDP in 2024 to a deficit of 2 percent of GDP in 2025. - Public debt: 26.5 percent of GDP at end-2025. - Financial and real estate cycles - Credit cycle: declining interest rates and some relaxation of credit standards increased credit demand, particularly from households; credit gap narrowed and may have turned positive. - Real estate: residential prices and transactions recovered; fiscal measures (reduction in registration rate and increased mortgage deductibility) supported recovery. Price overvaluation estimated to have declined to a broadly neutral level. - Banks: highly capitalized and liquid, well above regulatory minima; relatively low aggregate NPL ratio; profitability slightly below peers and likely past peak. - Investment funds: experienced outflows after April 2025 tariff announcement and start of the war in the Middle East, but confidence and inflows have since returned. ### External position and assessment - Current account surplus: 5.3 percent of GDP in 2025, mainly driven by net factor income. - External position assessed broadly in line with medium-term fundamentals and desirable policies; current account gap estimated at 0.5 percent of GDP. - Assessment limitations: EBA-lite model only partially captures Luxembourg’s large financial center and large share of commuters; data inconsistencies noted between national accounts and BOP. ### Outlook and risks - Baseline projections - Growth: 1.2 percent in 2026; 1.7 percent in 2027; gradual convergence to potential thereafter. - Inflation: projected to exceed 2 percent in 2026–27 and to gradually converge to 2 percent in the medium term. - Baseline assumes energy pricing as indicated in the futures curve as of the beginning of May 2026. - Downside risks - External: weaker-than-expected growth in key European partners; sharp global slowdown; renewed energy market volatility from prolonged conflict in the Middle East—risks to investment funds and market liquidity. - Domestic: persistent competitiveness pressures from rising labor costs, slower productivity gains, prolonged labor market softness, delays in construction sector recovery. - Geopolitical/shock channel: negative spillovers from the war in the Middle East; Germany’s fiscal stimulus may partially offset but slowdown elsewhere mutes net export contribution. - Illustrative downside sensitivity (calibrated on April 2026 WEO severe scenario) - Growth impact: decrease by about 0.6 percentage point in 2026 and 0.9 pp in 2027 relative to staff’s baseline. - Inflation impact: annual inflation could be 2 and 3 pp higher (2026 and 2027, respectively). - Fiscal impact: allowing automatic stabilizers while maintaining recommended structural effort projected to lead to a deficit increase of about 0.8 percent of GDP in 2026–27 annually and an increase in public debt of around 2.5 percent of GDP by 2031. - Crisis-response recommendations (from sensitivity analysis) - Avoid new broad energy support measures; use temporary and targeted discretionary measures for vulnerable groups if necessary. - Prudential measures: utilize releasable capital buffers and restrict dividend payouts to preserve bank resilience; investment funds should use a broad set of liquidity management tools to mitigate liquidity pressures and prevent adverse feedback loops. ### Fiscal policy: stance, medium-term risks, and recommendations - 2026 fiscal stance - 2026 budget kept the cost-of-living allowance from 2025 and introduced an electricity grid subsidy of around 0.2 percent of GDP. - Includes higher defense expenditure and an elevated public wage bill. - Projected general government deficit: 1.9 percent of GDP in 2026. - Staff view: a rebalancing toward more growth-enhancing investment (housing, AI, digitalization, energy and climate) would have been preferable; current spending increases need containment. - Medium-term fiscal projection and risks - Fiscal balance projected to deteriorate over the medium term, exceeding 3 percent of GDP in 2029. - Expenditure forecast to increase by 2.2 percent of GDP over the medium term, driven by higher social protection, increased interest payments, and aging-related health and pension expenses. - Planned single class income tax reform plus enhanced family allowances and CSA reform estimated to cost around 1.5 percent of GDP annually. - Staff baseline debt projection and suggested adjustment - Public debt projected to rise from 26.5 percent in 2025 to above 39 percent of GDP by 2031 under baseline. - Staff recommend moderate fiscal tightening over the medium term to stabilize debt and preserve buffers while accommodating growth-friendly investments. - Illustrative fiscal effort: - Stabilize public debt at around 33 percent of GDP by 2031: annual fiscal effort of 0.5 percent of GDP in 2027–30. - Stabilize debt around 30 percent of GDP by 2031: annual fiscal effort of 0.7 percent of GDP in 2027–30. - Adjustment options and efficiency gains - Expenditure containment: - Contain wage-bill growth; maintaining wage bill at its 2020–24 average could save about 1 percent of GDP. - Improve targeting of social protection (including further means-testing). - Enhance spending efficiency of capital expenditure, including via planned IMF PIMA assessment. - Revenue measures: - Broaden tax base through higher property and environmental taxes and streamline tax-benefit system. - Staff welcome single tax class to reduce disincentives for household second earners. - Proposed indexation of income tax brackets to prevent bracket creep. - Single tax class reform alone expected to cost around 1 percent of GDP annually starting from 2028; staff recommend identifying offsetting measures. ### Pension reform assessment - Key measures (2026 reform) - Maintain retirement age at 65. - Increase social security contribution rate from 24 to 25.5 percent, equally shared among employees, employers, and the state. - Introduce tax credit for workers not taking early retirement. - Extend contribution period required for early retirement by eight months over five years. - Recognize up to 9 years of study/training periods flexibly. - Introduce progressive pension in the general pension scheme for the private sector. - Fiscal impact - Reform has a positive impact on the general government balance of around 0.4 percent of GDP and delays depletion of the pension reserve fund by 4 years to 2048. - Staff assessment: reform is timely and welcome but insufficient for long-term sustainability. ### Fiscal framework and governance recommendations - Strengthen fiscal rules - Combine a debt anchor with an operational fiscal rule based on fiscal balances or expenditure limits. - Operational rule design should: - Allow flexibility to absorb shocks (exclude automatic stabilizers). - Accommodate investment needs. - Be legally binding with escape clauses aligned with the EU framework. - Strengthen fiscal council capacity in macro-fiscal forecasting, risk analysis, and DSA. - Budgeting and reporting - Improve fiscal reporting and government finance statistics. - Separate one-off cyclical tax factors from structural drivers given large lags in corporate tax collection. - Prioritize development of a fiscal risk framework for revenue, aging, climate, and contingent liabilities. ### Financial sector: systemic risk overview and vulnerabilities - Overall systemic risk: moderate, similar to last Article IV; heightened vigilance due to war in the Middle East. - Stress testing - Stress tests for banks and non-banks, including a system-wide stress test, indicate solid resilience under severe adverse scenarios. - Macro-financial vulnerabilities - Corporates: leverage remains high compared to peers despite deleveraging; exposed to shocks; construction and real estate strains persist. - Households: substantial net financial assets and worth, but one of the highest debt loads in Europe; borrower-based measures (DTI and LTV) remain elevated; share of variable-rate mortgages increased significantly since 2024. - Real estate: overvaluation reduced to broadly neutral; supply constraints likely to drive residential segment medium-to-long term; building permits increased since 2024 but dwellings-per-capita low among peers. - Banking sector - Solvency and asset quality: CSSF solvency stress test: very few banks (small share of assets) face significant capital depletion under adverse scenario. - Liquidity and funding: ratios well above regulatory minima but systemically important domestic banks exhibit lower ratios than EBA peers; funding tilted to unsecured wholesale and FX mismatches for some banks. - Insurance sector - Challenges: low profitability and relatively high concentration. - Capital and liquidity buffers: substantial but below EIOPA peers, particularly in life insurance. - Market risk exposure mitigated partially by a solid share of unit-linked business. ### Investment funds: resilience, interconnectedness, and policy implications - Resilience and vulnerabilities - Univariate stress test results and supervisor-led stress tests demonstrate significant resilience of UCITS to shocks. - Although average leverage is low for UCITS, some funds exceed the 250 percent gross leverage ratio. - About one-third of the bond portfolio is below investment grade or unrated, with a sizeable BBB segment. - Unregulated or indirectly regulated alternative investment funds are a nonnegligible share but predominantly have limited liquidity and leverage risks. - Under stress, funds historically increase deposits, boosting precautionary cash buffers. - Interconnectedness and systemic implications - Highly interconnected system: abrupt repricing and tighter financing could trigger NBFI rebalancing and amplify effects across banks, insurers, and funds. - Bank profitability sensitive to net fee and commission income from fund flows; tighter financing affects leveraged households and corporates, weighing on growth and bank asset quality. - Historically, increased fund deposits during stress have hedged bank liquidity risk. - Policy recommendations: banking supervision - Ensure robust bank risk management. - Asset quality: maintain conservative provisioning; conduct targeted reviews of vulnerable portfolios; improve forward-looking credit risk assessments; establish a credit registry. - Liquidity and funding: ensure adequate liquidity buffers and diverse funding sources; targeted reviews and FX hedging scrutiny for cross-border business. - Policy recommendations: non-bank supervision - Insurance: close scrutiny of liquidity and solvency buffers; monitor concentration risks; deploy supervisor-led stress testing. - Investment funds: close monitoring of liquidity and leverage; implement liquidity management tools; deepen supervision on synthetic leverage and use supervisor-led stress testing (ESMA (2026) Guidelines; CSSF Circular 26/910). - Macroprudential framework options - Incorporate insurance companies into the system-wide stress test. - Consider increasing releasable buffers: countercyclical capital buffer (CCyB) recommended level estimated at 1 percent for Luxembourg. - Alternatively, consider a sectoral systemic risk buffer (SyRB) targeting real estate exposures. - Borrower-based measures: introduce DSTI limits early in recovery; establish a credit registry; staff reiterate FSAP proposal of a stressed DSTI of 45–50 percent with a speed limit; consider guidance on residual income and gradual reduction of maximum LTV from 100 percent. - Progress and implementation - Operationalized solvency-liquidity stress testing; implemented system-wide stress test covering banks and investment funds; strengthened bank liquidity supervision (BCL–CSSF MoU); enhanced monitoring of fund liquidity and leverage. - Progress limited on macroprudential policy recalibration; authorities consider current stance adequate but remain open to review. ### Labor market reforms and housing - Wage indexation and flexibility - Automatic wage indexation boosts household income but pushes up real wages and constrains firms’ capacity to adapt; reforms to make indexation more flexible recommended (e.g., index to core inflation with targeted support for poorest). - Collective bargaining reforms and lowering public-private wage premium recommended to improve mobility and reduce private sector labor costs. - Increasing labor supply and participation - Recent pension reform could extend effective working ages. - Moving to single class taxation expected to reduce disincentives for second earners and female participation. - Support measures: flexible work, childcare support, active labor market policies. - Skilled and cross-border labor supply - Streamline and digitalize visa and work-permit procedures; invest in transport infrastructure and hybrid work arrangements to increase effective labor supply. - Housing market imbalances - High housing costs erode incomes and hinder mobility; rebalance toward supply-side measures and accelerate investment in social and affordable housing. - Phasing out untargeted demand-side support in 2025 welcomed. - Mobilize land and housing stock: national land mobilization tax proposed; design enhancements recommended (minimum tax rate, lower allowances). - Strong central oversight of local planning needed. ### Structural policy: productivity, AI, and innovation - R&D and digitalization - Luxembourg’s R&D spending as a share of GDP is one of the lowest in the OECD. - Authorities increased the investment tax credit in 2024 and expanded support for innovation projects. - Further initiatives: increase direct R&D grants complemented with indirect incentives; build digital infrastructure. - Access to finance and firm dynamics - Deepen venture capital and business‑angel markets through incentives and co‑investment mechanisms. - Proposed 28th regime reform to promote cross-border expansion; continued insolvency reforms to facilitate firm exit. - Administrative burden and skills - Simplify business registration, licensing, and compliance, especially for SMEs. - Address skills mismatches: align education and training with labor market needs (STEM, ICT); scale up reskilling and upskilling; Skills-Plang Bill (2025) encourages firm training plans. - AI exposure and labor market (Annex VI) - Around 90 percent of workers exposed to AI (STATEC, 2025); about 55 percent in occupations where AI augments tasks; around 14 percent of jobs automatable. - Distributional impacts: women face higher automation risk (~18 percent) vs. men (~11 percent); workers with only secondary education face highest automation risk. - Productivity potential: one analysis estimates medium-term (five-year) cumulative TFP gains from AI could reach around 2 percent in a preferred scenario. - Policy recommendations: expand lifelong learning and reskilling; active labor market policies targeting routine-intensive occupations; support SME AI uptake; implement proportionate, risk-based AI regulation. ### Individual taxation reform (Annex V) - Reform package name: “Mateneen. Fir all Famill. Fir all Kand.” (January 2026) - Main components - Single tax class effective 1 January 2028; 25-year transition for couples married or in civil partnerships before 2028. - Tax-exempt threshold doubled to 26,650 euros per taxpayer. - Indexation proposal: tax brackets indexed following every three wage indexations. - Higher tax-deductible limits and enhanced family support (monthly allowances, education allowance, back-to-school allowance, indexation of certain allowances). - Childcare service voucher (CSA) reform: uniform pricing by hours; children aged 1–4 get 20 free childcare hours weekly with licensed day-nannies; targeted relief for households with income ≤ 3.5 times social minimum wage. - Expected labor supply and purchasing power effects - Reform expected to increase labor force participation by incentivizing secondary earners; study indicates individual taxation could increase married women’s work incentives by 2.3 percent (intensive margin) and 2.6 percent (extensive margin). - Government estimate: single personal income tax bracket with tax-free threshold of 26,650 would reduce average tax bill for an individual by 33 percent and for a dual-income family by 49 percent. - Fiscal cost - Personal income tax reform revenue loss: estimated at 880–990 million euros (around 1percent of GDP) starting in 2028 annually. - Expanded family allowance and CSA reform: expected to cost around 420 million euro (around 0.5 percent of GDP) per year permanently. - No compensatory measures identified in presented text; government considering delaying bracket adjustment to generate around 450–500 million euros. ### Debt sustainability and sovereign risk (Annex IV) - Overall risk of sovereign stress: Low (near term: Low; medium term: Low; long term: Moderate). - Final DSA assessment: Debt is sustainable. - Baseline public debt (percent of GDP) - Actual (2025): 26.5 - 2026: 28.2 - 2027: 29.8 - 2028: 32.0 - 2029: 34.3 - 2030: 36.7 - 2031: 39.2 - 2032: 40.7 - 2033: 42.1 - 2034: 43.6 - 2035: 45.1 - Gross financing needs (percent of GDP) and debt service (selected) - Gross financing needs: 4.0; 3.7; 3.7; 3.6; 4.9; 4.8; 6.7; 5.3; 6.1; 6.6; 7.2 (series over projection horizon). - Debt service (contribution): 1.7; 1.8; 2.2; 1.2; 2.6; 2.6; 4.5; 3.1; 3.9; 4.4; 5.0. - Risk diagnostics - Debt fanchart index (DFI): 1.1 (Risk signal: Low). - GFN financeability index (GFI): 2.3 (Risk signal: Low). - Medium-term assessment: Low. ### Implementation of past IMF advice (Annex I) - Fiscal - 2026 stance broadly neutral but spending increase mainly driven by current expenditure. - Medium-term fiscal outlook worsened amid rising expenditure and softening revenue growth; limited progress on targeting and efficiency of social spending. - 2026 pension reform welcome but does not fully address long-term sustainability. - Financial sector - Monitoring active; system-wide stress testing broadened; supervision strengthened but vulnerabilities remain (pockets of weak bank credit risk practices and limited macroprudential recalibration). - Explicit income-based borrower measures not implemented. - Structural - Authorities increased investment tax credit and support for innovation; broader deregulation and administrative simplification limited. - Skills initiatives launched (Skills-Plang); automatic wage indexation largely unchanged. - Some demand-side housing support phased out in 2025; supply-side gaps remain. ### Staff appraisal — key policy recommendations (summary) - Fiscal - 2026: broadly neutral fiscal stance appropriate after 2025 deterioration; contain spending increases that crowd out priority investment. - Medium term: moderate fiscal adjustment to stabilize public debt—contain current expenditure, improve spending efficiency, broaden tax base; identify offsetting measures for income tax reform fiscal cost. - Strengthen fiscal anchor: adopt a national rule combining a debt anchor with an operational rule; enhance fiscal governance and fiscal risk analysis. - Financial stability and macroprudential policy - Ensure robust risk management across banks and non-banks; conservative provisioning and forward-looking credit assessments. - Ensure adequate liquidity buffers and diversified funding; continue close oversight of investment funds and insurers focusing on liquidity, leverage, concentration risks, and supervisor-led stress testing. - With nascent credit expansion, scope to strengthen releasable capital buffers and introduce explicit income-based borrower measures. - Structural reforms - Accelerate digital and AI adoption and address skill mismatches via reskilling and upskilling. - Labor market reforms to increase participation and flexibility, revisit automatic wage indexation. - Tackle housing affordability with decisive supply-side measures. - Advance EU single market integration, including Savings and Investment Union, to strengthen growth prospects. *Source: IMF staff report excerpt — 1luxea2026001* ### 1. Impact of External Headwinds _________________________________________________________________ 10 ### 1. Impact of External Headwinds ### Context and structural assessment - Luxembourg’s growth has stagnated since 2022 and is below its long-term trend after a strong post-pandemic recovery in 2021. - Recent growth has been increasingly driven by the public sector, masking weakness in private activity. - Cyclical headwinds: construction sector downturn, post‑pandemic adjustments in ICT, subdued external demand. - Structural constraints: subdued productivity and weak investment by nonfinancial corporates; elevated housing prices; rising labor cost. - Real estate sector: tentative signs of recovery supported by easing financial conditions and policy measures, but persisting vulnerabilities. - Fiscal and financial buffers: low public debt and a resilient financial sector; healthy household balance sheets support private consumption. - Policy context: pension reform enacted; individual taxation reform planned to boost labor supply; significant skill mismatches and predominance of public-sector employment create labor demand uncertainty. ### Recent developments (A. Recent Developments: Sluggish Growth Led by Public Sector) - Growth and demand - Real GDP expanded by 0.4 percent in 2024 and 0.6 percent in 2025. - Luxembourg’s 10-year average growth: 1.9 percent. - Domestic demand was supported by expansionary fiscal policy and real income gains; external demand weighed on growth. - Investment rebounded strongly in late-2025 due to large government purchases and a lower drag from construction (new dwellings activity turned positive). - Sectoral trends: elevated volatility in ICT and non-financial services, reflecting emerging competitiveness concerns. - Labor market - Employment gains in 2025 concentrated in the public sector (accounting for ¾ of the increase); private sector employment remained subdued. - The labor force expansion outpaced employment growth. - Unemployment rate: 6.1 percent at end-2025; 6.3 percent in Q1 2026. - Productivity growth remained weak and below historical levels; unit labor costs elevated. - Inflation - Headline inflation: 2.1 percent in 2024; 2.3 percent in 2025. - Core inflation eased to 1.8 percent in 2025 despite automatic wage indexation in May. - Early 2026: headline inflation eased to 1.3 percent after a new electricity grid subsidy introduced in January, then surged to 3.1 percent in April driven by a spike in fuel prices. - Fiscal outcomes - Spending bill increased by +8.8 percent y-o-y in 2025, driven by higher-than-budgeted capital spending, an increase in public wages (beyond automatic indexation), and rising social benefits. - Revenue growth slowed to 2.5 percent y-o-y in 2025 from around 10 percent in 2024 due to reduced CIT windfalls and lower PIT after a tax‑bracket adjustment and labor market softening. - General government fiscal balance: from a surplus of around 1 percent of GDP in 2024 to a deficit of 2 percent of GDP in 2025. - Public debt: 26.5 percent of GDP at end-2025. - Financial and real estate cycles - Credit cycle: declining interest rates and some relaxation of credit standards increased credit demand, particularly from households; credit gap narrowed and may have turned positive. - Real estate: residential prices and transactions recovered; fiscal measures (reduction in registration rate and increased mortgage deductibility) supported recovery. Price overvaluation estimated to have declined to a broadly neutral level. - Banks: highly capitalized and liquid, well above regulatory minima; relatively low aggregate NPL ratio; profitability slightly below peers and likely past peak. Insurance companies well capitalized and liquid though below peers. - Investment funds: experienced outflows after April 2025 tariff announcement and the beginning of the war in the Middle East, but confidence and inflows have since returned. ### External position and assessment - Current account surplus: 5.3 percent of GDP in 2025, mainly driven by net factor income. - External position: assessed to be broadly in line with medium-term fundamentals and desirable policies, with the current account gap estimated at 0.5 percent of GDP. - Assessment limitations: EBA-lite model only partially captures Luxembourg’s large financial center and large share of commuters in the workforce; data inconsistencies noted between national accounts and BOP. ### Outlook and risks (B. Outlook and Risks) - Baseline projections - Growth projected at 1.2 percent in 2026 and 1.7 percent in 2027, then gradually converge to potential as external demand recovers and private investment strengthens. - Inflation projected to exceed 2 percent in 2026–27 and to gradually converge to 2 percent in the medium term. - Baseline assumes energy pricing as indicated in the futures curve as of the beginning of May 2026. - Downside risks (heightened global uncertainty) - External: weaker-than-expected growth in key European partners or a sharp global slowdown; renewed energy market volatility from the prolonged conflict in the Middle East could widen risk premia, increase inflation, and trigger market repricing and liquidity stress—particularly affecting the large, cross-border investment fund sector. - Domestic: persistent competitiveness pressures from rising labor costs, slower productivity gains, prolonged labor market softness, and delays in construction sector recovery. - Geopolitical/shock channel: negative spillovers from the war in the Middle East affect trading partners and confidence; Germany’s fiscal stimulus may provide partial support but slowdown elsewhere mutes net export contribution. ### Illustrative downside sensitivity (Box 1: Impact of External Headwinds) - Under an illustrative sensitivity analysis calibrated on the April 2026 WEO severe scenario: - Growth impact: decrease in Luxembourg’s growth by about 0.6 percentage point (pp) in 2026 and 0.9 pp in 2027 relative to staff’s baseline. - Inflation impact: annual inflation could be 2 and 3 pp higher (2026 and 2027, respectively). - Fiscal impact: allowing automatic stabilizers to fully work while maintaining the recommended structural effort is projected to lead to a deficit increase of about 0.8 percent of GDP in 2026–27 annually and an increase in public debt of around 2.5 percent of GDP by 2031. - Recommended crisis-response measures (from sensitivity analysis) - Avoid new broad energy support measures; use temporary and targeted discretionary measures for vulnerable groups if necessary. - Prudential measures: utilize releasable capital buffers and restrict dividend payouts to preserve bank resilience; investment funds should use a broad set of liquidity management tools to mitigate liquidity pressures and prevent adverse feedback loops. ### Authorities’ views - Authorities broadly agreed with the assessment of underperformance relative to historical averages and identified structural factors contributing to this trend. - They noted early signs of construction sector recovery and highlighted binding constraints on constructable land supply. - Authorities expect growth to strengthen as external demand stabilizes and domestic consumption remains solid and agreed on the downside risks identified (heightened uncertainty, energy price pressures, construction sector strains). ### Policy discussion (A. Fiscal Policy: Safeguarding Fiscal Space and Improving Efficiency) - Fiscal stance to-date: multiple fiscal measures during crisis episodes supported income and employment; many temporary measures have become permanent. - Risks from fiscal trajectory: expanding public role risks crowding out private investment and employment and weakening incentives for resource reallocation to more productive sectors. - Policy priority: recalibrate policies to reignite private-sector-led growth by supporting transition toward innovation and productivity gains while safeguarding fiscal space in light of rising structural spending needs, including demographic pressures. *Source: IMF staff report excerpt — 1. Impact of External Headwinds* ### 14. A broadly neutral fiscal position in 2026 is appropriate following the notable ### 14. A broadly neutral fiscal position in 2026 is appropriate following the notable deterioration last year ### Fiscal stance in 2026 - The 2026 budget: - Kept the cost-of-living allowance from 2025. - Introduced new social support measures, including an electricity grid subsidy of around 0.2 percent of GDP. - Includes higher defense expenditure and an elevated public wage bill. - These measures, along with nominal revenue gains, are projected to keep the general government deficit at 1.9 percent of GDP. - Staff view: a rebalancing toward more growth-enhancing investment spending (housing, AI, digitalization, energy and climate) would have been preferable; current spending increases need to be contained to accommodate these investment needs. ### Medium-term fiscal projection and risks - Fiscal balance projection: - Fiscal balance is projected to deteriorate over the medium term, exceeding 3 percent of GDP in 2029. - Expenditure is forecast to increase by 2.2 percent of GDP over the medium term, driven by higher social protection, increased interest payments, and aging-related health and pension expenses. - Defense spending is expected to remain above 2 percent of GNI. - Revenue outlook: - Recent revenue gains were driven by the financial sector’s outperformance and a rising labor income share; these drivers are expected to wane with tax buoyancy reverting to historical averages. - The planned single class income tax reform plus an enhanced family and child allowance and childcare service voucher (CSA) reform is estimated to cost around 1.5 percent of GDP annually (Annex V). - PIT revenue is projected to gradually recover along with nominal wage increases. - Authorities’ medium-term fiscal structural plan (MTFSP) projects a smaller increase in the overall deficit of less than 1 percent of GDP by 2029, based on more optimistic revenue assumptions; the MTFSP estimate does not yet account for the impact of income tax reform and additional support measures. ### Staff baseline debt projection and suggested adjustment - Under the baseline, public debt is projected to rise from 26.5 percent in 2025 to above 39 percent of GDP by 2031, mostly driven by the rise in current expenditure. - Staff recommend moderate fiscal tightening over the medium term to stabilize debt and preserve buffers while accommodating growth-friendly investments. - Illustrative fiscal effort: - Stabilizing public debt at around 33 percent of GDP by 2031 would require an annual fiscal effort of 0.5 percent of GDP in 2027–30. - Stabilizing debt around 30 percent of GDP by 2031 would require an annual fiscal effort of 0.7 percent of GDP in 2027–30. - Caveats: - Baseline forecast subject to revenue uncertainties from a concentrated tax base, EU legislative changes on excise taxes, and increasing volatility in external demand. - Additional pressure could come from new energy support measures and further increases in defense spending. - In the event of a sharp downturn, automatic stabilizers should be allowed to work and temporary, targeted discretionary measures could be considered. ### Fiscal adjustment options and efficiency gains - Expenditure containment: - Containing wage-bill growth, notably by slowing public-sector hiring that has outpaced the rest of the economy, could generate sizable savings. - Maintaining the wage bill at its 2020–24 average could save about 1 percent of GDP. - Improving targeting of social protection (including further means-testing) could yield efficiency gains given poverty reduction lags peers that spent less. - Further enhancing spending efficiency of capital expenditure, including via the planned IMF PIMA assessment, could generate additional gains. - Revenue measures: - Broadening the tax base through higher property and environmental taxes and streamlining the tax-benefit system would raise revenue and enhance fairness. - Staff welcome introducing a single tax class as it is expected to reduce disincentives to labor participation among household second earners. - The proposed indexation of income tax brackets will help prevent inflation from pushing taxpayers into higher tax brackets (Annex V). - The single tax class reform alone is expected to cost around 1 percent of GDP annually starting from 2028; staff recommend identifying offsetting measures to mitigate the revenue loss. ### Pension reform assessment - Key measures in the 2026 pension reform: - Maintain retirement age at 65. - Increase the social security contribution rate from 24 to 25.5 percent, equally shared among employees, employers, and the state. - Introduce a tax credit for workers not taking early retirement. - Extend the contribution period required for early retirement by eight months over five years. - Recognize up to 9 years of study/training periods flexibly. - Introduce a progressive pension in the general pension scheme for the private sector to incentivize combining work income with a pension benefit. - Fiscal impact: - The reform has a positive impact on the general government balance of around 0.4 percent of GDP and delays depletion of the pension reserve fund by 4 years to 2048. - Staff assessment: reform is timely and welcome but insufficient to ensure long-term sustainability; it sets a framework facilitating future adjustments. ### Fiscal framework and budgeting recommendations - Strengthen fiscal rules: - Rising medium-term spending pressures and a weakening structural balance underscore the need for a strengthened fiscal rule to better anchor policy. - Staff propose combining a debt anchor with an operational fiscal rule based on fiscal balances or expenditure limits. - Operational rule design should: - Allow flexibility to absorb shocks (e.g., exclude automatic stabilizers). - Accommodate investment needs. - Be made legally binding and incorporate escape clauses in line with the EU framework. - Strengthen the fiscal council’s capacity and role in macro-fiscal forecasting, risk analysis, and debt sustainability assessment. - Budgeting and reporting: - Further improve fiscal reporting and government finance statistics. - Separate one-off cyclical tax factors from structural drivers given large lags in corporate tax collection. - Prioritize the development of a fiscal risk framework due to risks from revenue, aging, climate challenges, and contingent liabilities. ### Authorities’ views - Authorities emphasized commitment to maintain fiscal sustainability over the medium term. - Noted weakening fiscal performance due to softer-than-expected revenues and growing expenditure, including higher defense spending. - Confident in preserving fiscal sustainability underpinned by sustained revenue growth from the financial sector’s strong performance. - Exploring ways to contain expenditure growth and improve spending efficiency, including in capital spending, building on the upcoming IMF PIMA assessment. - Agreed that any new energy support measures should be targeted and temporary; stressed the importance of broad consultations with stakeholders. - Highlighted planned reforms to increase purchasing power: individual taxation reform, enhanced childcare support, and housing measures, while recognizing their fiscal impact. - Indicated the Medium-term Objective (MTO) continues to serve as national fiscal rule, with revisions to the fiscal framework envisaged in the near future. --- ### Financial sector: preserving resilience amidst heightened uncertainty — systemic risk overview - Overall systemic risk assessment: moderate, similar to the last Article IV, but risks from the war in the Middle East warrant vigilance. - Market stress related to the conflict has been significant but lower than the April 2025 tariff episode. - Continued deleveraging by households and corporates and increased bank capital buffers provide resilience. - Stress tests for banks and non-banks, including a system-wide stress test, indicate solid resilience under severe adverse scenarios. ### Macro-financial vulnerabilities - Corporates: - Leverage remains high compared to peers despite further deleveraging. - Susceptible to shocks, partly mitigated by looser financing conditions and a large share of intercompany loans. - Strains persist in construction and real estate; bankruptcies have been declining since 2024. - Weak growth and rising risk premia could deteriorate bank asset quality via an adverse feedback loop. - Households: - Substantial net financial assets and worth, but one of the highest debt loads in Europe. - Wealth unevenly distributed; poorer households more vulnerable due to limited liquidity of some assets. - Borrower-based risk measures (DTI and LTV) remain elevated across the distribution; sizable and persistent share of vulnerable mortgages, especially among high-income borrowers. - Share of mortgage loans with variable interest rates has increased significantly since 2024 for new loans. - Bank credit risk indicators show a modest increase in mortgage default probabilities since 2024. - Stress tests include a 200-basis point shock to interest rates at mortgage loan origination stage; tests show banking system resilience. - Real estate markets: - Overvaluation reduced to broadly neutral levels. - Residential segment likely to be driven by supply constraints over the medium to long term. - Building permits have increased since 2024 but supply may remain insufficient given one of the lowest dwelling-per-capita ratios among peers. - Absent supply-side reforms, prices could spike again and a subsequent correction could pressure financial stability. ### Banking sector resilience and vulnerabilities - Solvency and asset quality: - CSSF solvency stress test: very few banks, accounting for a small share of total assets, would face significant capital depletion under adverse scenario. - Average asset quality solid, but sectoral pockets of vulnerability concentrated in construction and real estate are healing gradually. - Comparatively low share of stage 2 loans with limited sensitivity to economic and financial outlook; some softening of lending standards observed. - Liquidity and funding: - Liquidity and funding ratios are well above regulatory minima, but ratios for systemically important domestic banks are lower than EBA peers. - LCR has a high share of both nonoperational deposits in cash outflows and financial customers in cash inflows; relatively low ratio for certain noneuro reserve currencies for select banks—warrants close oversight. - Risks partly mitigated by composition of nonoperational deposits (largely intra-group funding and short-term deposits from the investment fund industry) and by cash inflows from financial customers reflecting intra-group operations. - Funding structures tilted toward unsecured wholesale funding, with additional vulnerabilities from FX mismatches; relatively low NSFRs for some noneuro reserve currencies. - High proportion of unsecured wholesale funding mainly reflects investment fund services and intra-group lending activities. ### Insurance sector vulnerabilities - Challenges: low profitability and relatively high concentration. - Capital and liquidity buffers: - Substantial but below EIOPA peers, particularly in life insurance. - Lower capital buffers partly due to lower profitability and limited market expansion in non-life. - Concentration: - Recent expansion of life segment accompanied by notable increase in geographic concentration on the liability side. - Increased concentration on the asset side for both life and non-life, especially exposures to US assets. - Market risk exposure partially mitigated by a relatively solid share of unit-linked business (which passes risks to customers, though some residual risk may remain for insurers). *Source: IMF staff analysis in 1luxea2026001 - 14. A broadly neutral fiscal position in 2026 is appropriate following the notable deterioration last year.* ### 26. Investment funds appear broadly resilient. Univariate stress test results reported to the ### 26. Investment funds appear broadly resilient. ### Investment funds: Resilience and vulnerabilities - Univariate stress test results reported to the CSSF, as well as supervisor-led stress tests, demonstrate significant resilience of UCITS to shocks. - Although average leverage is low for UCITS, they have substantial US exposures and a nonnegligible share of UCITS exceeds the 250 percent ratio in terms of gross leverage. - About one-third of the bond portfolio is below investment grade or unrated, with a sizeable BBB segment, which could potentially face redemptions and forced sales if downgraded. - Unregulated or indirectly regulated alternative investment funds account for a nonnegligible share in total assets but: - These funds are under close oversight of the national supervisors. - They predominantly have limited liquidity and leverage risks. - Under stressed market conditions, investment funds have historically increased the share of deposits in their portfolios, boosting precautionary cash buffers (ESRB (2026) documents this phenomenon for earlier stress episodes and notes a similar reaction during the ongoing Middle East conflict). ### Interconnectedness and systemic implications - The outward-oriented and highly interconnected financial system requires a holistic and cross-sectoral approach to systemic risk assessment. - Elevated geopolitical risks and stretched asset valuations increase the likelihood of abrupt repricing and tighter financing conditions, potentially triggering NBFI portfolio rebalancing through fund redemptions and insurance policy surrenders. - Strong domestic and international interconnectedness across banks, insurers, and investment funds could substantially amplify these effects. - Bank profitability may be affected through sensitivity of net fee and commission income to investment fund flows. - Tighter financing conditions would also adversely affect leveraged households and corporates, weighing on growth and bank asset quality. - Historically, increases in investment funds’ deposits at times of market stress have provided banks with a hedge against liquidity risk. - Supervisor-led system-wide stress tests embedding interdependence between banks and investment funds suggest moderate losses, underscoring the importance of interconnectedness for systemic risk assessment. ### Policy recommendations: Banking supervision - Supervisors should ensure that banks continue to have robust risk management practices in place when navigating through elevated uncertainty and geopolitical risk. - Asset quality: - Continue ensuring that banks maintain conservative provisioning and conduct targeted reviews of vulnerable portfolios. - Banks should improve forward-looking credit risk assessments, given the low share of stage 2 loans and limited responsiveness to changes in economic and financial outlook. - Efforts should continue to establish a credit registry, as this would improve credit risk management and reduce loan losses. - Liquidity and funding: - Continue ensuring adequate liquidity buffers and diverse funding sources. - Given comparatively lower liquidity and funding ratios for domestic banks, targeted reviews, along with maintaining high buffers, including FX buffers, would help enhance resilience to liquidity and funding shocks. - Given the cross-border nature of the bank business model, with some currency mismatches, a continued close scrutiny of bank hedging practices is warranted. ### Policy recommendations: Non-bank supervision - Insurance companies: - Amid elevated market risk and relatively weak profitability, continue close scrutiny of liquidity and solvency buffers. - Closely monitor concentration risks, as well as domestic and international interconnectedness. - Recent EU initiatives on liquidity risk management plans and macroprudential oversight present an opportunity to further deepen supervision, complemented by supervisor-led stress testing (already in development). - Investment funds: - Given the importance of liquidity and leverage, especially pockets of high leverage in certain funds, close monitoring should continue, including concentration risks and interconnectedness. - European and international initiatives to enhance oversight of liquidity and leverage offer scope to deepen supervision, including on synthetic leverage and systematic use of supervisor-led stress testing, complemented by an ongoing but broader implementation of liquidity management tools (ESMA (2026) Guidelines on Liquidity Management Tools; CSSF Circular 26/910). ### Macroprudential framework: Evolution and options - Systemic risk analysis: - While the existing systemic risk analysis framework is very advanced and comprehensive, incorporating insurance companies into the system-wide stress test (which currently embeds banks and investment funds) would be an important extension given the size and interconnectedness of the sector (BCL (2025): A system-wide stress testing for Luxembourg financial sector). - Capital-based measures: - With the credit cycle entering a nascent expansionary phase and domestic bank capital requirements comparatively low, consideration could be given to increasing releasable buffers. - This could include increasing the countercyclical capital buffer (CCyB) and formalizing the positive neutral CCyB framework. - The CCyB rate is low compared to peers, with estimates suggesting a recommended level of 1 percent for Luxembourg. - Alternatively, activating a sectoral systemic risk buffer (SyRB) targeting real estate exposures could be a consideration. - Borrower-based measures: - Direct income-based measures, notably DSTI limits, should be introduced early in the recovery phase. - Establishing a credit registry would be essential to ensure comprehensive coverage of household debt and help calibrate income-based measures. - Given an elevated share of vulnerable mortgages, staff reiterates the FSAP proposal of a stressed DSTI of 45–50 percent with a speed limit that could be adjusted over the cycle. - A second-best option would be to introduce guidance on residual income after the interest rate stress test, and/or consider allowing limited asset use in DSTI assessments. - A gradual reduction of the maximum LTV limit of 100 percent should also be considered. - Together, these measures would reduce consumption at risk and improve housing affordability in the medium term; adverse impact on low-income households could be mitigated through higher investment in social housing. ### Progress, implementation, and supervision enhancements - Authorities have advanced a more integrated assessment of systemic risk by: - Operationalizing a solvency-liquidity stress testing framework for banks. - Implementing a system-wide stress test covering banks and investment funds. - Strengthening bank liquidity supervision through finalizing a memorandum of understanding between the BCL and CSSF. - Enhancing monitoring of liquidity and leverage for investment funds via more risk-based, data-driven supervision and development of a margin stress testing capturing liquidity risks from synthetic leverage. - Improving accountability and transparency of macroprudential policy with publication of factors underpinning policy decisions. - Expanding the national resolution handbook and participating in simulation exercises. - Progress has been limited in terms of macroprudential policy recalibration. ### Authorities’ views - Authorities broadly concurred with staff's assessment of systemic risks and emphasized the financial system remains resilient. - Banks’ large capital headrooms cushion potential shocks, as evidenced by stress test results and high provisioning. - Authorities remain vigilant to credit risk in the construction and real estate sector, ensuring prudent collateral valuations. - Noted continued close oversight of bank liquidity and funding risks; funding bases generally exceed credit portfolios, leading to significant short-term placements at the BCL, at intra-group and/or inter-bank levels. - Took note of staff advice on capital-based and borrower-based measures but considered the current stance adequate while remaining open to further review should the risk assessment change. - Underlined close oversight of the investment fund sector given prevailing geopolitical uncertainties and active contribution to international and European policy initiatives. - Noted progress in insurance supervision, with a top-down stress-testing framework to be deployed in the near future. ### Structural policy: Promoting productivity-led and AI-enabled growth - Rebalancing the economy toward private sector-led growth is essential to revive productivity; stalling productivity growth partly reflects weak business R&D and slow digital technology adoption. - Key policy directions: - Accelerate digital and AI diffusion with enhanced support: - Luxembourg’s R&D spending as a share of GDP is one of the lowest in the OECD. - Authorities intensified efforts in 2024 to facilitate companies’ digital and ecological transition by increasing the investment tax credit and expanding support for innovation projects. - Future initiatives could focus on increasing direct R&D grants complemented with indirect incentives (e.g. R&D tax credits) and building digital infrastructure. - Improve access to finance and facilitate firm exit: - Deepen venture capital and business‑angel markets through improved incentives and co‑investment mechanisms. - The proposed 28th regime reform would promote cross-border expansion. - Continued implementation of insolvency reforms would facilitate efficient firm exit and resource reallocation. - Reduce administrative and regulatory burdens: - Simplify business registration, licensing, and compliance requirements, especially for SMEs. - Address skills mismatches for AI-driven productivity gains: - Align education and training with labor market needs, emphasizing STEM, ICT, and technical skills. - Scale up reskilling and upskilling; the Skills-Plang (“Skills Plan”) Bill introduced in 2025 encourages companies to develop training and retraining plans. - Support labor market transitions toward AI-complementary jobs with career guidance, flexible training programs, and incentives for firms to invest in workforce reskilling. *Source: 1luxea2026001 - 26. Investment funds appear broadly resilient. Univariate stress test results reported to the* ### 36. Labor market reforms should be accelerated. With limited scope for continued labor force ### Labor market reforms should be accelerated. ### Labor market flexibility and wage indexation - Automatic wage indexation boosts household income but pushes up real wages and constrains firms’ capacity to adapt to shocks. - Decoupling of wages and productivity growth increases urgency to reform automatic wage indexation. - Reforms to make wage indexation more flexible and less distortive should be considered. - One option: index wages to core inflation and complement this as needed with targeted support for the poorest.23 - Collective bargaining reforms could improve labor mobility within and across sectors. - Lowering the public-private wage premium—one of the highest in Europe—could improve skills availability and reduce private sector labor costs. ### Increasing labor supply and participation - Recent pension reform could help extend effective working ages. - Moving toward single class taxation would reduce disincentives for second earners and female labor participation, helping to reduce large gender gap in employment. - Reforms should be supported by: - Flexible work arrangements. - Sufficient childcare support. - Active labor market policies to maximize take-up and effectiveness. - These reforms are expected to boost potential growth. ### Facilitating skilled and cross-border labor supply - Persistent skills shortages imply need to streamline and fully digitalize visa and work-permit procedures, particularly for occupations in shortage. - For cross-border workers, investments in transport infrastructure and expanded hybrid work arrangements would: - Reduce congestion. - Increase effective labor supply without exacerbating housing pressures. ### Addressing housing market imbalances - High housing costs erode real incomes, hinder talent mobility, and amplify shocks. - Rebalance housing policies toward supply to contain prices over the medium term and improve affordability. - Acceleration of investment in social and affordable housing in 2025 could mitigate supply constraints and support vulnerable households. - Phasing out untargeted demand-side housing support in 2025 is welcome. - Mobilize land and housing stock: - Proposed national land mobilization tax is a step in the right direction. - Design enhancements: set a minimum tax rate and lower allowances in the land valuation formula. - Strong central oversight of local planning decisions needed to align with national housing objectives. ### Deepening the European Single Market - Completing the Single Market for services would reduce regulatory fragmentation and compliance costs, strengthen Luxembourg’s role as a hub for high‑value business and financial services, and support high‑skill job creation. - Progress toward a Savings and Investment Union would deepen EU capital markets, increase demand for cross‑border financial intermediation, and reinforce Luxembourg’s position in securitization and asset servicing. - Enhanced cross-border labor mobility and mutual recognition of qualifications would help address skill matching and ease wage and capacity constraints. ### Transnational corruption risk and recent actions - Luxembourg joined the IMF's voluntary assessment of transnational aspects of corruption (Annex IX). - OECD WGB Phase 4 evaluation (2024) finds: - Moderate foreign bribery risk. - Significant risk of facilitation of foreign corruption. - Significant legislative and institutional changes introduced, but structural resource issues, insufficient detection, and weak enforcement remain. - Luxembourg updated the national risk assessment in 2025 and adopted legal amendments bolstering capacity to prosecute laundering of foreign proceeds of corruption. - Staff encourage authorities to: - Improve information sharing with foreign authorities on risk of laundering of foreign proceeds of corruption through cross border flows. - Maintain adequate investigative resources. - Strengthen oversight and sanctions for non-compliance, particularly regarding domestic fiducies, foreign trusts, accountants, professional directors and business centers. ### Authorities’ views - Authorities agree on need to expedite structural reforms and that the economy faces structural challenges. - They support accelerating AI adoption via expanding investment in digital infrastructure and facilitating technology transfer within sectors. - Ongoing efforts to expand targeted upskilling, reskilling initiatives, and talent retention to address skills mismatches and bolster labor supply were highlighted. - Authorities plan to implement a land-mobilization tax aimed at stimulating housing supply and support advancing single market reform at the EU level. - They acknowledge exposure to risks related to transnational corruption and emphasize implementation of OECD recommendations, risk-based supervision, enhanced information sharing, and targeted reviews. - Authorities reaffirm support for developing the Savings and Investments Union, stressing importance of reducing administrative and regulatory burden and simplifying rules, while cautioning that centralization of powers at the EU level would not advance objectives of the Union. ### Staff appraisal — outlook and key policy recommendations - Economic outlook: recovery remains tepid and uneven; growth lags euro area peers; activity increasingly driven by the public sector; labor market slack with employment gains concentrated in the public sector; inflationary pressures accelerated in 2026. - Risks to outlook: Middle East war, weaker external demand, domestic construction sector and labor market challenges; external position assessed broadly in line with fundamentals amid measurement challenges. Key fiscal recommendations: - 2026: broadly neutral fiscal stance appropriate after significant deterioration in 2025, but elevated wage bill and social benefits risk crowding out priority investment. - Medium term: focus on preserving buffers and stabilizing debt; fiscal balances projected to weaken under current policies due to interest costs and social benefits and softening revenue growth partly from planned individual taxation reform. - Staff recommend a moderate fiscal adjustment to stabilize public debt and safeguard fiscal space by: - Containing current expenditure. - Improving spending efficiency. - Broadening tax base. - Planned income tax reform could support labor supply and purchasing power but entails sizable fiscal costs; identifying offsetting measures is important. Fiscal framework and governance: - Need for a stronger fiscal anchor: adopt a well-designed national fiscal rule combining a debt anchor with an operational rule based on expenditures or fiscal balances. - Enhance fiscal governance: strengthen fiscal risk analysis, improve budgeting practices, bolster role of fiscal council. - Pension reform is welcome but additional measures needed for long-term sustainability. Financial system and macroprudential policy: - Financial system resilient; banks and non-banks well capitalized and liquid; policy priorities: - Ensure robust risk management across banks and non-banks. - Promote conservative provisioning and strengthen forward-looking credit risk assessment. - Ensure adequate liquidity buffers and diversified funding, given cross-border nature. - Continue close oversight of non-banks (investment funds and insurers) focusing on liquidity, leverage, concentration risks, supervisor-led stress testing and liquidity management tools. - Staff welcome progress in implementing 2024 FSAP recommendations, including enhanced system-wide stress testing covering banks and investment funds, strengthened bank liquidity and funding supervision, and advanced data-driven oversight of investment fund risks. - Macroprudential policy should remain proactive: - With credit cycle in early expansion phase, scope exists to further strengthen releasable capital buffers (in line with FSAP recommendation). - Introduce explicit income-based borrower measures to address high household indebtedness risks. - Continue enhancing systemic risk analysis, account for cross-sectoral interconnectedness, and strengthen stress-testing frameworks. ### Structural reforms priority - Prioritize accelerating digital and AI adoption and addressing skill mismatches through expanded reskilling and upskilling. - Labor market reforms to increase participation and flexibility are essential, including improving incentives, facilitating labor mobility, and revisiting automatic wage indexation. - Tackle housing affordability with decisive supply-side measures to contain costs, support labor supply, and enhance competitiveness. - Advance EU single market integration, including the Savings and Investment Union, to strengthen Luxembourg’s growth prospects. *Source: IMF staff report content (paragraphs 36–48 of the provided document).* ### 49. It is proposed that the next Article IV consultation with Luxembourg takes place on ### 1luxea2026001 - 49. It is proposed that the next Article IV consultation with Luxembourg takes place on ### Real Sector (Figures and Trends) - GDP evolution (Index 100=2019Q4, seasonally adjusted) series shown for: - GDP; GDP excl. the public sector; GDP excl. the public and financial sectors; VA public sector; VA financial sector. - Value Added by the Financial Sector (Index, 2015=100) presented in chain linked volumes, current price, and implicit deflator series. - Change in Real Value Added by Sector (percentage points) contributions for: - Industry, Construction, Financial sector, Non-financial services, Non-market activities (Note: Non-market activities refer to public sector activities). - Investment Contribution to Real GDP Growth (percent year over year, contributions in percentage points) detailed for: - Intellectual property products; Machinery & equipment excl. transport equipment; Transport equipment; Construction: other buildings; Construction: dwellings; Gross fixed capital formation. ### Labor Market (Figure 2) - Labor Market Tightness (Percent, seasonally adjusted): - Vacancy rate and Unemployment rate (RHS) series from Jan-20 to Jan-26. - Employment and Job Openings (Percent change, year over year): - Employment-Resident; Employment-Total; Job openings in percent of total employment (RHS). - Domestic Employment Growth (Percent, quarter over quarter, seasonally adjusted): - Residents; Cross-border workers; Domestic employment (series through 2025Q4). - Real GDP and Labor Market References (Percent, quarter over quarter, seasonally adjusted) series for: - Labor Force; Employment; Real GDP growth (rhs). ### Inflation (Figure 3) - Core and Underlying Inflation (Percent, year over year): - CPI underlying inflation; HICP core inflation (series through Apr-26). - Inflation Pass-through from Energy to Core (Percent, year over year): - Energy and Core (rhs, 6m lagged) series through Apr-26. ### Fiscal Sector (Figure 4) - CIT from Financial Sector (Percent of GDP) and Other CIT series from 2011–2025. - Contribution to Real Revenue Growth (Percent, adjusted by GDP Deflator) components: - Social contributions; PIT; CIT; VAT; Other tax revenues; Other revenues. - Contribution to Real Expenditure Growth (Percent, adjusted by GDP Deflator) components: - Social benefits; Compensation of employees; Investment (direct and indirect); Intermediate consumption; Other current transfers; Interest payments; Subsidies. - Central Government Fiscal Aggregates and Tax Base (Index 2015=100): Revenue excl. temporary COVID and cost of living measures; Compensation of employees; GDP (2016–2025). - General Government: Total Expenditure and Total Revenue (Percent of GDP) series (2011–2025). ### Banking Sector (Figure 5) - Net Stable Funding Ratio (Percent) for LUX (all banks), LUX (EBA), EU/EEA median (2021Q1–2025Q4). - Cost to Income Ratio (Percent) for LUX (all banks), LUX (EBA), EU/EEA median (2015Q1–2025Q3). - Return on Equity (Percent) for LUX (all banks), LUX (EBA), EU/EEA median (2015Q2–2025Q4). - Liquidity Coverage Ratio (Percent) for LUX (all banks), LUX (EBA), EU/EEA median (2016Q4–2025Q4). - Tier 1 Capital Ratio (Percent) for LUX (all banks), LUX (EBA), EU/EEA median (2015Q2–2025Q4). ### External Sector (Figure 6) - Linked indicators for current account and primary income balance, including: - Compensation of employees; Direct investment income; Portfolio investment income; Other investment income; Other components of Primary income balance (Q4-2002 to Q4-2025). - Net International Investment Position (Percent of GDP) and gross flows: - FDI; Portfolio investment; Other investment; NIIP (rhs) series (2011–2025). ### Structural Sector (Figure 7) - LinkedIn Hiring Rate (Percent, SA) series (Jan-17 to Jan-25) with sector breakdown: - Hiring Rate, SA: Financial Services; Professional Services. - LinkedIn Hiring Rate (Percent, SA, 2025) for Luxembourg (Dec-25). - Current Account Balance: Primary Income (Percent of GDP, 4-quarter cumulative sum) showing large negative primary income components (through Q4-2025). ### Table 1 — Selected Economic Indicators, 2020–31 (key entries, exact values preserved) - Real Economy (percent change): - Gross domestic product: -0.5 (2020); 6.9 (2021); -1.1 (2022); 0.1 (2023); 0.4 (2024); 0.6 (2025); 1.2 (2026); 1.7 (2027); 2.1 (2028); 2.1 (2029); 2.0 (2030); 2.0 (2031). - Total domestic demand: -2.7 (2020); 10.0 (2021); 0.3 (2022); 1.0 (2023); 2.5 (2024); 2.0 (2025); 1.5 (2026); 2.5 (2027); 2.2 (2028); 2.2 (2029); 2.1 (2030); 2.1 (2031). - Exports of goods and nonfactor services: 1.9 (2020); 11.3 (2021); 1.5 (2022); 0.6 (2023); -12.2 (2024); 1.2 (2025); -1.4 (2026); 2.2 (2027); 2.0 (2028); 2.1 (2029); 2.1 (2030); 2.0 (2031). - Imports of goods and nonfactor services: 1.4 (2020); 13.4 (2021); 2.4 (2022); 0.9 (2023); -13.6 (2024); 1.8 (2025); -1.4 (2026); 2.6 (2027); 2.0 (2028); 2.1 (2029); 2.2 (2030); 2.1 (2031). - Labor Market (thousands; unless indicated): - Resident labor force: 294.2 (2020); 298.3 (2021); 302.8 (2022); 309.2 (2023); 313.6 (2024); 318.2 (2025); 323.9 (2026); 328.7 (2027); 334.0 (2028); 339.3 (2029); 345.3 (2030); 351.1 (2031). - Unemployed (average): 18.7 (2020); 17.1 (2021); 14.6 (2022); 16.2 (2023); 18.0 (2024); 19.0 (2025); 20.0 (2026); 21.0 (2027); 21.2 (2028); 21.2 (2029); 21.6 (2030); 21.6 (2031). - Resident employment (levels and percent change): 275.5 (2020); 281.2 (2021); 288.3 (2022); 293.1 (2023); 295.6 (2024); 299.2 (2025); percent change: 1.5 (2020); 2.1 (2021); 2.5 (2022); 1.7 (2023); 0.9 (2024); 1.2 (2025); continuing through 2031. - Cross-border workers (net): 196.1 (2020); 203.9 (2021); 213.0 (2022); 217.9 (2023); 220.4 (2024); 222.9 (2025); 224.5 (2026); 227.6 (2027); 231.7 (2028); 236.5 (2029); 241.5 (2030); 246.7 (2031). - Total employment: 471.6 (2020); 485.1 (2021); 501.3 (2022); 511.0 (2023); 516.0 (2024); 522.2 (2025). - Prices and costs (percent change): - GDP deflator: 3.9 (2020); 5.9 (2021); 6.2 (2022); 6.9 (2023); 4.6 (2024); 3.2 (2025); 3.3 (2026); 2.3 (2027); 2.1 (2028); 2.1 (2029); 2.1 (2030); 2.1 (2031). - CPI (harmonized), p.a.: 0.0 (2020); 3.5 (2021); 8.1 (2022); 2.9 (2023); 2.3 (2024); 2.5 (2025); 4.3 (2026); 2.0 (2027); 2.1 (2028); 2.0 (2029); 2.0 (2030); 2.0 (2031). - CPI core (harmonized), p.a.: 1.2 (2020); 1.5 (2021); 4.2 (2022); 3.9 (2023); 2.5 (2024); 1.8 (2025); 1.8 (2026). - Wage growth 2/ (overall economy): 1.1 (2020); 5.3 (2021); 4.6 (2022); 7.5 (2023); 3.5 (2024); 4.3 (2025); 3.5 (2026); 2.6 (2027); 2.1 (2028); 2.3 (2029); 2.3 (2030); 2.3 (2031). - Public finances (percent of GDP): - General government revenues: 43.9 (2020); 43.5 (2021); 44.5 (2022); 45.7 (2023); 47.7 (2024); 47.1 (2025); 46.9 (2026). - General government expenditures: 47.0 (2020); 42.4 (2021); 44.3 (2022); 46.4 (2023); 46.8 (2024); 49.1 (2025); 48.8 (2026). - General government balance: -3.1 (2020); 1.1 (2021); 0.2 (2022); -0.7 (2023); 0.9 (2024); -2.0 (2025); -1.9 (2026). - General government gross debt: 24.5 (2020); 24.2 (2021); 24.9 (2022); 24.7 (2023); 26.3 (2024); 26.5 (2025); 28.2 (2026); 29.8 (2027); 32.0 (2028); 34.3 (2029); 36.7 (2030); 39.2 (2031). - Balance of Payments (percent of GDP): - Current account: 4.7 (2020); 5.0 (2021); 5.4 (2022); 6.8 (2023); 7.1 (2024); 5.3 (2025); 4.7 (2026); 4.4 (2027); 4.3 (2028–2031). - Balance on goods: 3.2 (2020); 0.2 (2021); -0.8 (2022); 1.5 (2023); 2.0 (2024); 2.1 (2025); 2.1 (2026). - Balance on services: 35.7 (2020); 38.6 (2021); 37.9 (2022); 36.7 (2023); 36.3 (2024); 33.8 (2025); 35.1 (2026). - Net factor income: -34.1 (2020); -34.0 (2021); -31.0 (2022); -30.6 (2023); -30.6 (2024); -29.9 (2025); -31.8 (2026). - Credit growth and interest rates: - Nonfinancial private sector credit (eop, percent change) 3/: 5.0 (2020); 4.8 (2021); 4.9 (2022); -2.9 (2023); -5.3 (2024); 0.8 (2025); 5.0 (2026). - 10-year government bond yield, annual average (percent): -0.4 (2020); -0.4 (2021); 1.5 (2022); 3.1 (2023); 2.7 (2024); 2.9 (2025). - Memorandum items (exact figures): - Land area = 2,586 sq. km; population in 2023 = 672,050; GDP per capita = €118,012. - GDP (billions of euro): 64.5 (2020); 73.0 (2021); 76.7 (2022); 82.1 (2023); 86.2 (2024); 89.5 (2025); 93.7 (2026); 97.5 (2027); 101.7 (2028); 106.0 (2029); 110.4 (2030); 115.0 (2031). - Output gap (percent deviation from potential): -2.1 (2020); 2.9 (2021); 0.6 (2022); -0.2 (2023); -0.5 (2024); -0.7 (2025); -0.5 (2026); -0.2 (2027); 0.0 (2028); 0.1 (2029); 0.0 (2030); 0.0 (2031). - Potential output growth: 1.9 (2020); 1.7 (2021); 1.2 (2022); 0.8 (2023); 0.7 (2024); 0.8 (2025); 1.0 (2026); 1.4 (2027); 1.9 (2028); 2.0 (2029); 2.1 (2030); 2.0 (2031). ### Table 2 — Balance of Payments, 2020–31 (selected exact entries) - Current account (percent of GDP): 4.7 (2020); 5.0 (2021); 5.4 (2022); 6.8 (2023); 7.1 (2024); 5.3 (2025); 4.7 (2026); 4.4 (2027); 4.3 (2028–2031). - Balance on goods and services: 38.8 (2020); 38.7 (2021); 37.1 (2022); 38.1 (2023); 38.3 (2024); 35.9 (2025). - Net factor income: -34.1 (2020); -34.0 (2021); -31.0 (2022); -30.6 (2023); -30.6 (2024); -29.9 (2025). - Financial account (percent of GDP): 4.4 (2020); 4.2 (2021); 4.2 (2022); 6.8 (2023); 7.1 (2024); 4.9 (2025). ### Table 3 — General Government Operations, 2020–31 (selected exact entries) - Revenue (percent of GDP): 43.9 (2020); 43.5 (2021); 44.5 (2022); 45.7 (2023); 47.7 (2024); 47.1 (2025); 46.9 (2026). - Taxes (percent of GDP): 27.2 (2020); 27.5 (2021); 27.9 (2022); 28.5 (2023); 30.4 (2024); 29.5 (2025). - Corporate income taxes: 4.8 (2020); 4.5 (2021); 4.5 (2022); 4.8 (2023); 6.5 (2024); 6.0 (2025); 5.9 (2026). - Personal income taxes: 11.1 (2020); 11.2 (2021); 11.7 (2022); 12.6 (2023); 12.6 (2024); 11.9 (2025). - Expenditure (percent of GDP): 47.0 (2020); 42.4 (2021); 44.3 (2022); 46.4 (2023); 46.8 (2024); 49.1 (2025); 48.8 (2026). - Net lending / borrowing (percent of GDP): -3.1 (2020); 1.1 (2021); 0.2 (2022); -0.7 (2023); 0.9 (2024); -2.0 (2025); -1.9 (2026). - Public gross debt (Maastricht definition, percent of GDP): 24.5 (2020); 24.2 (2021); 24.9 (2022); 24.7 (2023); 26.3 (2024); 26.5 (2025); 28.2 (2026). ### Table 4 — Financial Soundness Indicators, 2018–25 (selected exact entries) - All Banks: - Regulatory capital to risk-weighted assets: 24.8 (2018); 22.6 (2019); 24.8 (2020); 23.9 (2021); 23.0 (2022); 24.0 (2023); 23.0 (2024); 23.1 (2025). - Return on assets: 0.6 (2018); 0.5 (2019); 0.5 (2020); 0.6 (2021); 0.6 (2022); 1.1 (2023); 1.2 (2024); 1.2 (2025). - Return on equity: 7.4 (2018); 7.4 (2019); 6.2 (2020); 5.5 (2021); 5.0 (2022); 9.0 (2023); 9.0 (2024); 8.6 (2025). - Nonperforming loans to total gross loans: 0.9 (2018); 0.7 (2019); 1.0 (2020); 1.3 (2021); 1.6 (2022); 1.9 (2023); 2.3 (2024); 2.3 (2025). - Provisions to total non performing loans: 27.6 (2018); 32.8 (2019); 30.0 (2020); 51.4 (2021); 59.8 (2022); 50.3 (2023); 50.3 (2024); 51.3 (2025). - Liquidity Coverage Ratio: 167.6 (2018); 155.0 (2019); 165.9 (2020–2021); 166.9 (2024). - Net Stable Funding Ratio: 139.2 (2018); 136.3 (2019); 135.1 (2020–2021); 136.1 (2024). - Domestically Oriented Banks (selected): - Regulatory capital to risk weighted assets: 22.9 (2018); 22.5 (2019); 22.9 (2020); 23.1 (2021); 23.0 (2022); 23.0 (2023); 23.0 (2024); 24.0 (2025). - Return on assets: 0.8 (2018); 0.7 (2019); 0.7 (2020); 0.8 (2021); 0.8 (2022); 1.2 (2023); 1.1 (2024); 1.2 (2025). - Residential real estate loans to total loans: 24.9 (2018); 25.6 (2019); 28.0 (2020); 36.7 (2021); 37.0 (2022–2025). - Customer deposits to total (non interbank) loans: 112.0 (2018); 108.1 (2019); 99.0 (2020); 87.5 (2021); 89.0 (2022); 88.0 (2023); 92.0 (2024–2025). *Sources: STATEC; Eurostat; Haver Analytics; Central Service of Statistics and Economic Studies; BCL; CSSF; Data Partnership LinkedIn Data; IMF staff calculations.* ### Annex I. Implementation of Past IMF Advice ### Annex I. Implementation of Past IMF Advice ### Fiscal - Short term advice: "Adopt a less expansionary fiscal stance and review the effectiveness and targeting of support measures, while allowing automatic stabilizers to operate if downside risks materialize." - Progress/comments: - "The 2026 stance is expected to be broadly neutral, which is appropriate given cyclical conditions, but the spending increase is mainly driven by current expenditure." - Medium term advice: "Underpin the medium-term expenditure path with measures, including by containing the wage bill, improving the targeting and efficiency of social spending, diversifying revenue sources, and strengthening the fiscal framework. Expediting pension reform would help support long-term sustainability and intergenerational equity." - Progress/comments: - "The medium-term fiscal outlook has worsened amid rising expenditure and softening revenue growth. The wage bill will remain elevated, while there is little progress on improving targeting and efficiency of social spending." - "The 2026 pension reform is a welcome step to improve social security balances, but it does not fully address long-term sustainability." - "The planned individual taxation reform in 2028 is estimated to cost around 1 percent of GDP annually." ### Financial Sector - Risks advice: "Maintain close monitoring of risks stemming from the real estate sector and broader financial system, including vulnerabilities related to corporates and households, as well as to uncertainty, market volatility, and domestic and international interconnectedness." - Progress/comments: - "Monitoring has remained active as real estate risks eased, with granular analyses of vulnerabilities in corporates and real estate markets, including model-based assessments of price misalignment in the residential real estate market." - "Very granular analyses of exposures as well as domestic and cross-border interdependencies of investment funds have been added to the systemic risk assessment framework." - "Supervisors have broadened system-wide stress testing and analysis of bank–fund interconnectedness, supporting surveillance amid heightened uncertainty, market volatility." - Supervision advice: "Supervisors should ensure robust risk management and close oversight of banks in terms of asset quality, provisioning, and solvency and of non-banks in terms of liquidity and leverage." - Progress/comments: - "Supervision is being strengthened. This includes higher provisioning and supervisor-led stress tests for banks embedding both solvency and liquidity risks and for investment funds incorporating a wide range of shocks focused on liquidity and leverage risks." - "However, vulnerabilities remain: pockets of weak bank credit risk practices and comparatively lower liquidity/funding ratios, and limited leverage pockets in some funds." - Macroprudential framework advice: "Continuing strengthening the macroprudential framework in line with evolving risks, including through further development of systemic risk analysis, higher releasable capital buffers as the cycle recovers, and the early introduction of income-based borrower-based measures." - Progress/comments: - "The authorities have further strengthened the analytical toolkit, including system-wide stress testing of banks and investment funds, but key extensions remain pending (notably to insurance)." - "As the cycle turns, releasable buffers are unchanged." - "Explicit income-based borrower measures have not been implemented." - "The stress test on residual income and interest rate assuming a 200-basis point increase in the interest rate on new borrowers’ capacity to repay has been added to the toolkit." - Follow up on FSAP recommendations: - "The majority of key recommendations have been implemented (Annex VIII)." ### Structural - Productivity advice: "Promote private sector-led, productivity-driven growth by strengthening innovation support, accelerating digital and AI diffusion, improving access to finance for innovative firms, facilitating efficient firm exit, and reducing administrative and regulatory burdens." - Progress/comments: - "The authorities increased the investment tax credit and expanded support for innovation projects, helping advance the digital and green transition." - "However, broader deregulation and administrative simplification remain limited." - Labor market advice: "Accelerate labor market reforms to raise participation, reduce skill mismatches, and improve labor market flexibility, including by adapting education and training systems to evolving needs, expanding reskilling and upskilling, facilitating labor supply, and making wage-setting arrangements less distortive." - Progress/comments: - "The authorities launched a program (Skills-Plang) to support firm-level training and retraining, while the pension reform and planned move to single-class taxation should raise labor participation, including for older workers and second earners." - "Automatic wage indexation remains largely unchanged." - Housing market advice: "Address housing market imbalances by rebalancing policies toward supply-side measures, withdrawing untargeted demand-side support, and mobilizing land and housing stock." - Progress/comments: - "Some demand-side housing support was phased out in 2025." - "Supply-side action remains the main gap: the planned land tax reform is a step in the right direction; however, it needs to be accelerated, and stronger central oversight of local planning is still needed to mobilize land and housing stock." *Source: Annex I. Implementation of Past IMF Advice (1luxea2026001).* ### Annex IV. Sovereign Risk and Debt Sustainability Analysis ### Annex IV. Sovereign Risk and Debt Sustainability Analysis ### Overall Risk Assessment - Overall risk of sovereign stress: Low. - Near term: Low. 1/ - Medium term: Low. - Long term: Moderate. - Commentary: - The overall risk of sovereign stress is low in the near term. - In the medium term, debt is expected to continue to increase under current policy. - Idiosyncratic risks include changes in international taxation and spending pressures on defense, digital and climate transformation. - The recent pension reform could help improve social security balances in the near term; however, it is insufficient to ensure long-term sustainability. - The 2026 pension reform would delay the depletion of pension reserve fund by 4 years to 2048, and delay reserve below the threshold of 1.5 times the annual pension expenditure to 2042, but falls short of fully addressing long-term sustainability. - Medium-term risks are assessed as low against a mechanical low signal as well as the strength of institutions, the depth of the investor pool, and adequate fiscal resources. ### Debt Sustainability Assessment (DSA) — Summary - Final assessment: Debt is sustainable. - DSA commentary: - Luxembourg is at a low overall risk of sovereign stress and debt is sustainable. - Fiscal balance deteriorates amid revenue growth slowdown and increasing spending pressure, but there is still ample fiscal space, though narrowing. - Public debt remains at low levels and is projected to increase to around 39 percent of GDP over the medium-term. - Medium-term liquidity risks as analyzed by the GFN Financeability Module are low. - Recommendation: Continue with prudent fiscal policy measures and structural reforms to support growth. ### Debt Coverage and Disclosures - Coverage basis: Debt/GDP for the DSA is projected based on the stock of General Government debt in 2024, but evolves from 2025 according to Central Government flows, given the social security surplus. - Subsectors captured in the baseline: - Budgetary central government: Yes - Extra budgetary funds (EBFs): No - Social security funds (SSFs): Yes - State governments: No - Local governments: No - Public nonfinancial corporations: No - Central bank: Yes - Other public financial corporations: No ### Public Debt Structure Indicators — Key Points - Commentary: - The debt is held exclusively by external private creditors and is held in domestic currency limiting exchange rate risk. - With the bulk of the debt having a maturity > 5 years, the impact of the current increase in interest rates will only be felt gradually. - Residual maturity: 6. years (as reported) - Holder composition highlights: - External private creditors: (dominant; percent of GDP charts shown in source) - Domestic creditors and official creditors: minimal in the presented charts ### Baseline Scenario (Percent of GDP unless indicated otherwise) - Public debt (actual and projections): - Actual (2025): 26.5 - 2026: 28.2 - 2027: 29.8 - 2028: 32.0 - 2029: 34.3 - 2030: 36.7 - 2031: 39.2 - 2032: 40.7 - 2033: 42.1 - 2034: 43.6 - 2035: 45.1 - Change in public debt (yearly): - 0.2; 1.8; 1.5; 2.2; 2.3; 2.4; 2.5; 1.5; 1.5; 1.5; 1.5 - Contribution of identified flows: 1.3; 1.8; 1.5; 2.2; 2.3; 2.4; 2.5; 1.5; 1.5; 1.5; 1.5 - Primary deficit (percent of GDP): 2.5; 2.1; 1.7; 2.6; 2.5; 2.4; 2.4; 2.4; 2.4; 2.4; 2.4 - Noninterest revenues (percent of GDP): 32.1; 32.4; 32.7; 31.7; 31.9; 32.4; 32.4; 32.4; 32.4; 32.4; 32.4 - Noninterest expenditures (percent of GDP): 34.6; 34.5; 34.4; 34.3; 34.4; 34.8; 34.8; 34.8; 34.8; 34.8; 34.8 - Automatic debt dynamics: -1.0; -1.2; -1.0; -0.9; -0.9; -0.8; -0.8; -0.7; -0.7; -0.7; -0.7 - Real interest rate and relative inflation: -0.8; -0.8; -0.5; -0.3; -0.2; -0.2; -0.1; 0.0; 0.0; 0.1; 0.1 - Real growth rate: -0.2; -0.3; -0.5; -0.6; -0.6; -0.7; -0.7; -0.8; -0.8; -0.8; -0.9 - Other identified flows: -0.2; 0.9; 0.8; 0.5; 0.7; 0.9; 1.0; -0.1; -0.1; -0.1; -0.1 - (minus) Interest Revenues: -0.2; -0.2; -0.2; -0.2; -0.2; -0.2; -0.1; -0.1; -0.1; -0.1; -0.1 - Other transactions: 0.0; 1.0; 1.0; 0.7; 0.9; 1.1; 1.1; 0.0; 0.0; 0.0; 0.0 - Contribution of residual: -1.1; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0 - Gross financing needs: 4.0; 3.7; 3.7; 3.6; 4.9; 4.8; 6.7; 5.3; 6.1; 6.6; 7.2 - of which: debt service: 1.7; 1.8; 2.2; 1.2; 2.6; 2.6; 4.5; 3.1; 3.9; 4.4; 5.0 - Local currency: same series as debt service above - Foreign currency: 0.00 for all years shown - Memo: - Real GDP growth (percent): 0.6; 1.2; 1.7; 2.1; 2.1; 2.0; 2.0; 2.0; 2.0; 2.0; 2.0 - Inflation (GDP deflator; percent): 3.2; 3.3; 2.3; 2.1; 2.1; 2.1; 2.1; 2.1; 2.1; 2.1; 2.1 - Nominal GDP growth (percent): 3.9; 4.6; 4.1; 4.3; 4.2; 4.2; 4.1; 4.1; 4.1; 4.1; 4.1 - Effective interest rate (percent): 0.0; 0.0; 0.5; 1.1; 1.3; 1.6; 1.9; 2.2; 2.2; 2.3; 2.4 - Commentary: Public debt will gradually rise but is sustainable, reflecting expectations of a narrowing of primary deficits and stable economic conditions. ### Realism of Baseline Assumptions - Commentary: The realism analysis does not point to major concerns: past forecast errors do not reveal any systematic biases and the projected fiscal adjustment and debt evolution are well within norms. - Noted indicators and diagnostics include: - Forecast track record (t+1, t+3, t+5) - Historical output gap revisions (percentile ranks) - Public debt creating flows and 3-year debt reduction distributions - Laubach (2009) rule implication for implied spread ### Medium-term Risk Analysis - Debt fanchart module: - Fanchart width (percent of GDP): 13.2 - Value contribution: 0.2 (percent of GDP) - Terminal debt-to-GDP x institutions index: 3.4 - Debt fanchart index (DFI): 1.1 - Risk signal (DFI): Low (reference: low if DFI < 1.13) - Gross Financing Needs (GFN) module: - Average baseline GFN (percent of GDP): 4.6 - GFN financeability index (GFI): 2.3 - Risk signal (GFI): Low (reference: low if GFI < 7.6) - Medium-term index (combined): - Value contributions: Debt fanchart index 1.1; GFN financeability index 2.3 - Final assessment: Low - Prob. of missed crisis, 2026-2031, if stress not predicted: 0.0 pct. - Prob. of false alarms, 2026-2031, if stress predicted: 72.7 pct. - Commentary: Of the two medium-term tools, the Debt Fanchart Module is pointing to higher levels of risk, while the GFN Financeability Module suggests lower level of risk. In both cases, risks of debt distress are low. --- ### Annex V. Individual Taxation Reform ### Overview of the Reform Package (January 2026) - Name of package: “Mateneen. Fir all Famill. Fir all Kand.” - Three parts: 1. Introduction of a single tax class. 2. Enhanced benefits for families. 3. Reform of the childcare service voucher (Chèque-Service Accueil, CSA). ### Individual taxation reform — Key measures - Single tax class: - Effective from 1 January 2028. - Eliminates multiple tax classes and joint taxation benefits for married couples. - Couples married or in civil partnerships before 2028 have a 25-year transition period. - Tax-exempt threshold doubled to 26,650 euros per taxpayer. - Proposal to introduce indexation of tax brackets following every three wage indexations. - Higher tax-deductible limits: - Annual deductible limit for consumer loan interest and insurance premiums: rises from 672 to 900 euros. - Cap on deductible contributions to a home-savings schemes: increases to 1,500 euros (from 1,344) for young adults and to 900 euros (from 672) for others. - Flat deduction for household help, dependent care, and childcare expenses: raised to 6,000 euros per year, up from 5,400 euros. - Support for parents: - “Early childhood” tax allowance: 5,400 euros per year for each child under 3 years old. - Single parent tax credit: rises from 3,504 euros to 4,008 euros per year. - Allowance for a child not part of one parent’s household: raised from 5,424 euros to 5,928 euros. - Childcare service voucher reform: - All childcare providers charged with uniform pricing by hours used. - Children aged 1–4 get 20 free childcare hours weekly with licensed day-nannies. - Households with an income of 3.5 times or less the social minimum wage will receive targeted financial relief. ### Enhanced family support — Key measures - Monthly allowances: increase by 45 euros for children up to age 12 and by 60 euros for older children; monthly benefits now exceed 350 euros per child. - New education allowance: up to 3,000 euros annually per child, targeting low-income families with school-age children. - Back-to-school allowance: grows by 60 euros for ages 6–11 and by 90 euros for ages 12 and above. - Indexation: School allowance, the special supplemental allowance for disabled children, and birth grants will be automatically indexed to inflation going forward. ### Expected Impact on Labor Supply and Purchasing Power - Labor supply: - The reform is expected to increase labor force participation by incentivizing secondary earners. - Employment gender gap in 2025: about 70.5 percent of women employed vs. 77.3 percent of men. - A study indicates the individual taxation system could increase work incentives of married women by 2.3 percent on the intensive margin and 2.6 percent on the extensive margin. - Note: The 25-year transition period may slow the change as many existing one-earner couples will likely continue with joint taxation. - Purchasing power: - Government estimate: Implementation of a single personal income tax bracket (with a tax-free threshold of 26,650) would reduce the average tax bill for an individual by 33 percent, and for a dual-income family by 49 percent. - Improved family benefits and childcare support measures are expected to lower childcare costs and strengthen purchasing power, which could contribute to growth. ### Fiscal Cost and Spending Pressure - Projected fiscal impact: - Personal income tax reform revenue loss: estimated at 880–990 million euros (around 1percent of GDP) starting in 2028 annually. - Expanded family allowance and reform of CSA: expected to cost around 420 million euro (around 0.5 percent of GDP) per year and increase social spending permanently. - Policy implication: Measures would be needed to mitigate revenue loss and meet increased spending pressure. *Source: IMF staff.* ### 5. No compensatory measures have been identified, while the introduction of bracket ### 5. No compensatory measures have been identified, while the introduction of bracket ### Tax policy and revenue implications - The government is tentatively considering delaying income tax bracket adjustment to match the pre-2028 inflation, which could generate around 450–500 million euros revenue, to mitigate the cost. - If the reform implements tax bracket indexation, in line with staff’s recommendation, future measures to enhance revenues become important, including: - narrowing reduced VAT rates; and - improving recurrent property taxation. - No compensatory measures have been identified in the presented text. *Source: 1luxea2026001 - 5. No compensatory measures have been identified, while the introduction of bracket* ### Annex VI — AI and Labor Market: exposure, impacts, and policy implications - General context - Luxembourg is a high-income, service-oriented economy with a strong financial sector, high wages, and a large cross-border workforce; it is among the most exposed to AI in Europe. - AI adoption is likely to deliver productivity gains over the medium term but raises adjustment challenges for specific worker groups, notably those in routine intensive and mid-skill occupations. - Exposure, employment and distributional effects - Around 90 percent of workers in Luxembourg are exposed to AI (STATEC, 2025). - Exposure is predominantly complementary: about 55 percent of workers are in occupations where AI is expected to augment tasks. - Around 14 percent of jobs are classified as automatable. - Administrative support occupations face the highest automation risk; managers and intellectual or scientific professions face very low automation risk and are primarily in the “augmented” category. - By sector: finance, ICT, and professional services are highly exposed but largely in an augmenting way; trade, hospitality, and parts of public administration show higher shares of potentially automatable jobs. - Demographic and residential differences: - Women face a higher automation risk (around 18 percent) than men (about 11 percent). - Younger workers are more exposed; entry-level jobs are more likely to be affected. - Workers with only secondary education face the highest automation risk; workers with tertiary education, especially at the master’s level or above, are mostly in AI-complementary occupations. - Luxembourg residents face a higher share of automatable jobs than foreign residents and cross-border commuters, reflecting concentration of nationals in administrative occupations. - Transition risks: - Historical experience suggests technological change tends to reallocate labor rather than reduce total employment over the long run, but transitional effects could be significant, particularly for routine-intensive, middle-skill jobs. - Demand for AI-specific skills has not clearly translated into net job creation and may coincide with employment declines in occupations with high exposure and low complementarity. - Wages and distribution: - Jobs requiring new (including AI-related) skills command wage premia; diffusion of such skills is associated with higher wages. - Gains are uneven: high-skill workers benefit most directly, while middle-skill workers see fewer gains, reinforcing polarization. - In Luxembourg, high-skill workers in finance, ICT, and professional services are well positioned to capture AI-related productivity gains; workers in clerical, sales, and routine service face higher adjustment risks. - Productivity gains and uncertainty - One analysis estimates medium-term (five-year) cumulative TFP gains from AI in Luxembourg could reach around 2 percent in a preferred scenario, almost double the European average. - Regulatory constraints (occupation-level regulation, data-privacy rules, EU AI Act) could materially reduce realized productivity gains if they significantly constrain AI use in high-exposure sectors, highlighting a trade-off between safeguarding public interests and maximizing productivity benefits. - Considerable uncertainty surrounds pace and nature of AI diffusion: - Rapid adoption could exacerbate short-term labor-market disruptions if skills adjustment lags. - Slower diffusion would ease transitions but delay productivity gains. - Outcomes depend on the balance between automation and complementarity, emergence of new jobs, and Luxembourg’s openness and reliance on cross-border labor which may smooth adjustment or transmit shocks. - Policy implications and recommendations - Education and reskilling: - Expand lifelong learning and reskilling programs, emphasizing digital and AI-user skills across all fields of study. - Integrate AI literacy beyond ICT and strengthen STEM education to broaden pool of AI-complementary workers. - Active labor market policies: - Target support to workers in routine-intensive and mid-skill occupations, including tailored retraining, job-matching assistance, and support for occupational mobility. - Implement youth-focused programs (apprenticeships, digital traineeships) to avoid scarring effects. - Strengthen cooperation with neighboring countries on skills development, certification, and training portability given the large share of cross-border workers. - Firm adoption and diffusion: - Support AI uptake among SMEs through incentives for technology adoption and worker training to avoid concentration of productivity gains in large firms or a few sectors. - Regulatory balance: - Implement AI regulation in a risk-based and proportionate manner, preserving trust and safety while avoiding unnecessary barriers to productivity-enhancing adoption, particularly in high-value service sectors. *Source: 1luxea2026001 - 5. No compensatory measures have been identified, while the introduction of bracket* ### Annex VIII. Table 1. Luxembourg: FSAP 2024—Main Recommendations (continued) ### Annex VIII. Table 1. Luxembourg: FSAP 2024—Main Recommendations (continued) ### Investment funds, OFIs, and systemic risk analysis - Comprehensive monitoring covers investment funds (OIFs), financial companies, broker dealers, and structured financial vehicles, and accounts for interconnectedness between nonfinancial corporations (NFCs), government and households. - BCL vulnerability metrics reported for the FSB annual monitoring exercise include: - credit intermediation, maturity transformation and leverage; - disaggregated balance sheet items: total financial assets, credit assets, long-term assets with maturity over 12 months, liquid assets, long-term liabilities, short-term liabilities, net asset value and shareholder equity. - Analysis objectives: - identify overlapping portfolios, shared holdings, and common exposures to uncover vulnerabilities where excessive concentration could amplify liquidity systemic risks during market stress. - BCL analytical and monitoring tools and data: - use of financial account data and quarterly financial accounts to break down assets and liabilities of domestic and international institutional sectors by financial instruments; - network analysis tools to evaluate structural relationships between investment funds, captives and banks based on balance sheets; - a developed framework for System-wide Stress Testing (SWST) covering investment funds and banks to identify vulnerabilities from complex interconnections. ### Supervisory reporting, liquidity monitoring, and fund authorization - Recommendation: Enhance supervisory reporting, especially on investments and derivatives. - Authority: CAA; Priority: ST. - Progress: CAA regularly conducts thematic reviews to enhance reporting data quality in the context of Solvency II reporting. - Recommendation: Further monitor liquidity mismatches in newly emerging investment strategies of large AIF funds, including semi-liquid structures, liability driven investments, and those promoting “retailization”. - Authority: CSSF; Priority: MT. - Progress/observations: - CSSF examines liquidity profile and potential liquidity mismatches during authorization. A dedicated authorization questionnaire has been set up recently for ELTIF in the context of the ELTIF2 regulation to collect data at authorization. - Ongoing risk-based data-driven supervision enhanced via UCI Risk Dashboard and Outliers Analysis; further integration of investor information to monitor retailization trends and new fund cohorts (e.g., loan funds). - Semi-liquid funds subject to specific supervision for their liquidity risk profile. ### Macroprudential policy recommendations and status - 6. Enhance accountability and transparency by publishing factors underpinning macroprudential policy decisions, including where no action is taken. - Authority: CdRS; Priority: I. - Progress: CdRS publishes an annual report and started publishing a semi-annual report of current activities. - 7. Uphold the primacy of the financial stability objective of the CdRS by reducing the MoF’s role in macroprudential decision-taking. - Authority: MoF/CdRS; Priority: ST. - Progress: CdRS has assessed its structure as appropriate. - 8. Reassess whether the legal framework for borrower-based limits preserves the ability of the CdRS to act in a risk-sensitive manner. - Authority: CdRS/MoF; Priority: MT. - Progress: CSSF and Ministry of Finance analysis concluded current corridors in the Law on the Financial Sector (LSF) do not constrain appropriate national action. - 9. Activate income-based macroprudential measures—such as stressed debt-service-to-income limit—early in the recovery cycle and consider gradually reducing the maximum-LTV ratio from 100 percent. - Authority: CdRS/CSSF; Priority: ST. - Progress: CSSF stance that Borrower-Based Measures (BBMs) in place are appropriate. CSSF assesses bank lending practices, including interest rate stress of 2% on variable and revisable rate mortgages, as prudent. CSSF judges maximum limit applied to FTBs and borrowers purchasing their primary residence as in line with cross-country practices. - 10. Fortify banks’ resilience on stock vulnerabilities by raising capital buffer requirements, preferably through targeted capital-based measures on real estate exposures. - Authority: CdRS/CSSF; Priority: I. - Progress: Authorities continue to evaluate needs; CSSF assessed that RRE Stress on banks capital is lower than existing measures covering RRE risks but continues monitoring. - 11. Improve coordination with housing and other government policies with financial stability implications and establish a consultation mechanism with the CdRS. - Authority: MoF/CdRS; Priority: I. - Progress: CdRS broadened cooperation; topics with financial stability implications were regularly discussed in the CdRS forum and summarized in newly established reports providing additional detail on CdRS discussions since 2025. - 12. Future-proof CSSF and CAA independence by changes to the law; where legal amendments are not feasible, issue subsidiary legislation to establish procedural safeguards within legal constraints. - Authority: MoF/CSSF/CAA; Priority: MT. - Progress: CSSF confirms no practical impediment to operational independence; reflections on possible amendments to the CSSF founding law of 23 December 1998 are underway in the context of CRD VI implementation. CSSF cannot initiate legislative amendments. ### Financial sector oversight and supervision - 13. Promote EU-level depositary independence reforms; include supervision of depositary-fund manager group links as risk factors in the risk-based approach. - Authority: CSSF; Priority: MT/ST. - Progress: - Ministry of Finance primarily responsible for contributing to EU regulatory initiatives; recommendation should be addressed to EC & ESMA for convergence between EU NCAs. - CSSF plans to incorporate group link in future RBA prioritization tool development. - 14. Finalize BCL/CSSF MoU on bank liquidity supervision and specify criteria for selecting LSIs for which BCL assesses LSREP. - Authority: BCL/CSSF; Priority: ST. - Progress: MoU has been finalized. - 15. Initiate on-site inspection framework of investment fund delegates outside Luxembourg, with a risk-based approach. - Authority: CSSF; Priority: MT. - Progress: - Operational framework for supervisory cooperation between the UK FCA and the CSSF is in the final stages of formalization. - Two portfolio managers based in the US underwent inspection in Q4 2024. Further inspections contingent on harmonization of third-country inspection conduct at European level to ensure level playing field within the EU. - 17. Set up an internal audit function to evaluate and enhance CAA risk management, control, and governance. - Authority: CAA; Priority: MT. - Progress: CAA has not yet set up an internal audit function; modalities under Executive Committee discussion. CAA expects function to be in place before end of 2026. Requirement to have an internal audit function will be implemented in national law before end of 2026. - 18. Use macroeconomic data in analysis of cross-border payments to better manage ML/TF risks. - Authority: CSSF/FIU; Priority: MT. - Progress: - Meetings organized with BCL to obtain cross-border payments data. - CSSF implemented a software service to turn BCL data into exploitable visual data. - CSSF analysis started to take into account macro-economic data to identify ML/TF red flags; AML colleges used for cooperation with foreign AML authorities. - 19. Improve operational readiness of the FGDL for timely and reliable payouts; reassess staffing and asymmetry in time gaps for claims recovery. - Authority: CSSF/FGDL; Priority: MT. - Progress: - Discussions ongoing to improve IT system quality and reliability to automate payout process and meet the 7-working-day payout period; different scenarios envisaged. - PDI department staffed with 2 additional agents in 2025; CSSF can draw upon about 1’000 FTE workforce for additional staff on demand. - Discussions with MoF regarding introduction of the CMDI to improve insolvency framework and allow FGDL to file claims within the same time period as depositors (currently 10 years) and shorten timeline. - Dedicated working groups are in place. ### Financial safety net and crisis management - 20. Operationalize resolution tools, expand national resolution handbook, and participate in simulation exercises. - Authority: CSSF; Priority: MT. - Progress: - CSSF reviewed MoU with FDIC and proposed minor updates in September 2024; CSSF communicated availability to discuss proposed minor changes in February, May and early November 2025. On 3 November 2025, FDIC replied they would contact CSSF if necessary. - Review of cooperation agreements on recovery and resolution planning with non-EU countries indicates no other MOU updates needed as respective Luxembourg LSIs are earmarked for liquidation. - 21. Undertake liquidity assistance simulation exercises to test banks’ capabilities in mobilizing enough collateral. - Authority: BCL; Priority: ST. - Progress: BCL recognizes merit but does not plan to perform such tests in the short run because of the signaling effect. ### Transnational aspects of corruption — supply side (OECD WGB findings and recommendations) - OECD WGB Phase 4 evaluation (2024) findings: - Luxembourg has undertaken significant legislative and institutional reforms to combat foreign bribery risks, including: - an ambitious whistleblower protection law; - a significant constitutional reform to enhance and modernize the status of judges and prosecutors; - a judgment-upon-agreement mechanism (plea bargain) for complex financial cases; - more resources and strengthened legislative framework for mutual legal assistance; - legislative amendments extending the confiscation regime and establishing liability of legal persons for offences enabled by lack of supervision or control. - OECD WGB recommended additional steps to address: - structural resource issues across the criminal justice system; - insufficient detection and weak enforcement (low-level investigations and lack of prosecutions of legal persons); - improving dissuasiveness of fines for natural and legal persons; - strengthening detection of foreign bribery and related money laundering offences through better use of available sources and international cooperation in multi-jurisdictional cases. ### Transnational aspects of corruption — facilitation side (AML/CFT framework) - Progress and reforms: - Authorities have strong understanding of risks; corruption among main foreign proceeds of crimes reflected in suspicious transaction reports, FIU disseminations, and ML investigations/prosecutions. - CSSF noted improvement in compliance among Specialized PFS and decline in shelf companies and bearer share depositaries. - Registers of beneficial owners, fiducies and trusts support entity transparency. - December 2025 amendments to AML and criminal procedure frameworks: - expanded prosecutions to cover laundering of any foreign offences, including corruption; - strengthened prosecutor’s investigative powers; - reduced procedural delays in complex financial cases; - ended near-automatic use of suspended sentences for first-time offenders. - Remaining gaps and recommended actions: - Enhance exchange of risk-related information between domestic and foreign competent authorities to support parallel financial investigations into foreign proceeds of corruption. - Maintain adequacy of judicial and investigative resources given increasing volume and complexity of mutual legal assistance requests, including corruption-related requests. - Address very high risk of misuse for concealment of beneficial ownership at domestic fiducies and foreign trusts via consistent supervisory controls and effective sanctions for non-compliance with beneficial ownership reporting obligations. - Strengthen supervision of accountants and professional directors and business centers (gatekeepers in incorporation and domiciliation), including risk-based inspections and proportionate, dissuasive sanctions. ### Fund relations and key IMF financial statistics (as of April 30, 2026) - Membership Status: Joined December 27, 1945; Article VIII. - General Resources Account: - Quota: 1,321.80 SDR Million 100.00 percent - Fund Holdings of Currency: 981.82 SDR Million 74.28 percent - Reserve Tranche Position: 339.98 SDR Million 25.72 percent - SDR Department: - Net cumulative allocation: 1,513.51 SDR Million 100.00 percent - Holdings: 1,522.96 SDR Million 100.62 percent - Outstanding Purchases and Loans: None - Latest Financial Arrangements: None - Projected Payments to Fund (SDR Million) — based on existing use of resources and present holdings of SDRs: - Forthcoming 2026 2027 2028 2029 2030 - Principal: 0.01 0.01 0.01 0.01 0.01 - Charges/Interest: 0.01 0.01 0.01 0.01 0.01 - Total: 0.01 0.01 0.01 0.01 0.01 - Exchange Rate Arrangements: - The exchange rate arrangement of the euro area is free floating. - Luxembourg participates in a currency union (EMU) with 20 other members of the EU and has no separate legal tender. The euro floats freely. - Last Article IV Consultation: concluded on March 21, 2025. Luxembourg is on the standard 12-month consultation cycle. *Source: Annex VIII. Table 1. Luxembourg: FSAP 2024—Main Recommendations (continued) and accompanying sections from the provided IMF PDF content.* ### 2024. The FSSA and accompanying Reports on the Observation of Standards and Codes ### 2024. The FSSA and accompanying Reports on the Observation of Standards and Codes (ROSCs) ### Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) - In September 2023, the Financial Action Task Force (FATF) recognized the quality of the existing AML/CFT framework of Luxembourg and placed it under regular monitoring, which corresponds to the best possible result following a mutual evaluation. - The FATF report is available at the FATF website (link in source). ### IMF Staff Representative — Update (June 22, 2026) - Purpose: - Provides an update on information since the Staff Report was issued; this information does not change the thrust of the staff appraisal. - Resilience Package (tripartite agreement reached on June 8): - Three main pillars: - i) Support for households through a partial coverage of fuel price increases (via a reduction in excise duties), subsidies for electricity, gas, and heating oil prices through end-2026, a temporary tax credit covering Jun-Dec 2026, and an increase in the tax credit for minimum wage earners (from Jan 2027 onward). - ii) Targeted state aid for firms and affected sectors, including agriculture. - iii) Increased subsidies for green transition. - Expected parliamentary vote: by end-June. - Fiscal cost and fiscal stance: - Total cost estimated at around 180 million euros (0.2 percent of GDP) in 2026 and 250 million (0.25 percent) in 2027. - New tax credits for income and minimum wage account for the largest share of the cost. - Fiscal deficit projections: - Projected increase from 1.9 percent of GDP to around 2.1 percent in 2026. - For 2027, fiscal deficit would rise from 2 percent of GDP to around 2.3 percent. - Staff view: fiscal cost relatively contained; thrust of fiscal policy advice remains broadly unchanged; package does not change staff advice on need for a moderate fiscal adjustment over the medium term. - Assessment of design and targeting: - Temporary income tax credit for 2026 and its integration in the tax scale in 2027 broadly in line with staff’s previous Article IV advice; staff would have preferred a regular adjustment of income tax brackets for inflation. - Most energy-related measures are temporary but characterized by staff as untargeted, regressive, and weakening price signals. - Additional cushioning already present: automatic wage indexation and the electricity grid subsidy. - Minimum wage tax credit increase coincides with planned minimum wage increase starting January 2027 and an automatic wage increase in June 2026. ### Statement by Jeroen Clicq and Tom Englaro (June 22, 2026) — Observations from Luxembourg authorities - Recent economic developments and macroeconomic outlook: - Luxembourg described as one of Europe’s most open and interconnected economies, with exposure to external shocks. - External shocks noted: energy crisis from Russia’s war of aggression against Ukraine, geopolitical frictions, trade tensions, and the war in the Middle East. - Growth: sluggish growth of 0.3 percent on average over the past three years. - Inflation: rose from 2.1 to 2.3 percent in 2025. - Unemployment: reached 6.0 percent for the first time since the pandemic. - Government actions: decisive measures to protect households’ purchasing power and sustained high levels of public investments helped safeguard private consumption. - Resilience package (June 8, 2026) specifics reiterated: - Mix of temporary heating oil, gas, and electricity subsidies; fuel price support through excise duty reductions; two tax credits, one raising the minimum wage by EUR 200 without impacting companies’ bottom lines. - Public debt: 26.5 percent of GDP in 2025. - Package seen as foundation for gradual economic recovery over the medium term. - Fiscal policy (authorities’ view): - Taxation reform: - Replacement of three existing tax classes with a single tax class (individualized system), removing dependence on marital status. - Expected effects: reduce disincentives for secondary income earners, narrow gender gap in employment, eliminate complexities linked to joint taxation and automatic jumps in tax class. - Transition: a 25-year transition period envisaged to limit sudden tax increases for households benefiting from joint taxation under the current system. - Fiscal cost estimated by authorities at EUR 850-900 million. - Government abandoned previously announced plans to adjust tax brackets to past wage indexations to partly offset fiscal impact. - Investment and spending: - Government will maintain high level of growth-enhancing investments — averaging 4.5 percent of GDP per year through 2029 — to support green and digital transitions, address housing shortages, and honor international defense spending commitments. - Innovative financing for defense: first sovereign retail defense bond in Europe since World War II and a new National Defence Fund with an investment capacity of up to EUR 150 million in defense and dual-use technologies. - Higher defense expenditure accounts for a relatively significant portion of the higher-than-expected deficit in 2025. - National Action Plan against Poverty accompanies tax reform with measures to support vulnerable households. - Fiscal sustainability and framework: - Medium-term Objective (MTO) continues to serve as national fiscal rule pending revisions of the national fiscal framework. - Public Investment Management Assessment (PIMA) expected to enhance efficiency of public investment and generate savings. - Authorities expect revenues to regain momentum as growth strengthens, supported by higher household purchasing power from the tax reform and the EUR 450 million resilience package, and by the clearance of tax arrears. - Early revenue indication: year-on-year revenue increase of EUR 800 million by end-May. - Pension reform: - Agreed in September 2025 after broad public consultation. - Measures: balanced increase in contributions across employers, workers, and the state; incentives to extend working lives; stricter early retirement conditions via a gradual eight-month extension of the required contribution period over five years. - Authorities agree further action may be needed over time but view reform as a solid basis. - Financial sector (authorities’ view): - Banking sector: - Well capitalized and highly liquid. - Capital ratio: 25.2 percent. - Non-performing loans: 1.4 percent. - Investment fund sector: - Continues to perform strongly, supported by sustained growth in assets under management. - Risks described as contained with moderate leverage and limited liquidity vulnerabilities. - Liquidity management and stress testing: - Availability of liquidity management tools reinforced by recent regulatory developments. - Stress tests show very limited numbers of banks facing capital shortfalls and very limited numbers of funds with severe liquidity shortages under an adverse scenario. - Authorities have developed advanced stress-testing tools, including a system-wide stress test capturing interconnectedness between banks and investment funds, and an innovative stress test incorporating liquidity-solvency interactions (launch following an FSAP recommendation). - A stress test for the insurance sector is being developed. - Macroprudential measures and housing market assessment: - Authorities consider current macroprudential measures fit for purpose. - Authorities dispute staff’s characterization of the housing market as featuring a "sizable and persistent share of vulnerable mortgages," arguing the criteria used are not suited to Luxembourg context and call for clearer identification and segmentation of vulnerable borrowers by income. - Past real estate slumps did not significantly affect the banking sector, providing comfort. - Existing stress-testing framework, especially interest rate stress test on residual income, is said to capture borrower risk in a more tailored way than BBMs. - Structural policies: - Artificial intelligence (AI): - AI is central to government plans to boost productivity. - Government developed an AI strategy to position Luxembourg as a leading digital innovation hub. - Workforce upskilling: tailored training programs for professionals, specialized academic offerings, AI4All to foster broad AI literacy. - Firm adoption support: Luxembourg AI Factory as a one-stop shop for AI adoption; financial aid through Fit4AI (EUR 10,000 - 200,000) and SME packages – AI (up to EUR 25,000) to cover costs of external experts. - Housing market policies: - 2024 policy package to support construction firms combined direct financial assistance with targeted fiscal incentives; halted rise in bankruptcies and reinvigorated activity. - EUR 480 million envelope for public acquisition of housing units and off-plan purchases (VEFA) fully committed; will result in more social and affordable housing. - Structural reforms pursued to increase effective supply: land mobilization tax to discourage land hoarding; efforts to ease regulatory bottlenecks and accelerate building processes. - Energy transition: - Energy crisis underscores importance of energy transition. - Expansion of renewable energy sources continues. - Public support for energy-friendly renovation and sustainable construction set to reach close to EUR 500 million from 2026 to 2029. - Additional EUR 450 million set aside for solar panels. - Resilience package includes temporary financial aid for households installing non-fossil fuel boilers or undertaking energy retrofits. *Source: IMF staff statement and Luxembourg authorities’ observations (June 22, 2026).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2026/english/1luxea2026001.pdf_