## _cr12160 ## Source details **Canonical URL:** [_cr12160](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12160.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12160.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12160.pdf.json) --- ### Recent Developments in the Financial Sector - Financial center structure and role - Outward-oriented banking sector providing upstream liquidity to foreign parent banks; domestic intermediation limited to a handful of banks. - Investment fund industry large; financial center contributes to value added, employment, and a large share of fiscal revenues. - Banking sector: performance and vulnerabilities - Assets declined sharply from pre-crisis peak, increased modestly in H2 2011, then stabilized. - Banks remained profitable despite securities-portfolio valuation losses (including Greek sovereign exposures). - Highly capitalized and liquid overall; liquidity pressures contributed to the breakup of Dexia group in October 2011. - Dexia-related facts: - Share purchase agreement reached on April 5, 2012: Precision Capital S.A. will purchase 90 percent of DBIL shares; Grand Duchy of Luxembourg will keep the rest (subject to EC approval). - Belgium, France, and Luxembourg jointly guarantee group debt up to €90 billion; EC approved €55 billion on a temporary basis. - Luxembourg’s share of the guarantee amounts to 3 percent or roughly up to 8 percent of 2011 GDP. - In 2008, restructuring of Dexia and Fortis accounted for about 8 percent of GDP. - Investment fund industry - Assets under management: - Declined in H2 2011 but recovered beyond pre-crisis levels by early 2012. - Have remained above €2 trillion. - Number of funds increased by about 5 percent compared to pre-crisis level. - Key banking exposures and indicators - Exposures to distressed sovereigns: <2 percent of total assets; concentrated in a small number of banks with limited retail deposits. - Cross-border (mainly intragroup) exposures ≈ ¾ of Luxembourg-based banks’ loans. - Exposures to other credit institutions declined about 20 percent; credit to customers fell by less than 10 percent. - Capital adequacy ratio improved reflecting shrinking risk-weighted assets; liquidity ratio improved. - Profitability continued but substantially lower than pre-crisis; 2011 decline largely from securities-portfolio valuation losses. ### Evolution of Competitiveness and External Stability - Competitiveness trends - Competitiveness gap narrowed since 2010 after a decade of deterioration. - Wage indexation outstripped productivity gains for years; labor hoarding after the crisis caused a sharp decline in labor productivity. - Wage increases slowed recently due to sluggish labor market and postponement of automatic wage indexation adjustments. - 2011: competitiveness gains continued in unit labor cost–based real effective exchange rates and average CGER-based competitiveness gap. - CGER assessment (in percent) - Average competitiveness gap 0.34 - Macroeconomic balance approach -0.49 - Equilibrium real exchange rate approach 1.61 - External stability approach -0.10 - Memorandum (percent of GDP) - Current account Norm (percent of GDP) 6.52 - Projected current account (percent of GDP) 7.30 - External flows and volatility - Balance of payments flows dominated by financial sector; flows reflect liquidity-management and intragroup operations. - Global financial shocks reduce both inflows and outflows, moderating outward spillovers. ### Recent Macro Developments: growth, inflation, labor market, fiscal and current account - Growth and demand - Growth slowed in 2011 amid euro area debt crisis; private consumption slowed in H2 2011. - Large lumpy investments (mostly satellite-related) skewed investment and trade data in H2 2011. - Confidence indicators fell, particularly in Q4 2011. - Inflation and wages - Headline inflation rose to about 4 percent in H2 2011 before subsiding. - Inflation has remained above euro area average, partly due to wage increases. - 2011 wage increases broadly comparable to neighbors as automatic wage indexation was postponed. - Labor market - Employment growth remained stable recently but unemployment increased. - Long-term unemployment ≈ 45 percent of overall unemployment (vs. ≈ 30 percent before the global financial crisis). - Signs of skill mismatches and rising structural unemployment. - Fiscal - General government deficit in 2011 was about ½ of 1 percent of GDP lower than in the budget. - Staff estimates structural deficit about ½ of 1 percent of GDP, roughly unchanged from 2010. - Public debt almost tripled to about 20 percent of GDP since the outset of the global financial crisis. - Current account - Current account surplus narrowed in 2011. - Service-sector exports lost momentum during 2011. - Trade balance worsened in H2 2011 with imports boosted by lumpy investment goods. ### Selected macro and fiscal statistics (exact values reported) - Real GDP growth (change in percent): 2009: -5.3; 2010: 2.7; 2011: 1.6; 2012: 0.5; 2013: 2.0; 2014: 2.3; 2015: 3.0; 2016: 3.2; 2017: 3.2 - Nominal GDP (million euro): 2012: 43,494; 2013: 45,443; 2014: 47,586; 2015: 50,266 - Current account (percent of GDP): 2009: 6.5; 2010: 7.7; 2011: 7.1; 2012: 7.2; 2013: 7.3; 2014: 7.5; 2015: 7.3; 2016: 7.4; 2017: 7.4 - Resident labor force (thousands): 2009: 229.3; 2010: 233.5; 2011: 238.8; 2012: 242.7; 2013: 246.8; 2014: 250.9; 2015: 255.2; 2016: 259.5; 2017: 263.9 - Unemployed (thousands and rate): 2009: 13.2 (5.8 percent); 2010: 14.4 (6.2 percent); 2011: 13.5 (5.7 percent); 2012: 15.1 (6.2 percent) - CPI (harmonized), p.a.: 2009: 0.0; 2010: 2.8; 2011: 3.7; 2012: 2.3 - General government balance (percent of GDP): 2009: -0.8; 2010: -0.9; 2011: -0.6; 2012: -1.9 - General government gross debt (percent of GDP): 2009: 14.8; 2010: 19.1; 2011: 18.2; 2012: 21.4 ### Financial soundness indicators (selected, percent) - Regulatory capital to risk-weighted assets: 2008: 15.4; 2009: 18.9; 2010: 17.0; Jun-11: 17.0; Dec-11: 21.0 - Return on assets: 2008: 0.2; 2009: 0.6; 2010: 0.7; Jun-11: 0.7; Dec-11: 0.3 - Return on equity: 2008: 5.5; 2009: 11.6; 2010: 13.0; Jun-11: 14.0; Dec-11: 6.0 - Liquid assets to total assets: 2008: 59.0; 2009: 55.9; 2010: 56.0; Jun-11: 57.0; Dec-11: 59.0 - Customer deposits to total (non interbank) loans: 2008: 134.7; 2009: 137.5; 2010: 131.0; Jun-11: 128.0; Dec-11: 119.0 ### Current account, financial account, and IIP highlights - Pre-crisis (1995–2007) current account surplus averaged over 10 percent of GDP. - Services surplus reached over 50 percent of GDP in 2011. - Net IIP peaked at 152 percent of GDP in Q2 2008, dropped to about 67 percent, and recovered to >100 percent of GDP in Q3 2011. ### Risk Assessment Matrix (selected risks and attributes) - Strong intensification of the euro area crisis: Relative Likelihood: Medium; Impact if Realized: High - Failure of a parent bank: Relative Likelihood: Medium; Impact if Realized: High - Inability to carry out fiscal consolidation: Relative Likelihood: Low/Medium; Impact if Realized: High - Global financial regulation and tax reforms: Relative Likelihood: Low; Impact if Realized: High - Loss of confidence in investment fund industry: Relative Likelihood: Low; Impact if Realized: High (over the medium-term) ### Outlook and Risks - Near-term outlook (2012) - Economy expected to slow in 2012; activity to roughly come to a standstill in H1 2012 before a mild recovery in H2 2012. - Weak external demand and lingering uncertainty to weigh on exports and domestic demand. - Inflation expected to continue declining. - Balance of risks - Tilted to the downside given euro area uncertainties. - Euro-area slowdown consequences include increased unemployment, household debt servicing stress, potential weakening of domestically-oriented banks’ asset quality, and fiscal burdens. - Domestic credit impact likely limited because most bank lending is cross-border. - Strong intensification of the crisis could expose Luxembourg-based banks through parent-bank risks and large intra-group transactions; contingent fiscal liabilities for domestically-active banks could be large. - Investment fund industry risk - Euro area turbulence and loss in risk appetite could cause outflows; impact on Luxembourg’s economy likely limited—Luxembourg may be a conduit rather than an originator of outward spillovers. - Authorities’ view - Authorities broadly concur that downside risks increased but are more sanguine; cited reduced banking-sector exposure to distressed sovereigns and confidence in banks’ capital positions. ### Supervisory activity and reforms (CSSF, 2008–2011) - On-site inspections (banks): 2008 — 66; 2009 — 38; 2010 — 56; 2011 — 85 - On-site inspections (investment funds): 2008 — 7; 2009 — 20; 2010 — 13; 2011 — 19 - Enforcement actions (banks): 2008 — 1; 2009 — 2; 2010 — 1; 2011 — 8 - Enforcement actions (investment funds): 2008 — 0; 2009 — 4; 2010 — 19; 2011 — 72 - Progress: CSSF staff and resources increased; risk-based supervision more prevalent; deposit guarantee payout period reduced from three months to no more than 20 working days; new disclosure requirement on investor rights for investment funds implemented. ### Box 3 — Progress in Implementing Key Recommendations of the FSAP Update (highlights) - Institutional aspects - Legislation amended to improve CSSF operational independence; further measures under consideration. - Authorities exploring clarification of supervisory responsibilities of BCL and CSSF in light of ESRB recommendation. - Conduct of supervision - Increased staff and resources for CSSF; more frequent on-site inspections and enhanced risk-based supervision with stress testing integrated. - Organizational changes to expedite enforcement (internal rules; enforcement committee; division for investment fund enforcement). - Strengthened disclosure requirements for investment funds; EU-level proposals expected to standardize depositary roles in 2012. - Financial safety net - Law enacted for speedier payments by deposit insurance scheme. - Authorities studying enhancements to bank resolution framework, deposit insurance scheme, and contingency planning with Clearstream Banking Luxembourg. - Prospective impacts of global and EU-level regulatory reforms - Basel III / CRD IV: strong capital positions likely mitigate impact; tougher liquidity standards could be challenging. - Liquidity Coverage Ratio study: a number of banks, if assessed on a stand-alone basis, would face a shortfall of 65 billion euro (roughly 1½ times GDP). - Authorities encouraged to press banks to prepare for liquidity standards and discuss contingency planning for Clearstream. ### Recommended pragmatic steps (no legislation required) - Strengthen bank resolution via Recovery and Resolution Plans (RRPs) coordinated with home supervisors and supervisory colleges. - Consider mandatory provisioning for payments under existing ex-post deposit guarantee scheme to ensure availability of resources for bank resolution. - Continue pushing ahead with measures not requiring primary legislation while coordinating with EU-level developments. ### Institutional refinements and AML/CFT - Clarify CSSF and BCL roles on liquidity risk supervision; establish a national macro-prudential authority with central bank playing an important role. - Strengthen CSSF’s operational independence; current licensing authority rests with the Minister of Finance and senior management can be dismissed by government. - AML/CFT: progress made since FATF 2010 mutual evaluation; Luxembourg removed from enhanced review process in early 2011; further improvements needed in legal entities transparency and to address revised FATF standard on tax crimes. ### Policy Challenges and Reforms (summary of priorities) - Preserve stability and business-friendly climate by limiting financial sector vulnerabilities, ensuring fiscal sustainability, and promoting growth and employment. - Fiscal: arrest trend increases in current spending; implicit pension obligations pose risks. - Labor market: reform to counter disincentives to work, address skill mismatches, support life-long learning, and rebalance labor-market programs toward training. - Product markets: reduce entry barriers, simplify administrative approval procedures, particularly land use regulations, to spur productivity and diversification. - Wage indexation: recommendation to modify the reference index to exclude volatile prices (notably food and fuel) with a view of eliminating indexation in the medium term. ### Pension reform and long-term fiscal sustainability - Old-age pension system generosity will result in the largest aging-related expenditure increases in the EU. - Recent alignment of benefits to contributions will take 40 years to be fully effective and will not place the system on a sound footing. - Policy recommendations: - Increase statutory retirement age. - Curtail or eliminate complementary periods. - Limit benefit indexation to cost-of-living adjustments. - Reform benefit indexation to eliminate double-indexation to wages and prices. ### Labor market policies and human capital (selected) - Generous social transfers have diverted resources from active labor market policies. - Skill mismatches acute for local residents; long-term unemployment share increased. - Recommendations: - Rebalance programs to support marketable skills, life-long learning, and improved formal education. - Modify wage indexation (exclude volatile prices) with a view to eliminate indexation in the medium term. ### Staff appraisal — macroeconomic and financial stability (high-level) - Financial sector remained stable through crises. - 2012: economy expected to slow; fiscal deficit widen but remain low; headline inflation to slow; unemployment rate broadly unchanged though long-term joblessness remains large. - Supervision: increase CSSF resources; continue using supervisory colleges for EU banking groups; further develop multilateral supervisory structures for non-EU groups and UCITS funds. - Regulatory preparations: encourage banks to prepare for Basel III and CRD IV liquidity standards. ### Data and reporting - Uses SDDS flexibility options on timeliness of national accounts and BCL analytical accounts. - Table of Common Indicators (as of May 31, 2012) lists latest observation and reporting frequency for exchange rates, international reserve assets, reserve/base money, broad money, central bank balance sheet, consolidated banking system balance sheet, interest rates, CPI, fiscal data, external current account, GDP/GNP, gross external debt, IIP, and more (dates preserved in original table). *Source: IMF staff summary of “1. Recent Developments in the Financial Sector” from the Luxembourg 2012 Article IV Report.* ### 1. Recent Developments in the Financial Sector ......................................................................... ### 1. Recent Developments in the Financial Sector ### Context and Financial Center Structure - Luxembourg’s financial center comprises an outward-oriented banking sector—providing upstream liquidity to foreign parent banks with domestic intermediation limited to a handful of banks—and an investment fund industry. - The financial system’s diversification in businesses, customer bases and investment destinations has aided resilience through the global financial crisis and euro area turbulence. - The financial center contributes to value added, employment, and generates a large share of fiscal revenues; it also supports legal, accounting, and related service industries. ### Banking Sector: performance and vulnerabilities - Luxembourg-based banks’ assets declined sharply from their pre-crisis peak, increased modestly in the second half of 2011, and then stabilized. - Banks have remained profitable despite securities-portfolio valuation losses, including from Greek sovereign exposures. - Overall, Luxembourg-based banks are highly capitalized and liquid, though liquidity pressures from the euro area crisis led to the breakup (along national lines) of Dexia group in October 2011. - Spillovers from Dexia’s breakup were limited beyond the impact on Dexia’s Luxembourg subsidiary (DBIL)—one of the largest banks with retail business in Luxembourg. - Footnote developments related to Dexia: - A share purchase agreement has been reached on April 5, 2012. Precision Capital S.A. (a Qatari owned holding company), will purchase 90 percent of DBIL shares; the Grand Duchy of Luxembourg will keep the rest. This agreement is subject to the EC’s approval. - As part of the Dexia group resolution agreement, Belgium, France, and Luxembourg will jointly guarantee the debt issued by the group up to €90 billion. The EC has approved €55 billion on a temporary basis. - Luxembourg’s share of the guarantee amounts to 3 percent or roughly up to 8 percent of 2011 GDP. - In 2008, the restructuring of Dexia and Fortis accounted for about 8 percent of GDP. ### Investment Fund Industry - Assets under management: - Declined during the second half of 2011 reflecting unfavorable market developments, but recovered beyond their pre-crisis levels by early 2012. - Have remained above €2 trillion. - Number of funds: - Increased by about 5 percent compared to their pre-crisis level. - Industry dynamics: - Assets under management started recovering shortly after the crisis and in mid-2010 surpassed their pre-crisis peak; partially reversed in H2 2011; recovered as worldwide markets trended up in early 2012. ### Key banking-sector exposures and indicators - Bank exposures to distressed sovereigns: - Account for less than 2 percent of total assets and are concentrated in a small number of banks with limited retail deposits. - Cross-border exposures: - Cross-border (mainly intragroup) exposures still account for about ¾ of Luxembourg-based banks’ loans. - Recent balance-sheet movements: - Exposures to other credit institutions (mostly cross-border intra-bank group) declined about 20 percent; credit to customers fell by less than 10 percent. - Capital and liquidity: - Overall capital adequacy ratio has improved reflecting shrinking risk-weighted assets. - Overall liquidity ratio has improved. - Profitability: - Banks have continued to post profits, although substantially lower than before the global financial crisis; the 2011 decline largely reflected securities-portfolio valuation losses, particularly in European sovereign bonds. ### Macro-financial linkages and employment effects - Global financial shocks affect Luxembourg’s financial center asymmetrically, contributing to volatility in the international investment position; impact has been primarily on employment and tax revenues rather than on broad domestic credit. - Domestic intermediation implications: - Most bank lending is cross-border; domestic deposits exceed non-interbank loans, limiting pressure to reduce domestic credit. ### Supervisory activity (CSSF), 2008–2011 - On-site Inspections: - Banks: 2008 — 66; 2009 — 38; 2010 — 56; 2011 — 85 - Investment Funds: 2008 — 7; 2009 — 20; 2010 — 13; 2011 — 19 - Enforcement Actions: - Banks: 2008 — 1; 2009 — 2; 2010 — 1; 2011 — 8 - Investment Funds: 2008 — 0; 2009 — 4; 2010 — 19; 2011 — 72 ### Boxed findings: Recent Developments in the Financial Sector (summary) - Investment funds: assets under management remained above €2 trillion; number of funds up ~5 percent since pre-crisis. - Luxembourg-based banks: slower recovery, assets bottomed in February 2011; intragroup exposures fell about 20 percent; credit to customers fell <10 percent. - Exposures to distressed sovereigns <2 percent of total assets. - Cross-border/intragroup exposures ≈ ¾ of loans. --- ### Evolution of Competitiveness and External Stability - Competitiveness trends: - After a decade of deterioration, Luxembourg’s competitiveness gap has narrowed since 2010. - Wage increases associated with automatic backward wage indexation outstripped productivity gains for a number of years; labor hoarding after the crisis caused a sharp decline in labor productivity. - Recently, labor cost increases have slowed due to a sluggish labor market and postponement of automatic wage indexation adjustments. - In 2011, competitiveness gains continued in unit labor cost–based real effective exchange rates and average CGER-based competitiveness gap. - External flows and volatility: - Balance of payments flows are dominated by the financial sector; financial-sector flows reflect the liquidity-management role of Luxembourg-based banks (mainly intragroup operations). - Global financial shocks tend to reduce both inflows and outflows, moderating outward spillovers from Luxembourg. - CGER assessment (in percent): - Average competitiveness gap 0.34 - Macroeconomic balance approach -0.49 - Equilibrium real exchange rate approach 1.61 - External stability approach -0.10 - Memorandum (percent of GDP): - Current account Norm (percent of GDP) 6.52 - Projected current account (percent of GDP) 7.30 ### Recent macro developments: growth, inflation, labor market, fiscal and current account - Growth: - Amid the euro area debt crisis, growth slowed in 2011; private consumption slowed in the second half of 2011. - Large lumpy investments—mostly satellite-related—skewed investment and trade data in H2 2011. - Confidence indicators fell, particularly in Q4 2011, remaining in negative territory. - Inflation and wages: - Headline inflation rose to about 4 percent in H2 2011 before subsiding. - Inflation has consistently remained above the euro area average, partly due to wage increases. - In 2011, wage increases were broadly comparable to neighboring countries as automatic wage indexation was postponed. - Labor market: - Employment growth remained stable in recent months but unemployment increased. - Long-term unemployment accounts for about 45 percent of overall unemployment compared to about 30 percent before the global financial crisis. - Growing signs of skill mismatches and rising structural unemployment. - Fiscal: - The general government deficit in 2011 was about ½ of 1 percent of GDP lower than in the budget despite a small overrun in public investment. - The over-performance reflected continued current expenditure control and strong revenue growth, including temporary tax rate hikes in personal income taxes and corporation solidarity taxes. - Staff estimates suggest the structural deficit was about ½ of 1 percent of GDP, roughly unchanged from 2010. - Public debt has almost tripled to about 20 percent of GDP since the outset of the global financial crisis. - Current account: - The current account surplus narrowed in 2011. - Service-sector exports—primarily financial and related business services—lost momentum during 2011. - Trade balance worsened in H2 2011 with imports boosted by lumpy investment goods and exports declining. - Portfolio investment flows were stagnant through Q3 2011 compared to 2010. --- ### Outlook and Risks - Near-term outlook (2012): - Economy poised to continue slowing in 2012. - Economic activity expected to roughly come to a standstill in H1 2012, before a mild recovery in H2 2012. - Weak external demand (including euro area fiscal consolidation) will weigh on exports; lingering uncertainty will weigh on domestic demand. - Price pressures likely to ease; inflation expected to continue declining. - Balance of risks: - Tilted to the downside given euro area uncertainties. - A euro-area slowdown would likely: - Increase unemployment. - Hurt households’ ability to service loans. - Possibly weaken the quality of domestically-oriented banks’ assets. - Burden fiscal accounts. - Impact on domestic credit is likely to be limited because most bank lending is cross-border. - In a strong intensification of the euro area crisis: - Luxembourg-based banks would face risks from parent banks and from large cross-border intra-group transactions tied to upstream liquidity provision. - Contingent fiscal liabilities—limited to supporting domestically-active banks—could be large. - Investment fund industry risks: - Euro area turbulence and a loss in risk appetite could cause outflows from the investment fund industry. - The impact of such outflows on Luxembourg’s economy would be limited; Luxembourg is likely to be a conduit rather than an originator of outward spillovers. - A better-than-expected outlook could materialize if crisis-resolution efforts reduce market uncertainty and speed euro-area recovery. - Authorities’ assessment: - Authorities broadly concurred that downside risks have increased but were more sanguine on the outlook. - They noted reduced banking-sector exposure to distressed sovereigns and confidence in banks’ strong capital positions. - Authorities did not expect outward spillovers from the investment fund industry given its small exposures to distressed sovereigns; expected impacts would be confined to weaker tax revenues, employment, and moderate effects on the real estate market. --- ### Policy Challenges and Reforms - Overall policy challenge: - Preserve Luxembourg’s hallmark stability and business-friendly climate by limiting financial sector vulnerabilities, ensuring fiscal sustainability, and promoting growth and employment. - Forthcoming changes in the financial regulatory environment present challenges to the financial center. - On the fiscal front, need to arrest trend increases in current spending; implicit pension obligations pose risks to fiscal sustainability. - Boosting growth requires labor-market reforms to counter disincentives to work and address skill mismatches, and product-market reforms to spur productivity growth. A. Limiting Financial Sector Vulnerabilities - Supervisory and regulatory strengthening: - Substantial progress made in strengthening financial sector supervision and regulatory frameworks, consistent with the FSAP update’s recommendations. - CSSF staff and resources have been increased, resulting in more frequent on-site inspections and increased enforcement actions. - Risk-based supervision has become more prevalent; the financial industry has broadly recognized the value of stronger supervision. - Deposit guarantee and investor protection: - Deposit guarantee scheme’s payout period reduced from three months to no more than 20 working days, consistent with the current EU directive. - New disclosure requirement regarding the exercise of investor rights for investment funds implemented to bolster investor protection. *Source: IMF staff summary of “1. Recent Developments in the Financial Sector” from the Luxembourg 2012 Article IV Report.* ### Box 3. Progress in Implementing Key Recommendations of the FSAP Update ### Box 3. Progress in Implementing Key Recommendations of the FSAP Update ### A. Institutional Aspects - Legislation was amended to improve the operational independence of the CSSF granting it authorization power regarding some changes in financial institutions. Further measures are under consideration. - In light of the European Systemic Risk Board’s (ESRB’s) recommendation on establishing a national macroprudential authority, the authorities are exploring ways to clarify more broadly the supervisory responsibilities of the BCL and CSSF. ### B. Conduct of Financial Sector Supervision - Staff and resources available for the CSSF’s supervisory and enforcement functions have been increased substantially. This has translated into more frequent on-site inspections and enhanced risk-based supervision of banks and investment funds, with stress testing more integrated into supervisory planning. - Organizational and procedural changes to expedite enforcement actions include: - issuance of internal rules; - creation of the enforcement committee; - creation of a division devoted to investment fund enforcement. - The CSSF continues active participation in supervisory college meetings contributing to improve their monitoring of cross-border exposures to parent banks. - Following the EBA recommendations, relevant European supervisors have started to conduct joint risk assessments of banking groups following a common approach. - Disclosure requirements for investment funds were strengthened to clarify shareholder and ownership rights. - An EU-level legislative proposal standardizing and strengthening the role of depositaries is expected to be published in 2012. ### C. Financial Safety Net - A law requiring speedier payments by the deposit insurance scheme was enacted. - While waiting for progress of EU-level initiatives, the authorities have been studying options to strengthen the bank resolution framework and upgrade the deposit insurance scheme. - The authorities have been in discussions with Clearstream Banking Luxembourg to prepare contingency plans and have been studying the need for legislative actions. ### Follow-up analysis, risks, and recommended actions (paragraphs 12–18 and related text) - Cross-border supervision and supervisory colleges: - Continued improvements are required, particularly to further enhance cross-border supervision. - Supervisory colleges provide a venue to exchange data, analyze financial groups using a common methodology, and develop coherent group-level strategies, as required by the European Banking Authority (EBA). - Structures are less developed for non-EU banking groups; continued efforts are necessary to procure needed data and coordinate group-level recommendations at supervisory colleges. - Luxembourg should consider spearheading efforts to establish multilateral supervisory frameworks for investment funds to complement existing bilateral arrangements. - EU-level initiative delays and tradeoffs: - Key EU initiatives with critical importance for Luxembourg include harmonizing bank resolution mechanisms and deposit guarantee schemes, and the UCITS V Directive to strengthen depository regimes including asset segregation. - Slow progress at EU level creates a tradeoff: implementing reforms ahead of EU guidance risks future revision if contravening EU Directives; delaying reforms leaves the financial system less able to deal with potential risks. - Pragmatic steps that do not require legislative action: - Strengthen bank resolution via Recovery and Resolution Plans (RRPs) required for all major EU banks, coordinated with home supervisors, possibly within Crisis Management Groups or supervisory colleges. - Consider requiring mandatory provisioning for needed payments under the existing ex-post deposit guarantee scheme to ensure availability of needed resources for bank resolution. - Prospective impacts of global and EU-level regulatory reforms (paragraph 15): - Basel III and Capital Requirement Directive IV (CRD IV): - Given Luxembourg-based banks’ strong capital position, higher capital adequacy requirements would not likely pose difficulties. - Tougher liquidity standards could be challenging because many Luxembourg-based banks are subsidiaries of international banking groups and new standards may require changes in group-wide liquidity management. - The authorities’ recent study on the Liquidity Coverage Ratio shows that a number of banks would not meet those standards that, if applied on a stand-alone basis, would result in a shortfall of 65 billion euro (roughly 1½ times GDP). - Authorities should continue to urge banks to prepare for implementation of liquidity standards associated with Basel III and the forthcoming EU directive. - Central securities depositories regimes: - The European Commission’s (EC’s) legislative proposal to harmonize these regimes could result in stricter rules for depositories—such as Clearstream Banking Luxembourg—to provide banking services. - In due course, this may require revising the supervisory framework for Clearstream, which is currently supervised as a bank. - Authorities are encouraged to continue discussing ways to strengthen contingency planning for Clearstream and limit potential outward spillovers. - Institutional framework refinements needed (paragraph 16): - Clarify respective roles and duties of the CSSF and BCL on liquidity risk supervision, especially given forthcoming Basel III liquidity requirements and possible EU rules granting local authorities waiver powers. - Establish a national macro-prudential authority following the ESRB’s recommendations, with the central bank taking an important role; the authority must be able to identify, monitor, and assess systemic risks and take actions to mitigate risk and limit potential fallout. - Strengthen the CSSF’s operational independence: - Steps have been taken, but CSSF remains under the “direct authority” of the Minister of Finance. - Senior management can be dismissed by the government over a disagreement about policy or execution of its remit. - The ultimate licensing authority lies with the Minister. - AML/CFT progress (paragraph 17): - Authorities have made progress remedying shortcomings identified in the FATF’s 2010 mutual evaluation report. - Luxembourg was removed from the enhanced review process of the FATF’s International Cooperation Review Group in early 2011 and is now subject to a yearly follow up by the FATF. - The FATF noted additional improvements are needed, in particular in relation to legal entities transparency (i.e., beneficial ownership and control). - Going forward, authorities will need to take into account the revised FATF standard of tax crimes. - Authorities’ responses and intentions (paragraph 18): - On bank resolution and deposit insurance scheme: authorities stressed importance of moving in lockstep with EU-level regulations; increased capital requirements for all Luxembourg-based banks to a minimum 9 percent of risk-weighted assets in Core Tier I capital; agreed to continue exploring pragmatic ways to move ahead should EU delays persist. - On Clearstream: ongoing discussions on contingency planning focused on ensuring continuity of critical functions; authorities await final EU-level agreement to assess whether supervisory revisions are needed. - On supervisory and regulatory institutional settings: authorities will revisit arrangements to reflect FSAP update’s recommendations and the newly required national macro-prudential authority; intend legislative action to address institutional issues holistically, pairing operational independence with accountability and responsibility. - On AML/CFT: authorities committed to take needed measures to comply with revised FATF standards. *Source: Luxembourg 2012 Article IV Report — Box 3. Progress in Implementing Key Recommendations of the FSAP Update.* ### 28. Labor market policies will thus need ### _cr12160 - 28. Labor market policies will thus need ### Labor market policies and human capital - Existing generous social transfer schemes, including unemployment insurance, have diverted resources from active labor market policies (Annex IV). - Skill mismatches, particularly for local residents, have recently become more acute in the wake of the global financial crisis. - Labor market programs need rebalancing to support the continued development of marketable skills. - Human capital accumulation can be further supported by life-long learning and continued attention to improving formal education. - Labor market flexibility has been hindered by the long-standing automatic backward-looking wage indexation. - Luxembourg’s efforts to limit negative side-effects—delaying wage adjustments and limiting these to no more than once a year—have helped contain rising unit labor costs. - Reforms are needed to further reduce undesirable effects on competitiveness. - Recommendation: Modify the reference index to exclude volatile prices (notably food and fuel prices), with a view of eliminating indexation altogether in the medium term. ### Product market reforms and competition - Luxembourg has stringent product market regulations (PMR) compared to other European countries, notably entry barriers. - While other countries have made progress in reducing regulations, these have increased in Luxembourg (Annex V). - In 2011, Luxembourg sought to lower entry barriers for some professions by substituting work experience for formal education requirements. - While a step in the right direction, further reforms will be needed to foster a climate of active competition. - Specific further reforms: simplify administrative approval procedures, particularly regulations surrounding land use. - Expected outcomes: underpin productivity growth, enable resources to move freely across sectors, and possibly foster economic diversification. ### Authorities’ stance and measures undertaken - Authorities expressed concerns about labor markets and product market regulations’ negative impact on competitiveness. - Measures described: - Continuing education programs to strengthen human capital. - A program to help unemployed financial sector workers find new jobs after re-training, with reported some success. - Discussion of a reform to the unemployment categorization scheme to provide more incentives to work and reduce the fiscal burden. - Ongoing exploration of ways to limit the adverse impact of wage indexation on competitiveness. - Authorities emphasized the role of high profit margins—made possible due to weak competition—on competitiveness and the need for reforms addressing various aspects of competitiveness. ### Staff appraisal — macroeconomic and financial stability - The financial sector endured the global financial as well as the euro area crises and remained stable. - Outlook and near-term projections: - The economy will nonetheless slow in 2012, reflecting external conditions, and the fiscal deficit will widen but remain low. - Headline inflation will slow, as the impact of global fuel prices wanes and wage indexation is delayed. - The unemployment rate is expected to remain broadly unchanged, but long-term joblessness will still account for a large share of unemployment. - Financial supervision: - Luxembourg increased resources to the CSSF. - Recommendation: continue to take advantage of supervisory colleges for EU banking groups to exchange data and develop coherent group-level strategies. - Note: multilateral supervisory structures are less developed for non-EU financial groups and for UCITS funds; further efforts are needed to ensure coordination among relevant supervisors. - As EU-level regulatory initiatives progress slowly, Luxembourg should push ahead with actions not requiring legislation. - Authorities should continue to encourage banks to prepare for tougher liquidity standards associated with Basel III and CRD IV. ### Institutional arrangements for supervision and macroprudential policy - Coordination among supervisors has been smooth and there is no evidence of political interference in supervisory matters. - Revisions are needed to better align Luxembourg’s frameworks with international standards. - Importance of providing clear roles and responsibilities of the relevant authorities. - Ensure the operational independence and accountability of the CSSF and of the needed macro-prudential authority. ### Fiscal policy and consolidation - Challenge: implement a high-quality fiscal consolidation to ensure fiscal sustainability remains beyond doubt. - In 2012: - Strict adherence to the budget’s expenditure allocations is required, which foresee continuing current expenditure increases with a cap lowering public investment. - If downside risks materialize, automatic stabilizers should be allowed to operate while maintaining credibility. - Medium-term goal: - Balancing fiscal accounts by 2014 will help preserve fiscal stability in the face of medium-term challenges. - Needed consolidation should focus primarily on rationalizing current expenditure. - Recommendation: implement a medium-term fiscal framework including expenditure ceilings without delay. ### Pension reform and long-term fiscal sustainability - Luxembourg’s old-age pension system generosity will result in the largest aging-related expenditure increases in the EU. - Recent efforts to better align benefits to contributions are a step in the right direction, but: - These will take 40 years to be fully in effect and will not place the old-age pension system on a sound financial footing. - Policy recommendations: - Increase the statutory retirement age. - Curtail, if not eliminate, complementary periods. - Limit benefit indexation to cost-of-living adjustments. - Reform the benefit indexation rule to eliminate existing double-indexation of benefits to wages and prices and contribute to intergenerational fairness. ### Long-run growth, labor market, and competitiveness - Economic stability will hinge on bolstering long-run growth by employing resources fully and efficiently. - Priorities: - Address trend increases in unemployment, particularly long-term joblessness, by rebalancing labor market policies in favor of training and education. - Revamp labor market programs and the social safety net to better target subsidies, minimize adverse work incentives, and address growing skill mismatches. - Address long-standing labor market rigidities. - Continue efforts on wage indexation reform (delays have helped limit adverse competitiveness effects); revise the reference index with a view of eliminating indexation in the medium term. - Review product market regulations to foster competition, fuel productivity growth, and possibly support economic diversification. *2012 ARTICLE IV REPORT LUXEMBOURG* ### 37. It is recommended that the next ### _cr12160 - 37. It is recommended that the next ### Recommendation - It is recommended that the next Article IV consultation with Luxembourg be held on the standard 12-month cycle. ### Recent economic developments and outlook - Real GDP growth (Table 1, staff projections): 2009: -5.3; 2010: 2.7; 2011: 1.6; 2012: 0.5; 2013: 2.0; 2014: 2.3; 2015: 3.0; 2016: 3.2; 2017: 3.2 (change in percent). - Nominal GDP (Table 3, memo): 2012: 43,494; 2013: 45,443; 2014: 47,586; 2015: 50,266 (in million euro). - Current account (Table 5, percent of GDP): 2009: 6.5; 2010: 7.7; 2011: 7.1; 2012: 7.2; 2013: 7.3; 2014: 7.5; 2015: 7.3; 2016: 7.4; 2017: 7.4. ### Labor market and prices - Resident labor force (thousands): 2009: 229.3; 2010: 233.5; 2011: 238.8; 2012: 242.7; 2013: 246.8; 2014: 250.9; 2015: 255.2; 2016: 259.5; 2017: 263.9. - Unemployed (thousands and rate): 2009: 13.2 (5.8 percent); 2010: 14.4 (6.2 percent); 2011: 13.5 (5.7 percent); 2012: 15.1 (6.2 percent); 2013: 15.2 (6.1 percent); 2014: 14.9 (5.9 percent); 2015: 15.1 (5.9 percent); 2016: 15.4 (5.9 percent); 2017: 15.1 (5.7 percent). - CPI (harmonized), p.a.: 2009: 0.0; 2010: 2.8; 2011: 3.7; 2012: 2.3; 2013: 2.3; 2014: 2.4; 2015: 2.4; 2016: 2.4; 2017: 2.4. - Average nominal wage growth (overall economy): 2009: 1.8; 2010: 2.6; 2011: 2.0; 2012: 2.5; 2013: 2.6; 2014: 2.6; 2015: 3.6; 2016: 4.6; 2017: 5.6. - Nominal unit labor costs (overall economy): 2009: 8.6; 2010: 1.7; 2011: 3.3; 2012: 3.9; 2013: 2.7; 2014: 2.6; 2015: 3.0; 2016: 4.0; 2017: 4.9. ### Fiscal developments, consolidation, and projections - General government balance (percent of GDP, Table 1 and Table 2): 2009: -0.8; 2010: -0.9; 2011: -0.6; 2012: -1.9; 2013: -1.2; 2014: -1.1; 2015: -2.2; 2016: -2.1; 2017: -2.0. - General government gross debt (Maastricht definition, percent of GDP, Table 2): 2009: 14.8; 2010: 19.1; 2011: 18.2; 2012: 21.4; 2013: 23.5; 2014: 25.4; 2015: 27.7; 2016: 29.8; 2017: 31.7. - Table 3: Estimated effect of fiscal consolidation (in percent of GDP and million euro): - Total fiscal adjustment (in percent of GDP): 2012: 0.1; 2013: -1.2; 2014: -1.1; 2015: 0.1. - GDP Growth (staff estimates) (Table 3 memo): 2012: 0.5; 2013: 2.0; 2014: 2.3; 2015: 3.0. - Specific measures (examples, percent of GDP): Wage indexation single adjustment/12 months: 2012: -0.3; 2013: -0.1; 2014: -0.1; 2015: -0.1. Crisis tax phase out (0.8 percent): 2012: -0.2; 2013: 0.0; 2014: 0.0; 2015: 0.0. - Structural balance (Table 2, percent of GDP): 2009: 0.4; 2010: -0.5; 2011: -0.5; 2012: -1.5; 2013: -1.0; 2014: -0.9; 2015: -2.2; 2016: -2.2; 2017: -2.1. ### Banking sector and financial soundness - Central Bank of Luxembourg indicators summary (Figure 4): The banking sector is described as well capitalized and profitable, with non-performing loans relatively subdued and a continued high level of liquidity; intra-group exposures remain large. - Financial Soundness Indicators (Table 6, selected): - Regulatory capital to risk-weighted assets: 2008: 15.4; 2009: 18.9; 2010: 17.0; Jun-11: 17.0; Dec-11: 21.0 (percent). - Return on assets: 2008: 0.2; 2009: 0.6; 2010: 0.7; Jun-11: 0.7; Dec-11: 0.3 (percent). - Return on equity: 2008: 5.5; 2009: 11.6; 2010: 13.0; Jun-11: 14.0; Dec-11: 6.0 (percent). - Liquid assets to total assets: 2008: 59.0; 2009: 55.9; 2010: 56.0; Jun-11: 57.0; Dec-11: 59.0 (percent). - Customer deposits to total (non interbank) loans: 2008: 134.7; 2009: 137.5; 2010: 131.0; Jun-11: 128.0; Dec-11: 119.0. ### Competitiveness and real exchange rate - Unit labor costs and productivity (Figure 5 narrative): - The recent increase in unit labor costs (ULC) is higher than regional peers and is driven mainly by lower labor productivity growth. - Labor compensation increases are described as relatively moderate. - Real Effective Exchange Rate (2000=100) shows a trend real exchange rate appreciation since the early 2000's with signs of stabilization. ### Fiscal multipliers and openness - Fiscal multipliers (Figure 6 narrative): - Traditional analysis finds more open economies (measured by imports of goods and services/2005 GDP) tend to have smaller multipliers. Luxembourg's openness measure exceeds 1. - New evidence suggests fiscal consolidation in the context of negative output gaps could imply larger multipliers, particularly in larger economies. ### Public debt sustainability (stress tests) - Public Debt Sustainability (Figure 7 summary and notes): - Bound tests include permanent one-half standard deviation shocks, permanent 1/4 standard deviation shocks to real interest rate, growth rate, and primary balance, and a one-time real depreciation of 30 percent with a 10 percent of GDP shock to contingent liabilities in 2010 (real depreciation defined as nominal depreciation minus domestic inflation based on GDP deflator). - Gross financing need under baseline and scenarios shown; baseline and scenario box figures report average projections for respective variables. ### Pension system sustainability - Pension projections (Figure 8 summary): - Luxembourg's projected increase in pension and age-related spending to 2030 is among the highest in the sample, partly due to generous rules encouraging beneficiaries to retire years earlier than the official retirement age. - Increase in pension spending, 2010-2030 (in percent of GDP) shows Luxembourg among the higher increases relative to peers. ### External current account, financial account, and IIP (Annex I) - Current account dynamics (Annex I summary): - Luxembourg’s current account balance has been in persistent surplus, mainly driven by financial services. Pre-crisis (1995–2007) surplus averaged over 10 percent of GDP. - Financial services activity underpinned the recovery in the current account after the global financial crisis; services surplus reached over 50 percent of GDP in 2011. - Financial account and IIP: - Financial account has been in deficit, reflecting net accumulation of assets abroad and “other investment” activities tied to financial center activity (banking, investment funds, SPEs). - Net international investment position (IIP) displayed high volatility since 2003: peaked at 152 percent of GDP in Q2 2008, dropped to about 67 percent of GDP, and recovered to a net asset position exceeding 100 percent of GDP in Q3 2011. - Valuation effects (e.g., stock market index declines) significantly affected IIP; only a small fraction of flows are associated with domestic economic activity, limiting the IIP’s insight into domestic developments. *Source: 2012 ARTICLE IV REPORT LUXEMBOURG, INTERNATIONAL MONETARY FUND* ### 5. More broadly, Luxembourg’s ### _cr12160 - 5. More broadly, Luxembourg’s ### Financial sector size and macroeconomic volatility - Countries with large financial sectors are typically subject to higher macroeconomic volatility. - Output volatility appears to increase with the size of the financial sector (Figure A2). - The volatility of employment, current account balance, and IIP also appear to be associated with the importance of the financial sector, albeit less so. ### Current account, financial accounts, and IIP developments (Figure A1) - Charts presented for 1995–2011 show: - Current account balance (in percent of GDP) from 1995 to 2011. - Current account components: Transfers, Salaries, Investment, Services, Goods (1995–2011). - Financial account balance (2002–2011). - Financial account components: Portfolio investment, Other investment, Financial derivatives (2002–2011). - Net International Investment Position (in percent of GDP) and IIP components (Other investment, Portfolio investment, Direct investment, Financial derivatives) with overall net IIP position (2002–2011). ### Risk Assessment Matrix (Annex II) - Format: (Scale―high, medium, or low); Source of Risk; Relative Likelihood; Impact if Realized. - Strong intensification of the euro area crisis - Relative Likelihood: Medium - Impact if Realized: High - Key impacts: Output losses, further increases in unemployment; resilience of Luxembourg-based outward-oriented banks conditional on no major parent failures; liquidity pressures could resurface; domestically-oriented banks affected via higher unemployment and household inability to repay debt; possible losses from sovereign bond holdings threatening a few small banks. - Failure of a parent bank - Relative Likelihood: Medium - Impact if Realized: High - Key impacts: Major disruption due to intra-group exposures and reputation effects; potential large contingent fiscal liabilities for Luxembourg for domestically-active subsidiaries. - Inability to carry out fiscal consolidation in accordance with announced intentions - Relative Likelihood: Low/Medium - Impact if Realized: High - Key impacts: Public debt would almost double in five years with no policy change (Figure 7), and would more than double under a low growth scenario; limited capacity to withstand further shocks or manage looming pension obligations even if proposed pension reforms are implemented. - Global financial regulation and tax reforms - Relative Likelihood: Low - Impact if Realized: High - Key impacts: Cross-border activities could shrink; adverse impact on employment and value added in the medium-term. - Loss of confidence in investment fund industry - Relative Likelihood: Low - Impact if Realized: High (over the medium-term) - Key impacts: Temporary asset price depressions and liquidity needs from redemptions; medium-term loss of business hurting employment and value added. ### Pension reform in Europe (Annex III) — cross-country measures - Overview: EU countries have reformed old-age pensions by increasing statutory retirement age, modifying benefit indexation, boosting contribution rates and periods, and discouraging early retirement. - Selected country measures (years and measures preserved exactly as listed): - Finland 2005: Increase statutory retirement age five years to 68 with actuarially fair reductions for those retiring before the age of 63; Eliminate ceiling on pension benefits. - France 1985–91; 1993; 2003; 2010: Increase contribution rates by 1.85 percentage points to 6.55 percent; Increase the minimum contribution period for a full pension by 2½ years to 40 years; Change the base wage for calculating pensions from the top 10 years to the top 25 years; Change the pension benefit indexation from wages to prices; Link the number contribution years for full pension to life expectancy; Increase the minimum retirement age two years to 62 years of age. - Germany 2004; 2007: Introduce a “sustainability factor” linking pension replacement to the old-age dependency ratio to partially offset the effect of increases in the dependency to partially offset the effect of increases in the dependency ratio; Increase statutory retirement age by two years to 67 years after 2030. - Italy 1992; 1995; 2011: Increase the retirement age for full benefits for men by five years to 65; Increasing reference earnings five years to last 10 years; Raise contributing years for full pension five years to 20 years; Link pensions to lifetime contributions and GDP growth; Freeze pension indexation to 2012–13 levels except for the lowest pensions; Increase the minimum retirement age of woman to 62 and the full benefit retirement age to 67; Set the minimum retirement age to 66 in 2018 for men and women; Adjust the retirement age in the future according to life expectancy. - Spain 2002–05; 2011: Extend the effective minimum contribution period (from 12.8 to 15 years); Discourage early retirement by reducing contribution rates; Pension benefits are reduced by 6 to 7.5 percent per year depending on the numbers of years of contributions with a reduction of 8 percent for those before 1967; Increase the statutory retirement age by two years to 67 years of age; Increasing the minimum retirement age from 61 to 63 years with at least 33 years of contribution; Raising the numbers of years to calculate the earnings base (reference period) from 15 to 25 years; Raising the required contribution to qualify for the full pension from 35 to 38.5 years. - Sweden 1999: Index contributions to life expectancy and GDP growth; Increase pension benefits by about 60 percent if retirement is postponed to age 67. - UK 2007: Raise statutory retirement age three years to 68 years of age; Decrease eligibility for full pension: 44 to 30 years. - Sources: IMF and country authorities ### Unemployment and labor market programs (Annex IV) - Key findings: - Luxembourg’s unemployment rate has roughly doubled in the past ten years. - The increase was not driven by an individual geographical area; regions with largest increases tend to have larger shares of manufacturing jobs. - Cyclical factors do not fully explain the rise; unemployment started increasing well before the global financial crisis (2009–10). - Education and employment: - Increases in unemployment have afflicted workers regardless of formal educational level. - Although unemployment rate is lower for more educated workers, unemployment has been increasing faster for workers with above high-school education than for workers with less formal education (Figure A3). - Financial-sector employment: - Employment growth of locally-based financial sector professionals (about 4 percent of total employment) has been more variable than for foreign counterparts. - During 2000–10 the coefficient of variation for local financial professionals was 0.35, or more than three times higher than that for foreign professionals. - In the aftermath of the global financial crisis, employment of local financial sector professionals declined by 25 percent while employment of foreigners continued increasing, albeit at a lower rate. - Skills mismatch and Beveridge curve: - Rising unemployment has largely reflected skills mismatch. - The share of long-duration unemployment (joblessness in excess of three months) in total unemployment has increased. - The long-run Beveridge curve has moved in the North-East direction in the past decade (Figure A4). - Regression of job vacancy rate on unemployment confirms inverse relation, but average vacancy rate has drifted up over time for a given unemployment rate—indicating growing labor market skill mismatch. - Job vacancy regression results: - Dependent variable: job vacancy rate - Coefficient on Unemployment rate: -0.21***, T-stat -5.97 - Time dummies: - 2002/03: -0.05, T-stat -0.73 - 2004/05: 0.30***, T-stat 3.2 - 2006/07: 0.79***, T-stat 7.86 - 2008/09: 0.60***, T-stat 5.63 - 2010/11: 1.16***, T-stat 7.79 - Constant: 1.48***, T-stat 11.24 - Number of obs.: 140 - R2: 0.65 - Source: Staff estimation. Notes: * p < 0.1, ** p < 0.05, *** p < 0.01 - Regional employment profiles (Table A1, 2001–2010 unemployment rates and magnitude of increase 2001–2010): - Grand-Duchy de Luxembourg: Share of employment (2005) Industries 0.13 Services 0.76; Unemployment 2001 2.9, 2003 4.4, 2005 5.4, 2007 4.7, 2009 6.8, 2010 7.0; magnitude of increase in unemployment (2001–2010) 140% - Canton de Capellen: Share of employment (2005) Industries 0.20 Services 0.65; Unemployment 2001 1.9, 2003 3.0, 2005 3.6, 2007 3.3, 2009 4.9, 2010 4.6; magnitude 140% - Canton d'Esch-sur-Alzette: Share of employment (2005) Industries 0.24 Services 0.60; Unemployment 2001 3.4, 2003 4.9, 2005 5.9, 2007 5.9, 2009 8.5, 2010 9.0; magnitude 160% - Canton de Luxembourg: Share of employment (2005) Industries 0.05 Services 0.87; Unemployment 2001 2.9, 2003 5.0, 2005 6.2, 2007 4.2, 2009 6.5, 2010 6.7; magnitude 132% - Canton de Mersch: Share of employment (2005) Industries 0.54 Services 0.36; Unemployment 2001 2.0, 2003 3.1, 2005 4.4, 2007 3.8, 2009 5.2, 2010 5.1; magnitude 150% - Canton de Clervaux: Share of employment (2005) Industries 0.23 Services 0.52; Unemployment 2001 3.1, 2003 4.4, 2005 5.2, 2007 5.2, 2009 6.1, 2010 6.5; magnitude 109% - Canton de Diekirch: Share of employment (2005) Industries 0.11 Services 0.73; Unemployment 2001 2.9, 2003 3.6, 2005 5.2, 2007 5.0, 2009 6.5, 2010 6.5; magnitude 129% - Canton de Redange: Share of employment (2005) Industries 0.08 Services 0.73; Unemployment 2001 2.6, 2003 2.8, 2005 3.0, 2007 3.0, 2009 4.6, 2010 4.7; magnitude 78% - Canton Vianden: Share of employment (2005) Industries 0.18 Services 0.63; Unemployment 2001 4.3, 2003 5.3, 2005 6.6, 2007 6.2, 2009 6.8, 2010 6.9; magnitude 61% - Canton de Wiltz: Share of employment (2005) Industries 0.15 Services 0.74; Unemployment 2001 4.2, 2003 5.2, 2005 6.1, 2007 6.4, 2009 6.9, 2010 7.7; magnitude 87% - Canton d'Echternach: Share of employment (2005) Industries 0.31 Services 0.56; Unemployment 2001 3.9, 2003 4.3, 2005 6.1, 2007 4.4, 2009 7.6, 2010 7.5; magnitude 93% - Canton de Grevenmacher: Share of employment (2005) Industries 0.23 Services 0.58; Unemployment 2001 1.6, 2003 2.7, 2005 3.7, 2007 3.4, 2009 4.9, 2010 5.0; magnitude 214% - Canton de Remich: Share of employment (2005) Industries 0.09 Services 0.78; Unemployment 2001 2.1, 2003 3.5, 2005 4.0, 2007 3.6, 2009 5.4, 2010 5.6; magnitude 162% - Coef of variation (columns): 0.65, 0.21, 0.30, 0.24, 0.23, 0.25, 0.19, 0.21 - Mean values by column: 0.20; 0.65; 2.92; 3.99; 5.01; 4.53; 6.17; 6.32 - Min and Max values provided for relevant columns. - Sources: STATEC & staff calculation - Labor market program funding: - Funding for employment training programs has declined as a percent of GDP. - Luxembourg spends less on labor market programs than its peers (Figure A5). - Existing programs focus primarily on social safety net and work placement incentives. - Spending on safety net and placement programs has increased as a percentage of GDP, while funding for training programs has declined. - Note: Part of these declines are due to reclassification of spending but the evolution does not change qualitatively. ### Productivity and product markets (Annex V) - Aggregate productivity: - Luxembourg has experienced low labor productivity growth in recent years. - Aggregate productivity level is among the EU’s highest, but productivity growth has been substantially lower than competitors, especially during the recent crisis (Box 2). - Sectoral patterns: - Low productivity growth afflicts all sectors, especially manufacturing, which has experienced productivity losses in the past decade (Figure A6). - Manufacturing sector employs a disproportionate share of the labor force: the sector’s share of employment exceeds its share in output; the opposite holds for the service sector (Figure A6). - The pattern partly reflects dominance of financial and associated services and the underdevelopment of other services (Figure A7). - Finance and related services mostly employ highly educated and trained individuals, limiting labor-absorbing capacity. - Regulations and productivity: - Product market regulations (PMR) and employment protection legislation (EPL) are among the most restrictive in the OECD (Figure A8). - Luxembourg fares poorly in barriers to entrepreneurship and FDI, and sectoral regulations in transportation and communication, retail, and professional services. - PMR, EPL, and employment support programs have likely affected efficient allocation of resources, impacted productivity growth, and held back development of a diversified service sector that could generate higher employment. - Empirical evidence: - Panel regression for OECD countries shows manufacturing sector productivity growth is inversely related to the level of regulations (PMR and EPL). - An analogous inverse relation emerges for service sector productivity growth and professional service regulations (Table A2, Figure A9). - New-firm survival rates: - Luxembourg’s new-firm survival rates are generally higher compared to a number of European countries (Figure A10). - Higher survival rates may reflect regulations thwarting competition, allowing inefficient firms to continue operating with limited market pressure. - Exception: survival rate is lower in financial services, Luxembourg’s most internationally competitive service industry. *Source: 2012 ARTICLE IV REPORT LUXEMBOURG (selected sections and figures).* ### 6. Limited domestic market size may ### 6. Limited domestic market size may ### Major finding: domestic market and service-sector structure - Limited domestic market size may impede the service sector’s development beyond financial services. - Geographical size can contribute to a lopsided service sector, but other similarly-sized financial centers have developed more balanced service sectors (Figure A11). - In sharp contrast to Luxembourg, other financial centers—notably, Hong Kong and New York—have denser populations. - Sheer population size provides the domestic markets needed for service industries, which are primarily non-traded goods. ### Empirical evidence: productivity regressions (Table A2) - Dependent variables: Manufacturing productivity growth; Service sector productivity growth. - Lagged productivity level coefficients and t-statistics (as reported): - Manufacturing regressions: -0.12 (-1.67); -0.15* (-1.81). - Service regressions: -0.06*** (-2.80); -0.36*** (-3.25); -0.20*** (-4.64); -0.25** (-2.57); -0.36*** (-3.09). - Lagged PMR (product market regulation) coefficients and t-statistics: - -0.04*** (-3.14) - -0.05*** (-3.43) - -0.02 (-1.05) - -0.01 (-1.30) - Lagged EPL (employment protection legislation) coefficients and t-statistics: - -0.09*** (-3.89) - -0.03* (-2.02) - -0.01*** (-3.03) - -0.01* (-2.03) - Lagged professional service regulation: - -0.01** (-2.60) - -0.01 (-1.50) - Sample and model statistics: - N: 54; 75; 50; 50; 75; 54; 46 (as shown across specifications). - R2: 0.94; 0.87; 0.95; 0.91; 0.74; 0.86; 0.92. - Source: Staff estimation. Notes: fixed effect panel regressions. The sample includes 31 OECD countries for the period 2000–08. T-statistics in parentheses. * p < 0.1, ** p < 0.05, *** p < 0.01. ### Sectoral productivity and composition (Figures A6–A7, A10–A11) - Luxembourg experiences low productivity growth in both manufacturing sector and service sector (Figure A6). - Output share for the manufacturing sector is low relative to its employment share; the opposite is true for the service sector. - Financial industry dominates Luxembourg’s service sector and has limited employment capacity; other service industries are less developed compared to peer countries, including: - trade, - social and personal services, - education industry, - health care industry, - business services. - New firm survival rates: - New firm survival rate is high in the service sector compared to other countries, including in education industry, trade industry, real estate and business services, and transportation and communication. - Finance industry has lower survival rate than in many other countries. ### Regulation and productivity links (Figures A8–A9) - Luxembourg is among the most restrictive in various regulations, including: - regulation in professional services, - product market regulations, - retail trade regulations, - labor market regulations. - Manufacturing productivity growth is inversely related to the strictness of EPL. - Manufacturing productivity growth is also inversely related to product market regulations. - Service sector productivity growth is inversely related to PMR. - Service sector productivity growth is also inversely related to regulation in professional services. ### Cross-country employment composition (Figure A11 and employment shares) - Luxembourg relies heavily on finance and related industries; other financial centers are more diversified. - Hong Kong: large trade sector. - New York City: strong in education and health services. - Singapore: very balanced service sector. - Reported employment shares by industry (as shown in the figure panels; values preserved exactly as presented): - Luxembourg: 0.10, 0.13, 0.07, 0.05, 0.01, 0.12, 0.01, 0.16, 0.12, 0.13, 0.00, 0.05, 0.10, 0.15, 0.20, 0.25, 0.30, 0.35 (chart tick labels and plotted values shown together). - Hong Kong: 0.05, 0.32, 0.06, 0.10, 0.03, 0.08, 0.04, 0.12, 0.17, 0.03, 0.00, 0.05, 0.10, 0.15, 0.20, 0.25, 0.30, 0.35. - New York City (NYC): 0.02, 0.14, 0.04, 0.08, 0.05, 0.10, 0.04, 0.18, 0.24, 0.11, 0.00, 0.05, 0.10, 0.15, 0.20, 0.25. - Singapore: 0.15, 0.14, 0.10, 0.07, 0.05, 0.06, 0.02, 0.11, 0.23, 0.07. - Industry labels used in charts: Manufacturing; Wholesale & Retail Trade; Transportation & storage; Accommodation and Food Services; Information & communications; Finance and Insurance; Real Estate; Professional and Business Services; Educational and Health Services; Others. ### Policy implications and areas for reform (implied by evidence) - Addressing regulatory restrictions—particularly in product markets, retail trade, labor market regulations, and professional services—could improve productivity growth in manufacturing and services. - Diversifying the service sector beyond finance may require policies that compensate for limited domestic market size, for example by reducing regulatory barriers that impede the development of non-financial services and encourage firm creation and survival in trade, education, health care, and business services. - Enhancing domestic market depth could involve measures to increase labor market participation, attract residents, or strengthen regional integration to create larger effective markets for non-traded services. *Source: LUXEMBOURG 2012 ARTICLE IV REPORT (Informational Annex) — selected figures, tables, and accompanying text.* ### 2006. Uses SDDS flexibility options on the ### _cr12160 - 2006. Uses SDDS flexibility options on the ### Data coverage and reporting timeliness - Uses SDDS flexibility options on the timeliness of national accounts and analytical accounts of the central bank. - No data ROSC is available. - Luxembourg: Table of Common Indicators Required for Surveillance (As of May 31, 2012): - Exchange Rates — Date of Latest Observation: 05/31/12; Date Received: 5/31/12; Frequency of Data: D; Frequency of Reporting: D; Frequency of Publication: D - International Reserve Assets and Reserve Liabilities of the Monetary Authorities — Date of Latest Observation: 04/30/12; Date Received: 05/23/12; Frequency of Data: M; Frequency of Reporting: M; Frequency of Publication: M - Reserve/Base Money — Date of Latest Observation: 04/30/12; Date Received: 05/23/12; Frequency: M; Reporting: M; Publication: M - Broad Money — Date of Latest Observation: 04/30/12; Date Received: 05/23/12; Frequency: M; Reporting: M; Publication: M - Central Bank Balance Sheet — Date of Latest Observation: 04/30/12; Date Received: 05/23/12; Frequency: M; Reporting: M; Publication: M - Consolidated Balance Sheet of the Banking System — Date of Latest Observation: 04/30/12; Date Received: 05/23/12; Frequency: M; Reporting: M; Publication: M - Interest Rates — Date of Latest Observation: 05/31/12; Date Received: 05/31/12; Frequency: D; Reporting: D; Publication: D - Consumer Price Index — Date of Latest Observation: 04/30/12; Date Received: 05/09/12; Frequency: M; Reporting: M; Publication: M - Revenue, Expenditure, Balance and Composition of Financing – General Government — Date of Latest Observation: 2011 Q4; Date Received: 04/04/12; Frequency: Q; Reporting: Q; Publication: Q - Revenue, Expenditure, Balance and Composition of Financing – Central Government — Date of Latest Observation: 2012 Q1; Date Received: 04/27/12; Frequency: Q; Reporting: Q; Publication: Q - Stocks of Central Government and Central Government-Guaranteed Debt — Date of Latest Observation: 2011 Q4; Date Received: 04/04/12; Frequency: Q; Reporting: Q; Publication: Q - External Current Account Balance — Date of Latest Observation: 2011 Q4; Date Received: 04/08/12; Frequency: Q; Reporting: Q; Publication: Q - Exports and Imports of Goods — Date of Latest Observation: 03/31/12; Date Received: 05/25/12; Frequency: M; Reporting: M; Publication: M - GDP/GNP — Date of Latest Observation: 2011 Q4; Date Received: 04/04/12; Frequency: Q; Reporting: Q; Publication: Q - Gross External Debt — Date of Latest Observation: 03/12/12; Date Received: 04/08/12; Frequency: Q; Reporting: Q; Publication: Q - International Investment Position — Date of Latest Observation: 2011 Q4; Date Received: 03/30/12; Frequency: Q; Reporting: Q; Publication: Q - Footnotes from the table preserved: - 1 Including reserve assets that are pledged or otherwise encumbered. - 2 Both market-based and officially-determined, including discount rates, money market rates, rates on treasury bills, notes and bonds. - 3 Foreign, domestic bank, and domestic nonbank financing. - 4 The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments. - 5 Including currency and maturity composition. - 6 Includes external gross financial asset and liability positions vis-à-vis nonresidents. - 7 Daily (D); weekly (W); monthly (M); quarterly (Q); annually (A); irregular (I); and not available (NA). ### Background and macroeconomic developments - Executive Board concluded the 2012 Article IV consultation with Luxembourg on June 27, 2012. - Economic growth and labor market: - Economic growth slowed in 2011 amid the euro area sovereign debt crisis. - Private consumption held up in the first half of the year. - Employment growth remained stable in recent months but the unemployment rate rose; long-run joblessness accounts for about 45 percent of overall unemployment. - Inflation: - Inflation has eased, reflecting the waning impact of global fuel price increases and postponements in automatic wage indexation. - Fiscal stance and public debt: - Fiscal deficit fell in 2011, reflecting revenue overperformance and expenditure restraint. - Staff estimates structural deficit at ½ percent of GDP, roughly unchanged from 2010. - Public debt has almost tripled to about 20 percent of GDP since the outset of the global financial crisis and is poised to continue increasing given medium-term fiscal pressures. - Financial sector: - The financial sector has endured the crisis and remained stable. - Investment fund industry experienced valuation losses in 2011 due to euro area market turbulence but largely recovered, with assets under management surpassing €2 trillion in early 2012. - Luxembourg-based banks remained well capitalized, profitable, and liquid despite slower asset recovery. - Cross-border, mainly intragroup, exposures still account for about ¾ of bank loans. - Economic outlook: - Growth projected to decline to ½ percent in 2012. - Risks are tilted to the downside given ongoing uncertainties in the euro area. ### Executive Board assessment and key policy messages - Directors’ summary: - Welcomed continued stability of Luxembourg’s economy amid euro area turbulence. - Noted slowing activity and uncertain outlook call for further steps to limit financial sector risks, safeguard fiscal sustainability, and boost medium-term growth. - Financial sector recommendations: - Commended authorities on strengthening the financial sector and implementing FSAP update recommendations. - Supported further participation in EU supervisory colleges and developing arrangements for cross-border cooperation among supervisors of non-EU banking groups and investment funds. - Advised pursuing regulatory enhancements not requiring legislation and encouraging banks to prepare for tighter liquidity standards under Basel III. - Saw scope for revisiting institutional arrangements for regulation and supervision to better align with evolving international standards. - Noted authorities’ commitment to comply with revised FATF standards for AML/CFT. - Fiscal policy recommendations: - Welcomed 2012 budget support to the economy; urged adherence to expenditure allocations and cautioned that reliance on public investment caps could hurt long-term growth. - Agreed that automatic stabilizers should be allowed to operate if downside risks materialize, though some Directors questioned effectiveness given low fiscal multipliers and need to preserve credibility. - Encouraged high-quality consolidation measures supported by a medium-term fiscal framework. - Urged more comprehensive reform of pension and healthcare systems to ensure fiscal sustainability. - Structural and labor market policies: - Encouraged further steps to improve active labor market policies and social safety net to minimize work disincentives and address labor market rigidities. - Suggested revising or eliminating the wage indexation system in the medium term to limit adverse competitiveness effects. - Recommended reviewing product market regulations to foster competition, productivity growth, and economic diversification. ### Selected economic indicators (exact values reported) - Real economy (Change in percent, unless otherwise indicated): - Real GDP: 2009: -5.3; 2010: 2.7; 2011: 1.6; 2012 /1: 0.5 - Gross investment: 2009: -21.9; 2010: 16.2; 2011: 10.7; 2012 /1: 2.0 - Unemployment (as percent of the labor force): 2009: 5.8; 2010: 6.2; 2011: 5.7; 2012 /1: 6.2 - Resident employment (thousands): 2009: 216.0; 2010: 219.1; 2011: 225.3; 2012 /1: 227.6 - Total employment (thousands): 2009: 352.2; 2010: 357.8; 2011: 368.4; 2012 /1: 375.3 - CPI (harmonized), p.a.: 2009: 0.0; 2010: 2.8; 2011: 3.7; 2012 /1: 2.3 - Public finances (Percent of GDP): - General government revenues: 2009: 42.2; 2010: 41.6; 2011: 41.4; 2012 /1: 42.1 - General government expenditures: 2009: 43.0; 2010: 42.4; 2011: 42.0; 2012 /1: 44.0 - General government balance: 2009: -0.8; 2010: -0.9; 2011: -0.6; 2012 /1: -1.9 - General government gross debt: 2009: 14.8; 2010: 19.1; 2011: 18.2; 2012 /1: 21.4 - Balance of payments: - Current account balance: 2009: 6.5; 2010: 7.7; 2011: 7.1; 2012 /1: 7.2 - Balance of trade in goods and services: 2009: 39.3; 2010: 46.1; 2011: 41.3; 2012 /1: 39.5 - Factor income balance: 2009: -30.1; 2010: -36.8; 2011: -31.5; 2012 /1: -30.6 - Transfer balance: 2009: -2.8; 2010: -1.7; 2011: -2.8; 2012 /1: -1.7 - Exchange rates: - Member of the euro area - U.S. dollar per euro: 2009: 1.4; 2010: 1.3; 2011: 1.4; 2012 /1: ... - Nominal effective rate (2005=100): 2009: 104.9; 2010: 102.1; 2011: 102.6; 2012 /1: ... - Sources noted: Data provided by the authorities; IMF, WEO database; and IMF staff calculations. - Note: 1/ IMF Staff projections. ### Authorities’ statement and responses to staff analysis - Authorities’ overall stance: - Thank staff for comprehensive analysis but consider staff report structure not rightly balanced given heavy coverage of financial sector issues. - Broadly share staff views but would have preferred more analysis and advice on macro-policy and public finances. - Growth and labor market: - Authorities report 2010 growth of 2.7 percent and 2011 growth of 1.6 percent; Statistical Office (Statec) and Central Bank of Luxembourg (BCL) project real growth of 1 percent in 2012 and recovery to just above 2 percent in 2013. - Employment growth remained positive at 1.9 percent in April 2012; unemployment reached a historical peak of 6.1 percent in April 2012. - Authorities note structural unemployment concentrated among low-skilled (almost half) and older than 50 (a quarter). - Public finances and fiscal policy: - General government deficit declined from 0.9 percent of GDP in 2010 to 0.6 percent in 2011; debt-to-GDP ratio declined from 19.1 percent to 18.2 percent. - Government allows fiscal deficit to increase to 1.5 percent of GDP in 2012 given weak GDP-growth. - Stability and Growth Program (April 2012) includes fiscal consolidation measures for 2013–2015: projected reduction of deficit to 1.2 percent of GDP in 2013 and additional 1 percent of GDP annually thereafter compared to unchanged policies; adjustment measures include expenditure reductions for 2/3 and revenue increases for 1/3. - Authorities skeptical of letting automatic stabilizers operate given low fiscal multipliers. - Projected VAT regime change will cause a revenue loss of about 1 percent of GDP in 2015 due to shift from domicile of e-commerce provider to residence of consumer; phased transfer: 70 percent of VAT receipts transferred to consumer countries during first two-year period, 85 percent in 2017 and 2018, and 100 percent in 2019. - Authorities commit to adopt additional measures if medium-term objective of a structural surplus of 0.5 percent of GDP in 2015 is not achieved. - Note that net public debt is significantly lower and public debt entirely denominated in euros; emphasize maintaining low public debt levels well below Maastricht criteria. - Reforms: healthcare reform effective January 1, 2011; hospital sector restructuring starting in 2013; draft pension reform to be discussed in Parliament in second half of 2012; plans for a multi-year budgetary framework and multi-year expenditure ceilings. - Financial sector and supervision: - Aggregate bank balance sheet recovered to more than euro 800 billion in January 2012, receded and stabilized in April 2012 slightly higher than 2011 yearly average (780 billion euros). - Bank profits before taxes, depreciation and provisions declined by more than 11 percent in Q1 2012 to around 1.4 billion euros. - Investment fund assets in Luxembourg-domiciled regulated funds reached over 2.2 trillion euro in April 2012. - CSSF increased capital requirements for all Luxembourg based banks to a minimum 9 percent of risk-weighted assets in Core Tier I capital following EBA recommendation of 8 December 2011. - Authorities acknowledge potential challenges applying Basel III liquidity standards at solo/sub-consolidated level; CSSF and BCL closely following developments. - Supervisory enhancements: increased on-site inspections (from 38 in 2009 to 85 in 2011 for banks) and increased inspections of investment funds (72 in 2011); BCL expanded supervisory activities and created units for liquidity surveillance, oversight of payment and settlement infrastructures, and financial stability. - Authorities intend legislative actions in second part of 2012 to: clarify CSSF and BCL roles on liquidity risk supervision; establish a national macro-prudential authority with the central bank taking a leading role; and strengthen CSSF’s operational independence, stressing accountability and responsibility. - Diversification and competitiveness: - Financial sector accounts: close to 30 percent of GDP; contributes around 25 percent of total revenues and around 10 percent of employment. - Luxembourg Future Fund established early 2012 to support diversification; government will invest 120 million euro via SNCI and European Investment Fund will contribute another 30 million euros; government will invest in health sciences and technology via an existing private fund. - Authorities noted deterioration in price competitiveness driven by unit labor costs rising faster than in neighboring countries; automatic wage indexation linked to inflation. - Measures to improve competitiveness: law adopted in December 2011 to temporarily modify automatic indexation of wages — postponed indexation from March 2012 to October 2012; until 2014 at least 12 months should elapse between each indexation step of 2.5 percent. *2012 ARTICLE IV REPORT—INFORMATIONAL ANNEX LUXEMBOURG* ### introduction of this minimum interval, wages and benefits will no longer be fully indexed ### _cr12160 - introduction of this minimum interval, wages and benefits will no longer be fully indexed ### Modulation of the wage indexation system - Wages and benefits will no longer be fully indexed to the cost of living in the event that inflation exceeds 2.5 percent. - This measure is described as a “modulation of the wage indexation system”. - The modulation prevents an upward spiral of cost and price increases. - From 2015 on, the automatic indexation will return to its previous mode, but the counter for the next automatic wage indexation will be set to zero. ### Duration, permanence, and effects on competitiveness - The modulation will have a temporary effect on cost competitiveness, especially in times of high inflation. - As a consequence, some of the gains in cost competitiveness will be permanent. - The authorities recognize that the modulation is only temporary and that the room of manoeuvre in terms of productivity gains is getting smaller. ### Policy actions and social dialogue - During this temporary modulation period, the authorities will be working with unions and employers’ representatives on a more permanent solution which should not undermine social cohesion in Luxembourg. - It is essential to ensure competitiveness by limiting the growth of unit labor costs. *Source: _cr12160 - introduction of this minimum interval, wages and benefits will no longer be fully indexed* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12160.pdf_