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### Macroeconomic setting and political context
- Worsening euro area crisis since mid-2010 pushed Belgian sovereign bond spreads up through co-movement with program countries, Italy, and Spain, reflecting:
  - High public debt.
  - Large exposure of the banking sector to the three program countries, Italy, and Spain.
  - Increased government contingent liabilities from bank restructuring.
- Domestic factors also contributed to the rise in the Belgian government bond spread:
  - Domestic pressures intensified in 2011 during a prolonged caretaker government and market concerns about Dexia.
  - The domestic factor’s contribution to the spread halted after a fiscal consolidation plan was agreed in November 2011, paving the way for a new government.
- New federal coalition assumed office on December 6, 2011; government program includes the Sixth Reform of the State, a fiscal consolidation plan, and an entitlement reform.
  - Sixth Reform of the State (agreed October 2011; expected effect in 2014) devolves additional spending responsibilities amounting to 4.4 percent of GDP (some €16 billion) and grants Regions autonomy over personal income tax revenues amounting to 2.9 percent of GDP.

### Dexia resolution: structure, guarantees, and fiscal implications
- Breakup announced October 10, 2011; group split into three parts with key elements:
  - Sale of group’s share holdings in Dexia Bank Belgium (DBB) to the Belgian state for €4 billion (1.1 percent of Belgian GDP); Dexia SA retains an earn-out right if DBB is resold within five years.
  - France: February 10, 2012 agreement among CDC, Banque Postale, and the French state for public sector financing via a joint venture and new credit establishment (ownership shares: French State 31.7 percent, CDC 31.7 percent, DCL 31.7 percent, Banque Postale 4.9 percent).
  - Negotiations underway for sale of other parts including DBIL and Denizbank.
- Public guarantees and temporary approvals:
  - Joint guarantee by Belgium (60.5 percent), France (36.5 percent), and Luxembourg (3 percent) for up to €90 billion over 10 years.
  - European Commission temporary approval for a guarantee of up to €45 billion of financing with maturities of up to three years.
  - Belgium’s share in the temporary guarantee: €27 billion (about 7½ percent of GDP).
- Fiscal and contingent liabilities and fiscal costs:
  - Two shareholder entities insolvent and to be liquidated.
  - Based on current estimates, eventual fiscal cost may be up to ¾ percent of GDP.
  - Specific impacts:
    - Communal Holding liquidation loss: some €0.8 billion.
    - Arco Group guarantee for members’ capital: about 1.5 billion (net of proceeds).
    - Ethias support: €180 million in public sector support in January 2012 bond issue.
  - Immediate impact on general government debt small under current Eurostat rules: increase by purchase price of DBB (1.1 percent of GDP) to extent funds raised in debt markets; guarantees remain contingent unless called.

### Financial stress, bank vulnerabilities, and sovereign–bank nexus
- Dexia funding and balance-sheet indicators:
  - Short-term liabilities: €260 billion in 2008 → €96 billion by June 2011.
  - At 2008 bail-out, 43 percent of Dexia’s balance sheet financed by short-term instruments.
  - Reliance on short-term wholesale funding remained at one-fourth of Dexia’s total funding needs in June 2011.
  - Core Tier 1 ratio: 12.1 percent at end-2010; 10.4 percent under EBA July 2011 stressed scenario.
  - Risk-weighted assets: 21 percent of total assets; many assets had zero risk-weighting.
- Funding strains included margin calls on interest rate swaps, lack of unencumbered collateral, and depositor runs in early October 2011, prompting public authority intervention in Belgium, France, and Luxembourg.
- Banking sector exposures and contingent liabilities:
  - Total exposure of banking sector to the government as of September 2011: €111.3 billion (€66.7 billion in debt securities; €44.6 billion in loans) — about 9 percent of banking sector assets.
  - New contingent liabilities for Dexia currently reaching up to 7½ percent of GDP.
  - Previously issued guarantees related to KBC, Fortis, and Dexia amount to another 8 percent of GDP; combined contingent liabilities elsewhere amount to 15½ percent of GDP.
  - KBC’s net direct exposure to the Belgian sovereign: €21 billion (168 percent of Tier 1 capital) as of end-September 2011 (of which €14 billion held as available for sale in the banking book and €0.7 billion in the trading book).
  - Consolidated claims of Belgian banks on the three euro area program countries: €52.9 billion (94 percent of Tier 1 capital); exposures to sovereigns €14 billion (25 percent of bank Tier 1 capital).
- Market indicators and rollover needs:
  - Five-year sovereign CDS spread rose above 400 basis points before the December 2011 euro summit, then fell below 250 basis points by end-January 2012.
  - Rollover needs in February–March 2012: €24½ billion (6½ percent of GDP); another spike in September 2012 of €13 billion.
  - Sovereign downgrades reflect intimate ties between financial sector and the sovereign.

### Banking sector deleveraging and geography of exposures
- Consolidated Belgian banks (2007 → Sep-11, euro billion, percent changes):
  - Total assets: 1,578.4 → 1,184.7; % Change: -24.9
  - Loans and advances: 987.0 → 721.2; % Change: -26.9
    - Credit institutions: 320.8 → 211.3; % Change: -34.1
    - Corporate: 313.5 → 193.7; % Change: -38.2
    - Retail: 276.2 → 264.3; % Change: -4.3
    - Central governments: 16.4 → 6.6; % Change: -59.8
    - Non-credit institutions: 60.1 → 45.3; % Change: -24.6
  - Debt securities: 295.9 → 214.7; % Change: -27.4
    - Credit institutions: 80.2 → 27.2; % Change: -66.1
    - Corporate: 70.2 → 37.6; % Change: -46.4
    - Central governments: 136.6 → 142.4; % Change: 4.2
    - Non-credit institutions: 8.9 → 7.5; % Change: -15.7
  - Risk weighted assets: 583.5 → 361.3; % Change: -38.1
- External exposures:
  - Claims abroad of BIS-reporting Belgian banks: peak 300 percent of Belgian GDP at end-2008 → about 72 percent at end-September 2011.
  - Belgian foreign exposure fell to the euro area average and below France (110 percent of GDP) and the Netherlands (164 percent of GDP).
  - Largest remaining asset exposures: France, the Czech Republic, the U.K., and the U.S.
  - Emerging Europe exposures decreased by about 8 percent overall; mixed country picture (Czech Republic exposure increased; Turkey and Russia declined markedly; Poland and Hungary decreased less).
- Deleveraging in Emerging Europe poses risks: sales of foreign subsidiaries may be challenging and less profitable; reduced lending in host markets may affect profitability and require business model changes.
  - In Turkey, subsidiaries of Belgian banks account for 3.4 percent of total banking sector assets; in Russia 0.3 percent.
  - In the Czech Republic, Hungary, and the Slovak Republic, Belgian banks account for 20.2 percent, 11.4 percent, and 10.4 percent of banking sector assets, respectively.

### Growth outlook, potential output, and external spillovers
- Growth projections and risks:
  - Real GDP growth projected to stall in 2012, and to resume gradually from 2013 to almost 2 percent over the medium term.
  - Potential growth projected to revert to about 1½ percent over the medium term as the output gap closes.
  - Long-run growth estimated at just below 2 percent.
- Potential output estimation (three approaches and findings):
  - HP filter, production function, and multivariate (MV) Bayesian approaches used.
  - All estimates show potential GDP growth fallen from almost 2 to about 1 percent; potential GDP growth likely to recover to close to 1½ percent by 2016.
  - Production function attributes drop mainly to lower capital usage; employment losses contributed ¼ percentage points; TFP on a declining trend prior to 2008.
  - MV approach suggests fastest recovery; HP filter yields lowest estimate (1 percent by 2016).
- Spillovers and sensitivity:
  - Export-to-GDP ratio: 79 percent.
  - Three quarters of merchandise exports to EU; close to two thirds go to Germany, France and the Netherlands.
  - FDI position in Belgium: 93 percent of GDP; Belgian FDI abroad: 74 percent of GDP.
  - OLS regression: more than 50 percent of variation in Belgian q-on-q real GDP growth explained by contemporaneous growth of Germany, France, Italy, and Spain.
  - VAR estimates: a half-standard-deviation slowdown in domestic demand growth in program countries and Italy and Spain could reduce Belgian growth by ¾ percent in 2012 and ½ percent in 2013.
  - Trading partner fiscal consolidation projected to tighten structural balances by an average of 1 percent of GDP in 2012 and ½ percent in 2013; staff estimates this reduces Belgian growth by about ¼ percent in 2012–13.
  - Domestic fiscal consolidation would reduce growth by another ¼ percent in 2012 and ¾ percent in 2013, assuming a fiscal multiplier of 0.4.
  - Outward spillover of envisaged Belgian consolidation reduces main trading partner growth by less than 0.05 percent.

### Inflation, wage indexation, competitiveness, and labor market
- Inflation and indexation:
  - Annual consumer price inflation around 3½ percent through much of 2011, mainly due to energy price rises.
  - Automatic wage indexation mechanism triggered in early 2012; a 2 percent wage and benefit increase estimated to cost ½ percent of GDP and weaken wage cost competitiveness.
  - Real effective exchange rate (CPI-based) appreciated by 1¼ percent since mid-2010 trough; unit labor costs real appreciation of 3 percent since mid-2010 (productivity increase 1 percent).
- Labor market:
  - Unemployment rate receded to 7.3 percent in November 2011 from 8.5 percent in March 2010; long-term unemployment marginally fell to 3¾ percent.
  - Labor force participation rate remained 66.9 percent in 2011:Q3.
  - Subsidized employment schemes expanded access during the crisis; fiscal cost more than 1 percent of GDP and may hinder labor reallocation.
  - Regional unemployment (2010): West-Flanders 3.8 percent; Brussels 17.3 percent; high concentration in Wallonia and Brussels.
  - Average effective retirement age: 59 years in 2009; plan to raise minimum early retirement age from 60 to 62 years by 2016.
  - Increasing effective retirement age by one year estimated to yield structural savings of ½ percent of GDP.
- Policy recommendations on labor and pensions:
  - Abolish or significantly reconsider automatic wage indexation to increase wage flexibility and competitiveness.
  - Increase scope for tailor-made sectoral wage negotiations.
  - Reduce high labor tax wedge to boost labor demand; compensate lost revenue by broadening VAT base, streamlining tax expenditures, raising environmental taxes, and revising immovable property tax.
  - Aim to increase employment rate by 5 percentage points by 2020 (from current level of 68 percent).

### Fiscal consolidation, public debt dynamics, and scenarios
- 2011 outturn and 2012 measures:
  - Fiscal deficit: 4 percent of GDP in 2011 (target was 3.6 percent).
  - Stock of general government debt: 98.6 percent of GDP at end-2011.
  - Dexia-related fiscal support entailed some 0.2 percent of GDP to several entities.
  - 2012 budget contains fiscal consolidation measures of 2½ percent of GDP; structural consolidation about 1½ percent of GDP, bringing 2012 deficit to 2.9 percent of GDP.
  - Half of fiscal savings from revenue measures; offsetting factors include automatic indexation and an increase in pensioners raising pension outlays by ¼ percent of GDP in 2012.
- Additional consolidation 2013–15:
  - Additional measures required to achieve structural balance by 2015.
  - Government program includes measures of some ½ percent of GDP effective in 2013 (increased excise taxes on polluting cars; combating fiscal fraud; rising employment from labor reforms).
  - Revenue impacts from labor market reforms may not materialize if weak growth extends through 2013.
- Fiscal sensitivity and contingent liabilities:
  - Baseline: public debt rises to about 99 percent of GDP in 2012–13 before declining to about 88 percent by 2017.
  - A 1¼ percent of GDP increase in the primary deficit, a 1 percent interest rate increase, or a 1 percent slowdown in growth would raise general government debt above 100 percent of GDP in 2013 or 2014.
  - If half of contingent liabilities (15½ percent of GDP) came due in 2012, general government debt would rise to 106 percent of GDP in 2012 and remain above GDP until 2015.
- Composition of 2012 fiscal package (percent of GDP):
  - Revenues: 1.3
  - Tax revenues: 1.0
    - Notional interest tax deductibility: 0.4
    - Tax on movable property: 0.2
  - Nontax revenue: 0.2
  - Expenditures: 0.7
    - Health care: 0.2
    - Other: 0.6
  - TOTAL: 2.5

### Projections and selected quantitative indicators (highlights from 2007–17 series)
- Real GDP (2007–17): 2.9, 1.0, -2.8, 2.3, 1.9, -0.1, 0.8, 1.3, 1.6, 1.8, 1.9
- Potential output growth (2007–17): 1.9, 1.5, 1.1, 1.1, 0.9, 0.9, 1.0, 1.1, 1.2, 1.4, 1.5
- Output gap (percent): 2.0, 1.3, -2.4, -1.3, -0.3, -1.3, -1.5, -1.3, -0.9, -0.5, -0.1
- General government balance (percent of GDP): -0.3, -1.3, -5.8, -4.1, -4.0, -2.9, -2.2, -1.2, -0.4, -0.2, 0.0
- Debt (general government, percent of GDP): 84.1, 89.3, 95.9, 96.2, 98.6, 99.4, 99.4, 97.6, 94.8, 91.6, 88.1
- Unemployment rate (2007–17): 7.5, 7.0, 7.9, 8.3, 7.3, 8.0, 8.6, 8.8, 8.9, 8.6, 8.3
- Consumer prices (2007–17): 1.8, 4.5, 0.0, 2.3, 3.5, 2.2, 1.9, 1.9, 1.9, 1.9, 2.0
- Balance on current account (percent of GDP, 2007–17): 1.6, -1.6, -1.7, 1.5, 0.0, -0.1, 0.6, 1.0, 1.4, 1.5, 1.6

### Financial sector soundness and market indicators (selected)
- Regulatory Tier I capital to risk-weighted assets (2006–11): 8.7, 12.1, 11.3, 13.2, 15.5, 15.6
- Non-performing loans (NPL) as percent of gross loans (2006–11): 1.7, 1.4, 1.7, 2.7, 2.8, 2.8
- Household debt (percent of GDP, 2006–11): 45.9, 47.8, 50.1, 53.9, 55.5, 54.3
- Selected CDS spreads (period averages, basis points):
  - Dexia (recent series): 183.5, 185.2, 264.3, 287.1, 264.2, 320.7, 284.6, 575.1, 742.7
  - KBC (recent series): 150.6, 114.6, 123.6, 128.5, 152.6, 227.3, 187.8, 274.7, 383.9

### Policy recommendations and priorities
- Fiscal policy:
  - Implement a credible medium-term fiscal consolidation plan to preserve market confidence, address aging costs, and reduce public debt toward 60 percent of GDP over the longer term.
  - Reduce fiscal deficit below 3 percent of GDP in 2012 and achieve structural balance by 2015.
  - Focus consolidation on structural measures, notably entitlement reforms, to limit near-term growth damage and allow automatic stabilizers to operate where possible.
  - Strengthen the institutional framework with a rules-based, multi-year budgetary framework and a burden-sharing agreement across government levels; adopt a structural balance fiscal rule in line with EU requirements and the Fiscal Compact.
- Financial sector:
  - Enlarge bank capital buffers if needed, possibly provided by the state.
  - Further strengthen banking supervision and implement Basel III and Solvency II frameworks; develop macroprudential tools and crisis management and cross-border resolution frameworks.
  - Finalize deposit guarantee scheme legislation and enact covered bond legislation.
- Labor market, pensions, and product market reforms:
  - Raise effective retirement age and undertake comprehensive pension reform (national dialogue recommended).
  - Reduce labor tax wedge and re-balance with indirect taxes; broaden VAT base and reduce tax exemptions.
  - Abolish or reconsider automatic wage indexation; increase scope for sectoral wage negotiations; strengthen activation and job-search assistance.
  - Strengthen competition policy (including energy) and fully implement the EU Services Directive.
- Contingency and sequencing:
  - Prioritize expenditure-side consolidation given high revenue-to-GDP ratio near 50 percent.
  - If growth falls substantially below baseline, allow automatic stabilizers to operate provided government market access is not jeopardized.

*Italic source: 2011 ARTICLE IV REPORT — BELGIUM (Selected extracts) and IMF staff materials from the Belgium 2011 Article IV Report excerpt provided.*

### 1. Selected Economic Indicators, 2007–17 _______________________________________________________ 39

### 1. Selected Economic Indicators, 2007–17

### The macroeconomic setting: worsening euro area crisis and new political start
- Belgian sovereign bond spreads were pushed up since mid-2010 by co-movement with sovereign bond markets of the three euro area program countries, Italy, and Spain, reflecting:
  - High public debt.
  - Large exposure of the banking sector to the three program countries, Italy, and Spain.
  - Increase in government contingent liabilities from bank restructuring.
- A VAR analysis of sovereign bond spreads in fourteen European Union countries suggests domestic factors also contributed to the rise in the Belgian government bond spread.
  - Domestic pressures intensified during 2011 as a caretaker government persisted and market concerns rose about Dexia and attendant fiscal risks.
  - The domestic factor’s contribution to the spread halted after a fiscal consolidation plan was agreed in November 2011, paving the way for a new government.

### Financial stress, liquidity, and bank vulnerabilities
- Dexia’s accelerated deleveraging after its 2008 restructuring became infeasible as the euro area crisis intensified:
  - Short-term liabilities fell from €260 billion in 2008 to €96 billion by June 2011.
  - At the time of the 2008 bail-out, 43 percent of Dexia’s balance sheet was financed by short-term instruments.
  - Reliance on short-term wholesale funding remained at one-fourth of Dexia’s total funding needs in June 2011.
  - Core Tier 1 ratio was 12.1 percent at end-2010 and 10.4 percent under the stressed scenario in the EBA July 2011 stress test.
  - Risk-weighted assets were 21 percent of total assets; many assets had zero risk-weighting.
- Funding strains included margin calls on interest rate swaps, lack of unencumbered collateral, and depositor runs in early October 2011, prompting public authority intervention in Belgium, France, and Luxembourg.

### Resolution of Dexia (Box 1): structure and fiscal implications
- The breakup of Dexia Group (SA) was announced on October 10, 2011. The group was split into three parts:
  - Dexia SA’s Belgian operations: sale of group’s share holdings in Dexia Bank Belgium (DBB) to the Belgian state for an amount of €4 billion (1.1 percent of Belgian GDP). Dexia SA retains an earn-out right if DBB is resold within five years.
  - France: agreement on February 10, 2012 between CDC, Banque Postale, and the French state to secure public sector financing via a joint venture and creation of a new credit establishment (ownership shares: French State 31.7 percent, CDC 31.7 percent, DCL 31.7 percent, Banque Postale 4.9 percent). DCL to continue operating under a banking license.
  - Negotiations underway for sale of other parts including DBIL and Denizbank; other parts to be sold later depending on market conditions.
- Public guarantees and temporary approvals:
  - Governments of Belgium (60.5 percent), France (36.5 percent), and Luxembourg (3 percent) to guarantee funding of Dexia SA and DCL in a several guarantee of up to €90 billion over 10 years.
  - European Commission provided temporary approval for a guarantee of up to €45 billion of financing with maturities of up to three years while restructuring is finalized.
  - Belgium’s share in the temporary guarantee amounts to €27 billion (about 7½ percent of GDP).
- Fiscal and contingent liabilities and fiscal costs:
  - Two shareholder entities became insolvent and will be liquidated.
  - Based on current estimates, the eventual fiscal cost may be up to ¾ percent of GDP.
  - Specific fiscal impacts:
    - Communal Holding (14 percent stake in Dexia SA) to be liquidated at a loss of some €0.8 billion shared by Belgium’s Regions, the federal government, and DBB.
    - Arco Group (14 percent stake) received a government guarantee for individual members’ capital of about 1.5 billion (net of proceeds from asset sales); Arco will be liquidated.
    - Ethias (balance sheet of 7 percent of GDP and a 5 percent stake in Dexia) incurred losses; €180 million in public sector support in a bond issue in January 2012.
  - Immediate impact on general government debt is small under current Eurostat rules: increase by the purchase price of DBB (1.1 percent of GDP) to the extent funds are raised in debt markets; guarantees remain contingent liabilities unless called.

### Financial market volatility and sovereign–bank nexus
- Market indicators and developments:
  - In the run-up to the euro summit in December 2011, Belgium’s five-year sovereign CDS spread rose above 400 basis points, then fell below 250 basis points by end-January 2012.
  - Spreads expected to remain under pressure due to high public debt, financial sector vulnerability to euro area market turmoil, and close interlinkages between banks and the Belgian sovereign.
- Rollover needs and maturities:
  - Rollover needs (mainly sovereign) in February and March are sizable: €24½ billion, or 6½ percent of GDP.
  - Another spike in rollover needs (€13 billion) will occur in September 2012.
- Banks hold substantial amounts of government securities and loans to the public sector; the state has provided capital support and guarantees to financial institutions, increasing contingent fiscal liabilities.
- Recent sovereign downgrades by major rating agencies reflect the intimate ties between the financial sector and the sovereign.

### Political breakthrough and the Sixth Reform of the State
- After more than 540 days under a caretaker government, a new federal coalition assumed office on December 6, 2011. The government program includes:
  - A state reform (Sixth Reform of the State).
  - A fiscal consolidation plan.
  - An entitlement reform.
- The Sixth Reform of the State (agreed in October 2011; expected to come into effect in 2014) comprises political reform and enhanced fiscal decentralization:
  - Fiscal decentralization and new responsibilities:
    - Regions and Communities receive additional spending responsibilities amounting to 4.4 percent of GDP (some €16 billion) covering labor market and employment policies, long-term care, child benefits, and other items.
    - Regions gain autonomy over personal income tax revenues amounting to 2.9 percent of GDP.
    - A 10-year transfer arrangement ensures financing of the Walloon and Brussels-Capital Regions.
  - Political changes:
    - Flemish-speaking part broken out of the bilingual electoral district of Brussels-Halle-Vilvoorde.
    - From 2014, federal and regional elections held simultaneously in a five-year cycle.
    - Regions given the right to initiate popular consultations on regional issues.
    - Short-term fiscal saving measures included, such as a 5 percent ministerial pay cut.
- Key elements of enhanced fiscal decentralization (preserved wording and figures):
  - Devolution of responsibilities to Regions and Communities:
    - Regions: labor market policies (€4 billion) and policies on tax exemptions for mortgages, energy savings, and service vouchers (€2 billion).
    - Communities: child allowances (€6 billion), old-age care (€3 billion), and some other health care expenditures (€1 billion).
    - Total new responsibilities: some €16 billion (4.4 percent of GDP).
  - Greater tax autonomy for Regions:
    - Regions authorized to set their own schedule of regional PIT rates and brackets in addition to a federal PIT schedule.
    - Deviation in tax progressivity of the regional PIT schedule from the federal one is limited to €1,000 per tax payer.
    - Regional PIT revenues calibrated to represent €10.7 billion (2.9 percent of GDP).
  - Revised system of transfers to Regions:
    - Regions receive a transfer of 90 percent of the budget envelopes for employment policies and 60 percent of the fiscal expenditure budget for tax exemptions; remaining 40 percent part of amount transferred as revenues from greater tax autonomy.
    - Regions receive an 80 percent “solidarity transfer” of the difference between the Region’s share in the population and in PIT revenues.
    - Transitional transfer mechanism ensures no losses for Regions in the starting year.
    - Transfer amount fixed in nominal terms for first ten years, then reduced by 10 percent per year.
    - Brussels-Capital Region receives a permanent transfer of 0.1 percent of GDP for exceptional financing needs.
  - Revised funding of Communities:
    - Communities receive a budget transfer according to number of pupils (€14 billion) and distribution keys based on demographics to cover new spending responsibilities.
    - They receive an appropriation under the Regional fiscal allocation (€8 billion).
    - A transitional transfer mechanism analogous to that for Regions is foreseen.
  - Contribution for pensions of civil servants:
    - Regions and Communities will pay a contribution that will increase gradually to 8.86 percent of wages.

### Expected fiscal and institutional effects of the reform
- The state reform has no immediate impact on the overall general government balance but:
  - Strengthens federal government finances through smaller net spending responsibilities and more predictable budgeting.
  - Transfers some uncertainty of funding for devolved spending to Regions and Communities, who will bear the risk of fluctuating revenues.
  - Devolution of long-term care and labor market responsibilities is expected to better align incentives for containing costs.

*Source: 2011 ARTICLE IV REPORT — BELGIUM (Selected extracts).*

### 7.      However, the reform remains to be

### _cr1255 - 7.      However, the reform remains to be

### Fiscal framework and inter-governmental transfers
- Reform not yet set into a rules-based, multi-year budgetary framework in line with the EU Directive on Requirements for Budgetary Frameworks on the Member States approved in April 2011.
- Given complexity of the system of inter-governmental transfers, transparency should be improved through regular publication of comprehensive data on all transfers between each level of government.
- Improved transparency would clarify choices on inter-governmental burden sharing in the current fiscal consolidation.

### Growth momentum and recent performance
- Growth momentum slowed since early 2011 after a rebound in investment in 2010 and 2011:Q1 supported by solid export growth.
- Growth began to falter in 2011:Q2, alongside a marked slowdown in the rest of the euro area.
- Real GDP growth is estimated at 1.9 percent in 2011, above the euro area average (1.6 percent).

### Labor market developments
- Unemployment rate receded to 7.3 percent in November 2011 from its peak of 8.5 percent in March 2010.
- A wider group of workers was granted access to subsidized employment schemes during the crisis.
- Fiscal cost of these schemes is more than 1 percent of GDP.
- Long-term unemployment rate has fallen marginally to 3¾ percent but remained above the Netherlands (1½ percent) and Germany (2¾ percent).
- Labor force participation rate remained low at 66.9 percent in 2011:Q3.
- Subsidized employment has supported employment but hinders labor reallocation and new labor market entry.

### Inflation, wage indexation, and competitiveness
- Annual consumer price inflation remained around 3½ percent throughout much of 2011, mostly due to energy prices rising faster than in other EU countries.
- Automatic wage indexation mechanism for public sector employees and social benefits will be triggered in early 2012.
- The wage and benefit increase of 2 percent will represent a considerable burden on the budget (estimated at ½ percent of GDP) and further weaken wage cost competitiveness.
- The real effective exchange rate based on consumer prices appreciated by 1¼ percent since its post-crisis trough in mid-2010.
- Relatively high inflation, automatic wage indexation, and a modest 1 percent increase in labor productivity contributed to a 3 percent real appreciation in terms of unit labor costs since mid-2010.
- Risk that second-round effects of high past energy price inflation will widen the competitiveness gap and limit export growth.
- Current account surplus shrunk during first nine months of 2011 to virtual balance despite strong export growth to Asia.

### Private sector lending and corporate financing
- Private sector lending stabilized as bank deleveraging slowed during 2011.
- Credit standards for households and corporates did not change much in 2011 as larger global banks sought to regain home market share.
- Lending to households, especially mortgage lending, resumed since mid-2010.
- Lending to nonfinancial corporates remained weak as large enterprises substituted bond issuance for bank lending and credit demand dampened.

### Openness, trade concentration, and growth spillovers
- Export-to-GDP ratio is 79 percent.
- Three quarters of total merchandise exports are accounted for by the European Union; close to two thirds of exports go to Germany, France and the Netherlands.
- FDI position in Belgium is 93 percent of GDP (stock among the highest in the EU); Belgian FDI abroad is 74 percent of GDP.
- OLS regression of Belgian q-on-q real GDP growth on contemporaneous growth of Germany, France, Italy, and Spain: more than 50 percent of variation in Belgian GDP growth can be explained by those four countries’ growth rates.
- Long-run growth estimated at just below 2 percent.
- VAR estimates: a sharp slowdown in domestic demand growth—by half a standard deviation—in euro area program countries and Italy and Spain could reduce Belgian growth by ¾ percent in 2012 and ½ percent in 2013.
- Trading partner fiscal consolidation projected to tighten structural fiscal balances by an average of 1 percent of GDP in 2012 and ½ percent in 2013; staff estimates trading partner fiscal consolidation will reduce Belgian growth by about ¼ percent in 2012–13.
- Domestic fiscal consolidation would reduce growth by another ¼ percent in 2012 and ¾ percent in 2013, assuming a fiscal multiplier of 0.4.
- Outward spillover of envisaged Belgian fiscal consolidation reduces main trading partner growth by less than 0.05 percent.

### Banking sector deleveraging and exposures
- Claims abroad of BIS-reporting Belgian banks dropped from a peak of 300 percent of Belgian GDP at end-2008 to about 72 percent at end-September 2011.
- Belgian foreign exposure fell to the euro area average and is well below France (110 percent of GDP) and the Netherlands (164 percent of GDP).
- Largest remaining asset exposures are claims on France, the Czech Republic, the U.K., and the U.S.
- On a consolidated basis, BIS-reporting Belgian banks retained at end-September 2011 exposures to Italy, Spain, and other countries with weak growth prospects and stressed financial markets.
- Deleveraging and split of Fortis (and later breakup of Dexia) contributed to reductions in claims abroad; split of Dexia in October 2011 will result in a further reduction in 2011:Q4.

### Deleveraging geography and emerging market exposures
- External exposures to Europe and the United States decreased sharply during 2008–09; reduction of foreign exposures slowed in 2010–11.
- Main exposures to Emerging Europe decreased by about 8 percent overall; mixed country picture:
  - Exposure to the Czech Republic increased.
  - Exposures to Turkey and Russia declined markedly.
  - Exposures to Poland and Hungary decreased to a lesser extent.
- Deleveraging in Emerging Europe poses risks for banks and host markets: sales of foreign subsidiaries may be challenging and less profitable; reducing lending in host markets may affect group profitability and require business model changes.

*Source: IMF staff and materials from the Belgium 2011 Article IV Report excerpt provided.*

### Box 3. Deleveraging in Financial Markets—the Belgian Experience (continued)

### Box 3. Deleveraging in Financial Markets—the Belgian Experience (continued)

### Deleveraging in host emerging markets and bank foreign subsidiaries
- Deleveraging of foreign subsidiaries may negatively influence the supply of credit in the future for host emerging markets.
- Evidence so far from markets where Belgian banks have deleveraged does not indicate a reduction in the level of financial intermediation.
- Possible explanations:
  - Substitution of credit supply by other banks operating in these markets.
  - In the longer term, reduced parent funding to foreign subsidiaries may lead to more conservative credit underwriting and a more sustainable business model based on increased reliance on local savings.
- Supervisory considerations in host countries:
  - Supervisors will need to be satisfied with the ownership structure, governance, and financial strength of potential investors during ownership changes.
- Notes and country market shares:
  - In Turkey, subsidiaries of the Belgian banks account for 3.4 percent of total banking sector assets, while in Russia for only 0.3 percent.
  - In the Czech Republic, Hungary, and the Slovak Republic, Belgian banks account for 20.2 percent, 11.4 percent, and 10.4 percent of banking sector assets, respectively.
- Footnotes from source:
  - 1/ In the case of corporates, the decrease of the exposures may also be explained by a lower credit demand following the financial crisis.
  - 2/ A substantial part of the reduction of external assets in 2008 is attributed to Fortis, where the Dutch part of the financial group (Fortis Bank Netherlands) and an important part of the legacy portfolio have been carved out.
  - 3/ Announced restructuring plans indicate further disposals of subsidiaries in Emerging Europe.
  - 1/ (chart note) Amounts outstanding based on consolidated foreign claims of reporting banks on an ultimate risk basis.
  - Note: The Belgian banking sector data exclude ING Belgium and BNPP Fortis, classified respectively under the exposures of Dutch and French banks, and only include data from Dexia Bank Belgium and not other subsidiaries of Dexia Group.

### Banking sector exposures and sovereign interplay
- Total exposure of the banking sector to the government (including exposures to local authorities) as of September 2011:
  - €111.3 billion total exposure, comprising:
    - €66.7 billion in debt securities holdings.
    - €44.6 billion in loans.
  - This is about 9 percent of banking sector assets.
- Implications:
  - Sovereign downgrades could trigger additional impairments and increase funding costs, putting significant strains on the banking sector.
- State support and contingent liabilities:
  - The Belgian state holds significant participations in the three largest banks and has provided extensive guarantees.
  - New contingent liabilities for Dexia currently reaching up to 7½ percent of GDP.
  - Previously issued guarantees related to KBC, Fortis, and Dexia amount to another 8 percent of GDP.
  - Combined contingent liabilities noted elsewhere amount to 15½ percent of GDP (see fiscal scenarios below).
- Specific bank exposure note:
  - KBC’s net direct exposure to the Belgian sovereign amounted to €21 billion (168 percent of Tier 1 capital) as of end-September 2011, of which €14 billion is held as available for sale in the banking book and €0.7 billion in the trading book (subject to mark-to-market valuation).
- Consolidated claims of Belgian banks on public sectors in Greece, Italy, Ireland, Portugal and Spain, September 2011 (percent of Tier 1 capital) — exposures to the three euro area program countries totaled €52.9 billion (94 percent of Tier 1 capital), of which exposures to sovereigns were €14 billion (25 percent of bank Tier 1 capital). Exposures to the Greek sovereign amounted to €1 billion (1.7 percent of bank Tier 1 capital) after the 55 percent average impairment booked by the banks as of 2011:Q3.

### Macroeconomic outlook and risks
- Outlook and growth projections:
  - Real GDP growth is projected to stall in 2012, and to resume gradually from 2013 to almost 2 percent over the medium term.
  - Potential growth is projected to revert to its trend rate of about 1½ percent over the medium term as the output gap gradually closes.
- Inflation and labor:
  - Relatively high inflation in 2010–11 is being propagated by automatic wage indexation.
  - Sizable nominal wage increases would keep inflation above 2 percent in 2012; thereafter inflation is set to return within the ECB’s target range.
  - Unemployment is expected to rise with weak growth.
- Downside risks highlighted:
  - Vulnerability to financial market turmoil in the euro area and negative feedback loops between sovereign and financial sector.
  - Shocks to either sovereign or banks could significantly increase funding costs and trigger declines in credit and growth.
  - A sharper slowdown in key trading partners poses downside risks due to Belgium’s high trade openness and export concentration.
  - High household wealth may provide a buffer to the transmission of foreign shocks.

### Potential output (Box 4) — findings and methods
- Financial crises historically tend to be followed by lower output potential via channels including:
  - Decline in labor force participation.
  - Increases in structural unemployment.
  - Lower capital to labor ratios.
  - Limited access to finance hampering total factor productivity (TFP).
- Estimation challenges:
  - Estimating potential output is difficult after a recession; filtering techniques face end-point problems.
- Methods used to assess potential output (three approaches):
  - Hodrick-Prescott (HP) filter (univariate).
  - Production function approach (capital, labor, and TFP trends derived using HP filter).
  - Multivariate approach (MV) modeling joint behavior of output, unemployment, capacity utilization, inflation, and inflation expectations using Bayesian techniques to infer potential output and NAIRU.
  - 1/ (reference) A prior on the growth rate of potential output of 1.9 is applied in the MV estimation; estimation performed on quarterly data from 1995 onwards.
- Quantitative findings:
  - Potential GDP growth is likely to recover to close to 1½ percent by 2016.
  - Potential growth has fallen from almost 2 to about 1 percent according to all estimates, although over different horizons.
  - Production function approach attributes the drop largely to lower capital usage.
  - Employment losses contributed ¼ percentage points to the reduction in output potential.
  - Total factor productivity had been on a declining trend prior to 2008.
  - MV approach suggests the fastest recovery; HP filter yields the lowest estimate with only 1 percent by 2016.
  - Potential output growth of 1½ percent by 2016 is consistent with a linear extrapolation of the potential growth trend from 1996 to 2007 (trend implies gradual decline from 2 percent in 2007 to 1½ percent by 2016).
- Output gap dynamics:
  - The output gap narrowed rapidly from 2009 to 2011 but is estimated to widen again in 2012–13 and close by 2017.
  - Only when actual GDP growth regains strength from 2014 would the output gap start to close again and potential output recover driven by higher capital accumulation.
- Long-term demographic pressures:
  - Old age dependency ratio expected to rise from 26 percent in 2010 to 42 percent in 2060 and remain around that level for the following twenty years.
  - European Commission’s 2009 Aging Report estimates population aging could reduce potential real GDP growth by some ¾ percentage point.
  - Population aging would raise fiscal expenditures by 5½ percent of GDP between 2010 and 2060.

### Authorities’ views
- Authorities broadly agreed with staff’s outlook for 2012 but were somewhat more optimistic about 2013, expecting:
  - Progress with fiscal consolidation would bolster confidence and domestic demand.
  - Employment growth to be more resilient than staff projected due to planned labor market reforms.
- Authorities acknowledged downside risks and the damaging interaction between sovereign and financial sector and emphasized policies to reduce these risks.

### Policy discussions and recommendations
- Major policy objectives of the new government program:
  - Achieve fiscal sustainability over the medium term.
  - Contain risks in the financial sector.
  - Increase employment and growth.
- Fiscal policy recommendations:
  - A credible medium-term fiscal consolidation plan is needed to preserve market confidence, address aging costs, and reduce public debt to the 60 percent of GDP limit under the Stability and Growth Pact (SGP) over the longer term, in line with the EU Fiscal Compact.
  - Reducing the fiscal deficit below 3 percent of GDP in 2012 and achieving structural balance by 2015 are appropriate goals.
  - Consolidation should focus on structural measures, notably entitlement reforms, which do less damage to near-term growth.
  - Automatic stabilizers should be allowed to operate to cushion the slowdown’s impact.
- Financial sector recommendations:
  - Enlarge bank capital buffers if needed, possibly provided by the state, to enhance confidence and cope with worsening market conditions.
  - Further strengthen banking supervision and implement the Basel III and Solvency II frameworks.
  - Maintain strong safety nets and close cooperation between relevant authorities given market volatility.
- Labor market and pension reforms:
  - Reforms aimed at increasing the employment rate by 5 percentage points by 2020 (from current level of 68 percent) to boost potential growth and long-run fiscal sustainability.
  - Reform of pensions, unemployment benefits, and tax incentives to strengthen labor market participation and employment of weakly attached groups.

### Fiscal consolidation details and public debt dynamics
- 2011 fiscal outturn and debt:
  - Fiscal consolidation in 2011 was less than expected due to financial sector support and cyclical drop in revenues.
  - Fiscal support related to Dexia restructuring entailed some 0.2 percent of GDP to several entities.
  - Fiscal deficit remained at 4 percent of GDP in 2011, above the target of 3.6 percent of GDP.
  - Stock of general government debt rose to 98.6 percent of GDP at end-2011, partly due to nationalization of Dexia Bank Belgium (DBB).
- 2012 consolidation measures:
  - The 2012 budget contains fiscal consolidation measures of 2½ percent of GDP, including an expenditure freeze to be replaced by structural measures.
  - Structural consolidation effort amounts to some 1½ percent of GDP, bringing the 2012 deficit to 2.9 percent of GDP.
  - Half of fiscal savings are from revenue measures, especially taxes on various savings vehicles.
  - Offsetting factors include automatic wage and benefit indexation in early 2012 and an increase in pensioners raising pension outlays by ¼ percent of GDP in 2012.
  - If growth falls substantially below baseline, automatic stabilizers should operate freely provided government market access is not jeopardized.
- Additional consolidation 2013–15:
  - Additional measures will be necessary to achieve structural balance by 2015.
  - Government program includes measures of some ½ percent of GDP effective in 2013 (increased excise taxes on polluting cars; revenue gains from combating fiscal fraud; rising employment from labor market reforms).
  - Revenue impacts from labor market reforms may not materialize if weak growth extends through 2013.
- Public debt scenarios and sensitivities:
  - Under the baseline (if consolidation fully adhered to), public debt rises to about 99 percent of GDP in 2012–13 before declining to about 88 percent by 2017.
  - A 1¼ percent of GDP increase in the primary deficit, a 1 percent interest rate increase, or a 1 percent slowdown in growth would raise general government debt above 100 percent of GDP in 2013 or 2014.
  - Substantial contingent liabilities from bank support exist:
    - Funding guarantee approved to Dexia SA and Dexia Crédit Locale in December 2011 and contingent liabilities related to previously issued guarantees to KBC, Fortis, and Dexia amount to 15½ percent of GDP.
    - If half of these contingent liabilities came due in 2012, the stock of general government debt would rise to 106 percent of GDP in 2012 and remain above GDP until 2015.
- Fiscal savings measures (percent of GDP) contributing to the 2½ percent package in 2012 (source: Belgian authorities and IMF staff estimates):
  - Revenues: 1.3
  - Tax revenues: 1.0
    - of which: Notional interest tax deductibility: 0.4
    - Tax on movable property: 0.2
  - Nontax revenues: 0.2
  - Expenditures: 0.7
    - of which: Health care: 0.2
    - Other: 0.6
  - TOTAL: 2.5

*Italic source: IMF staff summary of "Box 3. Deleveraging in Financial Markets—the Belgian Experience (continued)" from the Belgium 2011 Article IV Report.*

### 29.      The additional consolidation effort

### 29.      The additional consolidation effort

### Main recommendations
- Additional consolidation should be centered on containing expenditures through entitlement reform and streamlining public sector employment, as well as on broadening the tax base.
- With a revenue-to-GDP ratio near 50 percent, and above that in the Netherlands and Germany, additional saving efforts should now focus on the expenditure side, especially further entitlement reform that will also boost potential growth.

### Pension reforms (findings and measures)
- Additional pension reforms are needed to contain rising aging-related costs; a national dialogue should be started to prepare a comprehensive pension reform.
- Key statistics and targets:
  - The average effective retirement age—at 59 years one of the lowest in the OECD in 2009—needs to be raised closer to the official retirement age (65 years).
  - The government has decided to gradually raise the minimum age for early retirement from 60 to 62 years by 2016.
  - An increase in the effective retirement age by one year is estimated to yield structural savings of ½ percent of GDP.
- Possible additional measures:
  - Removing fiscal indicatives for pre-pension benefits.
  - Further raising the early retirement threshold.
  - Counting spells of unemployment to a lesser degree towards pension benefits.
  - Introducing actuarially neutral discounts on pensions granted before the official retirement age of 65 to compensate for the longer benefit and shorter contribution periods.

### Health care spending
- Recommendation: Reduce the real growth norm for health care spending from 4½ percent to 2 percent to strengthen incentives for tighter expenditure control.
- Suggested instruments to achieve this:
  - Efficiency improvements.
  - Strengthening cost-saving incentives for health care providers and customers.
  - Aligning pharmaceutical reimbursement reference prices to those of generic products.
  - Increasing co-pay.

### Public sector employment
- Observation: Public sector employment is among the highest in the European Union as a share of total employment, resulting in a relatively high government wage bill.
- Opportunity: One-third of public servants are expected to retire by 2020, providing an opportunity to reduce wage costs by not replacing a sizable number of them at all levels of government.

### Revenue measures
- On the revenue side, considerable scope remains to reduce federal and regional tax exemptions.
- Reducing exemptions could help offset the fiscal impact of reducing the labor tax wedge and rebalance the relative weight of tax revenues towards indirect taxes.

### Institutional framework and fiscal rules
- The consolidation effort should be set into a strengthened institutional framework.
- A rules-based fiscal framework for the general government would add credibility to consolidation and long-term fiscal sustainability.
- A structural balance fiscal rule, in line with the EU Directive on Requirements for Budgetary Frameworks and the draft Treaty on Stability, Coordination, and Governance in the Economic and Monetary Union (Fiscal Compact), should include a provision that unforeseen additional revenues be assigned to public debt reduction.
- A transition period will be necessary as Belgium’s consolidation strategy aims at reducing the structural fiscal deficit below the general Fiscal Compact ceiling of 0.5 percent of GDP by 2015.
- Full implementation of the government’s medium-term consolidation strategy would reduce the public debt ratio by more than 10 percentage points by 2017, in line with the debt targets under the Fiscal Compact.

### Multi-year perspective and intergovernmental burden sharing
- A multi-year perspective, based on realistic revenue assumptions and an in-depth expenditure review, would help prioritize spending programs.
- Such a rules-based, multi-year framework for the general government would need to be complemented with a burden-sharing agreement between the different levels of government, including spending caps for each level.
- Close coordination between the regions and municipalities should help ensure adherence to the overall fiscal targets committed to at the European level.
- A burden-sharing agreement will become increasingly important as the state reform takes effect in 2014 and the degree of fiscal federalism widens.

### Authorities’ views (summary)
- The authorities broadly concurred with staff’s view.
- They reiterated their strong commitment to reduce the deficit below 3 percent of GDP in 2012, and confirmed that durable measures of sufficient magnitude (about ½ percent of GDP) would be identified to this end during the February budget review.
- Further budget reviews in 2012 would provide an opportunity to monitor progress against the budget targets and take further measures, if needed.
- The authorities agreed that additional consolidation would be needed to achieve structural balance by 2015, and stressed that medium-term consolidation would also need to include options to raise revenue.
- They considered reinforcing the institutional fiscal framework important, notably the adoption of a fiscal rule engaging all levels of government.

*Source: _cr1255 - 29.      The additional consolidation effort*

### chapter 3.

### _cr1255 - chapter 3.

### Regional unemployment and labor market structure
- In 2010, unemployment rates in Belgium ranged from 3.8 percent in West-Flanders to 17.3 percent in Brussels.
- High unemployment rates are concentrated in French-speaking Wallonia and Brussels and in provinces with formerly large mining sectors and steel industry.
- Provinces formerly dominated by mining industries exhibit the highest unemployment rates.
- Language barrier: "nine out of ten jobseekers in Wallonia and Brussels do not speak Dutch," which is a major obstacle to finding a job in Flanders and in Brussels.
- Mobility impediments include a fairly high rate of home ownership coupled with large transaction costs when people want to move.
- Regional disparities in the implementation of the unemployment benefit system:
  - In 2007, sanctions per hundred unoccupied job seekers were: Wallonia 2.51, Brussels 2.02, Flanders 6.92.
  - The relative ranking was reversed in 2010.

### Labor market and pension reform recommendations
- Abolish or significantly reconsider the automatic wage indexation mechanism to:
  - Increase flexibility in sectoral wage negotiation.
  - Improve wage cost competitiveness.
  - Avoid second-round effects of energy price volatility and potential increases in indirect taxation.
- Increase scope for tailor-made sectoral wage negotiations to:
  - Support competitiveness and job creation.
  - Reduce pressures to downsize staffing in recession-hit sectors.
  - Limit pressures on the budget.
- Reduce the high labor tax wedge to boost labor demand, while increasing the differential between wages and unemployment benefits to enhance incentives for job search.
  - OECD estimate referenced: "a 10 percentage point reduction in the tax wedge can increase employment over time by 3.7 percentage point in an average OECD country."
- Compensate lost revenue from lower labor taxation by:
  - Broadening the VAT tax base.
  - Streamlining tax expenditures.
  - Raising collection of environmental taxes to reach EU-15 levels.
  - Revising the immovable property tax.

### Fiscal revenue and tax indicators (selected figures)
- VAT revenue ratio in Belgium (total VAT revenue relative to its potential base) at end-2008: 0.49.
- Comparator VAT revenue ratios: EU-15 average 0.55; Germany 0.55; the Netherlands 0.6.
- Revenue from the immovable property tax at end-2008: 1.2 percent of GDP.
  - Comparator immovable property tax yields: France 2.4 percent of GDP; United Kingdom 3.5 percent of GDP; United States 3.1 percent of GDP.
- Legal retirement age referenced: 65 years.

### Competition policy and product/service market reform
- Strengthen competition policy further, including in the energy sector:
  - Reduce barriers to entry.
  - Strengthen regulatory oversight to limit rents and bring energy prices closer to levels in neighboring countries.
- Fully implement the EU Services Directive in national legislation; further steps needed to achieve full implementation.

### Authorities’ views (summary)
- Authorities view planned labor market reforms as important to increase employment and growth and expect measures to increase employment while monitoring progress carefully.
- Additional reforms may be considered to raise the effective retirement age closer to the official age.
- Support stepped up activation policies, including firms increasing employment of older workers and expanded and more efficient job search assistance.
- Authorities will keep the automatic wage indexation system under examination but cautioned that addressing it now could jeopardize support for ongoing labor market and pension reforms.
- Authorities agree that a reduction in labor taxation could help boost employment and growth; they concur with increasing environmental taxes and reducing tax expenditures but note coordination challenges because immovable property taxes are levied at the local authority level.

### Staff appraisal — macroeconomic outlook and fiscal priorities
- A recession in Belgium is underway since the third quarter of 2011; real GDP is expected to stagnate in 2012 with a slow recovery in 2013.
- Downside risks are significant due to Belgium’s open economy and large financial sector vulnerable to turmoil in the euro area.
- High public debt and strong interlinkages between banks and the sovereign pose continuing risks; risk of negative feedback loops between sovereign and financial sector endures.
- The government program aims to achieve a structurally balanced budget by 2015, complete financial sector restructuring, and raise the low employment rate by 5 percent by 2020.
- Priority: reduce the deficit in 2012 below the Stability Program’s ceiling of 3 percent of GDP.
  - The 2012 budget plus a partial spending freeze contain sizeable fiscal savings measures.
  - Important that the ad hoc spending freeze is replaced at the February budget review by structural measures sufficient to reach the deficit target.
- Consider reconsidering the costly automatic wage and benefit indexation against other spending priorities.
- If growth falls significantly below current projections, allow automatic stabilizers to operate to buffer the downturn as long as financial market access is not jeopardized.

### Medium-term consolidation and structural fiscal measures
- After 2012, additional consolidation will be required to achieve structural balance by 2015.
- With revenues already at almost 50 percent of GDP, focus should be on expenditure-side measures:
  - Further pension reforms to raise the effective retirement age.
  - Measures to contain the growth rate of health care spending.
  - Curtailing public sector employment by not replacing a sizable share of retiring public servants at all levels of government.
- Allow automatic stabilizers to operate freely around the consolidation path given weak near-term growth prospects.
- The consolidation effort should be set into a rules-based framework for the general government and be based on a renewed burden-sharing agreement between all levels of government, becoming increasingly important as the Sixth Reform of the State takes effect in 2014.

### Financial sector vulnerabilities and recommendations
- The financial sector is highly vulnerable to sovereign and market turmoil in the euro area; interplay with the sovereign has intensified.
- Deleveraging remains challenged by difficult asset disposals; profits likely under pressure from intensifying domestic competition and a worsening economic outlook.
- Restructuring of Dexia Group needs to continue under intense oversight to limit contagion and fiscal costs, in close cooperation with Belgian and foreign authorities.
- Priorities:
  - Build strong capital buffers.
  - Be ready to provide necessary backstops if private capital cannot be tapped.
  - Strengthen supervisory resources and develop the macroprudential toolkit.
  - Finalize the legislative process for the newly designed deposit guarantee scheme, taking account of synergies with other resolution mechanisms.
  - Promptly enact relevant covered bond legislation.
- The Belgian experience underscores the need for an effective crisis management approach and a cross-border resolution framework in Europe.

*Source: _cr1255 - chapter 3.*

### 54.      It is recommended that the next

### _cr1255 - 54.      It is recommended that the next

### Recommendation
- It is recommended that the next Article IV consultation with Belgium be held on the standard 12-month cycle.

### Real economy — key projections and indicators (2007–17)
- Real GDP: 2.9, 1.0, -2.8, 2.3, 1.9, -0.1, 0.8, 1.3, 1.6, 1.8, 1.9
- Private consumption: 1.7, 1.9, 0.8, 2.5, 0.6, 0.2, 0.8, 1.1, 1.3, 1.6, 1.7
- Gross fixed investment: 6.0, 2.0, -8.1, -0.7, 4.5, -0.5, 1.1, 2.6, 3.1, 3.5, 3.8
- Exports, goods and services: 5.2, 1.7, -11.2, 9.9, 4.7, -0.8, 3.2, 4.2, 4.6, 4.6, 4.4
- Imports, goods and services: 5.5, 3.1, -10.7, 8.7, 5.3, -0.9, 3.2, 4.3, 4.6, 4.9, 4.7
- Household saving ratio (in percent): 16.4, 17.0, 18.3, 16.4, 16.8, 17.5, 17.1, 16.7, 16.5, 16.1, 15.9
- Potential output growth: 1.9, 1.5, 1.1, 1.1, 0.9, 0.9, 1.0, 1.1, 1.2, 1.4, 1.5
- Output gap (in percent): 2.0, 1.3, -2.4, -1.3, -0.3, -1.3, -1.5, -1.3, -0.9, -0.5, -0.1

### Labor market and prices
- Unemployment rate: 7.5, 7.0, 7.9, 8.3, 7.3, 8.0, 8.6, 8.8, 8.9, 8.6, 8.3
- Employment growth: 1.7, 1.8, -0.1, 0.8, 1.2, -0.3, 0.2, 0.6, 0.9, 1.1, 1.2
- Consumer prices: 1.8, 4.5, 0.0, 2.3, 3.5, 2.2, 1.9, 1.9, 1.9, 1.9, 2.0
- GDP deflator: 2.3, 2.2, 1.2, 1.8, 2.7, 2.3, 1.8, 1.8, 2.0, 2.0, 2.2
- ULC (in whole economy): 2.1, 4.5, 3.8, 0.0, 2.8, 3.4, 1.3, 1.8, 2.1, 2.1, 2.0

### Public finance — levels and projections (percent of GDP)
- Revenue: 48.0, 48.6, 48.0, 48.8, 48.4, 49.8, 49.8, 49.8, 49.8, 49.8, 49.8
  - Tax revenue 1/: 43.2, 43.5, 42.7, 43.2, 43.7, 44.7, 44.7, 44.7, 44.7, 44.7, 44.6
  - Nontax revenue: 4.8, 5.1, 5.2, 5.5, 4.7, 5.1, 5.1, 5.1, 5.1, 5.1, 5.1
- Expenditure: 48.3, 49.9, 53.8, 52.9, 52.5, 52.8, 52.1, 51.1, 50.3, 50.2, 49.9
  - Primary expenditure: 44.4, 46.1, 50.1, 49.5, 48.8, 48.9, 48.3, 47.9, 47.4, 47.6, 47.7
  - Interest payments: 3.9, 3.8, 3.7, 3.5, 3.7, 3.9, 3.8, 3.3, 2.9, 2.6, 2.3
- General government balance: -0.3, -1.3, -5.8, -4.1, -4.0, -2.9, -2.2, -1.2, -0.4, -0.2, 0.0
- Structural balance: -1.1, -1.9, -4.5, -3.5, -3.7, -2.2, -1.4, -0.6, 0.0, 0.0, 0.0
- Primary balance: 3.5, 2.5, -2.2, -0.7, -0.4, 0.9, 1.5, 1.9, 2.4, 2.2, 2.1
- Structural primary balance: 2.8, 2.0, -0.8, 0.0, 0.0, 1.7, 2.4, 2.7, 3.0, 2.6, 2.3
- Debt (general government): 84.1, 89.3, 95.9, 96.2, 98.6, 99.4, 99.4, 97.6, 94.8, 91.6, 88.1

### Public sector debt dynamics and assumptions (2008–17)
- Baseline public sector debt: 89.3, 95.9, 96.2, 98.6, 99.4, 99.4, 99.3, 97.6, 94.8, 91.6, 88.1
- Change in public sector debt: 5.3, 6.5, 0.3, 2.5, 0.8, -0.2, -1.7, -2.8, -3.2, -3.5
- Identified debt-creating flows (4+7+12): -0.6, 7.5, 6.9, -1.1, 0.8, -0.2, -1.7, -2.8, -3.2, -3.5
- Primary deficit: -2.5, 2.2, 0.7, 0.4, -0.9, -1.5, -1.9, -2.4, -2.2, -2.1
- Automatic debt dynamics 2/: 1.3, 5.1, -0.3, -0.5, 1.7, 1.3, 0.2, -0.4, -1.0, -1.4
  - Contribution from real interest rate: 2.1, 2.6, 1.8, 1.2, 1.6, 2.0, 1.5, 1.0, 0.7, 0.3
  - Contribution from real GDP growth: -0.8, 2.6, -2.1, -1.7, 0.1, -0.7, -1.3, -1.5, -1.7, -1.6
- Gross financing need (percent of GDP): 10.5, 22.0, 25.1, 25.4, 26.4, 24.0, 21.2, 19.9, 17.9, 16.7
- Key macro and fiscal assumptions:
  - Real GDP growth: 1.0, -2.8, 2.3, 1.9, -0.1, 0.8, 1.3, 1.6, 1.8, 1.9
  - Average nominal interest rate on public debt: 4.7, 4.1, 3.8, 4.1, 4.0, 3.9, 3.4, 3.1, 2.8, 2.6
  - Average real interest rate: 2.5, 2.8, 2.0, 1.4, 1.7, 2.1, 1.6, 1.1, 0.8, 0.3
  - Inflation rate (GDP deflator): 2.2, 1.2, 1.8, 2.7, 2.3, 1.8, 1.8, 2.0, 2.0, 2.2
  - Growth of real primary spending: 4.6, 5.7, 0.9, 0.5, 0.1, -0.4, 0.4, 0.6, 2.1, 2.1

### Balance of payments (2007–17)
- Balance on current account: 1.6, -1.6, -1.7, 1.5, 0.0, -0.1, 0.6, 1.0, 1.4, 1.5, 1.6
- Balance on goods and services: 1.5, -2.2, 0.3, 0.8, -0.3, 0.7, 0.9, 1.1, 1.4, 1.5, 1.6
- Exports of goods and services (percent of GDP): 81.3, 82.4, 70.4, 78.1, 81.9, 79.5, 80.0, 81.1, 82.5, 83.9, 85.0
- Imports of goods and services (percent of GDP): 79.8, 84.6, 70.1, 77.3, 82.2, 78.7, 79.1, 80.1, 81.2, 82.4, 83.3
- Direct investment, net: 2.9, -5.3, 11.1, 4.9, 1.9, 1.8, 1.7, 1.7, 1.7, 1.7, 1.7
- Portfolio investment, net: -8.9, 10.0, 9.1, -0.1, 2.3, 0.1, -0.9, -1.4, -1.8, -2.0, -2.1
- Other investment, net: 4.2, -3.6, -18.3, -6.5, -3.3, -1.5, -1.2, -1.0, -1.0, -1.0, -1.0

### Financial market indicators (2009–11)
- Selected bank equity indices (period averages, indexed):
  - Dexia: 4.9, 4.0, 3.4, 3.2, 2.9, 2.8, 2.4, 1.7, 0.5
  - Fortis: 37.0, 37.7, 31.3, 28.5, 27.6, 30.1, 33.3, 26.6, 17.3
  - KBC: 32.3, 33.7, 33.2, 33.9, 29.9, 28.7, 24.7, 20.5, 12.8
  - ING: 7.5, 7.1, 6.8, 7.3, 7.6, 8.5, 8.5, 6.3, 5.7
- Credit default swap spreads (basis points, 5-year EUR SR CDS spreads, period average):
  - Dexia: 183.5, 185.2, 264.3, 287.1, 264.2, 320.7, 284.6, 575.1, 742.7
  - Fortis: 60.6, 70.5, 109.8, 114.3, 115.4, 114.5, 113.1, 190.7, 244.6
  - KBC: 150.6, 114.6, 123.6, 128.5, 152.6, 227.3, 187.8, 274.7, 383.9
  - ING: 65.0, 74.6, 108.0, 111.0, 127.0, 120.2, 103.3, 170.3, 215.3
- Government 10-year interest rates (percent): 3.6, 3.7, 3.4, 3.1, 3.6, 4.2, 4.2, 4.1, 4.5
- Money market risk spread (basis points): 33.0, 36.1, 41.1, 45.9, 30.7, 24.2, 25.2, 51.7, 57.2

### Banking sector financial soundness (2006–2011)
- Return on assets: 0.7, 0.4, -1.3, -0.1, 0.5, 0.0
- Return on equity: 22.4, 13.2, -36.5, -2.7, 10.7, 0.7
- Net interest income to total income: 47.9, 50.3, 75.0, 79.1, 68.3, 70.7
- Cost/income ratio: 55.7, 61.1, 86.1, 76.1, 77.7, 68.6
- Total assets (as share of GDP): 4.5, 4.7, 4.1, 3.5, 3.2, 3.2
- Loans to customers (percent of assets): 41.6, 42.2, 39.1, 45.0, 44.0, 43.0
- Mortgage loans (in billion euro): 190, 208, 132, 158, 179, 185
- Non-performing loans (NPL) as percent of gross loans: 1.7, 1.4, 1.7, 2.7, 2.8, 2.8
- Regulatory capital to risk-weighted assets: 11.9, 11.2, 16.2, 17.3, 19.3, 19.1
- Regulatory Tier I capital to risk-weighted assets: 8.7, 12.1, 11.3, 13.2, 15.5, 15.6

### Non-banking financial sectors and households (2006–11)
- Insurance sector solvency ratio: 252.6, 222.6, 223.3, 230.0, 214.0, 196.0
- Insurance return on equity (annualised): 20.8, 31.7, -27.5, 6.3, 9.9, 0.3
- Household debt (percent of GDP): 45.9, 47.8, 50.1, 53.9, 55.5, 54.3
- Interest burden (percent disposable income): 2.1, 2.9, 3.0, 1.9, 1.5, 1.7
- Savings rate (percent): 15.7, 16.4, 16.8, 18.4, 16.2, 16.7
- House price inflation (Houses): 12.3, 9.9, 4.5, -0.3, 5.0, 3.6
- Mortgage loans as percent of total loans: 34.0, 32.7, 24.3, 30.3, 37.3, 38.2
- Variable rate mortgages (percent of total new loans): 7.4, 1.2, 2.9, 34.0, 37.6, 15.3

### Risk Assessment Matrix — main threats, likelihood, and impact
- 1. Sharp slowdown in Eurozone
  - Overall level of concern: Medium
  - Likelihood of severe realization in next 1–3 years and channel: High
    - Belgium has strong trade and financial links with Eurozone member countries. Historically, these have explained about half of real GDP growth.
  - Expected impact if realized: High
    - A slowdown of similar magnitude as in 2009 could reduce Belgian growth to -3½ to -4 percent.
    - The impact would be more severe than in 2009 because, in light of the high public debt, there is no policy room to buffer a sharp downturn.
- 2. Drying up of financial markets
  - Overall level of concern: Medium
  - Likelihood of severe realization in next 1–3 years and channel: High
    - Government rollover needs remain substantial with peaks in issuance expected in March and September.
    - The threat to the banking sector has been reduced following the introduction of the ECB 3-year funding facility.
  - Expected impact if realized: High
    - Sovereign rollover needs are high around €54 billion in 2012 and those of the three largest banks another €21 billion.
- 3. Energy price hike
  - Overall level of concern: Low
  - Likelihood of severe realization in next 1–3 years and channel: Medium
    - The pass-through of global energy price shocks into Belgian inflation is higher than in other countries.
    - Automatic wage indexation increases the pass-through of inflation shocks into wages and, hence, competitiveness.
  - Expected impact if realized: Medium
    - Deteriorating competitiveness would dampen an incipient recovery.

*Sources: Data provided by the Belgian authorities, and IMF staff projections.*

### 4. Breakdown of

### _cr1255 - 4. Breakdown of coalition government Low

### Coalition government composition and mandate
- The coalition government consists of six parties across the political spectrum.
- The government has a two-year mandate. The next general election is scheduled for 2014.

### Political implications for reforms and policy space
- Medium-term policy effects:
  - New structural reforms initiatives would be put on hold.
  - However, financial market stress constrains policy options of any government while public debt remains high.

### Macro-financial outlook and vulnerabilities (staff and Executive Board findings)
- Growth and inflation:
  - Real GDP: 2007: 2.9; 2008: 1.0; 2009: -2.8; 2010: 2.3; 2011: 1.9; 2012 (Proj.): -0.1.
  - Consumer prices: 2007: 1.8; 2008: 4.5; 2009: 0.0; 2010: 2.3; 2011: 3.5; 2012 (Proj.): 2.2.
  - ULC (in whole economy): 2007: 2.1; 2008: 4.5; 2009: 3.8; 2010: 0.0; 2011: 2.8; 2012 (Proj.): 3.4.
- Labor market and potential:
  - Unemployment rate (in percent): 2007: 7.5; 2008: 7.0; 2009: 7.9; 2010: 8.3; 2011: 7.3; 2012 (Proj.): 8.0.
  - Employment: 2007: 1.7; 2008: 1.8; 2009: -0.1; 2010: 0.8; 2011: 1.2; 2012 (Proj.): -0.3.
  - Potential output growth: 2007: 1.9; 2008: 1.5; 2009: 1.1; 2010: 1.1; 2011: 0.9; 2012 (Proj.): 0.9.
- Public finances:
  - Revenue (percent of GDP): 2007: 48.0; 2008: 48.6; 2009: 48.0; 2010: 48.8; 2011: 48.4; 2012 (Proj.): 49.8.
  - Expenditure (percent of GDP): 2007: 48.3; 2008: 49.9; 2009: 53.8; 2010: 52.9; 2011: 52.5; 2012 (Proj.): 52.8.
  - General government balance (percent of GDP): 2007: -0.3; 2008: -1.3; 2009: -5.8; 2010: -4.1; 2011: -4.0; 2012 (Proj.): -2.9.
  - Structural balance (percent of GDP): 2007: -1.1; 2008: -1.9; 2009: -4.5; 2010: -3.5; 2011: -3.7; 2012 (Proj.): -2.2.
  - Primary balance (percent of GDP): 2007: 3.5; 2008: 2.5; 2009: -2.2; 2010: -0.7; 2011: -0.4; 2012 (Proj.): 0.9.
  - General government debt (percent of GDP): 2007: 84.1; 2008: 89.3; 2009: 95.9; 2010: 96.2; 2011: 98.6; 2012 (Proj.): 99.4.
- External sector:
  - Trade balance (percent of GDP): 2007: 1.5; 2008: -2.2; 2009: 0.3; 2010: 0.8; 2011: -0.3; 2012 (Proj.): 0.7.
  - Current account (percent of GDP): 2007: 1.6; 2008: -1.6; 2009: -1.7; 2010: 1.5; 2011: 0.0; 2012 (Proj.): -0.1.

### Financial sector stresses and policy responses
- Observations:
  - As the euro area crisis unfolded, Belgian sovereign and bank spreads came under pressure.
  - The restructuring of Dexia led to nationalization of its Belgian retail operations at a cost of 1 percent of GDP; the remainder of the group received guarantees from the governments of Belgium, France, and Luxembourg.
  - Contingent liabilities from bank support, combined with an already high stock of public debt, contributed to rising bond yields and CDS spreads on Belgian sovereign debt during late 2011.
- Staff and Board recommendations/actions:
  - Strengthen banking supervision and implement the Basel III and Solvency II regulatory frameworks.
  - Continue bank restructuring and strengthen capital buffers; be prepared to provide a backstop if private capital cannot be tapped.
  - Improve crisis management and cross-border resolution mechanisms in Europe.
  - Address interplay between the financial sector and the sovereign to contain downside risks.

### Fiscal consolidation, structural reforms, and labor market measures
- Government program and measures:
  - The Sixth Reform of the State increases fiscal federalism by devolving additional spending responsibilities to subnational governments and reforming their funding.
  - The 2012 budget includes a fiscal consolidation package of 2½ percent of GDP to reduce the fiscal deficit below 3 percent of GDP in 2012.
  - Structural reforms target raising the employment rate (for 20–64 year olds) by 5 percentage points.
  - Key labor and pension measures include:
    - Greater degressivity in unemployment benefits.
    - Stricter enforcement of job search requirements.
    - Gradual limitation of pre-pension benefits for older workers.
    - Stepwise increase in the minimum age for early retirement from 60 to 62 years by 2016.
- Executive Board guidance:
  - Medium-term fiscal consolidation is key to mitigating sovereign market pressures; focus on expenditure containment, particularly in pensions, health care, and public sector employment.
  - Consider rationalization of wage and benefit indexation to generate savings.
  - Adopt a rules-based framework and a burden-sharing agreement between all levels of government to strengthen credibility.
  - Allow automatic stabilizers to operate around the consolidation path while safeguarding fiscal targets.
  - Push ahead with labor and product market reforms; reform of the wage indexation scheme would help boost competitiveness.
  - Job-friendly tax reform could increase trend growth, but any reduction in high labor taxes would have to be offset by an increase in indirect tax revenues given limited fiscal space.

### Statistical and institutional context relevant for surveillance
- Missions: Brussels, November 30–December 12, 2011 and January 24–27, 2012.
- Staff team: Mr. De Vrijer (Head), Ms. Ohnsorge, Mr. Weber (all EUR), Mmes. Erbenova and Nedelescu (MCM), and Mr. Acosta-Ormaechea (FAD).
- Data and statistical capacity:
  - Belgium subscribes to the Fund’s Special Data Dissemination Standard (SDDS).
  - The National Bank of Belgium (NBB) regularly publishes comprehensive economic and financial data; NBB compiles national accounts and publishes quarterly accounts within a lag of three months.
  - General government revenue, expenditure, and balance on an accrual basis (ESA95) are published annually; monthly data on central government operations and quarterly data on general government operations since April 2007.
- FSAP and supervisory assessment:
  - FSAP concluded the financial system is resilient with cautious bank risk attitudes, large holdings of government securities, extremely low holdings of equity by banks, stable funding, and a high standard of banking supervision.
  - Issues identified include heavy exposure abroad, openness to global developments, and the importance of the Euroclear Group, creating vulnerability to contagion.
  - Supervisory reforms implemented following FSAP recommendations: streamlined CBFA management committee, enhanced synergies between CBFA and NBB, regular stress tests, upgraded insurance prudential supervision, and reinforced pension fund regulation.

*Source: BELGIUM — STAFF REPORT FOR THE 2011 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX (as provided).*

### 1.      This statement provides additional information on economic and financial

### _cr1255 - 1.      This statement provides additional information on economic and financial

### Overview
- This statement provides additional information on economic and financial developments in Belgium since the issuance of the Article IV consultation staff report.
- The additional information does not change the thrust of the staff appraisal.

### Domestic demand and business confidence
- Indicators point to weak domestic demand in the first quarter of 2012, in line with expectations.
- Domestic orders as well as business confidence in construction and domestic trade continued to weaken in January and February.
- Overall business confidence in February improved for the third month in a row, mirroring the recent improvement in German business confidence.
- The improvement followed a decline in September–November that was linked to a sharp drop in exports.

### Inflation and automatic wage indexation
- Annual consumer price inflation in February was 3 ¾ percent.
- The main drivers of inflation in February continued to be energy prices.
- The increase in consumer prices thus far remains below the threshold that triggers an automatic wage and benefit increase in the public sector.
- It is expected that the automatic wage indexation will take place in March.

### Banking sector developments
- Several large banks announced their 2011 results; results were broadly in line with expectations.
- Dexia Group announced substantial losses (€12 billion) for 2011, reflecting losses from asset disposals, including of Dexia Bank Belgium, and impairment on Greek sovereign debt.
- KBC and ING Belgium announced net profits in 2011.
  - Despite a doubling in net profits over 2010, ING Belgium decided not to distribute dividends in order to further strengthen its capital base.
  - KBC’s net profits were substantially smaller than in 2010, reflecting loan loss provisions on its exposure to Ireland and Hungary, and the impairment recorded on Greek sovereign debt.
  - KBC distributed a small technical dividend to remain on track with its restructuring plan.
- KBC sold its Polish subsidiary Kredyt Bank to Santander in a transaction that should raise KBC’s Tier 1 capital by 0.8 percentage point (compared with 12.3 percent at end-December 2011).

### Dexia restructuring and financial stability
- The authorities and Dexia SA’s management are finalizing the restructuring plan to be submitted to the European Commission in late March.
- Dexia Crédit Locale has issued €41 billion in government guaranteed bonds, within the envelope of sovereign guarantees of €45 billion.
- Proceeds have been used to reimburse unsecured liabilities to Dexia Bank Belgium (recently renamed Belfius), emergency liquidity assistance of the Belgian and French central banks, and to satisfy the funding needs of Dexia SA.
- As a result, the unsecured exposure of Belfius to Dexia SA has fallen substantially, thus almost eliminating a significant financial stability risk for Belgium arising from Dexia’s restructuring.

### Government funding
- The government has made good progress towards meeting its funding needs.
- By end-February, a quarter of the sovereign medium- and long-term funding needs for 2012 were met.

*International Monetary Fund — additional information on economic and financial developments in Belgium (since Article IV staff report).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1255.pdf_