## _cr15144

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---

### Executive summary — background and recent developments
- Growth and employment
  - Growth was close to 3 percent in 2014, and is projected at 2½ percent in 2015, with continued strong job creation.
  - Real GDP expanded by 2½ percent y/y in the first three quarters of 2014, with net service exports as the largest driver.
  - Job growth has exceeded 2 percent y/y; almost half of the new jobs go to cross border workers.
  - Commuters from neighboring Belgium, France, and Germany account for more than 40 percent of domestic employment.
  - Domestic unemployment rate among residents is 7 percent.
- Economic model and fiscal position
  - Central government net asset position of about 20 percent of GDP.
  - Luxembourg is one of two euro area sovereigns rated ‘AAA’ by all major rating agencies.
- Financial sector structure and scale
  - Banking system assets are some 16 times GDP; locally active banks (that lend domestically) have assets of about 2¾ times GDP.
  - Credit to domestic households and firms amounts to some 90 percent of GDP.
  - The investment fund industry has assets under management of €3½ trillion; total number of funds stood at 3,893 as of February 2015.
  - Investment fund assets increased by half a trillion euros in the last seven months (to Feb 2015).
  - Insurance industry assets are about 4 times GDP; life insurance dominates with some two-thirds of total assets.
- External sector and central bank
  - Large TARGET2 net claims expand the central bank’s balance sheet; the government has pledged to augment the central bank’s capital base.
  - The current account surplus has narrowed, driven by a growing factor income deficit linked to growth in investment fund assets.
  - Positive net international investment position is dwarfed by massive gross asset and liability positions reflecting domiciliation of MNCs, securities issuers, banks, and funds.

### Growth outlook, scenarios, and risks
- Staff baseline and potential
  - Staff’s baseline: growth slowing from almost 3 percent in 2014 to 2¼ percent over the medium term.
  - Potential growth estimate: 1½–2¼ percent (combining filtering techniques and production function approaches).
  - Real GDP projections (percent change): 2012: -0.2; 2013: 2.0; 2014: 2.9; 2015: 2.5; 2016: 2.3; 2017: 2.3; 2018: 2.2; 2019: 2.2; 2020: 2.2.
  - Contribution to growth (percentage point contributions): Domestic demand (2012–20 sample): 0.0, 0.4, 1.3, 1.6, 1.5, 1.7, 1.7, 1.7, 1.7; Net exports (2012–20 sample): -0.5, 1.1, 1.7, 1.3, 0.8, 0.6, 0.6, 0.5, 0.5.
- Forecast uncertainty and main vulnerabilities
  - Main country-specific risks: foreign tax policy initiatives that could diminish Luxembourg’s tax base; financial sector events that could blemish Luxembourg’s reputation.
  - Examples: EU and OECD initiatives to tighten tax transparency standards; U.S. proposals to tax offshore cash pools of U.S. firms; failure of the Espírito Santo group of companies.
- Scenario transmissions
  - Near-term risks broadly symmetric around staff’s baseline.
  - Positive transmission: cheaper term funding, QE, EU Investment Plan could boost investment and services exports.
  - Negative transmission: prolonged slow growth in advanced economies would hurt goods exports; severe global financial market volatility could trigger valuation effects and outflows from the fund industry.
  - Low interest rates risk: potential credit-fueled housing bubble; credit to households growth about 7 percent y/y.

### Fiscal position, consolidation, and pensions
- Fiscal position and measures
  - General government net asset position: over 40 percent of GDP.
  - Gross debt: 23 percent of GDP in 2014.
  - Budget 2015 measures to address falling e-VAT revenues:
    - Retained e-VAT revenue set to more than halve in 2015, to about 1 percent of GDP, and halve again by 2018.
    - Authorities raised VAT rates by 2 percentage points, expected to yield ½ percent of GDP in 2015 with full impact from 2016.
    - Introduced a temporary personal income tax set at ½ percent of income to balance the budget.
    - Some paring down of social spending to begin in 2015 after a 2014 expenditure review.
  - Fiscal balance projections (percent of GDP): authorities’ general government deficit target for 2015: 0.2 (after a surplus of 0.6 in 2014); staff projection for 2015 deficit under a more conservative macro framework: 0.5.
  - Impact of 2015 budget measures on fiscal balance (Percent of GDP): General govt. balance under unchanged policy (incl. e-VAT loss): -2.1; VAT hike: 0.5; Other revenue measures: 0.2; Expenditure measures: 0.3; Stronger macroeconomic projections and 2014 outcome: 0.6; Staff baseline projection: -0.5.
- Medium-term plan and wealth fund
  - Fiscal adjustment averaging about ⅓ percent of GDP annually through 2018.
  - Total spending slated to grow by 4 percent annually through 2018.
  - By 2018, general government would reach a surplus of about 0.2 percent of GDP, with gross debt still below 26 percent of GDP.
  - Wealth fund: fuel duties and remaining e-VAT totaling about €50 million annually to flow to the fund; target size: €1 billion (just over 2 percent of 2014 GDP) by 2035; staff view: fund is small relative to projected future pension financing needs.
- Pensions and long-term sustainability
  - EU Working Group on Ageing projects annual pension obligations will increase by only 2 percent of GDP through 2050 (down from OECD projection of 8 percent of GDP).
  - Caution: about half of improvement in EU projection comes from Eurostat demographic projections assuming net immigration will almost double Luxembourg’s population by 2050.
  - Staff (OECD) recommendations to contain future liabilities:
    - (i) abolish early retirement schemes to raise the effective retirement age;
    - (ii) introduce progressive reductions of the replacement rate;
    - (iii) limit credits for time spent outside work;
    - (iv) institute actuarial neutrality around the statutory retirement age;
    - (v) index the retirement age to longevity.
  - Authorities could use the 2016 review of pension finances to adopt at least some changes.

### Tax transparency, revenue risks, and recommendations
- Exposure and risks
  - Taxes on the financial sector and on cross-border retail trade (fuel, tobacco, other goods) yield over a quarter of total revenues and could be susceptible to changes in EU and OECD tax standards and U.S. moves to tax U.S. firms’ profits held abroad.
  - Firm-specific tax rulings: staff advised care to ensure tax rulings avoid encouraging unduly complex structures, especially in the financial sector.
- Staff recommendations
  - Develop options to make the revenue system more robust and achieve additional expenditure savings (to be quantified as details evolve).
  - Use the 2015–16 tax policy review to assess options, including adjusting property related taxes, corporate tax exemptions, and selected financial sector levies.
  - Seek further expenditure savings informed by regular expenditure reviews.
  - Prioritize measures that are equitable, durable, and minimize the drag on growth.
  - Continue to engage fully in EU and OECD tax transparency initiatives, assess the impact of any tax base erosion, and quantify tax challenges and risks.

### Financial sector policy, supervision, and macroprudential frameworks
- Prudential and supervisory actions
  - Plans include faster passage of EU banking laws, operationalizing a systemic risk committee, and advocating strong cross-border oversight.
  - Focus on effective EU regulatory arrangements for nonbank companies that control banks.
- Banking soundness and infrastructure
  - Capital ratios are high and capital quality is strong; fully loaded Basel III requirements are easily met by most banks.
  - The ECB Comprehensive Assessment identified an end-2013 capital shortfall at one bank operating in Luxembourg that was deemed eliminated by capital raisings during 2014.
  - Banks with negative net income in 2014 accounted for some 4 percent of system assets.
  - Legal transposition deadlines: BRRD must be transposed into national law by end 2015 at the very latest.
- Investment funds, insurance, and spillovers
  - Almost 40 percent of fund assets are in debt securities, raising global market liquidity concerns in stress.
  - Roughly half of total assets are invested outside Europe, and roughly half of those in the United States.
  - Insurance industry investment portfolios and profitability merit close monitoring; life segment may be challenged by low interest rates.
  - Staff advice: maintain strong oversight, monitor links between banks and funds, and attend to potential market liquidity risks.
- Macroprudential and housing
  - Systemic Risk Committee established (law on April 1, 2015) to monitor risks across banking, market, and insurance sectors and recommend macroprudential measures.
  - CSSF measures from late 2012 advised banks to limit loan-to-value (LTV) ratios to 80 percent and imposed higher risk weights on mortgages with higher LTV ratios.
  - Staff advised stepped-up data collection on property lending and preparation of targeted macroprudential tools.

### External sector assessment
- Current account and composition
  - Current account surplus narrowed from more than 10 percent of GDP in 2006–07 to about 5 percent in 2013–14.
  - Financial and other nonfactor services surplus: over 37 percent of GDP.
  - Workers’ remittances deficit: 17 percent of GDP.
  - Net investment income deficit: 15 percent of GDP.
- EBA-lite quantitative findings (percent of GDP unless otherwise indicated)
  - (1) Current account: Projected 4.7
  - (2) Current account: Fitted 8.7
  - (3) Policy gap 0.5
  - (4) =(2)-(3) Current account: Norm 8.2
  - (5) =(1)-(4) Current account: Gap -3.5
  - (6) Elasticity of CA to REER (ratio) -1.3
  - (7) =(5)/(6) Real exchange rate gap (percent) 2.6
  - Using EBA-lite, current account is projected at some 3½ percent of GDP below its norm of 8 percent of GDP in 2015.
- Exchange rate alignment
  - Staff estimate: the real effective exchange rate is overvalued by about 2½ percent relative to its equilibrium level; conclusion: no evidence of substantial misalignment.

### Key statistics and indicators (selected exact figures from the report)
- 2014 growth: close to 3 percent
- 2015 growth projection: 2½ percent
- Investment fund assets: €3½ trillion
- Number of funds (Feb 2015): 3,893
- Fund assets increase: half a trillion euros in last seven months (to Feb 2015)
- Banking system assets: some 16 times GDP
- Locally active banks’ assets: about 2¾ times GDP
- Insurance industry assets: about 4 times GDP
- Credit to domestic households and firms: some 90 percent of GDP
- Central government net asset position: about 20 percent of GDP
- Domestic unemployment rate (residents): 7 percent
- Job growth: exceeded 2 percent y/y
- Cross-border commuters’ share of domestic employment: more than 40 percent
- General government net asset position: over 40 percent of GDP
- Gross debt: 23 percent of GDP in 2014
- Budget 2015: VAT hike expected to yield ½ percent of GDP in 2015; temporary personal income tax set at ½ percent of income
- Staff fiscal projection for 2015 deficit: 0.5 percent of GDP
- EBA-lite real exchange rate gap (percent): 2.6
- Selected public finance figures (percent of GDP, 2012–20 sequences presented in report): see full table entries in the source content
- Memorandum items: Land area = 2,586 sq. km; population in 2015 = 563,000; GDP per head = €84,400.
- Discussions took place on March 4–17, 2015 (in Luxembourg) and March 27 (teleconference with the ECB).
- Date on document: April 27, 2015.

*Source: IMF staff report excerpt provided in the content unit.*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Background and recent developments
- Growth and employment
  - Growth was close to 3 percent in 2014, and is projected at 2½ percent in 2015, with continued strong job creation.
  - Real GDP expanded by 2½ percent y/y in the first three quarters of 2014, with net service exports as the largest driver.
  - Job growth has exceeded 2 percent y/y, although almost half of the new jobs go to cross border workers.
  - Commuters from neighboring Belgium, France, and Germany account for more than 40 percent of domestic employment.
  - Domestic unemployment rate among residents is 7 percent.
- Economic model and fiscal position
  - Luxembourg’s model emphasizes maintaining fiscal stability and openness, conservative prudential oversight, and responding to investor needs.
  - Central government net asset position of about 20 percent of GDP; Luxembourg is one of two euro area sovereigns rated ‘AAA’ by all major rating agencies.
- Financial sector structure and scale
  - Banking system assets are some 16 times GDP; locally active banks (that lend domestically) have assets of about 2¾ times GDP.
  - Credit to domestic households and firms amounts to some 90 percent of GDP.
  - The investment fund industry is the second largest in the world, with assets under management of €3½ trillion (more than doubled since 2008).
  - Total number of funds stood at 3,893 as of February 2015.
  - Investment fund assets increased by half a trillion euros in the last seven months alone.
  - Insurance industry assets are about 4 times GDP; life insurance dominates with some two-thirds of total assets.
- External sector and central bank
  - Large TARGET2 net claims expand the central bank’s balance sheet; the government has pledged to augment the central bank’s capital base.
  - The current account surplus has narrowed, driven by a growing factor income deficit linked to growth in investment fund assets.
  - The positive net international investment position is dwarfed by massive gross asset and liability positions reflecting domiciliation of MNCs, securities issuers, banks, and funds.

### Recent challenges and strategic priorities
- Need for proactive adjustment
  - Recent challenges to the model necessitate a proactive approach to adjust to a changing landscape.
- International tax transparency and fiscal robustness
  - Authorities are committed to positive engagement in the international tax transparency agenda.
  - Having adjusted fiscal policy for lower revenues from electronic commerce, authorities should address additional base erosion risks and explore options to make the tax system more robust.
- Pension reform
  - Authorities should pursue further reforms to make the pension system more resilient to population aging.
- Sovereign credit posture
  - Policy initiatives together with the authorities’ commitment to a modest budget surplus over the medium term should fortify Luxembourg’s ‘AAA’ sovereign credit standing.

### Financial sector policy and regulation
- Prudential and supervisory actions
  - Plans include faster passage of EU banking laws (banking union being especially beneficial to Luxembourg), operationalizing a purposeful systemic risk committee, and advocating strong cross-border oversight.
  - Focus on effective EU regulatory arrangements for nonbank companies that control banks, given large intragroup activity transiting through Luxembourg.
- Banking sector soundness
  - Capital ratios are high and capital quality is strong; fully loaded Basel III capital requirements are easily met by most banks.
  - The ECB Comprehensive Assessment identified an end-2013 capital shortfall at one bank operating in Luxembourg that was deemed eliminated by capital raisings during 2014.
  - Declining interest margins are partly offset by growing fee income from services to the investment fund industry; banks with negative net income in 2014 accounted for some 4 percent of system assets.

### Outlook and risks
- Near-term prospects
  - Provided the challenges ahead are well managed, growth in the near term could beat staff’s baseline, helped by a firmer euro area recovery.
- Medium-term prospects
  - In the medium term, success of authorities’ initiatives to diversify the economy will play out against a backdrop of lower potential growth.
  - It is therefore important efforts continue to better equip workers with relevant skills and to lift youth and women’s participation in the labor force.

### Key statistics and indicators (as presented)
- 2014 growth: close to 3 percent
- 2015 growth projection: 2½ percent
- Investment fund assets: €3½ trillion
- Number of funds (Feb 2015): 3,893
- Fund assets increase: half a trillion euros in last seven months (to Feb 2015)
- Banking system assets: some 16 times GDP
- Locally active banks’ assets: about 2¾ times GDP
- Insurance industry assets: about 4 times GDP
- Credit to domestic households and firms: some 90 percent of GDP
- Central government net asset position: about 20 percent of GDP
- Domestic unemployment rate (residents): 7 percent
- Job growth: exceeded 2 percent y/y
- Cross-border commuters’ share of domestic employment: more than 40 percent
- Discussions took place on March 4–17, 2015 (in Luxembourg) and March 27 (teleconference with the ECB).
- Date on document: April 27, 2015

_Source: EXECUTIVE SUMMARY (Luxembourg), IMF staff report._

### 7.      Staff’s baseline has growth slowing from almost 3 percent in 2014 to 2¼ percent over

### 7.      Staff’s baseline has growth slowing from almost 3 percent in 2014 to 2¼ percent over

### Growth outlook and potential
- Staff’s baseline: growth slowing from almost 3 percent in 2014 to 2¼ percent over the medium term.
- Near-term prospects have brightened, with improvements for the euro area.
- Potential growth estimate: combining filtering techniques and production function approaches, staff puts potential growth at 1½–2¼ percent.
- Luxembourg’s growth rates are projected to remain bounded by euro area and world growth.
- Domestic sentiment: improving but remains below the long-run average (Economic Sentiment Indicator: Index, long-term average = 100).
- Real GDP projections (selected years, percent change):
  - 2012: -0.2
  - 2013: 2.0
  - 2014: 2.9
  - 2015: 2.5
  - 2016: 2.3
  - 2017: 2.3
  - 2018: 2.2
  - 2019: 2.2
  - 2020: 2.2
- Contribution to growth (percentage point contributions):
  - Domestic demand (2012–20 sample): 0.0, 0.4, 1.3, 1.6, 1.5, 1.7, 1.7, 1.7, 1.7
  - Net exports (2012–20 sample): -0.5, 1.1, 1.7, 1.3, 0.8, 0.6, 0.6, 0.5, 0.5
- CPI inflation (percent change): 2.9, 1.7, 0.7, 0.6, 1.6, 1.7, 1.9, 2.0, 2.2 (2012–20 sequence)
- Unemployment rate (percent, national definition): 6.1, 6.9, 7.1, 6.9, 6.7, 6.6, 6.5, 6.3, 6.2 (2012–20 sequence)
- Current account balance (percent of GDP): 5.7, 4.9, 5.2, 4.7, 4.6, 4.4, 4.4, 4.3, 4.3 (2012–20 sequence)

### Forecast uncertainty and country-specific vulnerabilities
- Macroeconomic projections are fraught with higher-than-usual uncertainty due to Luxembourg’s city state characteristics: strong growth, high output volatility, and large revisions to historical data.
- Migration, commuting, and financial services activity are especially difficult to forecast.
- Main country-specific risks:
  - Foreign tax policy initiatives that could diminish Luxembourg’s tax base.
  - Financial sector events that could blemish Luxembourg’s reputation.
- Examples of risks noted:
  - EU and OECD initiatives to tighten tax transparency standards.
  - U.S. proposals to tax offshore cash pools of U.S. firms.
  - Failure of the Espírito Santo group of companies as a reminder reputation can be tested.

### Scenarios and transmission channels
- Near-term risks broadly symmetric around staff’s baseline.
  - If Luxembourg-specific challenges are well managed, domestic demand and net exports could beat the baseline.
  - Lower oil prices: impact on disposable incomes largely offset by higher VAT (a rate hike took effect on January 1, 2015).
  - Investment could be boosted by cheaper term funding, lower threshold returns related to the ECB’s quantitative easing (QE), and the EU Investment Plan.
  - Goods exports would suffer under prolonged slow growth in advanced economies.
  - Service exports tied to global investor demand for asset management services; QE has positive effects tempered by expectations of U.S. tightening.
- In the event of geopolitical tensions or renewed euro area financial stress triggering global financial market volatility:
  - Negative: severe reversal of benign financial conditions would hurt equity markets and risk appetite, triggering valuation effects and outflows from the fund industry.
  - Positive: banking system could receive safe haven inflows, as during the global financial crisis in 2008–09.

### Credit, housing, and financial sector risks
- Risk that protracted low interest rates could spawn a credit-fueled housing bubble.
- Credit to households growth: about 7 percent y/y.
- Household debt: appears manageable (data vary by source).
- If a bubble develops, potential outcomes include housing price correction, compressed household consumption, defaults, and possible disruption to credit.
- Housing prices have risen over decades, reflecting population and job growth combined with supply constraints (zoning and other rules).
- Volatile aggregate credit to firms reflects prevalence of MNCs with cross-border financing arrangements and treasury operations run out of Luxembourg.
- Mortgage exposure: share of mortgages in locally active banks’ assets has increased significantly (comparative chart includes France, Germany, Luxembourg, Netherlands, Belgium with years 2008 and 2013).

### Fiscal position and consolidation
- General government net asset position: over 40 percent of GDP, providing flexibility to tackle revenue and long-term pension challenges.
- Gross debt: 23 percent of GDP in 2014 (up from single digits pre crisis).
- Long-term pension position: challenging.
- Appropriateness of targeting a budget surplus over the medium term for a small open economy.
- Budget 2015 measures to address falling e-VAT revenues:
  - Retained e-VAT revenue set to more than halve in 2015, to about 1 percent of GDP, and halve again by 2018.
  - Authorities raised VAT rates by 2 percentage points, expected to yield ½ percent of GDP in 2015 with full impact from 2016.
  - Introduced a temporary personal income tax set at ½ percent of income to balance the budget.
  - Some paring down of social spending to begin in 2015 after a 2014 expenditure review.
- Fiscal balance projections and staff estimates (percent of GDP):
  - General government deficit target by authorities for 2015: 0.2 percent of GDP (after a surplus of 0.6 percent in 2014).
  - Staff’s projection for 2015 deficit under a more conservative macro framework: 0.5 percent of GDP.
- Impact of 2015 budget measures on fiscal balance (Percent of GDP):
  - General govt. balance under unchanged policy (incl. e-VAT loss): -2.1
  - Policy measures in Budget 2015:
    - VAT hike: 0.5
    - Other revenue measures: 0.2
    - Expenditure measures: 0.3
    - Stronger macroeconomic projections and 2014 outcome: 0.6
  - Staff baseline projection: -0.5
- Medium-term budgetary plan:
  - Fiscal adjustment averaging about ⅓ percent of GDP annually through 2018.
  - Total spending slated to grow by 4 percent annually through 2018, down from about 5 percent in 2010–14.
  - By 2018, general government would reach a surplus of about 0.2 percent of GDP, with gross debt still below 26 percent of GDP.
  - New fiscal framework covers all three sub sectors of general government; adherence to fiscal rules to be monitored by a newly established Fiscal Council (as required under the EU Fiscal Compact).
- Wealth fund:
  - Fuel duties and remaining e-VAT totaling about €50 million annually to flow to the fund.
  - Target size: €1 billion (just over 2 percent of 2014 GDP) by 2035.
  - Staff view: fund is small relative to projected future pension financing needs and too small to meaningfully discipline fiscal policy.
  - Staff suggestion: consider transferring some central government financial assets to the fund and channeling all future extraordinary receipts (divestment proceeds, principally) to it.

### Pensions and long-term fiscal sustainability
- New projections by the EU Working Group on Ageing suggest annual pension obligations will increase by only 2 percent of GDP through 2050, down from the 8 percent of GDP increase projected by the OECD.
- Caution: almost half of the improvement in the EU projection comes from Eurostat demographic projections that assume net immigration will almost double Luxembourg’s population by 2050.
- Staff recommendations to contain future liabilities (OECD recommendations):
  - (i) abolish early retirement schemes to raise the effective retirement age;
  - (ii) introduce progressive reductions of the replacement rate;
  - (iii) limit credits for time spent outside work;
  - (iv) institute actuarial neutrality around the statutory retirement age;
  - (v) index the retirement age to longevity.
- Authorities could use the upcoming review of pension finances in 2016 to adopt at least some of these changes.

### Tax transparency, revenue risks, and recommendations
- Several international tax initiatives have ramifications for Luxembourg (summary of initiatives and implications appears in Box 2).
- Taxes on the financial sector and on cross-border retail trade (fuel, tobacco, other goods) yield over a quarter of total revenues and could be susceptible to changes in EU and OECD tax standards and U.S. moves to tax U.S. firms’ profits held abroad.
- Staff recommendations:
  - Develop options to make the revenue system more robust and achieve additional expenditure savings (to be quantified as details evolve).
  - Use the 2015–16 tax policy review to assess options, including adjusting property related taxes, corporate tax exemptions, and selected financial sector levies.
  - Seek further expenditure savings informed by regular expenditure reviews.
  - Prioritize measures that are equitable, durable, and minimize the drag on growth.
- Firm-specific tax rulings:
  - Staff advised care to ensure tax rulings avoid encouraging unduly complex structures, especially in the financial sector.
  - Concern: some rulings could give rise to layers of holding companies transacting with each other in hybrid instruments, multiplying challenges for regulators and supervisors.

*Source: IMF staff report excerpt provided in the content unit.*

### 21.      The authorities stressed their commitment to sound fiscal policies. They expressed

### _cr15144 - 21.      The authorities stressed their commitment to sound fiscal policies. They expressed

### Fiscal policy and pensions
- Authorities are committed to sound fiscal policies and confident budget targets for 2015 and the medium term will be met or exceeded, with planned consolidation measures either implemented in full or substituted with equally strong alternatives.
- On pensions:
  - Eurostat long-term population projections that assume large net immigration should be viewed with caution.
  - Importance of further structural reforms to pension arrangements was acknowledged.
- Staff appraisal:
  - Targeting budget surpluses over the medium term is appropriate for Luxembourg as a small open economy.
  - Budget 2015 and the medium-term fiscal plan respond to falling e-VAT revenues.
  - The new wealth fund is positive but “too small to exert a meaningful impact on fiscal discipline.” Future divestment proceeds (including from significant state shareholdings in the financial sector) should flow to it.
  - Social security assets of about 30 percent of GDP prefinance only part of the large future increase in age-related spending; deeper pension reforms should not be deferred.
  - EU projections for very strong population growth should be treated with caution.

### Tax transparency and revenue risks
- Authorities committed to engaging fully in EU and OECD standard setting on tax transparency but considered it early to assess revenue impacts.
- Key points from the Ministry of Finance:
  - Most rules are still evolving; initiatives have not yet translated into specific risks to the revenue base that would warrant a policy response.
  - Luxembourg is participating fully in exchanges of tax information, including for firm specific rulings upon request.
  - Corporate tax rates and exemptions are being analyzed in detail ahead of envisaged tax reform.
  - Taxes on fuel and tobacco: EU harmonization initiatives have not gained traction; rates are finely tuned to avoid increasing CO2 emissions while preserving fiscal revenues.
  - Indirect financial sector taxation: no comparable tax exists in other financial centers; adjustments must be carefully pondered.
  - Emphasized a consultative approach to the tax policy review and a continued strong role for expenditure measures.
- Staff recommendation:
  - Continue to engage fully in EU and OECD tax transparency initiatives, assess the impact of any tax base erosion, quantify tax challenges and risks, and use the upcoming tax policy review to identify options.
  - Seek further expenditure savings; measures on both revenue and expenditure sides should be equitable, durable, and minimize drag on growth.

### Financial sector policies and banking union
- Banking union viewed as especially positive for Luxembourg; transition needs to be accelerated.
- Systemic features and benefits:
  - Luxembourg banking system concerns center on maturity transformation and leverage.
  - Given the system’s large size and extensive foreign ownership, Luxembourg will benefit particularly from the common backstop of the Single Resolution Fund, which will eventually exceed 100 percent of Luxembourg GDP.
  - More integrated prudential oversight under the Single Supervisory Mechanism (SSM) should help remove blind spots for Luxembourg supervisors.
- Legal transposition and timelines:
  - Resource constraints and other factors have delayed Luxembourg’s transposition of the Fourth Capital Requirements Directive and the Bank Recovery and Resolution Directive (BRRD). Further delays should be minimized.
  - Efforts should be made to promptly adopt the Deposit Guarantee Schemes Directive.
  - BRRD must be transposed into national law by end 2015 at the very latest; once transposed, the CSSF will become the recognized national resolution authority for both banks and bank holding companies and will interact closely with the Single Resolution Mechanism at the EU level.
- Recent case study and implications:
  - Banco Espírito Santo episode highlighted potential lacunae in EU oversight arrangements for cross border banking groups, including permissive approaches to mixing banking and commerce and principles-based identification of nonbank companies exercising “dominant influence.”
  - EU Capital Requirements Regulation does not mandate capital-holding requirements for nonbank companies that control banks, but member states are not forbidden from writing such rules into national law.
  - Luxembourg should consider measured national actions and lead broader EU debate on oversight of nonbank companies that control banks.

### Supervisory resources and coordination
- Supervisory workload and staffing:
  - Banks owning more than 80 percent of Luxembourg banking assets fall under direct ECB supervision, individually or via consolidated supervision of euro area parents.
  - Both the CSSF and the Banque Centrale du Luxembourg (BCL) contribute to SSM joint supervisory teams (JSTs).
  - CSSF staff strength increased by one-quarter over 2013–14 while its complement of bank supervisors doubled.
  - CSSF and BCL supervisors are engaged in 32 JSTs (of which five are for banks headquartered in Luxembourg).
- Recommendations:
  - Expand resources as needed; the increase in CSSF fees from 2013 was helpful.
  - Consider a memorandum of understanding between CSSF and BCL formalizing responsibilities on JSTs and modalities for information sharing.

### Market infrastructure, Clearstream, and settlement
- Luxembourg is set to benefit from the Central Securities Depository Regulation and the launch of the ECB’s TARGET2-Securities platform for settlement in central bank money; these developments should help expand Clearstream and other Luxembourg depositories’ business.
- CSSF–BCL cooperation will be important to:
  - Enforce requirements for settlement and depository functions.
  - Verify contingency plans for operational risks in stress scenarios.
  - Ensure any ancillary banking operations are adequately capitalized.

### Investment funds, insurance, and spillovers
- Fund industry observations:
  - Growth of investment funds requires strong oversight and attention to spillovers.
  - Regulatory norms largely determined at EU level (UCITS Directive, Alternative Investment Fund Managers Directive of mid 2013).
  - Enforcement is national competency.
  - Links to banks, direct and indirect, should be closely monitored primarily through banking supervision.
  - Given the large size of the industry relative to the banking system, funds’ cash balances, while small as a share of total assets, make up a significant share of bank deposits.
  - Almost 40 percent of fund assets are in debt securities, raising global market liquidity concerns in stress and risk of sharp drops in fund value.
  - The investor base that would absorb losses is overwhelmingly in Europe; U.S. promoters are barred from marketing non U.S. fund products to U.S. retail investors and thus distribute mostly in Europe.
  - Roughly half of total assets are invested outside Europe, and roughly half of those in the United States.
- Insurance sector:
  - Insurance industry investment portfolios and profitability merit close monitoring; current low interest rate conditions may challenge the life segment in particular.
- Staff advice:
  - Maintain strong oversight, monitor links between banks and funds, and attend to potential market liquidity risks.

### Macroprudential framework and housing market
- Systemic risk committee:
  - Legislation provides for a systemic risk committee extending well beyond banking, bringing together BCL, CSSF, Commissariat aux Assurances, and the Ministry of Finance.
  - Duties include risk monitoring, identification of regulatory gaps, and recommending corrective actions.
  - Suggested focal areas: housing market, links between banks and funds, and holding company oversight in cross border contexts.
- Housing market risks and actions:
  - Growth in housing exposures of locally active banks warrants continued monitoring and readiness to deploy macroprudential tools.
  - Housing prices and mortgage lending continue to rise, raising concentration risks and potential household overstretching.
  - Late 2012 CSSF measures advised banks to limit loan-to-value (LTV) ratios to 80 percent and imposed higher risk weights on mortgages with higher LTV ratios.
  - Staff advised stepped-up data collection on property lending and preparation of appropriately targeted macroprudential tools for deployment if needed.

### Financial Stability Assessment (FSA) and timelines
- Luxembourg is a systemic jurisdiction subject to mandatory FSAs.
- Last Financial System Stability Assessment was discussed by the IMF Executive Board on May 13, 2011.
- Assuming the next Article IV Consultation concludes on or before May 13, 2016, the next FSA may feed into the 2017 Article IV Consultation.
- Staff encouraged authorities to proceed early with the next FSA.

### Authorities’ views and national initiatives
- Authorities’ positions:
  - The banking union presents important opportunities; delays in transposing related EU directives are regrettable.
  - CSSF reports improved flow of information on risks to Luxembourg units of foreign banking groups under the SSM and expressed ability and willingness to increase staffing contributions to JSTs, subject to fee constraints.
  - Switch to automatic exchange of financial account information has been managed smoothly.
  - Ministry of Finance attributed legislative delays to surge in EU directives coinciding with a new national government and affirmed transpositions are underway.
  - Keen to build a track record implementing new AML/CFT standards; a later FSAP judged potentially more productive, but no formal decision taken.
- National initiatives to reinforce brand:
  - Legislation establishing a systemic risk committee and a proposal to restrict the use of a bank’s franchise name by unregulated and unaffiliated nonbanks to cut unwanted reputational linkages.
  - Authorities decided in principle to initiate and lead a debate on EU regulatory arrangements for nonbank companies that control banks.

### Policies for growth, labor, and diversification
- Priority areas:
  - Education and labor market reforms to support diversification.
  - Promising financial-sector activities: alternative investment funds, Islamic finance (in September 2014 Luxembourg became the first sovereign issuer of a euro denominated sukuk), and renminbi operations (in September 2014 one Chinese bank subsidiary in Luxembourg was granted clearing privileges with the People’s Bank of China).
  - Nonfinancial opportunities: logistics sector for low skilled employment; biotech, ICT, green technology require advanced skills.
- Policy recommendations:
  - Deliver education quality commensurable with high public spending; make vocational training more nimble.
  - Implement more active labor market policies and better targeting of social benefits to raise labor force participation and preserve incentives to work.
  - Focus on increasing women’s participation in the labor force, remove disincentives to work, modernize the employment agency for personalized treatment and better employer links.
  - Continue training schemes for youth and the long-term unemployed and reform minimum guaranteed income to promote second-earner participation.

*Source: _cr15144 - 21.      The authorities stressed their commitment to sound fiscal policies. They expressed (IMF staff report content supplied).*

### 42.      In other policies to lift growth prospects, diversification efforts need to be supported

### In other policies to lift growth prospects, diversification efforts need to be supported

### Growth, labor market, and structural policies
- Job creation is strong, yet joblessness among residents remains elevated by historical standards, reflecting:
  - the important (and positive) role of cross border workers, and
  - generous benefits for, and skills mismatches among, residents.
- Policy emphasis:
  - Equip workers with relevant skills.
  - Make vocational training in particular more nimble.
  - Continue steps being taken to lift youth and women’s participation in the labor force.

### IMF staff procedural recommendation
- Staff recommends the next Article IV Consultation with Luxembourg be held on the standard 12 month cycle.

### Selected economic indicators (highlights from Table 1)
- Real economy (percent change):
  - GDP: -0.2 (2012); 0.0 (2013); 2.0 (2014); 2.9 (2015); 2.5 (2016); 2.3 (2017); 2.3 (2018); 2.2 (2019); 2.2 (2020 Est.).
  - Domestic demand: 0.0 (2012); 0.5 (2013); 1.8 (2014); 2.2 (2015); 2.1 (2016); 2.3 (2017); 2.3 (2018); 2.3 (2019); 2.4 (2020 Est.).
  - Exports of goods and nonfactor services: 2.9 (2012); 5.6 (2013); 2.3 (2014); 2.7 (2015); 2.3 (2016); 2.3 (2017); 2.3 (2018); 2.2 (2019); 2.2 (2020 Est.).
- Labor market (levels and changes):
  - Resident labor force: 244.7 (2012); 251.0 (2013); 257.3 (2014); 262.6 (2015); 268.4 (2016); 274.3 (2017); 280.3 (2018); 286.5 (2019); 292.8 (2020 Est.).
  - Unemployed (thousands): 15.0 (2012); 17.2 (2013); 18.3 (2014); 18.0 (2015); 18.0 (2016); 18.1 (2017); 18.1 (2018); 18.1 (2019); 18.1 (2020 Est.).
  - Unemployment rate (percent of labor force): 6.1 (2012); 6.9 (2013); 7.1 (2014); 6.9 (2015); 6.7 (2016); 6.6 (2017); 6.5 (2018); 6.3 (2019); 6.2 (2020 Est.).
  - Cross border workers (net): 149.1 (2012); 151.7 (2013); 156.8 (2014); 161.0 (2015); 165.0 (2016); 169.7 (2017); 174.2 (2018); 178.8 (2019); 183.6 (2020 Est.).
  - Total employment: 379.1 (2012); 386.6 (2013); 395.7 (2014); 405.5 (2015); 415.6 (2016); 425.9 (2017); 436.4 (2018); 447.2 (2019); 458.3 (2020 Est.).
- Prices and costs:
  - CPI (harmonized): 2.9 (2012); 1.7 (2013); 0.7 (2014); 0.6 (2015); 1.6 (2016); 1.7 (2017); 1.9 (2018); 2.0 (2019); 2.2 (2020 Est.).
  - Wage growth (overall economy) 2/: 1.5 (2012); 3.6 (2013); 2.2 (2014); 1.7 (2015); 2.2 (2016); 2.2 (2017); 2.4 (2018); 2.5 (2019); 2.7 (2020 Est.).
- Public finances (percent of GDP):
  - General government revenues: 43.6 (2012); 44.4 (2013); 44.8 (2014); 44.1 (2015); 44.2 (2016); 44.1 (2017); 44.3 (2018); 44.3 (2019); 44.4 (2020 Est.).
  - General government expenditures: 43.5 (2012); 43.6 (2013); 44.2 (2014); 44.5 (2015); 44.2 (2016); 44.1 (2017); 44.1 (2018); 44.1 (2019); 44.1 (2020 Est.).
  - General government balance: 0.1 (2012); 0.9 (2013); 0.6 (2014); -0.5 (2015); 0.1 (2016); 0.1 (2017); 0.2 (2018); 0.2 (2019); 0.3 (2020 Est.).
  - General government gross debt: 21.4 (2012); 23.6 (2013); 23.3 (2014); 24.4 (2015); 24.9 (2016); 25.5 (2017); 25.9 (2018); 26.2 (2019); 26.4 (2020 Est.).
- Balance of payments:
  - Current account (percent of GDP): 5.7 (2012); 4.9 (2013); 5.2 (2014); 4.7 (2015); 4.6 (2016); 4.4 (2017); 4.4 (2018); 4.3 (2019); 4.3 (2020 Est.).
- Memorandum items:
  - Land area = 2,586 sq. km; population in 2015 = 563,000; GDP per head = €84,400.
  - GDP (billions of euro): 43.8 (2012); 45.3 (2013); 46.9 (2014); 48.6 (2015); 50.8 (2016); 52.8 (2017); 55.1 (2018); 57.3 (2019); 59.9 (2020 Est.).
  - Potential output growth (percent): 2.6 (2012); 1.4 (2013); 1.9 (2014); 2.3 (2015); 2.3 (2016); 2.3 (2017); 2.3 (2018); 2.3 (2019); 2.2 (2020 Est.).

### Balance of payments (highlights from Table 2)
- Current account (percent of GDP): 5.7 (2012); 4.9 (2013); 5.2 (2014); 4.7 (2015); 4.6 (2016); 4.4 (2017); 4.4 (2018); 4.3 (2019); 4.3 (2020 Est.).
- Trade and services:
  - Trade balance (percent of GDP): -3.7 (2012); -2.4 (2013); -0.9 (2014); -2.7 (2015); -2.9 (2016); -3.4 (2017); -3.5 (2018); -3.9 (2019); -4.0 (2020 Est.).
  - Balance on services (percent of GDP): 34.6 (2012); 35.7 (2013); 37.5 (2014); 38.3 (2015); 38.2 (2016); 38.3 (2017); 38.2 (2018); 38.1 (2019); 37.8 (2020 Est.).
  - Services exports (percent of GDP): 134.9 (2012); 147.1 (2013); 158.2 (2014); 161.3 (2015); 159.4 (2016); 158.7 (2017); 157.6 (2018); 157.0 (2019); 155.7 (2020 Est.).
- Net factor income (percent of GDP): -24.6 (2012); -28.7 (2013); -31.4 (2014); -31.0 (2015); -30.8 (2016); -30.6 (2017); -30.3 (2018); -30.0 (2019); -29.6 (2020 Est.).
- Capital and financial account (percent of GDP): -5.7 (2012); -4.9 (2013); -5.4 (2014); -4.7 (2015); -4.6 (2016); -4.4 (2017); -4.4 (2018); -4.3 (2019); -4.3 (2020 Est.).
- Notable entries (percent of GDP):
  - Direct investment, net: -89.4 (2012); 17.5 (2013); -26.7 (2014); -24.5 (2015); -22.2 (2016); -20.1 (2017); -18.1 (2018); -16.4 (2019); -14.8 (2020 Est.).
  - Portfolio investment, net: -438.7 (2012); -204.3 (2013); -197.8 (2014); -197.8 (2015); -197.8 (2016); -197.8 (2017); -197.8 (2018); -197.8 (2019); -197.8 (2020 Est.).

### Risk Assessment Matrix (Table 3): main risks, likelihood, and policy responses
- Business model risk: Impact of changes in financial sector regulatory landscape larger than expected
  - Relative likelihood: Medium
  - Transmission: Luxembourg’s attraction as a financial center for cross border activities could diminish, and financial and commercial flows routed through Luxembourg could decline
  - Impact if realized: High — Significant impact on total factor productivity, growth, exports, jobs, and revenues
  - Policy response: A range of proactive steps, consistent with relevant standards, to preserve Luxembourg’s reputation as a solid financial jurisdiction
- Business model risk: Changes in EU and international taxation rules result in further revenue losses
  - Relative likelihood: Medium
  - Transmission: A significant share of revenue relates to cross border activities, including remaining e-VAT, corporate taxes, and fuel and tobacco excises
  - Impact if realized: High — Significant hit to revenues, growing deficits, and shrinking government net worth
  - Policy response: Proactively adjust tax and expenditure policies and advance pension reform
- G-RAM risk: Protracted period of slower growth in advanced economies (including the euro area)
  - Relative likelihood: High
  - Transmission: Strong trade and financial linkages make Luxembourg particularly vulnerable to developments in the euro area
  - Impact if realized: Medium — Exports and overall growth held back
  - Policy response: Diversify financial services exports toward non euro area markets and advance structural reforms to boost competitiveness
- G-RAM risk: A surge in financial market volatility as investors reassess underlying risk
  - Relative likelihood: High
  - Transmission: Portfolio reallocation in investment fund industry, bond market stress in euro area, and possible safe haven inflows through the banking system
  - Impact if realized: Low — Moderate impact on domestic economy unless the global stress is especially severe
  - Policy response: Monitor financial sector exposures, conduct stress tests, and ensure robust contingency planning for operational risks
- G-RAM risk: Protracted period of low interest rates spawns excessive mortgage borrowing and housing price increases
  - Relative likelihood: Low
  - Transmission: Stability risks limited by large buffers at banks and full recourse lending; greater risk may be compression of consumption if households become overstretched
  - Impact if realized: Medium — Hit to domestic demand and overall growth, with possible modest disruption of domestic credit
  - Policy response: Monitor risk concentrations and stand ready to take well targeted macroprudential measures

### Fiscal consolidation and public debt (highlights from Tables 5–8)
- General government operations (percent of GDP, Table 5):
  - Revenue: 43.6 (2012); 44.4 (2013); 44.8 (2014); 44.1 (2015); 44.2 (2016); 44.1 (2017); 44.3 (2018); 44.3 (2019); 44.4 (2020 Est.).
  - Expenditure: 43.5 (2012); 43.6 (2013); 44.2 (2014); 44.5 (2015); 44.2 (2016); 44.1 (2017); 44.1 (2018); 44.1 (2019); 44.1 (2020 Est.).
  - Net lending / borrowing: 0.1 (2012); 0.9 (2013); 0.6 (2014); -0.5 (2015); 0.1 (2016); 0.1 (2017); 0.2 (2018); 0.2 (2019); 0.3 (2020 Est.).
- Measures underlying consolidation scenario (Table 6, millions of euros and percent of GDP):
  - Expenditures consolidated: -150 (2015); -286 (2016); -363 (2017); -422 (2018); -437 (2019); -444 (2020) corresponding to -0.3, -0.6, -0.7, -0.8, -0.8, -0.7 (percent of GDP).
  - Revenues measures: -347 (2015); -241 (2016); -375 (2017); -359 (2018); -497 (2019); -517 (2020) corresponding to -0.7, -0.5, -0.7, -0.7, -0.9, -0.9 (percent of GDP).
  - Projected e-VAT loss (memorandum): -700 (2015); -706 (2016); -864 (2017); -875 (2018); -1,035 (2019); -1,082 (2020) corresponding to -1.4, -1.4, -1.6, -1.6, -1.8, -1.8 (percent of GDP).
  - Total fiscal balance change: -197 (2015); 45 (2016); -126 (2017); 3 (2018); -60 (2019); -73 (2020) corresponding to -0.4, 0.1, 0.0, 0.1, -0.1, -0.1 (percent of GDP).
- Public Sector Debt Sustainability Analysis (Table 8, percent of GDP):
  - Nominal gross public debt: 12.9 (2013); 23.6 (2014); 23.3 (2015); 25.1 (2016); 25.7 (2017); 26.5 (2018); 27.1 (2019); 27.8 (2020).
  - Public gross financing needs: 1.0 (2013); 0.7 (2014); 1.4 (2015); 2.6 (2016); 3.2 (2017); 2.1 (2018); 3.1 (2019); 2.0 (2020); 1.7 (year shown).
  - Real GDP growth (in percent): 2.6 (2013); 2.0 (2014); 2.9 (2015); 2.5 (2016); 2.3 (2017); 2.3 (2018); 2.2 (2019); 2.2 (2020).
  - Inflation (GDP deflator, in percent): 3.5 (2013); 1.4 (2014); 0.7 (2015); 0.9 (2016); 2.2 (2017); 1.5 (2018); 2.0 (2019); 1.8 (2020); 2.2 (year shown).
  - Effective interest rate (in percent): 3.4 (2013); 2.1 (2014); 1.6 (2015); 1.9 (2016); 2.2 (2017); 2.3 (2018); 2.7 (2019); 2.7 (2020); 2.4 (year shown).
  - Cumulative change in gross public sector debt (2015–20): 4.9 (percent of GDP).
  - Identified debt-creating flows cumulative: 8.0 (percent of GDP); Primary deficit cumulative: 10.7 (percent of GDP).

### Financial soundness and fiscal balance sheet (highlights)
- Financial soundness indicators (Table 7, selected):
  - All Banks: Regulatory capital to risk weighted assets: 17.0 (2010); 16.0 (2011); 19.0 (2012); 21.0 (2013); 19.0 (Q3 2014).
  - All Banks: Customer deposits to total (non interbank) loans: 131.0 (2010); 119.0 (2011); 129.0 (2012); 147.0 (2013); 160.0 (Q3 2014).
  - Domestically Oriented Banks: Regulatory capital to risk weighted assets: 24.0 (2010); 22.2 (2011); 24.4 (2012); 26.0 (2013); 22.0 (Q3 2014).
- General government financial balance sheet (Table 4, memorandum items):
  - Net financial worth (percent of GDP): 48.4 (2012); 49.5 (2013); 43.2 (2014 Q3).
  - Financial assets (percent of GDP): 77.9 (2012); 79.2 (2013); 72.4 (2014 Q3).
  - Liabilities (percent of GDP): 29.6 (2012); 29.7 (2013); 29.2 (2014 Q3).
  - GDP (millions of euros): 43,812 (2012); 45,289 (2013); 46,944 (2014 Q3).

*Source: IMF staff; Luxembourg authorities (as presented in the IMF staff report).*

### Appendix I. External Sector Assessment

### Appendix I. External Sector Assessment

### EBA-lite methodology and approach
- The EBA-lite methodology estimates a country’s current account norm based on economic fundamentals, cyclical factors, and desirable policy variables.
- Using a calculated elasticity, exchange rate misalignment is derived as the adjustment necessary to restore the current account balance to its norm.
- The EBA-lite approach extends to more countries than the EBA.

### Current account developments and decomposition
- Luxembourg’s current account surplus narrowed from more than 10 percent of GDP in 2006–07 to about 5 percent in 2013–14.
- Components contributing to the recent current account configuration:
  - Financial and other nonfactor services surplus: over 37 percent of GDP.
  - Workers’ remittances deficit: 17 percent of GDP.
  - Net investment income deficit: 15 percent of GDP (reflecting distribution of investment returns linked to strong growth in investment fund assets booked in Luxembourg).

### EBA-lite quantitative findings (percent of GDP unless otherwise indicated)
- (1) Current account: Projected 4.7
- (2) Current account: Fitted 8.7
- (3) Policy gap 0.5
- (4) =(2)-(3) Current account: Norm 8.2
- (5) =(1)-(4) Current account: Gap -3.5
- (6) Elasticity of CA to REER (ratio) -1.3
- (7) =(5)/(6) Real exchange rate gap (percent) 2.6
- Using the EBA-lite approach, the current account is projected at some 3½ percent of GDP below its norm of 8 percent of GDP in 2015.

### Exchange rate alignment
- On staff estimates, the exchange rate remains broadly in line with fundamentals.
- The EBA-lite methodology indicates Luxembourg’s real effective exchange rate is overvalued by about 2½ percent relative to its equilibrium level.
- Conclusion: There is no evidence of substantial misalignment.

*Source: Luxembourg authorities; and IMF staff estimates.*

### 0.6 percent of GDP of additional revenue. A temporary personal income tax, set at 0.5

### _cr15144 - 0.6 percent of GDP of additional revenue. A temporary personal income tax, set at 0.5

### Fiscal developments and revenue measures
- Recent measures and developments expected to generate additional revenue and savings:
  - 0.6 percent of GDP of additional revenue.
  - A temporary personal income tax, set at 0.5 percent of income, expected to generate additional revenue of 0.2 percent of GDP.
  - Favorable economic developments expected to generate additional revenue of about 0.3 percent of GDP.
  - Additional expenditure savings of about 0.15 percent of GDP.
- Authorities view on tax-transparency initiatives:
  - Authorities consider it premature to assess revenue impacts from evolving EU and OECD tax-transparency standard setting; most rules are still evolving and have not yet translated into specific risks to the revenue base warranting a policy response.
  - Authorities are closely monitoring developments in the EU and OECD to make necessary adjustments to be fully compliant with international standards.
- Policy planning:
  - Authorities committed to sound fiscal policies.
  - A tax policy review will take place in 2015-2016 to review the structure, composition and economic rationale behind several taxes while preserving the current level of fiscal revenue.

### Public debt, budget framework, and fiscal institutions
- Public debt and assets:
  - Debt-to-GDP ratio is at 23 percent in 2014 - entirely denominated in euro - well below the 60 percent level of the Maastricht criteria.
  - Taking government assets into account, the public sector is a net creditor.
  - First euro-denominated Sukuk issued in October 2014 to diversify public debt structure and develop Islamic finance.
  - Public debt projected to remain around 24 percent of GDP over the period 2015-2019.
  - Authorities committed to keep public debt below 30 percent of GDP.
- Budgetary framework and fiscal oversight:
  - A law establishing a multi-year budgetary framework was adopted in 2014 and implemented for the 2015 Budget; framework applies to all levels of government and includes multi-year expenditure ceilings for the central government consistent with the EU “six-pack” and the Fiscal Compact.
  - An independent Fiscal council has been set up, provided with sufficient resources and expertise and expected to be fully operational for the 2016 budgetary process.

### Long-term fiscal sustainability and pension reform
- Ongoing initiatives to strengthen public finances:
  - Health care reform (since 2011).
  - Pension reform (since 2013).
  - Consolidation measures following the expenditure review (since 2015).
- Pension system assessment and next steps:
  - Staff and authorities agree on the need to place the old-age pension system on a sustainable path; pension system still suffers from costly rigidities and deeper pension reforms remain necessary.
  - Under the 2013 pension regime, authorities may appraise every 5 years, using actuarial studies, the consistency between assumptions underlying the reform and the updated financial trajectory.
  - Given the importance of pension expenditure, authorities decided to advance the review by 1 year.
  - Authorities agreed with staff that long-term population projections by Eurostat, assuming large net immigration, should be viewed with some caution.

### Financial sector: resilience, banking, investment funds
- Overall assessment:
  - Luxembourg’s financial sector remains resilient and sound; it is a financial hub within the euro area serving private and institutional investors globally.
  - Significant European and international regulatory changes represent challenges; authorities are closely monitoring these changes and stand ready to take necessary measures to consolidate and strengthen competitiveness.
  - Continued diversification of financial sector across business activities, investment destinations and customer bases expected to contribute to financial stability, growth and job creation.
- Banking sector:
  - Aggregate banking sector balance sheet contracted with the financial crisis but stabilized in 2013-2014 due to increased asset values and some new inflows.
  - Capitalization and liquidity ratios are sound; non performing loans (NPLs) are very low.
  - Banking sector remains profitable and an important liquidity provider.
  - ECB’s Comprehensive Assessment did not identify any capital shortfall in Luxembourg banks; the six Luxembourg credit institutions which underwent the Comprehensive Assessment are robust, reliable and sustainable.
  - Authorities view the European banking union, including the Single Supervisory Mechanism (SSM), as especially positive for Luxembourg.
- Investment fund industry:
  - The investment fund industry remains an important component of the financial system and continues to grow rapidly, benefiting from favorable financial markets, increased assets under management, and new inflows; it invests in a diversified class of assets and serves a diverse pool of investors.

### Regulatory strengthening and systemic risk oversight
- Supervisory enhancements:
  - Authorities have made substantial progress strengthening financial sector supervision, enhancing on-site supervision and significantly increasing the staffing resources of the supervisory authority (CSSF).
  - Banque centrale du Luxembourg (BCL) has expanded and reinforced its supervisory activities and will provide the Secretariat for the national Systemic Risk Committee.
  - Authorities committed to progressively increase the capital base of the BCL starting this year.
- Systemic Risk Committee (SRC):
  - SRC established by law on April 1, 2015; involves banking, market and insurance supervisors, the BCL and the Ministry of Finance.
  - SRC will strengthen collaboration and exchange of information, closely monitor links between banks and the fund industry and developments in the housing market.
  - SRC expected to recommend additional macro-prudential measures if financial stability becomes in peril.
  - Authorities noted staff recommendation that the Committee’s duties should include identification of regulatory gaps and impediments to effective policy action.
- Financial Stability Assessment:
  - Authorities plan to undertake the Financial Stability Assessment (FSA) exercise scheduled for 2016 to help strengthen Luxembourg’s financial model.

### Tax transparency and automatic exchange of information
- Recent and planned actions:
  - Introduction of automatic exchange of information on interest payments under the EU Savings Directive (since January 1, 2015).
  - Extension of automatic exchange to other sources of income as well as account balances (starting in 2017).
  - Implementation of the OECD Standard for Automatic Exchange of Financial Account Information in Tax Matters (by 2017).
- Authorities emphasize strong commitment to fully engage in EU and OECD standard settings on tax transparency.

### Housing market and macroprudential monitoring
- Factors affecting supply-demand imbalance:
  - Demand-side drivers: high demand from residents and cross-border workers; relatively high population and immigration growth; government policies on housing benefits; low mortgage interest rates.
  - Supply-side constraints: administrative constraints and low recurring taxes on real estate property.
- Policy responses:
  - Expenditure review introduced changes to some housing policies expected to reduce demand somewhat.
  - SRC expected to monitor high domestic residential real estate exposure of domestically-oriented banks and recommend macro-prudential measures if needed.

### Authorities’ remark
- Authorities regret that concerns expressed during meetings with staff about the selected issues report were not fully taken into account.
  - In particular, they believe holdings’ regulation and supervision should be addressed in a different report (e.g., the IMF euro area staff report) rather than the Luxembourg selected issues report, since it primarily highlights potential shortcomings in EU legislation that require EU-level consideration.
  - Preserving a level playing field in European financial markets is a priority for the authorities.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15144.pdf*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15144.pdf_