## _cr16118

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### Growth and outlook
- Real GDP: 4.8 percent in 2015; projected at 3.5 percent in 2016.
- Growth drivers:
  - Net exports of financial services were the main driver of recent growth.
  - Expansion benefited from the world’s major central banks’ quantitative easing (QE) and a global search for yield.
- Labor market and inflation:
  - Resident employment: 242.8 thousand in 2015; projected 247.8 thousand in 2016.
  - Total employment: 405.7 thousand in 2015; projected 416.0 thousand in 2016.
  - Unemployment: 6.9 percent in 2015; projected 6.4 percent in 2016.
  - CPI (harmonized): 0.1 percent in 2015; projected 0.5 percent in 2016.
- Medium-term outlook and projections:
  - GDP growth: expected to ease to about 3½ percent in 2016 and to its long-term trend of 3 percent thereafter.
  - Inflation: pick up to 1.3 percent in 2017, and reach around 2 percent over the medium term; "Over the medium term, inflation is projected to average 1.6 to 2 percent."
  - Private consumption: expected to rebound from the "low base of 2015."
  - From 2017, domestic demand should get a boost from planned personal income tax cuts.
- Downside risks to growth:
  - Weakening international activity.
  - Financial market stress affecting Luxembourg’s performance.
  - Implementation of the international tax transparency agenda could weigh on activity and tax revenue.
  - Other risks: weaker-than-expected growth in the euro area, Brexit, another surge of refugees.

### Fiscal position and policy
- 2015 fiscal outcomes:
  - Fiscal surplus of 1 percent of GDP in 2015.
  - General government revenues: 42.9 percent of GDP in 2015; projected 42.8 percent in 2016.
  - General government expenditures: 41.9 percent of GDP in 2015; projected 41.8 percent in 2016.
  - General government balance: 1.0 percent of GDP in 2015; projected 0.9 percent in 2016.
  - General government gross debt: 21.6 percent of GDP in 2015; projected 22.6 percent in 2016.
- Public net wealth:
  - Positive public net wealth of 43 percent of GDP at end-2015:Q3.
- Tax reform and medium-term stance:
  - Tax reform proposal (tabled in 2016, implementation date January 1, 2017) would significantly reduce personal taxation and reduce corporate income taxes starting in 2017; estimated cost "around 0.6 and 0.8 percent of GDP for the period 2017–2020."
  - Authorities project fiscal position to remain in a small surplus over the medium term and "well above the newly adopted MTO" for 2017–2020.
  - Directors endorsed targeting a broadly balanced fiscal position and low public debt over the medium term.
- Policy recommendations:
  - Adopt contingency measures to address revenue risks from weakening international activity, tax transparency implementation, and financial market stress.
  - Broaden the tax base (e.g., phase out the IP Box tax regime) and eliminate special tax regimes while lowering statutory tax rates.
  - Target a small fiscal surplus of around ½ percent of GDP over the medium term to place public debt-to-GDP on a slightly downward path.
  - Limit the size of announced tax cuts or use fiscal space for growth-enhancing measures.
  - Continue deeper pension reforms to ensure long-term viability.

### Financial sector structure and risks
- Size and role:
  - Gross international assets increased by €1.1 trillion to €9.5 trillion in 2015 (180 times GDP).
  - Financial sector contributes about ¼ of GDP, 18 percent of budget revenues, and 11 percent of employment.
- Banking system:
  - 144 banks located in Luxembourg; nearly all are foreign-owned; only five banks are domestically owned.
  - Banking system CAR: nearly 20 percent on average.
  - Total bank assets around €770 billion.
  - Very low non-performing loans.
- Investment funds:
  - Assets under management (AUM) jumped 28 percent y/y to €3.6 trillion in May 2015; stagnated thereafter amid volatility.
  - Net inflows in funds: €298 billion in 2015, accounting for 72 percent of the increase in AUM for the year.
  - Since end-2008, about 20 percent (or €1.2 trillion) of all new net inflows into investment funds worldwide came to Luxembourg funds.
- Financial stability concerns and recommendations:
  - Strengthen oversight of the financial system and maximize benefits from the Banking Union.
  - Advocate for better European-level oversight of nonbank holding companies that include banks.
  - Continue strong oversight of investment funds; analyze and monitor linkages between investment funds and banks, including at the European level.
  - Closely monitor risks in the real estate market.
  - Directors encouraged an increase in the capital of the central bank to bolster its financial buffer.

### Financial sector vulnerabilities and bank–fund linkages
- Investment fund sector risks:
  - Investor base: 75 percent from Europe; exposures: euro area 35 percent, U.S. 26 percent, emerging markets 13 percent.
  - Credit risk: corporate bond exposure rose from €141 billion (or 29 percent of total bond investments) at end-2008 to €648 billion (or 45 percent of total bond investments) in October 2015.
  - Counterparty risk: from securities lending, repos, and derivatives.
  - Market risk: leverage and growing use of derivatives increase sensitivity.
  - Redemption risk: first-mover advantages increase likelihood of sudden runs on funds.
  - Liquidity risk: some funds may be less liquid than redemption terms and conditions.
- Transmission channels to banks (2015:Q3):
  - Investment funds hold claims on banks amounted to €821 billion; 73 percent of which outside Luxembourg.
  - Investment funds’ liabilities to banks amounted to €175 billion.
  - Derivatives: €133 billion of derivative contracts included in funds’ liabilities.
  - Cash balances: investment funds held €220 billion, about half concentrated in Luxembourg’s depository banks, totaling 50 percent of their liabilities.
  - Deposit volatility: standard deviation of monthly net deposit inflows is about €5 billion since 2009.
  - Historical episodes: aggregate net redemptions reached around €100 billion between September and December 2008; deposits then declined by €13.7 billion in 2009:Q1, of which €5 billion were withdrawn from Luxembourg banks. In 2011:Q4, deposits declined by €9 billion, of which €3.6 billion from Luxembourg banks.
- Policy recommendations:
  - Joint scenario analysis between banks and investment funds, including liquidity stress tests.
  - Authorities should advocate further financial stability analysis of bank–fund linkages in the SSM and include them in joint fund–bank stress test scenarios.
  - Ensure banks are compliant with local LCR with good collateral; Eurosystem should stand ready to provide liquidity if a shock materializes.

### Banking sector and real estate risks; macroprudential measures
- Mortgage lending and household debt:
  - Mortgage loans: €23 billion at end-October 2015, or about 45 percent of GDP for banks that lend domestically.
  - Household debt: rose by 10 percent of GDP since 2008; 59 percent of GDP in 2015.
- Macroprudential actions and legal transpositions:
  - 2013: CSSF raised capital provision requirements from 35 percent to 75 percent for new mortgage loans with LTV above 80 percent.
  - Law transposing CRDIV adopted in July 2015.
  - Capital buffers for systemically important banks increased by an extra 0.5–1 percent by January 2019; countercyclical capital buffers introduced initially with zero values.
  - Law transposing BRRD and DGSD passed Parliament in December 2015.
  - Banks will make contributions to the Single Resolution Fund (SRF) for eight years reaching in total at least 1 percent of covered deposits.
- Recommendation:
  - Explore effectiveness of recent measures and consider further macroprudential tools such as additional limits to loan-to-value ratios.

### Oversight of investment funds and supervisory framework (Section 21)
- Legal coverage:
  - UCITS directives III and IV cover 80 percent of the funds in Luxembourg; other funds covered by the AIFM Directive.
- Reporting and supervision:
  - CSSF receives data reporting enabling precise information on individual funds and oversight over liquidity stress tests performed by asset managers.
  - Adequate resources should be allocated to oversight to ensure sound risk management practices and prudential norms governing liquidity, leverage, redemptions and asset valuation at both fund and asset manager levels.
- Specific supervisory priorities:
  - Data monitoring to detect early warning signs of market, credit or liquidity risk and shocks through redemptions.
  - Scrutinize use of derivatives, securities lending, and liquidity mismatches.
  - Evaluate funds’ resilience with stress tests that allow for correlated shocks and large portfolio reallocations.
  - Test liquidity risk management toolkit (redemption fees, gates, side pockets, suspension of redemptions) against severe stress scenarios.
- CRS and macroprudential priorities:
  - CRS added analysis of fund–bank linkages to national work program and should ensure examination at the ESRB and recommend corrective actions if needed.

### Banque Centrale du Luxembourg (BCL) capital
- Recommendation:
  - Authorities should increase BCL capital through an agreement between government and BCL to ensure adequate financial buffers.
- Rationale and exposures:
  - BCL currently operates with little financial buffers to cover net present value of operating expenses.
  - Exposures: very limited exposures to financial institutions (€6 billion); liabilities of €57 billion to depository institutions reflecting creditor position in Target 2.
  - Adding capital now should anticipate potential falls when monetary policy is normalized and preserve operational coverage and Eurosystem functioning.

### AML/CFT progress and ongoing work
- Progress (legislation passed in 2014–15):
  - All acts of terrorist financing covered by the 2012 standard are criminalized.
  - Bearer shares must be immobilized.
  - Authorized operators in the Luxembourg Freeport are subject to AML/CFT measures.
- Ongoing work and recommendations:
  - Implement revised FATF standard and the 4th AML/CFT EU Directive.
  - Include tax crimes among predicate offenses to money laundering.
  - Facilitate timely access to information on beneficial owners.
  - Maintain AML/CFT supervision intensity commensurate with risks.

### External sector, IIP and taxation transparency
- Current account and trade:
  - Current account balance: 5.5 percent of GDP in 2015; projected 5.4 percent in 2016.
  - Balance of trade in goods and services: 35.5 percent of GDP in 2015; projected 36.0 percent in 2016.
  - Factor income balance: -30.6 percent of GDP in 2015; projected -31.2 percent in 2016.
- International investment position (IIP, 2015):
  - Gross foreign assets: €9.5 trillion in December 2015.
  - IIP structure (assets, 2015): Foreign direct investment €4,081 billion; Portfolio investments €4,263 billion; Other investments €925 billion; Financial derivatives €185 billion.
  - GDP (2015): €52.1 billion.
- Tax transparency and state aid issues:
  - EC decision: advance tax rulings (Fiat, Starbucks, Belgian scheme) found to involve improper state aid; repayments for Fiat and Starbucks could amount to €20–30 million; Belgium about €700 million from at least 35 companies.
  - Luxembourg appealed the EC decision.
  - OECD/G20 BEPS and EU automatic exchange: Luxembourg committed to join EU-wide automatic exchange of advance tax rulings effective from 2017; signed agreements for automatic exchange of country reports from 2017.
  - "LuxLeaks" revealed rulings that allowed effective tax rates as low as 1 percent.
  - OECD Global Forum removed Luxembourg from its list of non-compliant countries in October (year as given in source).
- Staff recommendation:
  - Use tax reform to broaden the tax base, phase out IP Box, eliminate special regimes while lowering statutory rates; develop contingency measures including revisiting low real estate taxes if negative revenue risks materialize.

### Pension system and demographic projections
- Current situation:
  - Pay-as-you-go pension system generous and currently generating surpluses; effective retirement age low; replacement rate among highest in Europe.
  - Pension-related assets set aside: -29.4 percent of GDP at the end of 2015 (specialized dedicated fund).
- Long-term projections and concerns:
  - EC 2012 Ageing Report: pension expenditures increase from 9.2 percent of GDP in 2010 to 18.6 percent of GDP by 2060.
  - 2015 Ageing Report: pension expenditures increase from 9.4 percent of GDP in 2013 to 13.4 percent of GDP in 2060.
  - Staff notes 2015 Ageing Report projection is more optimistic than UN population projection; caution on strong population growth assumptions via long-term net migration.
- Recommended reforms:
  - Increase effective retirement age.
  - Lower benefits.
  - Improve sustainability and fairness across generations.
  - 2012 reform measures to be strengthened by additional parametric reforms (replacement rate decline, automatic indexation decline, contribution increases, incentives to postpone retirement).
  - 2016 pension review should propose additional parametric reforms (minimum contributions period, conditions for early retirement).

### Structural reforms, labor market, and refugee integration
- Structural priorities:
  - Diversify economy beyond financial sector; promote automotive components, eco-innovation, healthcare and biotechnologies, information and communication, materials and production, space technologies.
  - Ease zoning requirements for real estate construction; remove restrictions for weekend and after-hours work.
  - Align wages with productivity; reduce inactivity traps.
- Labor market and skills mismatch:
  - Unemployment rose from 2 percent in 2000 to 7 percent in 2014; nearly half was long-term unemployed.
  - Share of people who did not finish secondary school among unemployed: 43 percent.
  - Strong growth and ADEM measures helped reduce unemployment to 6.5 percent in early 2016.
  - Labor force composition (2015Q4, percent): Luxembourg citizens 27.6; Resident non-citizens 27.6; Cross-border commuters 44.8.
- Refugee influx and integration:
  - Asylum applications increased "about threefold year-on-year" from September 2015.
  - Luxembourg hosts around 3500 asylum seekers since mid-2015, nearly 0.5 percent of its population.
  - Authorities prioritize families with children and enrolled asylum seekers in schools, training and language classes; retired teachers called back to work.
  - Reduced time between asylum application and work permit from 9 to 6 months; recommendation to issue temporary employment permits while applications are considered and extend employment-promotion programs to refugees.

### Financial soundness and selected indicators (highlights)
- Real GDP growth (percent change): 2013=4.3, 2014=4.1, 2015=4.8, 2016=3.6, 2017=3.3, 2018=3.2, 2019=3.1, 2020=3.0, 2021=3.0.
- CPI (harmonized, percent change): 2013=1.7, 2014=0.7, 2015=0.1, 2016=0.5, 2017=1.3, 2018=1.6, 2019=1.7, 2020=1.9, 2021=2.1.
- General government balance (percent of GDP): 2013=0.7, 2014=1.4, 2015=1.0, 2016=0.9, 2017=0.1, 2018=0.1, 2019=0.1, 2020=0.1, 2021=0.1.
- General government gross debt (percent of GDP): 2013=23.3, 2014=22.9, 2015=21.6, 2016=22.6, 2017=22.9, 2018=23.1, 2019=23.1, 2020=23.2, 2021=23.1.
- Current account (percent of GDP): 2013=5.7, 2014=5.5, 2015=5.5, 2016=5.4, 2017=5.3, 2018=5.2, 2019=5.1, 2020=5.0, 2021=5.0.
- GDP (billions of euro): 2013=46.5, 2014=48.9, 2015=52.1, 2016=54.7, 2017=57.5, 2018=60.3, 2019=63.4, 2020=66.6, 2021=70.0.
- Financial soundness indicators (percent):
  - Regulatory capital to risk weighted assets (All banks): 2011=16.9, 2012=18.3, 2013=19.9, 2014 Sep=19.4, 2014 Dec=20.6, 2015=20.9.
  - Return on assets (All banks): 2011=0.6, 2012=0.7, 2013=0.7, 2014 Sep/Dec=0.7/0.8, 2015=0.8.
  - Household debt to GDP: 2011=53.0, 2012=55.1, 2013=55.4, 2014 Sep/Dec=58.6/59.3, 2015=59.3.

### Public debt sustainability and scenarios
- Nominal gross public debt (percent of GDP): 2014=14.9, 2015=22.9, 2016=21.6, 2017=22.6, 2018=22.9, 2019=23.1, 2020=23.1, 2021=23.2, projection 23.1.
- Public gross financing needs (percent of GDP): 2014=0.8, 2015=0.7, 2016=0.1, 2017=1.5, 2018=1.6, 2019=2.2, 2020=1.1, 2021=3.7; cumulative=0.65.
- Baseline assumptions (selected): Real GDP growth 2016=3.6, 2017=3.3, 2018=3.2; Inflation (GDP deflator) 2016=1.6, 2017=1.4, 2018=1.7; Effective interest rate 2016=1.5, 2017=1.5, 2018=1.7.
- Risk Assessment Matrix (selected risks and responses):
  - Business model risk (tax rule changes): Relative likelihood Medium; Impact High; Policy response: diversify fiscal revenue base, contingency plans, continue pension reform.
  - G-RAM risk (structurally weak growth abroad): Relative likelihood High; Impact Medium; Policy response: diversify services exports, structural reforms, infrastructure investment.
  - G-RAM risk (sharp asset price decline): Relative likelihood Medium; Impact Medium; Policy response: monitor exposures, conduct stress tests, ensure contingency planning and liquidity readiness.
  - Refugee surge risk: Relative likelihood High; Impact Low; Policy response: integrate refugees quickly via language classes and training.
  - Brexit risk: Relative likelihood High; Impact High; Policy response: contingency planning for operational risks.

### Appendix I — EC State Aid Decision and international initiatives
- EC findings:
  - EC decided that advance tax rulings of Fiat in Luxembourg and Starbucks in the Netherlands and the Belgian "excess profit" scheme involved improper state aid.
  - Repayments could amount to €20–30 million for Fiat and Starbucks; Belgium would need to recover about €700 million from at least 35 companies.
  - EC probing Amazon and McDonald’s advance tax rulings in Luxembourg and Apple’s in Ireland.
  - National authorities have appealed EC decisions at the European Court of Justice.
- International tax transparency timelines:
  - Automatic sharing of national advance tax rulings from 2017.
  - Luxembourg switched to automatic exchange on interest payments under the EU Savings Directive from 2015; extension to account balances and dividends from 2017.
  - G20 endorsed OECD BEPS recommendations and automatic exchange of information for tax purposes from 2017.
  - Luxembourg committed to OECD Standard for Automatic Exchange of Financial Account Information and signed agreements for automatic exchange of country reports from 2017.
- Domestic response and implications:
  - "LuxLeaks" revealed rulings allowing effective tax rates as low as 1 percent.
  - Authorities expect some short-term fiscal losses from transparency measures but see potential long-term benefits and commitments to greater transparency.
  - Staff advice: use tax reform to broaden base and prepare contingency measures.

### Recommendation and next steps
- Staff recommends the next Article IV Consultation be held on the standard 12 month cycle.
- Implementation priorities highlighted:
  - Strengthen oversight and resources for CSSF commensurate with financial sector size and complexity.
  - Advocate for European-level oversight of nonbank holding companies and fund–bank linkages under the SSM.
  - Increase BCL capital via government–BCL agreement.
  - Continue pension reforms and structural measures to reduce inactivity traps and improve skills alignment.
  - Maintain a small fiscal surplus and low public debt to buffer revenue risks from tax transparency and volatile financial flows.

*Source: LUXEMBOURG STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION, April 20, 2016.*

### 4.8 percent in 2015, well above the EU average, and was driven by net exports of financial

### _cr16118 - 4.8 percent in 2015, well above the EU average, and was driven by net exports of financial services also benefiting from the world’s major central banks’ quantitative easing.

### Growth and outlook
- Real GDP: 4.8 percent in 2015; projected at 3.5 percent in 2016.
- Growth drivers:
  - Net exports of financial services were the main driver of recent growth.
  - Expansion benefited from the world’s major central banks’ quantitative easing (QE) and a global search for yield.
- Labor market and inflation:
  - Continued strong job creation; resident employment rose to 242.8 thousand in 2015 and projected 247.8 thousand in 2016.
  - Total employment: 405.7 thousand in 2015 and projected 416.0 thousand in 2016.
  - Unemployment: 6.9 percent in 2015; projected 6.4 percent in 2016.
  - CPI (harmonized): 0.1 percent in 2015; projected 0.5 percent in 2016.
- Downside risks to growth:
  - Weakening international activity.
  - Financial market stress affecting Luxembourg’s performance.
  - Implementation of the international tax transparency agenda could weigh on activity and tax revenue.

### Fiscal position and policy
- 2015 fiscal outcomes:
  - Fiscal surplus of 1 percent of GDP in 2015, attributed to buoyant tax revenues from higher-than-expected economic activity.
  - General government revenues: 42.9 percent of GDP in 2015; projected 42.8 percent in 2016.
  - General government expenditures: 41.9 percent of GDP in 2015; projected 41.8 percent in 2016.
  - General government balance: 1.0 percent of GDP in 2015; projected 0.9 percent in 2016.
  - General government gross debt: 21.6 percent of GDP in 2015; projected 22.6 percent in 2016.
- Public net wealth: positive public net wealth of 43 percent of GDP at end-2015:Q3 (public sector assets exceed liabilities).
- Policy measures and recommendations:
  - A tax reform proposal tabled in 2016 would significantly reduce personal taxation and reduce corporate income taxes starting in 2017; measures are expected to result in a broadly balanced fiscal position over the medium-term.
  - Directors recommended contingency measures to address revenue risks arising from weakening international activity, implementation of international tax transparency, and financial market stress.
  - Directors endorsed targeting a broadly balanced fiscal position and low public debt over the medium term.
  - Directors recommended deeper pension reforms to ensure long-term viability of the system.

### Financial sector structure and risks
- Size and role:
  - Gross international assets increased by €1.1 trillion to €9.5 trillion in 2015 (180 times GDP).
  - Financial sector contributes about ¼ of GDP, 18 percent of budget revenues, and 11 percent of employment.
- Banking system:
  - Nearly all 144 banks located in Luxembourg are foreign-owned; only five banks are domestically owned.
  - Banking system CAR (capital adequacy ratio): nearly 20 percent on average.
  - Total bank assets around €770 billion (post-global financial crisis fluctuation).
  - Very low non-performing loans.
- Investment funds:
  - Assets under management (AUM) jumped 28 percent y/y to €3.6 trillion in May 2015; stagnated thereafter amid volatility.
  - Net inflows in funds: €298 billion in 2015, accounting for 72 percent of the increase in AUM for the year.
  - Since end-2008, about 20 percent (or €1.2 trillion) of all new net inflows into investment funds worldwide came to Luxembourg funds.
- Financial stability concerns and recommendations:
  - Need to strengthen oversight of the financial system and maximize benefits from the Banking Union.
  - Advocate for better European-level oversight of nonbank holding companies that include banks.
  - Continue strong oversight of investment funds; analyze and monitor linkages between investment funds and banks, including at the European level.
  - Closely monitor risks in the real estate market.
  - Directors encouraged an increase in the capital of the central bank to bolster its financial buffer.

### External sector and taxation transparency
- Current account and trade:
  - Current account balance: 5.5 percent of GDP in 2015; projected 5.4 percent in 2016.
  - Balance of trade in goods and services: 35.5 percent of GDP in 2015; projected 36.0 percent in 2016.
  - Factor income balance: -30.6 percent of GDP in 2015; projected -31.2 percent in 2016.
- International investment position (IIP):
  - Massive gross foreign assets and liabilities; gross foreign assets €9.5 trillion in December 2015.
  - IIP structure (assets, 2015): Foreign direct investment €4,081 billion; Portfolio investments €4,263 billion; Other investments €925 billion; Financial derivatives €185 billion; Total AUM components listed accordingly.
  - GDP (2015): €52.1 billion.
- Tax transparency and state aid issues:
  - The European Commission decided that the advance tax ruling of Fiat involved improper state aid; Luxembourg appealed.
  - EC investigations into Amazon and McDonald’s advance tax rulings (Appendix I).
  - Luxembourg participated in OECD/G20 BEPS and committed to join the EU-wide automatic exchange of advance tax rulings effective from 2017.
  - OECD Global Forum removed Luxembourg from its list of non-compliant countries in October (year as given in source).

### Structural reforms, social integration, and other recommendations
- Structural priorities:
  - Diversify the economy beyond the financial sector to enhance resilience.
  - Reduce inactivity traps and ensure wages align with productivity.
  - Ease supply-side constraints in the real estate market.
- Refugee/integration policy:
  - Authorities praised for policies to cope with elevated refugee inflows; asylum seekers enrolled in language classes and other training programs.
  - Recommendation to extend programs designed for the long-term unemployed to asylum seekers and focus diversification efforts on creating local lower-skill jobs.

*Source: LUXEMBOURG STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION, April 20, 2016.*

### 7.      The country is coping well with the refugee influx. From September 2015, asylum

### _cr16118 - 7.      The country is coping well with the refugee influx. From September 2015, asylum

### Refugee influx and integration
- Asylum applications have increased "about threefold year-on-year" from September 2015.
- Authorities prioritize accommodating families with children as they are "considered easier to integrate over time."
- To enroll refugees in schools, training programs, and language classes, authorities "called on retired teachers to return to work."

### Outlook and growth projections
- GDP growth is expected to "ease to about 3½ percent in 2016 and to its long-term trend of 3 percent thereafter."
- Over the medium term growth is underpinned by "robust domestic demand and net exports."
- Net exports of services are projected to make a "strong contribution" reflecting Luxembourg’s role as a financial hub.
- Private consumption is expected to rebound from the "low base of 2015."
- "From 2017, domestic demand should get a boost from planned personal income tax cuts."
- Unemployment is projected to remain "at about 6 percent over the medium term" due to skills mismatches, inactivity traps, and refugees entering the labor market.
- Inflation projections: "pick up to 1.3 percent in 2017, and reach around 2 percent over the medium term."

### External position and current account
- The current account surplus is expected to "hover around 5 percent of GDP over the medium term," supported by a "large surplus in services partially offset by net income payments and a negative balance on goods."
- Luxembourg’s positive net international investment position is expected to "gradually increase over the medium term."
- External Balance Assessment (EBA-lite) approaches indicate the external position is "broadly consistent with its fundamentals" though the REER "appears slightly overvalued" and the current account is "relatively close to its norm."

### Risks to the medium-term outlook
- Tax transparency adjustments: "EC probes into the advance tax rulings and other EU and international tax transparency initiatives can undermine Luxembourg’s tax advantages and prompt transnational companies to relocate."
- If tax-related risks materialize, they "could affect both the country’s growth prospects and fiscal revenues."
- Offsetting factors: creating a taxation level playing field could benefit Luxembourg via "AAA ratings from all three major rating agencies, political stability, prudent fiscal stance, business friendly environment, and qualified multilingual labor force."
- Financial market stress: severe external shocks could "prompt dislocations in markets or institutions beyond the scope of the national authorities" and lead to sharp asset price adjustment and decompression of credit spreads affecting investment funds and banking system.
- Tail risk remains that banking sector difficulties could force national authorities to step in with a bail-out of domestic banks despite the new EU resolution framework.
- Other risks: "weaker-than-expected growth in the euro area, Brexit, and another surge of refugees."
- Need to "diversify its services exports away from Europe and boost competitiveness, especially of non-financial sectors."

### Financial sector vulnerabilities and linkages
- Investment fund sector as a conduit of global volatility:
  - Investment funds have a "diversified investor base (75 percent from Europe)" and global exposures with the euro area "accounting for 35 percent of these exposures, the U.S. 26 percent, and emerging markets 13 percent."
  - Banks have cross-border and foreign currency interbank claims "accounting for 54 percent of total banking assets at mid-2015; 60 percent of these claims are intra-group claims."
  - Fiscal revenues from the financial sector "overall accounting for about 8 percent of GDP in 2014" are sensitive to market fluctuations.
- Increasing risks for the investment fund industry:
  - Credit risk: exposure of Luxembourg funds to corporate bonds rose from "€141 billion (or 29 percent of total bond investments) at the end of 2008 to €648 billion (or 45 percent of total bond investments) in October 2015."
  - Counterparty risk: from securities lending, repos, and derivatives.
  - Market risk: leverage and growing use of derivatives increase sensitivity to market movements.
  - Redemption risk: "first-mover advantages increase the likelihood of sudden runs on investment funds."
  - Liquidity risk: some funds may be less liquid than redemption terms and conditions.
  - Diversification benefits can dwindle as asset prices increasingly move in unison.
- Transmission channels from investment funds to banks:
  - Direct exposures: investment funds hold claims on banks "amounted to €821 billion in 2015:Q3, 73 percent of which [is] outside Luxembourg."
  - Investment funds’ liabilities to banks "amount[ed] to €175 billion in 2015:Q3."
  - Derivatives: €133 billion of derivative contracts included in funds’ liabilities in 2015:Q3.
  - Cash balances: investment funds held "€220 billion in 2015:Q3, about half of which are concentrated in Luxembourg’s depository banks, totaling 50 percent of their liabilities."
  - Deposit volatility: standard deviation of monthly net deposit inflows is "about €5 billion since 2009."
  - Historical episodes: aggregate net redemptions reached "around €100 billion between September and December 2008"; deposits then declined by "€13.7 billion in 2009:Q1, among which €5 billion were withdrawn from Luxembourg banks." In 2011:Q4, deposits declined by "€9 billion, of which €3.6 billion from Luxembourg banks."
  - Links include liquidity support by asset managers, banks providing services to funds, business integration, and reputational risks.

### Banking sector and real estate risks
- Mortgage lending and household debt:
  - Mortgage loans amounted to "€23 billion at end-October 2015, or about 45 percent of GDP" for the handful of banks that lend domestically.
  - Since 2008, household debt "has risen by 10 percent of GDP, but remains moderate at 59 percent of GDP."
- Macroprudential measures:
  - In 2013, CSSF raised capital provision requirements from "35 percent to 75 percent for new mortgage loans with a loan-to-value ratio above 80 percent."
  - The law transposing the Fourth Capital Requirements Directive (CRDIV) was adopted in July 2015.
  - Luxembourg’s banking supervisor raised capital buffers for systemically important banks by "an extra 0.5–1 percent by January 2019" and introduced countercyclical capital buffers initially "with zero values."
  - The law transposing the Bank Recovery and Resolution Directive (BRRD) and the Deposit Guarantee Schemes Directive (DGSD) passed Parliament in December 2015.
  - For eight years, banks will be making contributions to the Single Resolution Fund (SRF) "reaching in total at least 1 percent of covered deposits."

### Authorities’ views and policy implications
- Authorities projected higher economic growth than staff, expecting growth "at around 4 percent in 2016–19" before converging to "about 3 percent over the long run."
- Authorities concurred that Luxembourg’s external position is "broadly in line with fundamentals."
- Authorities believe proactive implementation of tax transparency measures will mitigate downside risks and could motivate some companies to increase presence in the country, while elimination of aggressive tax regimes could accentuate Luxembourg’s competitive advantages such as its "triple-AAA rating."
- Policy recommendations and implementation priorities highlighted:
  - Take advantage of the Single Supervisory Mechanism (SSM) to "advocate for better oversight at the European level of nonbank holding companies" and take "pro-active steps to improve risk monitoring."
  - Ensure steady deepening of interagency collaboration in the context of the SSM and SRM, with timely flow of micro-prudential information where the CSSF has primary access.
  - Grant waivers to large exposure limits and national LCR only "under strict criteria and deep analysis."
  - Ensure CSSF capacity is "commensurate with the increasing size and complexity of the financial sector."
  - Develop rigorous liquidity management infrastructures for banks that upstream liquidity to their parent to comply with LCR requirements.
  - Continue implementation of EU banking union directives and the Single Rule Book.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16118.pdf*

### 21.      Oversight of investment funds and asset managers should remain strong and continue

### 21.      Oversight of investment funds and asset managers should remain strong and continue

### Risk monitoring and supervisory framework for investment funds
- UCITS directives III and IV cover 80 percent of the funds in Luxembourg; other funds are covered by the AIFM Directive.
- The CSSF receives data reporting that allows obtaining precise information on individual investment funds and has oversight over liquidity stress tests performed by asset managers.
- Adequate resources should be allocated to oversight to ensure sound risk management practices and prudential norms or rules governing liquidity, leverage, redemptions and asset valuation at both the fund and asset manager levels.
- Specific attention areas:
  - Data monitoring should allow detecting early warning signs of realization of market risk, credit risk or liquidity risk and possible shocks through redemptions.
  - Data monitoring should allow identifying funds’ sensitivity to interest rates and credit market movements.
  - The use of derivatives that could boost yields and leverage, securities lending, and liquidity mismatches between assets and redemption terms should be more specifically scrutinized, especially given the increased use of derivative leverage by several of Luxembourg’s bond funds in recent years.
  - The CSSF should evaluate investment funds’ resilience under various stress test scenarios, assessing risks not only at the investment fund level but also from a financial stability perspective, allowing for correlated shocks across funds and for significant large portfolio reallocations between funds and net redemptions.
  - The toolkit of liquidity risk management of investment funds by asset managers and regulators—comprising redemption fees, gates, side pockets and suspension of redemptions—should be tested to severe stress scenarios and continue to evolve with international best practice.

### Linkages between banks and investment funds
- Joint scenario analysis between banks and investment funds, including liquidity stress tests, should be undertaken.
- Rationale and transmission channels:
  - Large fund exposures to corporate bonds could turn illiquid and cause sharp movements in fund value which, combined with redemptions and shocks to other asset classes, could have indirect effects on banks’ income.
  - Changes in direct exposures to banks could affect banks’ liquidity position and funding.
- Policy recommendations:
  - Authorities should advocate further financial stability analysis of bank–fund linkages in the SSM, and include them in the design of joint fund–bank stress test scenarios, including asset managers owned by systemic banks.
  - To mitigate potential shocks, banks should be compliant with the local LCR with good collateral, while the Eurosystem should stand ready to provide liquidity to banks if a shock materializes.

### Role of the Comité de Risque Systémique (CRS) and macroprudential priorities
- The CRS (Ministry of Finance, BCL, CSSF, and Commissariat aux Assurances) has added analysis of linkages between investment funds and banks to its national work program.
- The CRS should ensure linkages are examined at the European Systemic Risk Board (ESRB) and recommend corrective actions if needed.
- Housing market: given ever rising housing prices, authorities should explore the effectiveness of recent measures in containing risk and whether further macro-prudential measures such as limits to loan-to-value ratios in addition to those already taken in 2013 would be appropriate.

### Banque Centrale du Luxembourg (BCL) capital
- Recommendation: the authorities should increase the capital of the BCL.
- Rationale:
  - Adding capital now should anticipate that capital may fall when monetary policy is normalized, and ensure that BCL operational expenses are well covered.
  - The comprehensive net worth of the central bank is important from a risk management perspective despite redenomination risks of Target 2 claims having receded.
  - An agreement between the government and the BCL should be reached and implemented swiftly.
- Box 2 highlights:
  - The BCL would benefit from a one-off capital increase.
  - The BCL currently operates with little financial buffers to cover its net present value of operating expenses.
  - Exposures: very limited exposures to financial institutions (€6 billion); liabilities of €57 billion to depository institutions reflecting creditor position in Target 2.
  - Market risk and currency risk arise mainly from large exposures vis-à-vis non-euro area residents.
  - The financial strength of the BCL matters for the functioning of the Eurosystem and for national central banks’ ability to avoid political interference and to standby to recapitalize the ECB if needed.

### AML/CFT progress and ongoing work
- Progress made in implementing the 2012 AML/CFT standard through legislation passed in 2014–15:
  - All acts of terrorist financing covered by the 2012 standard are criminalized.
  - Bearer shares must be immobilized.
  - Authorized operators acting in the Luxembourg Freeport are subject to AML/CFT measures.
- Ongoing implementation work:
  - Implement the revised FATF standard and the 4th AML/CFT EU Directive.
  - Include tax crimes among predicate offenses to money laundering.
  - Facilitate timely access to information on beneficial owners of legal persons and arrangements.
- Recommendation: authorities are encouraged to pursue these efforts on a timely basis and ensure AML/CFT supervision intensity remains commensurate with the level of money laundering and terrorist financing risks.

### Financial Stability Assessment (FSA) and Banking Union
- The upcoming mandatory Financial Stability Assessment (FSA) is an opportunity to review the financial system in greater depth.
  - For timely completion, the Financial Sector Stability Assessment (FSSA) report must be discussed in the Board with the 2017 Article IV consultation.
  - Staff encouraged considering further analysis of bank–fund linkages as part of the FSA.
- Authorities’ view on the Banking Union:
  - Considered strongly positive for the euro area and Luxembourg.
  - Support achieving the common European deposit insurance scheme to complete the Banking Union backstop.
  - Being a full member of the SSM generates benefits and facilitates home–host discussions, including for non-EU cross-border banks.
  - Waivers to large exposure limits or the LCR would follow strict supervisory rules and assessment by the JSTs with decisions taken at the SSM Supervisory Board.
  - Oversight of nonbank holding companies of banks: measures are taken to monitor ownership links at the time of authorization.

### Authorities’ stance and fund oversight implementation
- Authorities agreed that bank–fund linkages warrant further macro-prudential analysis and inclusion in joint fund–bank stress test scenarios; the CRS added this work to its program.
- Investment strategies of funds are advertised in prospectuses; management companies must perform mandatory liquidity risk management and stress tests reviewed by the CSSF.
- Authorities consider existing EU Directives provide a solid framework for risk monitoring, risk management and supervision of Luxembourg’s investment funds, and welcomed UCITS V and AIFM Directives clarifying depository banks’ responsibilities.
- Authorities view diversification strategies across many funds as a buffer to market volatility; they agree the housing market merits continued monitoring.

### Key statistics and figures cited in this section
- UCITS directives III and IV cover 80 percent of the funds in Luxembourg.
- BCL exposures and positions cited: €6 billion (exposures to financial institutions); €57 billion (liabilities to depository institutions).
- References to policy timelines and documents: Chapter 3 of the April 2015 Global Financial Stability Report; mandatory FSA with FSSA to be discussed in the Board with the 2017 Article IV consultation.

*International Monetary Fund staff summary of section 21 from the Luxembourg report.*

### 36.      The authorities acknowledged that implementing EU and OECD tax transparency

### 36.      The authorities acknowledged that implementing EU and OECD tax transparency requirements could lead to some fiscal losses upfront but benefit the country in the long run.

### Tax transparency and fiscal impact
- Authorities acknowledged that implementing EU and OECD tax transparency requirements could lead to some fiscal losses upfront but benefit the country in the long run.
- Losses from changing EU rules on allocating VAT from e-commerce proved less than initially estimated as several large companies preferred to stay in Luxembourg, and some even expanded their operations.
- Authorities considered that the OECD and EU initiatives countering tax base shifting and, in time, creating a more level international taxation playing field, would motivate some companies to increase their economic presence in Luxembourg, which could offset the immediate fiscal losses from enhanced tax transparency.
- Authorities reaffirmed disagreement with the EC decision that the advance tax ruling provided to FIAT involved improper state aid; they appealed this decision in court and expect the court hearings to take a few years.
- Staff recommendation: the ongoing tax reform is an opportunity to broaden the tax base and adjust to the changing international taxation environment. The tax reform should aim at:
  - widening the corporate tax base, such as by phasing out the IP Box tax regime,
  - eliminating special tax regimes while lowering statutory tax rates.
- Staff also advised developing contingency measures, including revisiting the low real estate taxes, in case negative revenue risks materialize.

### Pension reform and fiscal projections
- Luxembourg’s pay-as-you-go pension system is generous and currently generating surpluses; effective retirement age is low while replacement rate is amongst the highest in Europe.
- Public pension expenditures are lower than pension contributions owing to the current advantageous demographics, but pension expenditures are expected to increase significantly over time.
- EC 2012 Ageing Report projection: increase in pension expenditures from 9.2 percent of GDP in 2010 to 18.6 percent of GDP by 2060, owing to adverse demographics due to population ageing.
- 2015 Ageing Report forecast: increase in pension expenditures from 9.4 percent of GDP in 2013 to 13.4 percent of GDP in 2060, mainly due to more robust population growth, via net migration.
- Staff note: the 2015 Ageing Report projection appears more optimistic than the recent population projection produced by the United Nations; the very strong population growth projection, through long-term net migration, should be treated with caution.
- Continued reform of the pension system is advisable. Additional pension reform options include:
  - increasing the effective retirement age,
  - lowering benefits,
  - improving sustainability and fairness across generations.
- The 2012 pension reform measures that additional measures would strengthen:
  - (i) a slow and gradual decline in the replacement rate;
  - (ii) automatic decline in indexation, benefits and increase in contributions in the event that future expenditures exceed contributions;
  - (iii) incentives to postpone retirement.
- Staff recommendation: the ongoing 2016 pension review should propose additional parametric reforms of the pension system, such as of the minimum contributions period and conditions for early retirement.

### Structural reforms for growth and employment
- Government steps to diversify the economy to enhance resilience and create jobs for low-skilled workers by promoting priority sectors: automotive components, eco-innovation, healthcare and biotechnologies, information and communication, materials and production, and space technologies.
- Authorities champion Luxembourg’s role as a logistical transit hub in the EU, engaged in the pan-European project to build a supercomputer, and announced plans to create a legal framework for investing in mining asteroids.
- Structural reforms recommended to address supply-side constraints include:
  - easing zoning requirements for real estate construction,
  - removing restrictions for weekend and after hours work.
- Staff appraisal: expanding activity beyond the financial sector is important and should be supported with measures to better align workers’ skills with the economy’s demands and reduce inactivity traps while ensuring that real wages remain in line with productivity.

### Labor market outcomes, skills mismatch, and refugees
- Unemployment dynamics:
  - Unemployment rate increased from 2 percent in 2000 to 7 percent in 2014, of which nearly half was long-term unemployed.
  - Share of people who did not finish secondary school among the unemployed is 43 percent, more than double their share in the labor force.
  - Strong growth and ADEM measures helped reduce the unemployment rate to 6.5 percent in early 2016.
- Labor force composition (2015Q4, Percent):
  - Luxembourg citizens: 27.6
  - Resident non-citizens: 27.6
  - Cross-border commuters: 44.8
- Education attainment (comparison noted in charts):
  - Primary, Secondary-low, Secondary-high, Higher distributions shown for Entire labor force (2011) and Unemployed (Dec 2015), with 43 percent of unemployed not completing secondary school.
- Beveridge Curve (2000-15): Unemployment increased despite more unfilled vacancies—indicative of structural mismatches.
- Policy options to reduce inactivity traps and promote employment of low-skilled locals and incoming refugees:
  - deeper reforms to address skill mismatches,
  - upgrade education outcomes,
  - improve quality of vocational training and enhance apprenticeship system,
  - refocus generous unemployment and social benefits to promote active job search and acceptance of available vacancies while ensuring real wages remain in line with productivity.
- Refugee integration:
  - Government allocated sufficient budget financing to refugee accommodation programs.
  - For faster labor market integration, authorities could consider issuing temporary employment permits to asylum seekers while their applications are considered.
  - Extend to refugees granted asylum the employment promotion programs currently available for the long-term unemployed.
  - Authorities underscored ADEM’s personalized programs, vocational training, apprenticeship programs, subsidized partial employment, and Youth Guarantee Scheme contributions to reducing long-term unemployment.
  - Past experience (Bosnian war in early 1990s) informs current emphasis on language training and favoring families with children as easier to assimilate.

### Financial sector oversight, risks, and macroprudential considerations
- Staff appraisal: Luxembourg’s growth prospects remain strong but subject to downside risks from weakening international activity and stress in financial markets.
- Risks identified:
  - Implementation of the international tax transparency agenda could weigh on economic activity and tax revenue.
  - Financial volatility from reassessment of underlying risks could adjust asset prices and financial flows, adversely affecting Luxembourg’s financial system.
  - Other risks: weaker-than-expected growth in the euro area, Brexit, and another surge of refugees.
- Banking Union benefits: SSM should improve supervision, especially of cross-border banks; enlargement of CSSF resources is welcome and should be commensurate with sector size and complexity.
- SRM role: ensure swift intervention ahead of insolvency, with financial support from industry pooled in the SRF.
- Recent transposition: Deposit Guarantee Scheme Directive and Bank Recovery and Resolution Directive complete legal implementation of the Single Rule Book in Luxembourg.
- Recommendations on oversight and monitoring:
  - Advocate for better European-level oversight of nonbank holding companies that include banks and take pro-active steps to improve risk monitoring.
  - Continued strong oversight of investment funds and their management companies is necessary; scrutinize use of derivatives that boost leverage, liquidity mismatches, and securities lending.
  - Data monitoring should allow identifying funds’ sensitivity to interest rates and credit market movements.
  - Risk monitoring and regulatory frameworks should account for linkages between banks and investment funds (direct exposures, services provided by banks, and ownership).
  - Luxembourg should propose discussing these linkages at the European level and include them in the design of joint fund-bank stress test scenarios; assess risks from a broader financial stability perspective.

### Real estate and fiscal stance
- Real estate risks: steadily rising house prices appear to mainly reflect supply bottlenecks against growing demand.
- Authorities should explore effectiveness of recent macro-prudential measures and whether further measures such as limits to loan-to-value ratios are appropriate.
- Fiscal stance recommendation: run a small fiscal surplus and maintain low public debt to buffer revenue risks from the international tax transparency initiatives and volatile financial flows.
  - Target: a small fiscal surplus of around ½ percent of GDP over the medium term to place public debt-to-GDP ratio on a slightly downward path.
  - Staff advised limiting the size of announced tax cuts or using fiscal space for growth-enhancing measures.

*Source: IMF staff report excerpts provided in the supplied content.*

### 52.      Staff recommends the next Article IV Consultation with Luxembourg be held on the

### _cr16118 - 52.      Staff recommends the next Article IV Consultation with Luxembourg be held on the

### Recommendation
- Staff recommends the next Article IV Consultation with Luxembourg be held on the standard 12 month cycle.

### Selected Economic Indicators (highlights, 2013–21 projections)
- Real GDP growth: 2013=4.3, 2014=4.1, 2015=4.8, 2016=3.6, 2017=3.3, 2018=3.2, 2019=3.1, 2020=3.0, 2021=3.0 (percent change).
- Domestic demand: 2013=0.5, 2014=5.7, 2015=2.4, 2016=3.1, 2017=3.4, 2018=3.2, 2019=2.9, 2020=2.8, 2021=2.8 (percent change).
- CPI (harmonized): 2013=1.7, 2014=0.7, 2015=0.1, 2016=0.5, 2017=1.3, 2018=1.6, 2019=1.7, 2020=1.9, 2021=2.1 (percent change).
- Wage growth (overall economy): 2013/14/15/16/17/18/19/20/21 = 3.6, 3.0, 0.8, 0.8, 3.0, 2.5, 2.5, 2.5, 2.5 (percent change).
- General government balance (percent of GDP): 2013=0.7, 2014=1.4, 2015=1.0, 2016=0.9, 2017=0.1, 2018=0.1, 2019=0.1, 2020=0.1, 2021=0.1.
- General government gross debt (percent of GDP): 2013=23.3, 2014=22.9, 2015=21.6, 2016=22.6, 2017=22.9, 2018=23.1, 2019=23.1, 2020=23.2, 2021=23.1.
- Current account (percent of GDP): 2013=5.7, 2014=5.5, 2015=5.5, 2016=5.4, 2017=5.3, 2018=5.2, 2019=5.1, 2020=5.0, 2021=5.0.
- GDP (billions of euro): 2013=46.5, 2014=48.9, 2015=52.1, 2016=54.7, 2017=57.5, 2018=60.3, 2019=63.4, 2020=66.6, 2021=70.0.
- Memorandum: Land area = 2,586 sq. km; population in 2016 = 576,000; GDP per head = €90,400.

### Balance of Payments (2013–21 highlights)
- Current account (percent of GDP): see Selected Economic Indicators (5.7 → 5.0).
- Balance on goods (trade balance, percent of GDP): 2013=-2.1, 2014=-0.4, 2015=-4.2, 2016=-3.9, 2017=-4.2, 2018=-3.9, 2019=-4.0, 2020=-4.0, 2021=-3.8.
- Balance on services (percent of GDP): 2013=34.9, 2014=34.4, 2015=39.7, 2016=39.9, 2017=39.8, 2018=39.7, 2019=39.9, 2020=39.8, 2021=39.7.
- Net factor income (percent of GDP): 2013=-28.0, 2014=-29.3, 2015=-30.6, 2016=-31.2, 2017=-30.9, 2018=-31.2, 2019=-31.4, 2020=-31.4, 2021=-31.5.
- Financial account (percent of GDP): 2013=4.0, 2014=3.5, 2015=4.3, 2016=4.3, 2017=4.2, 2018=4.1, 2019=4.0, 2020=3.9, 2021=3.9.
- Portfolio investment, assets (percent of GDP): 2013=343.7, 2014=494.1, 2015=492.2, 2016=492.0, 2017=492.0, 2018=492.0, 2019=492.0, 2020=492.0, 2021=492.0.
- Portfolio investment, liabilities (percent of GDP): 2013=523.0, 2014=680.7, 2015=681.9, 2016=688.1, 2017=688.1, 2018=688.1, 2019=688.1, 2020=688.1, 2021=688.1.

### General Government Operations (2013–21, percent of GDP)
- Revenue: 2013=44.0, 2014=43.8, 2015=42.9, 2016=42.8, 2017=41.8, 2018=41.7, 2019=41.6, 2020=41.7, 2021=41.7.
- Taxes: 2013=27.0, 2014=27.0, 2015=26.5, 2016=26.6, 2017=25.6, 2018=25.5, 2019=25.4, 2020=25.4, 2021=25.5.
- Expenditure: 2013=43.3, 2014=42.4, 2015=41.9, 2016=41.8, 2017=41.7, 2018=41.6, 2019=41.6, 2020=41.5, 2021=41.6.
- Net lending / borrowing: 2013=0.7, 2014=1.4, 2015=1.0, 2016=0.9, 2017=0.1, 2018=0.1, 2019=0.1, 2020=0.1, 2021=0.1.
- Structural balance (memorandum): 2013=1.1, 2014=1.6, 2015=0.7, 2016=0.7, 2017=0.0, 2018=0.1, 2019=0.0, 2020=0.1, 2021=0.1.
- Public gross debt (Maastricht definition): see Selected Economic Indicators (23.3 → 23.1).

### General Government Financial Balance Sheet (2012–15, millions of euros)
- Net financial worth: 2012=21,231; 2013=22,489; 2014=22,744; Q3 2015 closing balance=22,485.
- Financial assets: 2012=34,491; 2013=36,358; 2014=39,126; Q3 2015 closing balance=38,963.
- Liabilities: 2012=13,260; 2013=13,869; 2014=16,382; Q3 2015 closing balance=16,478.
- Memorandum (percent of GDP): Net financial worth = 48.7, 48.3, 46.5, 43.1 (for the relevant years).

### International Investment Position (2011–15)
- International investment position (billions of euros): 2011=12.5, 2012=15.5, 2013=16.3, 2014=9.1, 2015=16.5.
- Assets (billions of euros): 2011=5,365.1, 2012=6,175.8, 2013=6,703.7, 2014=8,358.7, 2015=9,470.5.
- Liabilities (billions of euros): 2011=5,352.6, 2012=6,160.3, 2013=6,687.4, 2014=8,349.6, 2015=9,454.0.
- Direct investment assets (billions of euros): 2011=2,241.3, 2012=2,724.5, 2013=2,990.6, 2014=3,949.5, 2015=4,583.3.
- Portfolio investment (percent of GDP, memorandum): assets and liabilities reflect large cross-border positions (e.g., portfolio investment assets in percent of GDP: 2011=4,919.6; 2015=6,707.4).

### Financial Soundness Indicators (2011–2015, percent)
- All banks: Regulatory capital to risk weighted assets: 2011=16.9, 2012=18.3, 2013=19.9, 2014 Sep=19.4, 2014 Dec=20.6, 2015=20.9.
- All banks: Return on assets: 2011=0.6, 2012=0.7, 2013=0.7, 2014 Sep/Dec=0.7/0.8, 2015=0.8.
- Household debt to GDP: 2011=53.0, 2012=55.1, 2013=55.4, 2014 Sep/Dec=58.6/59.3, 2015=59.3.
- Sectoral distribution of loans (residents / nonresidents, percent of total loans): All banks 2011: Residents 22.2 / Nonresidents 77.8; 2015: Residents 27.0 / Nonresidents 73.0.
- Liquidity (All banks): Liquid assets to total assets: 2011=58.5, 2012=59.3, 2013=59.9, 2014 Sep=60.3, 2014 Dec=57.9.

### Public Sector Debt Sustainability Analysis (DSA) — Baseline Scenario (As of April 29, 2016)
- Nominal gross public debt (percent of GDP): 2014=14.9, 2015=22.9, 2016=21.6, 2017=22.6, 2018=22.9, 2019=23.1, 2020=23.1, 2021=23.2, (projection) 23.1.
- Public gross financing needs: 2014=0.8, 2015=0.7, 2016=0.1, 2017=1.5, 2018=1.6, 2019=2.2, 2020=1.1, 2021=3.7, cumulative=0.65 (percent of GDP for listed years).
- Real GDP growth (percent): see Selected Economic Indicators (2.5, 4.1, 4.8, 3.6, ...).
- Inflation (GDP deflator, percent): 2014=3.5, 2015=1.0, 2016=1.6, 2017=1.4, 2018=1.7, 2019=1.7, 2020=1.9, 2021=2.0, projection 2.1.
- Effective interest rate (percent): 2014=3.2, 2015=1.8, 2016=1.5, 2017=1.5, 2018=1.7, 2019=1.7, 2020=1.5, 2021=1.5.
- Change in gross public sector debt (cumulative): 2014=1.9, 2015=-0.4, 2016=-1.3, 2017=0.9, 2018=0.4, 2019=0.1, 2020=0.1, 2021=0.0, total=1.5.
- Identified debt-creating flows (cumulative): 2014=1.0, 2015=0.2, 2016=-0.7, 2017=1.0, 2018=0.5, 2019=0.3, 2020=0.3, 2021=0.3, cumulative=2.7.
- Primary deficit (percent of GDP, yearly): 2014=1.3, 2015=1.0, 2016=0.3, 2017=0.6, 2018=1.2, 2019=1.0, 2020=1.1, 2021=1.1; cumulative primary deficit = 6.2.
- Automatic debt dynamics contribution (cumulative): -0.3, -0.7, -1.1, -0.7, -0.7, -0.7, -0.8, -0.8, -0.8, cumulative = -4.5.
- Residual, including asset changes (cumulative): 2014=0.9, 2015=-0.6, 2016=-0.5, 2017=-0.1, 2018=-0.1, 2019=-0.2, 2020=-0.2, 2021=-0.3, cumulative=-1.2.

### Public DSA — Alternative Scenarios & Composition (underlying assumptions)
- Baseline underlying assumptions (percent): Real GDP growth = 3.6 (2016), 3.3 (2017), 3.2 (2018), 3.1 (2019), 3.0 (2020), 3.0 (2021); Inflation = 1.4, 1.7, 1.7, 1.9, 2.0, 2.1; Primary Balance = -0.6, -1.2, -1.0, -1.1, -1.1, -1.1; Effective interest rate = 1.5, 1.7, 1.7, 1.5, 1.5, 1.5.
- Historical scenario, constant primary balance scenario, and contingent liability shock are specified with alternative trajectories (table lists numerical assumptions for each scenario, e.g., Contingent Liability Shock primary balance in 2017 = -9.2).
- Composition of public debt charts indicate majority medium and long-term maturity and domination by local currency-denominated debt in recent years.

### Risk Assessment Matrix (selected risks, likelihood, impact, and policy responses)
- Business model risk: Changes in EU and international taxation rules and transparency standards for cross-border activities.
  - Relative likelihood: Medium.
  - Impact if realized: High — tax base erosion and reduction of budget revenues.
  - Policy response: Diversify fiscal revenue base, develop contingency plans, and continue pension reform.
- G-RAM risk: Structurally weak growth in key advanced and emerging economies.
  - Relative likelihood: High.
  - Impact if realized: Medium — adverse impact on export and GDP growth.
  - Policy response: Diversify financial services exports toward non euro area markets, advance structural reforms and infrastructure investments to boost competitiveness.
- G-RAM risk: Sharp asset price decline and decompression of credit spreads.
  - Relative likelihood: Medium.
  - Impact if realized: Medium — moderate impact via investment funds and banks; could be limited if Luxembourg receives safe-haven inflows.
  - Policy response: Monitor financial sector exposures, linkages between investment funds and banks, conduct stress tests, ensure robust contingency planning and liquidity support readiness.
- G-RAM risk: Heightened risk of fragmentation/security dislocation in parts of Middle East, Africa, and Europe, leading to sharp rise in refugees.
  - Relative likelihood: High.
  - Impact if realized: Low — short-term fiscal costs proportional to refugee inflows; large inflows could undermine social cohesion.
  - Policy response: Integrate refugees into the labor force quickly through language classes and training.
- G-RAM risk: British voters elect to leave the European Union in their June 23 referendum.
  - Relative likelihood: High.
  - Impact if realized: High — potential negotiations, heightened uncertainty, elevated financial volatility, potential contagion.
  - Policy response: Ensure robust contingency planning for operational risks, re-double efforts to secure benefits of economic integration and cooperation across Europe.

*Source: IMF staff (from document _cr16118).*

### Appendix I. Luxembourg: The EC State Aid Decision and

### Appendix I. Luxembourg: The EC State Aid Decision and International Tax Transparency Initiatives

### EC State Aid Decision: findings and implications
- The EC decided that the advance tax rulings of Fiat in Luxembourg and Starbucks in the Netherlands and the Belgian "excess profit" tax scheme involved improper state aid.
- The EC has requested national tax authorities to recover the improper tax savings.
  - For Fiat and Starbucks, the repayments could amount to €20–30 million.
  - Belgium would need to recover about €700 million from at least 35 companies.
- National authorities disagreed with the EC decision and have appealed it at the European Court of Justice, which could take a few years to consider the cases.
- The EC decision sets an important precedent for reexamining tax treatment of multinational companies in Luxembourg and across the EU.
  - The EC is probing the legality of Amazon’s and MacDonald’s advance tax rulings in Luxembourg and of Apple’s in Ireland, where potential repayments can be much higher.
  - The same approach could be applied for re-examining tax payments of any company that obtained a favorable tax ruling from national authorities in Luxembourg and other EU countries over the last 10 years.

### International tax transparency initiatives and timelines
- EU developments:
  - Hitherto confidential national advance tax rulings have been open for bilateral exchange between tax authorities upon request and will be automatically shared from 2017.
  - Luxembourg switched to automatic exchange of information on interest payments under the EU Savings Directive from 2015.
  - Luxembourg agreed to implement an extension of that Directive to cover account balances and other sources of income including dividends from 2017.
- OECD/G20 developments:
  - The G20 summit in November 2015 endorsed recommendations of the OECD project on combating Base Erosion and Profit Shifting (BEPS) that address harmful tax practices and pave the way for automatic exchange of information for tax purposes from 2017.
  - In late 2014, Luxembourg committed to implement the OECD Standard for Automatic Exchange of Financial Account Information.
  - In January 2016, Luxembourg and 30 other OECD countries signed agreements for the automatic exchange of country reports from 2017.
- Public revelations and domestic responses:
  - “LuxLeaks” publications in late 2014 revealed that Luxembourg’s tax rulings allowed companies to legally reduce their effective tax rates to as low as 1 percent.
  - In the U.S., a proposal to tax overseas profits of U.S. corporations—currently not subject to U.S. taxation until repatriated—stirred debates, but did not make it to the “omnibus” budget bill adopted in December 2015.
- Luxembourg commitments:
  - Luxembourg has committed to greater transparency in its tax practices and to the automatic exchange initiatives described above.

*Source: IMF staff report Appendix I, Luxembourg: The EC State Aid Decision and International Tax Transparency Initiatives.*

### 2015. Over the medium term, inflation is projected to average 1.6 to 2 percent. The current

### _cr16118 - 2015. Over the medium term, inflation is projected to average 1.6 to 2 percent. The current

### Macroeconomic outlook
- Inflation: "Over the medium term, inflation is projected to average 1.6 to 2 percent."
- Current account: recorded a surplus of 5.5 percent in 2015 and is expected to stay close to 5 percent in the medium term, reflecting a surplus in services partly offset by a negative balance in goods.

### Public finances — status and recent developments
- Budget balance: recorded a surplus of around 1.3 percent of GDP on average over the last three years.
- Gross public debt: stabilized slightly above 20 percent of GDP; debt-to-GDP ratio at 21.6 percent of GDP in 2015.
- Maastricht benchmarks: budgetary safety margin with respect to the Maastricht deficit reference value of 3 percent of GDP; public debt well below the Maastricht debt reference value of 60 percent of GDP.
- Structural fiscal objective: government adopted a lower medium term objective (MTO), a structural deficit of 0.5 percent of GDP, over the period 2017–2019, in line with new minima-requirements calculated by the EC.

### 2015 fiscal drivers and measures
- Main factors characterizing public finances in 2015:
  - Entry into force of the new regime for the VAT on e-commerce resulting in a loss of 1 percent of GDP of VAT revenues.
  - Implementation of a multi-annual counter-financing strategy with an impact of 0.7 percent of GDP in its first year.
  - Improvement of macroeconomic conditions with a positive impact on government revenue.
- Outcome: these elements combined allowed the general government balance to reach a surplus of 1.3 percent of GDP—"a much better outcome than initially estimated."

### Tax reform (announced February 29, 2016; specified April 21)
- Objectives: make the tax system more simple, competitive, efficient, and fair; targets companies and households (households are the largest beneficiaries).
- Implementation date: January 1, 2017.
- Estimated cost: "around 0.6 and 0.8 percent of GDP for the period 2017–2020."
- Fiscal affordability: non-neutral impact justified by favorable recent general government balances, positive economic outlook, and relatively low public debt.
- Projection: fiscal position is projected to remain in a small surplus over the medium term, even with the cost of tax reform taken into account, and "well above the newly adopted MTO" for the entire 2017–2020 period.
- Public investment: will remain high over 2017–2020 to support development and potential growth; high investment justified by population growth and continuous increase of employment.

### Public debt and assets
- Debt composition: public debt "entirely denominated in euro."
- Pension-related assets: "significant assets to fund future pension liabilities -29.4 percent of GDP at the end of 2015-have been set aside in a specialized and dedicated fund."
- Net position: "taking all government assets into account, the public sector is a net creditor."
- Debt projection: public debt projected to remain around 23 percent of GDP over the period 2016-2020; government commitment to keep public debt below 30 percent of GDP.

### Fiscal risks and structural challenges
- Risks to public revenues:
  - Decline in potential growth.
  - High degree of openness and specialization in financial services, making revenues vulnerable to high volatility.
  - Several tax initiatives (e.g., OECD/G20 BEPS project or EU rule changes and investigations) underway that "might have some consequences for the public revenues."
- Demographics: ageing population will impact public finances over the long-term.
- Pensions: government concurs with staff on need to place the old-age pension system on a sustainable path; actuarial review of the 2013 pension regime advanced to 2016 (government can assess every 5 years using actuarial studies). Government "took note of staff’s recommendations and stands ready to consider them in this review."
- Retirement policy measures already in place: reform of the pre-retirement regime, professional reclassification, and complementary pension amendments to delay the effective retirement age.

### Financial sector — overall assessment
- General: "forward-looking financial sector remains resilient and sound"; Luxembourg is a financial hub serving private and institutional clients globally; diversification continues with Fintech activities.
- Regulatory environment: ongoing European and international regulatory changes are challenges monitored by authorities; authorities stand ready to take measures to consolidate and strengthen competitiveness and resilience.

### Banking sector
- Balance sheet and performance: aggregate banking sector balance sheet stabilized in recent years, reflecting increased asset values and new inflows.
- Soundness indicators: capitalization and liquidity ratios are sound; NPLs are very low; banking sector remains profitable and an important liquidity provider.
- European banking union: authorities view the banking union as beneficial for Luxembourg; support for completing the banking union with a common European backstop for the single resolution fund and a common European deposit insurance scheme.
- Oversight of nonbank bank-holding companies: measures taken to monitor ownership links at authorization.

### Investment fund industry
- Importance: growing investment fund industry remains an important component of the financial system.
- Recent trends: industry benefited from favorable financial markets, increased assets under management, and new inflows; diversified asset classes and investor base without major concentration risks.
- Risk management and supervision: investment strategies set out in prospectuses; management companies must perform mandatory liquidity risk management and stress tests reviewed by the Commission de Surveillance du Secteur Financier (CSSF); existing EU Directives provide a framework for risk monitoring, risk management and supervision; UCITS V and AIFM Directives have clarified and strengthened depository banks' roles and responsibilities.
- Authorities' view on IMF staff analysis: authorities acknowledge risk factors identified by staff but note the benefits of the industry's growth for Luxembourg and the euro area; emphasize existing supervisory and risk-management frameworks.

### Macroprudential coordination and analysis
- Systemic Risk Committee (SRC): recently established; will monitor links between banks and the fund industry and developments in the housing market; BCL provides Secretariat to the SRC and has conducted a study on bank–fund linkages.
- FSAP: IMF’s FSAP exercise scheduled for the year is expected to cover bank–fund linkages; authorities look forward to cooperating with IMF staff.

### BCL capital
- Government commitment: to find a progressive and sustainable solution to endow the Banque centrale du Luxembourg (BCL) with adequate capital; discussions between the government and the BCL are ongoing.

### Economic diversification and innovation
- Diversification efforts: government focused on creating a climate for business and investment; targeted sectors include logistics, ICT and bio- and eco-technologies.
- Early outcomes: diversification efforts beginning to bear fruit, notably in the rapidly growing logistics sector.
- Innovation initiatives: pan-European project to build a supercomputer and a plan to create a legal framework for space mining cited as recent examples.
- Financial sector diversification: diversification across business activities, investment destinations and customer bases expected to further enhance resilience.

### Refugee influx and policy response
- Scale: Luxembourg hosts around 3500 asylum seekers since mid-2015, which account for nearly 0.5 percent of its population.
- Integration measures: enroll children in schools from day one; provide intensive language courses; issue work permits rapidly; reduced time between asylum application and work permit from 9 to 6 months.
- Administrative responses: mobilized retired teachers to return part-time; examining diploma recognition approaches modeled on the German example.
- Fiscal capacity and limits: successful coping so far helped by sound fiscal position; warning that any renewed strong influx of refugees would likely put pressure on hosting capacity.

*Source: IMF staff report content as provided in the supplied PDF excerpt.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16118.pdf_