Luxembourg: Staff Concluding Statement of the 2017 Article IV Mission
IMF News, March 7, 2017
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- Published: March 7, 2017
Risks and macro outlook
- Growth and employment prospects for Luxembourg remain strong and the international economy has shown resilience to shocks, but downside risks have increased.
- Identified downside risks:
- possible global retreat from cross-border integration with negative consequences for the very open Luxembourg economy;
- policy uncertainty in the U.S. and associated with the outcome of elections in Europe as well as post-Brexit arrangements;
- potential impact on the economy and tax revenue of the international tax transparency and anti-avoidance agenda which Luxembourg is implementing;
- still vulnerable recovery in the euro area;
- possible intensification of insecurity in parts of the world leading to a renewed surge in refugees.
- Domestic risks:
- high and rising real estate prices and growing affordability issues could affect competitiveness and financial stability;
- over the longer term the sustainability of the pension system is at stake.
- Policy imperative: maintain sound policies to sustain strong activity and preserve room for policy maneuver.
Fiscal policy — findings and recommendations
- Recommendation to stabilize the public debt ratio at about its current level , to maintain buffers for use in case of need.
- Fiscal targets proposed:
- target a small fiscal surplus in 2017;
- target a balanced budget over the medium term, broadly in line with the current policy stance.
- Recent developments:
- Strong economic activity created fiscal space, used in good part for the significant tax reform.
- In 2016, buoyant tax revenues and somewhat lower-than-expected capital outlays resulted in a sizable fiscal surplus.
- Under current policies, including ongoing revenue trends and implementation of the Zukunftspak, the surplus would drop in 2017 and disappear thereafter.
- Policy stance guidance:
- No need for further fiscal stimulus given vigorous expansion and an already high level of public investment; keep room for maneuver in case downside risks materialize.
- Tax transparency and corporate taxation:
- Continue to support and implement the G20/OECD anti-Base Erosion and Profit Shifting (BEPS) initiative and the new EU tax rules, including by promptly transposing the Anti-Tax Avoidance Directive into national law.
- Further corporate tax reform should aim at widening the tax base by ensuring that special tax regimes and transfer pricing arrangements are aligned with evolving international standards, while lowering statutory corporate tax rates in a revenue neutral manner.
- To address fiscal revenue risks, develop contingency measures, including by revisiting the low real estate valuation tax bases and enhancing green taxation.
- Pensions:
- Continued reform of the pension system is advisable; population ageing will put significant pressure with current surpluses projected to disappear in the medium term and accumulated reserves to be used up thereafter.
- The newly formed Pensions Group, comprised of representatives of the social partners and government, should aim to propose a mix of policy options ahead of next year’s elections, including measures to increase the low effective retirement age.
Financial sector policies — findings and recommendations
- Need for a continued pivot towards risk-based supervision and further increase in resources for entities engaged in safeguarding financial stability to complement recent reforms.
- Structural vulnerabilities:
- size and interconnectedness of the financial system;
- elevated real estate valuations.
- Regulatory and supervisory progress:
- Luxembourg authorities have pursued a domestic reform agenda including adoption of key recommendations from the 2011 FSAP and a strengthening of the Anti-Money Laundering/Combating the Financing of Terrorism regime.
- Banking supervision:
- Intense supervision of banks’ large cross-border exposures is required.
- Many foreign bank subsidiaries in Luxembourg aggregate liquidity from investment funds and wealth management operations and ‘upstream’ it to their parents abroad where maturity and currency transformation may take place.
- Oversight by Luxembourg authorities may be limited where parents are not regulated under the Single Supervisory Mechanism.
- Recommendations: introduce more frequent on-site inspections; require banks to periodically demonstrate continued eligibility for the waiver to large exposure limits; reinforce oversight of non-bank holding companies of banks; continue to advocate for a coordinated approach at the European level.
- Investment funds:
- The investment fund supervisory regime and risk monitoring should continue to be strengthened to safeguard financial stability.
- Severe shocks to investment funds could result in a drawdown of bank deposits to meet redemptions and affect banks’ fee income.
- Recommendations: increase frequency of on-site inspections; introduce comprehensive inspections; seek close engagement with regulators in jurisdictions where delegated activities such as portfolio and risk management are prominent.
- Macroprudential framework:
- The new macroprudential policy framework appears to be working well and could be improved further.
- Legal enhancements: remove potential inaction bias from unanimity in voting; enshrine into law the leading role of the Banque centrale du Luxembourg (BCL).
- Expand instrument toolkit as further macroprudential tightening may be required if credit conditions ease and amplify the uptrend in property prices.
- Real estate market:
- Risks should continue to be closely monitored, and further actions taken if needed .
- House prices have risen significantly since the global financial crisis, reflecting demand from employment growth meeting supply constraints.
- Recent measures have discouraged riskier lending practices and built buffers in the banking system.
- Recommendations: increase supply of housing; assess merits of setting limits to loan-to-value ratios or debt-service-to-income ratios.
- Governance and institutional arrangements:
- Introduce a formal framework to govern the relationship between the government and banks with state involvement.
- Enshrine the operational independence of the Commission de Surveillance du Secteur Financier (CSSF) and Commissariat aux Assurances (CAA) in law.
- Board members of CSSF, CAA, and the BCL should be bound by codes of conduct in line with best practices.
Policies for sustainable and inclusive growth
- Economic diversification:
- Further expand activity beyond the financial sector to enhance resilience and broad-based job creation.
- Complement government efforts to promote new sectors with product market reforms to support firm creation by removing restrictions and alleviating operational requirements in business services and the retail sector.
- Housing and infrastructure:
- Insufficient housing supply poses a bottleneck; central and local governments should increase housing supply by easing zoning requirements for construction and shortening the period required to obtain permits.
- Maintain adequate and efficient public investment to provide high quality infrastructure commensurate with expansion.
- Labor market and inclusion:
- Unemployment is edging down with strong growth and active labor market policies , but remains higher than before the financial crisis while a large share of new jobs is filled by cross border workers, mainly due to skills mismatches.
- Public employment agency (ADEM) should increasingly target interventions at the most vulnerable groups: the young and low-skilled, as well as non-EU immigrants and refugees.
- Employment subsidies should be limited to avoid windfalls to employers without creating durable jobs.
- Further link unemployment benefits to job search and training to reduce inactivity traps.
- With resumption of the wage indexation, ensure real wages are in line with productivity.
- Education reforms should focus on upgrading outcomes in a multi-lingual society and improving vocational training to better match labor market needs.
Source: Luxembourg: Staff Concluding Statement of the 2017 Article IV Mission (March 7, 2017).