Luxembourg - Staff Concluding Statement of the 2021 Article IV Mission
IMF News, March 15, 2021
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- Published: March 15, 2021
Context
- The authorities consented to publication; views are those of IMF staff and do not necessarily represent the views of the IMF’s Executive Board.
- Luxembourg managed the COVID-19 pandemic relatively well due to "unprecedented policy support, both domestically and globally, and a quick adjustment to teleworking given the structure of the economy."
- The economy is "dominated by financial services" and adapted quickly to teleworking.
- Sizeable and flexible policy support and quick reopening—underpinned by a large-scale testing and tracking strategy—helped attenuate the economic fallout.
- The economy "contracted last year driven by weak domestic demand" despite faring much better than the euro area.
Outlook and risks
- GDP performance:
- "Following a mild GDP contraction of 1.3 percent in 2020, IMF staff anticipate a rebound in 2021, with GDP increasing around 4½ percent amid continuing targeted policy support and accommodative global financial conditions."
- Medium-term forecast:
- Output is forecast to remain slightly below the pre-crisis trend, partly reflecting "some impairment in corporate balance sheets and scarring in the labor market."
- Risk balance:
- Risks are "skewed to the downside and are dominated by the virus dynamics in the near term."
- Upside: "quicker containment of the infection could bring back activity significantly faster."
- Downside: "a prolongation of the health crisis into 2021 could delay the recovery."
- Broader risks: tightening of financial conditions; acceleration of de-globalization; "potentially non-negligible revenue loss from changes in international taxation."
Fiscal policy: Supporting a strong, sustainable, and greener recovery
- Policy stance:
- Fiscal policy "should remain supportive until a firm recovery is underway, increasingly focusing on the most vulnerable as the recovery gains speed."
- Fiscal normalization "should be state contingent and start only when output has broadly recovered to its pre-COVID level."
- The unwinding of policy support "should be carefully calibrated against the evolution of the pandemic and economic conditions."
- Targeting and safety nets:
- Subsequent measures should be "targeted to the most vulnerable, including lower-income households and firms in the most affected sectors."
- "Allowing automatic stabilizers to fully operate would continue to support those groups, while unwinding the extraordinary policy measures."
- Greening and investment:
- Luxembourg should proceed with greening the economy and "maintain high levels of public investment to close infrastructure gaps."
- Specific measures in the 2021 budget welcomed by staff include:
- "the introduction of a carbon tax, accompanied with a tax credit to mitigate the impact on the most vulnerable,"
- "the reduction of the subscription tax for sustainable investment funds,"
- "the provision of additional incentives for green investments."
- Continue transition to a data-driven economy by "accelerating the digitalization of public services and further incentivizing business investment."
- Continue to close physical infrastructure gaps (such as in transportation) by maintaining public investment "in line with the government’s multi-year spending plan."
- Fiscal risks and revenue diversification:
- International transparency and anti-tax avoidance initiatives "could help strengthen the corporate tax base" but may "reduce tax revenues in Luxembourg."
- Climate mitigation efforts (notably road transportation) "may also pose potentially non-negligible revenue loss due to lower sales of fuel and complementary goods."
- Staff recommend exploring revenue diversification, including "increasing environmental levies (such as the low transport taxes) and housing taxation (such as outdated property valuations)."
- Public investment management and procurement:
- Improve public investment efficiency, including "the introduction of independent and systematic ex-post project evaluations."
- Staff welcome authorities’ readiness to strengthen public procurement framework, including COVID-related spending, and "encourage the collection and publication of information on beneficial ownership of winners of public tenders."
Financial sector policies: Addressing rising vulnerabilities and risks
- Balance-sheet and liquidity concerns:
- Liquidity support measures—especially the short-time work scheme—and favorable lending conditions "helped alleviate potentially costly vulnerabilities concentrated in the sectors most exposed to the pandemic (notably wholesale, retail, and hospitality)."
- Liquidity pressures could intensify and may turn into insolvencies if state support is withdrawn prematurely or recovery delayed.
- In the event of significant unemployment, "household debt repayment capacity could weaken," with lower-income households being most vulnerable.
- Banking sector:
- The sector "remained well capitalized and liquid overall."
- Higher provisions are "weighing on bank profitability" but will "alleviate the impact of potential credit losses."
- Staff analysis suggests domestically oriented banks "would remain resilient even in an adverse scenario, but results vary among banks."
- Continued vigilance is required because asset quality deterioration could worsen "already weak bank profitability," especially if the health crisis persists.
- Structural profitability issues in certain banking segments—such as "high reliance on capital market developments and relatively low cost-efficiency"—should continue to be monitored.
- Investment fund sector:
- The sector "weathered the crisis well" but displayed vulnerabilities:
- During March 2020 market turmoil, funds increased holdings of cash and liquid assets, leading to "a procyclical selling of assets."
- After the turmoil, funds reverted to "increasing liquidity, maturity, and currency mismatches," leaving open-ended funds "prone to widespread outflows and procyclical selling of less liquid assets in a market downturn."
- Staff recommend deepening macroprudential-based surveillance and regulation, and advancing implementation of the 2017 FSAP recommendations.
- Authorities should develop "internal methodologies for system-wide liquidity stress testing" and remain proactive in international fora to advance the macroprudential reform agenda.
- Macroprudential stance and real estate:
- Authorities tightened macroprudential stance in 2020 as real estate risks rose.
- Introduction of differentiated loan-to-value (LTV) limits is "a step in the right direction."
- If household indebtedness continues to increase, "the current LTV setup should be revisited, and/or other tools provided in the legal framework for borrower-based measures explored."
- Counter-cyclical buffer was appropriately maintained unchanged given the current credit cycle position.
- As the recovery firms and credit market pressures reemerge, "some tightening of the macroprudential stance may help alleviate these pressures."
Structural policies: Mitigating scarring effects and ensuring inclusive recovery
- Labor market and reallocation:
- The pandemic "seems to have disproportionately affected vulnerable workers" and increased unemployment among "the youth, low-skilled, and foreign born."
- Extension of the expanded short-time work scheme "until mid-2021" is welcomed.
- As the recovery firms up, policy should shift "from preserving jobs to helping workers, especially among the most vulnerable groups, to facilitate labor reallocation."
- Recommended measures include hiring subsidies for viable firms, such as "subsidies for employer-sponsored apprenticeships," and continued support for training programs (e.g., Future Skills) to upgrade skills and promote reintegration.
- Housing market:
- Steps in 2020 to improve housing supply are welcome; the pandemic and rising house prices make affordable housing more pressing.
- Examples of 2020 actions:
- Pacte Logement 2.0 links subsidies to municipalities to the amount of social housing built.
- 2021 budget measures include those "intended to discourage speculation in the real estate market and support rental supply (such as by lowering the depreciation rate for rented properties)."
- Staff recommend continuing efforts, including modernizing "the rigid urban zoning/planning" and updating communal development legislation to increase the supply of buildable land.
Closing
- Staff project a rebound in output in 2021 but emphasize downside risks dominated by virus dynamics.
- Fiscal support should remain supportive and progressively targeted to protect vulnerable households and firms, while pivoting to greening the economy and sustaining public investment as recovery allows.
- Financial sector vulnerabilities—in banking and investment funds—warrant continued monitoring and implementation of the 2017 FSAP recommendations.
- Structural policies should focus on reducing labor market scarring and improving inclusiveness in the housing market.
- The IMF team thanks Luxembourg authorities and interlocutors for constructive discussions.
Source: Luxembourg - Staff Concluding Statement of the 2021 Article IV Mission, March 15, 2021.