Luxembourg: Staff Concluding Statement of the 2020 Article IV Mission
IMF News, February 14, 2020
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- Published: February 14, 2020
Context and recent performance
- IMF mission led by Mr. Emil Stavrev visited Luxembourg during February 3-14 to conduct the 2020 Article IV consultation.
- Growth performance:
- 2018 growth: 3.1 percent.
- 2019 estimated growth: 2.6 percent.
- Labor market: solid employment gains and a significant decline in unemployment, though the labor market is cooling off somewhat.
- Data and statistics: frequent and substantial GDP revisions noted; recent addition to national accounts staff at STATEC welcomed, but substantially more resources recommended.
- Fiscal position: gross public debt remains low and structural fiscal balance well above the Medium-Term Objective (MTO).
- Tax transparency: strong commitment to international anti-tax avoidance and transparency initiatives has bolstered reputation.
Outlook and downside risks
- Medium-term GDP growth: projected to remain strong, underpinned by robust domestic demand and net export of services.
- External risks:
- Rising protectionism.
- A sharp increase in risk premia could raise financial volatility and hit financial sector profitability.
- Changes in global corporate taxation could pose non-negligible fiscal revenue risks by reallocating taxing rights to jurisdictions where MNEs’ customers are located.
- Domestic risks:
- Continued high growth of real estate prices could reduce housing affordability and exacerbate household indebtedness.
Fiscal policy assessment and recommendations
- 2020 fiscal stance:
- Government adopted an expansionary budget for 2020 with permanent spending increases on wages and plans to step up public investment.
- Government envisages an ambitious tax reform package including: (i) generalizing individual taxation to enhance labor market participation; (ii) reforming environmental taxation; (iii) modernizing housing taxation.
- Revenue risks:
- Corporate income tax revenues have increased partly due to temporary factors.
- Transposition of EU Anti-Tax Avoidance Directive II into national law and other international initiatives could strengthen the tax base but may also be changing MNE behavior.
- Fundamental international taxation changes under discussion could lead to a non-negligible tax revenue loss.
- Policy recommendations:
- Maintain a prudent fiscal policy and preserve comfortable buffers given fiscal risks from global tax reforms.
- Target an overall structural surplus of around 1 percent of GDP.
- Explore options to diversify revenues, including:
- Increase low transport taxes, for example by introducing one-off car registration fees.
- Remove preferential VAT treatment of heating energy while protecting the most vulnerable.
- Modernize outdated property valuation.
- Improve public investment efficiency by strengthening the budgetary framework (such as introducing a spending review mechanism) and governance arrangements (notably conducting independent and systematic ex-post project evaluations).
- Carefully consider potentially large fiscal risks from intended domestic tax reforms.
Financial sector resilience: findings and recommendations
- Overall assessment:
- Financial sector has coped well with low-for-long interest rates.
- Banks’ profitability overall comfortable but with wide variation across segments; commission-based activities faring better.
- Investment funds posted a strong performance though search for yield has continued.
- Life insurance sector performed well, reflecting a prudent business model and increased activity partly due to Brexit.
- Vulnerabilities:
- Structural profitability issues in some banking segments (high reliance on capital market developments; relatively low cost-efficiency).
- Build-up of balance-sheet vulnerabilities: larger liquidity mismatches in the fund sector; greater reinvestment risk for life-insurance companies due to search-for-yield.
- Stress test results (top-down by supervisory authorities):
- (i) Banks have generally sufficient capital and liquidity buffers to withstand severe macro/liquidity shocks.
- (ii) Bond funds could meet large redemptions under stressed market conditions within a reasonable timeframe.
- (iii) Insurance companies would generally remain solvent in the face of severe shocks.
- Follow-up and specific recommendations:
- Continue to follow up on 2017 FSAP recommendations to further strengthen financial sector resilience.
- Banks:
- Completion of resolution planning for most less systemic institutions (LSIs) is welcome.
- Continue efforts to strengthen supervision of banks’ large cross-border exposures and review waivers to large exposure limits for intra-group transactions.
- Maintain high engagement with supervisors of parent/group of Luxembourg’s LSIs located outside the euro area.
- Investment funds:
- CSSF’s active involvement in EU-level discussions (including ESMA liquidity stress test guidance) is welcome.
- Authorities involved in macroprudential policy should take lead roles internationally on: (i) guidance on liquidity management tools; and (ii) design of macroprudential toolkit for investment funds.
- Continue progress on a risk dashboard, close data gaps (asset liquidity and average maturity), strengthen liquidity stress testing capacity, build system-wide indicators for leverage and asset quality, and develop methodologies for system-wide liquidity stress testing.
- Macroprudential policy and governance:
- Adoption of the borrower-based limits law, publication of macro-financial risk analysis substance, and preparatory work for a national credit register are welcome.
- Authorities appropriately increased the counter-cyclical capital buffer, but activation of borrower-based limits is recommended to address growing household balance-sheet vulnerabilities.
- De-facto lead role of Banque Centrale du Luxembourg (BCL) in financial stability analysis and operational independence of the CSSF and the CAA should be enshrined in legislation.
- Money laundering and terrorist financing (ML/TF):
- 5th EU Anti-Money Laundering Directive expected to be fully transposed into national law this spring, including registries for ultimate beneficiary owners of trusts and fiduciaries as well as bank accounts.
- CSSF efforts to address ML/TF risks (implementation of 2019 EBA peer review recommendations, issuing circular on determining beneficial ownership, conducting sub-sectoral risk assessment) should continue.
- Vertical risk assessment targeting virtual assets and terrorism financing will be carried out this year following National Risk Assessment recommendations.
Boosting potential and making growth more inclusive: housing and labor market policies
- Housing market and supply-side constraints:
- Real house prices continued rising rapidly in 2019, weighing on affordability.
- Recommendations to expand housing supply:
- Modernize rigid urban zoning and planning and administrative rules.
- Amend the law on communal development to increase supply of buildable land.
- Adopt Pacte Logement 2.0 by end-2020; this is welcomed and would link municipal subsidies to amount of social housing built.
- Establish a national register for social housing.
- Gradually phase out sizeable tax incentives that support housing demand while sheltering vulnerable groups.
- Labor market and inclusion:
- Structural unemployment remains relatively high despite strong job creation; vulnerable groups include women, older workers, and low-skilled workers.
- Recommendations to reduce structural unemployment:
- Address disincentives from the tax/benefit system to raise participation of vulnerable groups.
- Generalizing individual taxation would help make the tax system more gender-neutral by reducing the marginal tax rate applied to secondary earners’ income, often women.
- Further reduce generosity of the welfare system by phasing out early retirement benefits, combined with planned introduction of the Occupational Inclusion Assistance, to increase elderly labor market participation.
- Revenu d’Inclusion Sociale recently implemented and would alleviate some work disincentives, especially for low-skilled and older workers.
- Continue skill foresight exercises and explore future skill needs; build on initiatives such as the Digital Skills Bridge program.
Closing
- Luxembourg has space to fund envisaged public spending increases and the ambitious tax reform package, but preserving comfortable fiscal buffers and contingency planning is important given external and taxation-related risks.
- Continued implementation of financial sector reforms and macroprudential measures is recommended to strengthen resilience.
- Structural reforms in housing and labor markets are critical to improve affordability, reduce household vulnerabilities, and make growth more inclusive.
- The mission thanks the authorities and other interlocutors for constructive discussions.
International Monetary Fund — Staff Concluding Statement of the 2020 Article IV Mission (February 14, 2020)