Luxembourg: Staff Concluding Statement of the 2025 Article IV Mission
IMF News, March 21, 2025
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- Published: March 21, 2025
Key takeaways
- While fundamentals remain strong, Luxembourg’s economic performance was lackluster during 2022-24, with a tepid recovery underway supported by public consumption.
- Near-term policy priorities: secure a more private sector-led recovery, address confidence issues in the real estate sector, and better anchor fiscal policy in a medium-term perspective to enhance predictability.
- Medium-term priorities: prudent fiscal policy, tax reforms to diversify revenues and reduce revenue uncertainty, labor market flexibility, and strengthened macroprudential frameworks.
Recent developments
- GDP growth:
- Estimated at ½ percent in 2024 (based on data for the first three quarters), below the EA average for the third consecutive year.
- Labor market:
- Employment growth outside the public sector has been sluggish.
- Unemployment rate has continued to rise, surpassing the long-term average of 5½ percent.
- Housing and credit:
- Demand for mortgages started to recover in 2024H2 and house prices have stabilized, but demand for new construction remains weak.
- Credit growth to the nonfinancial private sector has remained negative.
- Banks’ asset quality has deteriorated, mainly driven by nonfinancial firms, though at manageable levels.
- Debt-service dynamics: debt service-to-income on new mortgages has remained high at 44 percent.
- Fiscal and financial buffers:
- Buoyant fiscal revenues financed generous support packages while maintaining relatively low public debt and ample —albeit declining— fiscal space.
- The large financial sector has weathered recent shocks; the 2024 FSAP found it sound and well-diversified.
Outlook and risks
- Growth projections under baseline:
- GDP growth is projected to rebound to about 2 percent in 2025 and accelerate further to about 2½ in 2026-27, driven by the private sector.
- Inflation: the phasing out of electricity price controls in the beginning of this year will temporarily increase inflation to about 2¼ percent.
- Fiscal outlook:
- Under unchanged policies, the fiscal deficit is projected to widen and debt to steadily increase amid spending pressures from defense, aging, climate and other investment needs.
- Main recent drivers of revenue—exceptional bank profitability and an increase in the labor income share—are projected to wane.
- Downside risks:
- 2025 headwinds from weaker external demand and higher global financial volatility due to geoeconomic uncertainties and trade actions.
- Domestic risks from real estate sector challenges.
- Fiscal risks from concentrated taxpayer base and reliance on revenue from nonresidents, plus implicit contingent liabilities from the financial sector.
- Demographic risks: pension spending pressures with reserves projected to be depleted by [2045] under current policies.
Fiscal policy recommendations and findings
- 2025 stance:
- With continued normalization of ECB policy, a neutral fiscal stance would be appropriate in 2025.
- Fiscal policy is projected to be expansionary in 2025 after contracting in 2024.
- Staff caution against further delays in unwinding remaining discretionary measures and encourage saving any revenue overperformance or underspending.
- Income-support measures are likely less effective given high saving rates and low fiscal multipliers; reliance on automatic stabilizers would be sufficient.
- Medium-term guidance:
- Guard against growing spending pressures and revenue uncertainty by balancing fiscal discipline with strategic needs.
- Contain current expenditure growth of central and local governments and avoid further narrowing of the tax base.
- Spending-side measures:
- Staff welcome the authorities’ expenditure path in the Medium-term Structural Fiscal Plan (MTSFP) which reduces current spending excluding social security to enable some increase in capital and interest spending; essential to underpin this with clearly defined measures.
- Suggested measures: contain wage bill growth (including leveraging digitalization), rationalize tax expenditures, better target social spending.
- Revenue-side measures:
- Tax reforms should reduce revenue uncertainty and be budget-neutral or compensated by other measures (e.g., diversify revenues through higher property or environmental taxation and excise taxes).
- Modernization of direct tax administration is welcome to bolster long-term revenue and reduce delays in corporate tax collection.
- Fiscal institutions:
- Implementing a national fiscal rule is supported to enhance credibility and reduce policy uncertainty; staff recommend a debt anchor combined with an operational fiscal rule (fiscal balances, multi-year expenditure ceilings, or an expenditure rule).
- Strengthen the fiscal council to develop independent macro fiscal projections, risk assessment, and debt sustainability analysis.
- Budget framework improvements:
- Improve fiscal statistics and reporting, strengthen revenue performance analysis and projections, revamp fiscal risk assessment.
- Enhance transparency via costing of policies and systematic explanations of budget deviations.
- Promote performance-based budgeting, regular spending reviews (including public investment), and ex-post policy assessments.
- Pensions:
- Authorities’ consultation on pension reform is timely; pension expenditure projected to grow significantly and exceed contributions already next year, with reserves expected to be depleted by [2045] under current policies.
- Recommended directions: disincentivize early retirement, increase retirement age, reduce pension generosity, and consider increasing contribution rates while weighing labor market impacts.
Financial sector policies and recommendations
- Overall assessment:
- Financial sector resilient and well-capitalized; CSSF and FSAP stress tests show sufficient loss-absorption capacity on aggregate in a downside scenario.
- Cyclical systemic risks remained moderate as at time of the 2024 Article IV.
- Vulnerabilities and monitoring:
- Rapid increase in nonperforming loans for resident real estate and SMEs in domestic banks should be closely monitored given banks’ large exposure to this sector.
- Investment funds’ liquidity risks manageable; leverage relatively low except for hedge funds.
- Household indebtedness remains elevated despite decline in debt-to-income ratio; credit risk could resurface if unemployment rises more than expected.
- Prudential stance:
- Current level of the countercyclical capital buffer (CCyB) is broadly appropriate given expected turn in the credit cycle, alongside need to maintain releasable buffers.
- Supervisory authorities should ensure sufficient loss absorption capacity, adequate provisioning of expected losses, and scrutinize credit risk management and collateral valuation practices.
- If credit cycle turns:
- Consider increasing releasable buffers, preferably through sectoral systemic risk buffers (or gradually increasing the CCyB and formalizing a positive neutral CCyB framework).
- Introduce income-based measures to tackle high household indebtedness and improve borrower resilience.
- Gradually reduce the maximum LTV limit of 100 percent.
- Real estate confidence measures:
- Authorities urged to work with banks and industry to address sources of lack of confidence in real estate companies (e.g., reforming the completion guarantee scheme) and consider contingency measures if confidence does not return.
- Macroprudential and safety-net enhancements:
- Continue implementing 2024 FSAP recommendations on bank and investment funds supervision.
- Strengthen macroprudential governance by reducing Ministry of Finance’s role in decision-making, enhancing communication, and improving coordination with other policies (e.g., housing).
- Better integrate systemic risk assessments by enhancing data collection on other financial intermediaries and analyzing linkages between investment funds and banks.
- Finalize and build on the memorandum of understanding between BCL and CSSF to strengthen liquidity supervision and the financial safety net.
- Enhance resilience to operational risks, including cyberattacks and AI-related risks.
- Further enhance monitoring of money laundering/terrorist financing risks of cross-border flows and exchange of information with domestic and foreign authorities.
Structural challenges and reform priorities
- Productivity and labor:
- Growth to date driven by expanding labor force (immigrants and cross-border workers) while labor productivity growth has lagged peers; not sustainable given ageing population and infrastructure bottlenecks.
- Need for greater labor market flexibility, including more flexibility in the automatic wage indexation system and collective bargaining reforms that preserve labor mobility.
- Reduce entry requirements to professional services while preserving quality to boost competition.
- Labor supply policies:
- Recent law facilitating labor market access for third-country nationals is welcome.
- Further focus on incentivizing senior labor participation, reducing the gender gap (enhance work flexibility and switch to individual taxation), and consider financial incentives for firms to hire and retain senior workers through life-long learning and age-management practices.
- Progress on skills mismatches and increased training provision is welcome.
- Housing supply and affordability:
- Restore affordability through supply-side measures; welcome streamlining of building permits and careful calibration of land tax reform to mobilize unused land.
- Invest in mobility and encourage firm presence near borders to ease hub pressure.
- Gradually withdraw demand-side measures such as interest payment deductibility from income tax, starting with those directed to investment properties.
- Innovation and technology:
- Enhance innovation and technology adoption to boost productivity; the SMEs digital support program is welcome.
- Reduce regulatory burden for SMEs, provide targeted incentives, invest in infrastructure to catalyze private sector investment in intangible assets and R&D.
- Upcoming AI strategy is welcome; harnessing AI requires tackling labor shortages in the IT sector through agile labor and education policies.
- Complement domestic reform with European-level reforms to tackle barriers to entry in services.
IMF staff concluding statement, March 21, 2025.