Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.

Belgium—2006 Article IV Consultation
Preliminary Conclusions

Brussels, November 13, 2006

1. Supported by sound economic policies and a favorable international environment, the economy has been performing well and the financial sector has gained further resilience. As is broadly recognized, these policies will need to be strengthened to meet the long-run challenges posed by population aging and globalization. Achieving balanced budgets or small surpluses for seven years running is an enviable record, which has firmly established the credibility of fiscal policy. Coping with the costs of aging now requires building up budget surpluses, which implies that the inopportune trend decline in the primary surplus will have to be reversed, as is planned for 2007. The implementation of the Generation Pact has been improving labor market performance. Broadening labor market reforms and further advancing reforms in product markets and education will boost labor productivity. Responsibly, social partners have kept wages broadly in line with agreed norms. In this spirit, it will be important that they reach agreement on wage moderation going forward to recoup the recent erosion of competitiveness. To preserve adequate pensions and high quality health care in the long run, policy actions need to be taken early on. Hence, a decisive strengthening of these policies should be at the top of the next government's policy agenda.

2. In terms of broad policy orientation, a resolute reduction in primary public expenditure growth is key to resolving apparent tensions in the pursuit of multiple policy objectives, especially those of achieving fiscal consolidation and promoting higher employment rates. Such tensions are evident in several areas. For example, cuts in social security contributions, while good for employment, undermine fiscal adjustment, unless accompanied by spending cuts. Reductions in corporate taxes promote investment, though more in capital than in labor intensive sectors. Similarly, shifting from income taxes to indirect taxes increases incentives to work and may benefit the environment, but—through the universal practice of wage indexation—pushes up wage demands, thus slowing job creation, while raising the public wage bill.

3. Economic activity has been buoyant and is expected to settle at a more moderate pace going forward. GDP growth could approach 3 percent in 2006 before easing to 2.2 percent in 2007. Three factors contribute to the projected slowdown: fiscal policy will turn neutral after being strongly procyclical in 2006; residential investment will slow in the second half of 2007 as interest rates rise and the impact of favorable fiscal measures wanes; and the external environment will soften. In this context, with oil prices projected to remain stable, inflation is likely to fall well below 2 percent. Uncertainties surrounding this outlook are associated with economic developments in neighboring countries and the evolution of oil prices and interest rates on the external side, and with wage developments on the domestic side.

4. Addressing the projected rise in aging-related spending requires a mix of up-front fiscal adjustment, entitlement reforms, and growth-enhancing policies. Even assuming that the employment rate goes up to nearly 70 percent and productivity growth increases appreciably, population aging will boost public expenditure by nearly 6 percentage points of GDP by 2050. Dealing with this burden involves a multi-pronged approach, which is partly under way and broadly recognized in principle, but needs to be fully implemented in practice:

• For intergenerational fairness, significant prefunding of the rise in aging-related spending is necessary. With aging costs now higher than previously estimated, the fiscal surplus will have to climb to about 1.8 percent of GDP by 2012 in evenly paced annual adjustments, along a path that is more ambitious than that of last year's stability program update.

• In addition, some further reforms of the pension system will be helpful: fully phasing out early retirement schemes, establishing complete actuarial fairness, and tying contribution periods to life expectancy. Building on recent commendable progress, the growth of health care spending should be durably reduced.

• Employment rates will go up significantly as younger generations have higher participation rates, while the implementation of the Generation Pact will increase labor supply and demand. Even so, additional reforms of labor market institutions will be key to reach the targets consistent with a successful strategy to deal with aging (¶¶10-11).

• Finally, ongoing reforms in the product markets, such as the liberalization of network industries and the reduction in the administrative burden on the private sector, are welcome initiatives to raise growth. To further boost productivity growth, obstacles to competition in the services sector need to be removed.

5. The surplus targeted in the 2007 draft budget is fully consistent with the strategy to deal with aging, but to reach the target some additional measures are likely to be required in the context of the traditional budget control. On the positive side, one-off measures are being reduced. However, primary spending growth is set to slightly exceed GDP growth in real terms, and revenue projections appear to be on the optimistic side. As a result, additional measures to reduce spending by about 0.3 percent of GDP may be necessary to attain the surplus objective. These measures should be of durable nature so as to contribute to steadily rising surpluses in the future.

6. The authorities need to articulate a medium-term strategy of primary expenditure restraint to deliver the envisaged fiscal adjustment. It will be essential to further reduce and to renounce reliance on one-off measures that have budgetary costs in the future to avoid eroding fiscal credibility and public confidence. Areas for expenditure savings include civil service reform, by taking advantage of attrition and information technology, a streamlining of functions across levels of government, and entitlement reform in support of labor market objectives. Reducing primary spending growth will require a further shift in the culture of the public sector toward more accountability, and the implementation of performance-based budgeting, as has become the norm in other effectively reforming countries.

7. Successful consolidation will involve efforts at all levels of government and a revision of fiscal federalism arrangements. For now, emerging imbalances have been successfully managed through unplanned adjustments to budget targets of regional entities, but these imbalances are set to widen. The federal government and social security together (Entity I) are facing a decline in their relative share of revenues, while spending pressures are intensifying. At the same time, the sub-federal governments (Entity II) have little incentive to save the increase in revenues they are experiencing. In revising the arrangements, it will be important that any further devolution be accompanied by strengthened accountability and stronger coordination among federal and sub-federal entities of both budgetary and other economic policies.

8. While Belgium has enjoyed the benefits of strong fiscal institutions, maintaining the momentum of fiscal consolidation in a federal state calls for a further strengthening of these institutions, including the internal stability pact. Accordingly, the resumption of the activities of the High Council for Finance (HCF) is timely and welcome. These activities should include establishing guidance on budgetary objectives for different levels of government in the context of stability programs and the strategy to deal with aging, and assessing compliance with these objectives by various levels of government.

9. Low employment rates are evidence of labor market rigidities. Although employment growth picked up in response to recent strong economic activity, the unemployment rate has so far only modestly declined and employment rates continue to lag those of neighboring countries. Demographic developments as well as higher labor force participation—associated with better economic conditions and activation policies—have contributed to a welcome increase in labor supply. However, labor demand has not kept pace, with industry witnessing job losses, and unemployment rates continuing to be structurally very high for the low skilled and the young, though with sharp regional differences.

10. Building on the initial steps taken with the Generation Pact, further labor market reforms will be essential to make work pay. In this context, the sharpened focus on activation policies by the authorities is highly appropriate. To raise their effectiveness, active labor market policies will need to be streamlined, systematically evaluated, and coordinated across regions. In a balanced package and mindful of the implications for the budget, the tax wedge on labor should be further reduced, early retirement schemes phased out, and the generosity of out-of-work benefits reviewed. The eligibility for unemployment benefits will have to be effectively tightened, the duration of benefits limited, and efforts to improve training and education enhanced.

11. Going forward, wage moderation will be essential to recoup the recent erosion in competitiveness. Social partners, who are increasingly taking into account the need to reduce unemployment and create jobs, should ensure that this concern is reflected in the outcome of the ongoing wage negotiations, in line with their March 2006 agreement. With sectors and enterprises facing very different conditions, the overall wage norm should not be considered a target. More broader use of "all-in" agreements will be crucial to minimize wage deviations stemming from inflation surprises. It will be important for social partners to ensure that any cuts in taxes and social security contributions be used solely to reduce labor costs. In the longer run, changes to the existing wage formation framework are necessary to make it more conducive to job creation. In particular, productivity differentials need to be better taken into account in setting wages at the sectoral and enterprise levels. This will help resolve regional disparities in labor market performance and allow the economy to benefit fully from globalization.

12. The financial system is strong and resilient and there are no stability concerns. The financial sector has been benefiting from a benign international environment, low interest rates and, more recently, buoyant equity markets. Reflecting these developments, major bancassurance groups are experiencing high profits, enhanced solvability, and comfortable liquidity positions. Stress tests conducted within the context of the Financial Stability Committee show the system to be resilient to plausible shocks, confirming the findings of last year's financial stability assessment by the IMF.

13. Importantly, rapidly evolving strategies of the bancassurance groups, with expansions in non-traditional areas and markets, are changing the systemic risk profile of the financial system. In response, supervisors need to sharpen the focus of resources and attention on these emerging issues. Further, the strong international dimension of Belgium's financial system and the large cross-border exposures underscore the necessity of strengthening the information exchange and international cooperation among supervisors and adapt and test the existing framework for crisis management.

14. Since its recent creation, the unified supervisor (CBFA) has made major strides in improving the quality of supervision which will need to be build upon further. The CBFA's main achievements include (i) the alignment of regulations and supervision in banking, insurance, securities, payments and settlement with international standards; (ii) the upgrading of insurance and pension supervision; (iii) the enhancement of internal controls and functioning and; (iv) the cooperation with the National Bank of Belgium (NBB). Having successfully met the challenges of integration, priority now has to shift to taking fuller advantage of the synergy between the NBB and the CBFA, as envisaged in the law. Key objectives should be to further increase the effectiveness and efficiency of the CBFA.



IMF EXTERNAL RELATIONS DEPARTMENT

Public Affairs    Media Relations
E-mail: publicaffairs@imf.org E-mail: media@imf.org
Fax: 202-623-6220 Phone: 202-623-7100