Staff Report for the 2005 Article IV Consultation

This 2005 Article IV Consultation highlights that Belgium’s growth has picked up following weakness in early 2005, mainly reflecting a negative contribution from the external sector and weak household consumption owing to high energy prices. The authorities and the IMF staff project GDP growth to strengthen into 2006 to somewhat more than 2 percent, as demand from trading partners increases further. Private consumption is projected to pick up in response to tax cuts, and residential construction is likely to remain resilient, even though housing price growth is likely to slow.


This 2005 Article IV Consultation highlights that Belgium’s growth has picked up following weakness in early 2005, mainly reflecting a negative contribution from the external sector and weak household consumption owing to high energy prices. The authorities and the IMF staff project GDP growth to strengthen into 2006 to somewhat more than 2 percent, as demand from trading partners increases further. Private consumption is projected to pick up in response to tax cuts, and residential construction is likely to remain resilient, even though housing price growth is likely to slow.

I. Economic Background and Outlook1

1. Growth has been slightly better than in the euro area (Figure 1 and Table 1). In 2004, encouraged by low interest rates and permanent tax cuts, households reduced their savings rate and invested in housing. Enterprises stepped up capital formation, reflecting rising profits, the low cost of funding, and a catch-up from earlier depressed levels. While these developments boosted imports, the increase in oil prices choked consumption in late 2004 and, together with a sudden decline in external demand, caused near stagnation of economic activity in early 2005 (Text Table 1). Since then, private consumption and exports have been gaining strength while investment remained resilient, prompting a modest acceleration in growth.

Figure 1.
Figure 1.

Belgium: Economic Developments

(Annualized quarterly growth rates; unless otherwise indicated)

Citation: IMF Staff Country Reports 2006, 074; 10.5089/9781451803235.002.A001

Sources: AMECO; BelgoStat; Eurostat; OECD Economic Outlook; and IMF, WEO.
Table 1.

Belgium: Basic Data, 2000–06

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Sources: Data provided by the authorities; and IMF staff estimates and projections.

Contribution to growth.

Percent of the labor force.

Harmonized consumer price index.


Since 1999, euro rate.

Includes UMTS license revenue of 0.2 percent of GDP in 2001 and proceeds from the transfer of Belgacom’s pension fund of 1.9 percent of GDP in 2003.

Excludes UMTS license revenue of 0.2 percent of GDP in 2001 and proceeds from the transfer of Belgacom’s pension fund of 1.9 percent of GDP in 2003.

Belgium entered the final stage of EMU on January 1, 1999 at a rate of 40.3399 Belgian francs to the euro.

Based on relative unit labor costs in manufacturing.

Text Table 1.

Belgium: Selected Indicators of Economic Activity, 2004–05

(Percent change from previous period; unless otherwise noted)

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Sources: Belgostat; and IMF staff calculations.

Contribution to GDP growth.

2. As elsewhere, oil price hikes have boosted headline inflation. Harmonized consumer price inflation peaked at 3 percent in September 2005 but fell back as oil prices decreased somewhat and temporary tax rebates on heating oil took effect. Excess headline inflation over the euro area average can be attributed to transitory factors (Figure 2). Underlying inflation has been hovering at about 1.4 percent, reflecting limited pricing power due to intense international competition and economic slack. Private sector hourly wages are estimated to have risen by about 2.3 percent in 2005, while unit labor costs grew by 2.1 percent.

Figure 2.
Figure 2.

Belgium: Inflation Analysis 1/

(Percent change over same period of previous year)

Citation: IMF Staff Country Reports 2006, 074; 10.5089/9781451803235.002.A001

Sources: Cronos database; and IMF staff calculations.1/ Permanent (common) and transitory (idiosyncratic) components extracted with a Generalized Dynamic Factor Model applied to 4-digit categories of the HICP.

3. Policy conditions have been supportive of activity (Figure 3). Low interest rates have been sustaining domestic demand while the return of the euro to a more depreciated level helped rekindle exports. The procyclicality implied by the pursuit of balanced budgets has been limited through the use of one-off measures, which allowed masked operation of automatic stabilizers. Even so, with the economy very open and mainly producing for the euro area, fiscal multipliers have been small, and monetary conditions appropriate for the area as a whole have been fine for Belgium as well. Conversely, membership of the monetary union has imparted discipline on domestic policies, with the authorities underscoring that their forward-looking approach had been important to preserve confidence.

Figure 3.
Figure 3.

Belgium: Monetary and Fiscal Policy Conditions

Citation: IMF Staff Country Reports 2006, 074; 10.5089/9781451803235.002.A001

Sources: IMF, IFS; and European Central Bank.1/ The monetary conditions index (MCI) is a weighted average of the real effective exchange rate (weight=0.3) and the short-term real interest rate (weight=0.7).2/ Real effective exchange rate index based on normalized unit labor costs.

4. The economic recovery is expected to strengthen. The staff projects GDP growth to increase from 1.5 percent in 2005 to about 2.1 percent in 2006, marginally (0.1 percentage point) less than assumed in the 2006 budget. Demand from key trading partners has been edging up, and global growth is projected to remain robust in 2006. Domestically, income tax cuts will compensate for the loss of purchasing power from higher oil prices and, based on approved building permits, residential construction should remain resilient. Nonetheless, household spending will soften somewhat, with the savings rate expected to stop falling. The expansion of fixed investment is expected to moderate, given its exceptional strength in 2005. Harmonized consumer price inflation is projected to average 2.4 percent in 2006.

5. Foreign demand and global imbalances pose external risks, while wage growth and developments in residential property prices constitute domestic sources of uncertainty. A faltering of growth in Europe and a disorderly euro appreciation would dampen growth. If the 2005–06 wage agreement is implemented as envisaged, domestic wage increases will exceed those of key trading partners. While this might support demand in the short run, it would adversely impact competitiveness in the medium run. Risks connected to the buoyant housing market seem confined. The recent rise in residential real estate prices is the combined result of low interest rates, the investment in housing of capital repatriated in the context of the 2004 fiscal amnesty, the introduction of frontloading of the tax deductibility of interest payments, and more aggressive mortgage lending by banks (Box 1 and Selected Issues Chapter I). While further increases in interest rates would dampen house price growth, several factors imply that such an event would impact the economy only gradually and mainly through residential construction. Household mortgage debt and bank exposure to mortgages is relatively low, and there has been no notable evidence of equity withdrawal and thus no direct support from housing wealth for consumption.

6. More fundamental are the interrelated challenges of population aging and increasing international competition. Aging will adversely impact the budget directly, but also indirectly through its negative affect on potential growth, which is already being hampered by low employment rates. Increased scope for outsourcing should support growth, though only if labor and product markets are sufficiently flexible to respond. In international comparison, Belgium’s relative strengths are its high level of labor productivity, recent per capita GDP growth, and progress in product market deregulation (Figure). Labor market indicators signal an area of comparative weakness, however. Public debt has been declining at a steady pace, strengthening debt sustainability, but the level of public debt remains high and vulnerable to growth shocks (Figure 4 and Table 2).

Figure 4.
Figure 4.

Belgium: Public Debt Sustainability Bound Tests 1/

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2006, 074; 10.5089/9781451803235.002.A001

Sources: IMF, country desk data; and IMF staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent ¼ standard deviation shocks applied to real interest rate, growth rate, andprimary balance.3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2006, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).
Table 2.

Belgium: Public Sector Debt Sustainability Framework, 2000–10

(In percent of GDP, unadjusted for working days; unless otherwise indicated)

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Covers general government. Gross debt is used.

Derived as [(r − π(l +g) + g + as(l+r)]/(l+g+7r+gπ)) times previous period debt ratio, withr = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r − π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as as(l+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Buoyant Housing Market: How Large a Risk?

Residential real estate prices have been increasing strongly in Belgium, with some of the pickup prompted by fiscal measures. Year-on-year increases have nonetheless been less than in some of the neighboring countries, such as the Netherlands and the United Kingdom. In contrast to other countries, where there have been recent cycles, Belgian housing prices have been rising continuously during the last 20 years. In real terms, they increased by 44 percent since the previous peak and 86 percent since the previous trough. In 2004, when Belgium introduced a tax amnesty, there was an acceleration as, reportedly, investment in secondary homes was a popular outlet for repatriated capital. Further, the new fiscal regime for mortgage loans permitting frontloading of the fiscal advantage, may have induced households that previously could not afford a home to enter the market. In addition, reductions in transactions costs and the newly-introduced ability to carry over taxes from the purchases of the first home to the next in the Flanders region may have bolstered demand.

If interest rates increased, residential construction could experience a significant slowdown, but risks to the economy are confined since households’ and bank’ exposure to real estate is not highs. The main driver of housing prices in Belgium has been the unusually low interest rate environment. Rising interest rates are likely to slow house price growth or trigger a brief reversal in real terms. However, risks to the economy are limited. Mortgage debt to GDP in Belgium is 47 percent, higher than in France (26 percent), but well below the United Kingdom (75 percent) and the United States (69 percent). Mortgage loans constitute only about 10 percent of bank’ assets, lower than in neighboring countries. Further, even though variable rate mortgage contracts increased considerably in recent years, caps on these contracts will limit the impact on disposable income when rates rise. In addition, there is little evidence of equity withdrawal. Consequently, a slowdown in the housing market will have little direct impact on consumption, but residential construction, which is sensitive to house prices and makes up roughly 5 percent of GDP, would slow down, dampening overall growth.


Inflation Adjusted Residential Property Prices

(BIS calculations based on national data; cumulative real growth rates)

Citation: IMF Staff Country Reports 2006, 074; 10.5089/9781451803235.002.A001


Belgium: Economic Developments in International Perspective

Citation: IMF Staff Country Reports 2006, 074; 10.5089/9781451803235.002.A001

Note: The scale used in these charts has been normalized to facilitate comparison. Hence, its absolute value has no meaningful interpretation.

7. Even though the regular pension system has been reformed, the remaining incremental cost of aging could push public debt onto an unsustainable path.2 Assuming that employment rates can reach Lisbon targets, the authorities project aging to add 3.6 percentage points of GDP to budgetary outlays by 2030. With public debt still at 95 percent of GDP, deficits of such magnitude would become unfinanceable. Options for further reform of the pay-as-you-go component of the regular pension system are limited, as replacement rates are already among the lowest in the EU and further projected to decline since pensions are indexed to prices only. Thus the authoritie’s strategy to address the budget impact of aging relies on a further reduction in debt and use of the savings from the interest bill to cover most of the cost of aging.

8. Demographics will reduce trend growth. The dependency ratio is already rising, but the labor force is projected to increase as well for the next five years, thus supporting growth. Thereafter, under unchanged policies, demographics would lower annual potential growth by almost 1 percentage point. However, the employment rate could rise faster than its progression as the result of the demographic increase in female participation. Indeed, the overall employment rate (15–64 years) in Belgium was about 60 percent in 2003, almost 7 percentage points less than the (unweighted) average of its three key trading partners. High labor costs, a high tax wedge on labor, open-ended unemployment benefits, and ubiquitous early retirement schemes seem to be the underlying causes (Figure 5). Regional differences in unemployment rates point to skill mismatches and lack of mobility.

Figure 5.
Figure 5.

Belgium: Labor and Product Market Indicators

Citation: IMF Staff Country Reports 2006, 074; 10.5089/9781451803235.002.A001

Sources: OECD; Cronos database, and IMF staff estimates.1/ In percent of population aged 15–64 years.2/ In percent of population aged 55–64 years.3/ Income tax plus employee and employer contributions as percent of labor costs (single persons without children).4/ OECD index of overall product market regulation.

9. Challenged by globalization, the wage bargaining framework faces difficulties in preserving competitiveness.3 Designed to maintain competitiveness vis-à-vis a trade-weighted average of France, Germany, and the Netherlands, as enshrined in the 1996 competitiveness law, the framework has nonetheless allowed wages to outpace this average since 2001 (Text Table 2), while productivity growth has broadly kept pace. So far, the resulting erosion of competitiveness has been limited, as evidenced by continuing large trade and current account surpluses and the behavior of export market shares (Figure). For 2005–06, because of partial indexation to higher-than-expected inflation and lower-than-expected wage increases in Germany and the Netherlands, competitiveness is set to erode more substantially.4 Conversely, globalization could positively affect productivity through outsourcing, but not much margin appears to be left as Belgium appears to be already among the biggest outsourcers on some measures.5

Text Table 2.

Belgium: Interprofessional Wage Agreements and Evolution of Labor Costs, 1999–2006

(Hourly labor costs in private sector, percent change)

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Sources: Belgian authorities; and IMF staff estimates.

France, Germany, and the Netherlands; based on OECD data, June 2005.

Conseil central de l’économie: Rapport Technique du Secrétariat sur les Marges Maximales Disponibles pour l’Evolution du Coût Salarial , November 2005.

II. Policy Issues

10. Policy discussions focused on how to achieve the necessary fiscal consolidation, promote higher potential growth, and uphold the good track record of financial stability. There was broad agreement on the authoritie’s policy objectives and the direction of reforms, but the staff saw a need to broaden reforms, enhance their effectiveness, and ensure that reform measures do not jeopardize the required buildup of fiscal surpluses (Section A). The authorities concurred with the findings of the FSSA—which accompanies this report and is discussed separately in Section B below. They intend to implement most of its recommendations, in line with their receptivity to past Fund advice (Box 2).

11. The authoritie’ strategy is to deal with population aging through further up-front fiscal adjustment, a durable balancing of the social security accounts, and structural reforms to promote higher trend growth. This overall approach enjoys broad consensus, including among social partners, though views differ on the specifics required to achieve these goals. Given decentralized policy-making, regions and communities will need to contribute to overall consolidation and structural reforms, while agreements between labor unions and employers are necessary for efficient social security and labor market reforms. To help sustain reform efforts, the authorities favor a strengthening of cooperation on structural policy changes at the EU level.


Belgium: Competitiveness Indicators

Citation: IMF Staff Country Reports 2006, 074; 10.5089/9781451803235.002.A001

Sources: IMF; WEO, DOT; and IMF staff estimates.

Effectiveness of the Policy Dialogue

The authorities and staff generally agree on economic policy objectives and directions. The authorities see the scope and speed of reform constrained by the long-standing tradition of building consensus among social partners and the country’s federal structure and the sensitive interregional relations. They also attach high value to social peace and the preservation of confidence. Consequently, implementation of Fund recommendations has been slow-paced and remains incomplete.

Fiscal policy

Fund recommendations: reduce primary spending growth durably in order to achieve the authoritie’ twin objectives of further fiscal consolidation and a reduction of the tax burden; adopt a multi-year expenditure-based framework to lock in structural fiscal adjustment and achieve budgetary surpluses to prepare for population aging.

Policy developments: fiscal consolidation has been impressive with the budget in balance since 2000 and public debt steadily falling as a share of GDP. The primary surplus declined recently as interest savings were used for tax cuts and spending increases. The authorities continue to focus on achieving annual nominal balance targets.

Labor and product market reforms

Fund recommendations: reform labor market institutions to boost low labor utilization; specifically, phase out early retirement arrangements, modify the wage-bargaining framework to ensure that cuts in social security contributions lead to lower labor costs, curb the duration of unemployment benefits, and enforce job search requirements; in product markets, continue deregulation and liberalization.

Policy developments: labor market reforms have relied mostly on active labor market programs, including cuts in the labor tax wedge, but recently, employment services have been strengthened and a Generation Pact adopted with specific measures to raise employment of the young and old. Product market reforms are complying with timelines set by the EU, while the administrative and regulatory burden on enterprises is being reduced considerably and the competition authority strengthened.

Financial sector

Fund recommendations: Continue to adapt supervisory arrangements to changing market developments, enhance macro-prudential supervision and cooperation between the central bank and supervisors, upgrade insurance supervision, and strengthen pension supervision earnestly.

Policy developments: banking and insurance supervisors have been merged, the central bank has begun publishing financial stability reviews, and a Financial Stability Committee has been set up including representatives from supervisors. An FSAP is being completed with this consultation.

12. In the staff’s view, the authoritie’ policies, while guided by a coherent set of medium-term objectives, are not sufficient to jointly achieve the envisaged fiscal consolidation and increase in trend growth. Fiscal consolidation necessitates public expenditure restraint and would benefit from higher growth, while higher growth, especially in the context of heightened global competitive pressure, requires more flexible labor markets, including a lower labor tax wedge, and more competitive product markets. The authoritie’ actions focus foremost on cuts in taxes and social security contributions and other budgetary measures to promote job creation and growth, supported by some structural reforms, though without tackling key labor market rigidities. As an alternative, the staff proposes to reduce these rigidities more directly. Simulations with the Fund’s Global Economic Model indicate that comprehensive labor market reforms, which do not rely on up-front tax cuts, could raise GDP by about 6 percent in the long run.6 Further reforms in product and services markets combined could yield a similar increase. In such a scenario, the tax wedge on labor can fall appreciably without requiring additional expenditure restraint and without jeopardizing fiscal sustainability.

A. Achieving Sustainable Public Finances and Higher Growth

Fiscal consolidation

13. The authoritie’ objective is to shift the budget gradually into surplus. For 2006, the budget is targeted to be again in balance (Figure 6 and Tables 3 and 4). The authorities feel very strongly that achieving announced nominal targets has been essential to establish and maintain the credibility of their fiscal strategy, even if recourse to one-off measures has been necessary to cope with cyclical effects. They observe that recourse to such measures has been declining since 2003, implying an improvement in the underlying position. For 2007, a small surplus (0.3 percent of GDP) is envisaged. Thereafter, the surplus would be built up gradually by 0.2 percent of GDP per year until it reaches 1.5 percent of GDP. This surplus is expected to be maintained through around 2020, after which it will be allowed to decline to fund the incremental costs of aging. Technically, this assures fiscal sustainability (i.e., a stable debt-to-GDP ratio in 2030 at about 25 percent), provided the employment rate rises by several percentage points as envisaged under the Lisbon strategy.

Figure 6.
Figure 6.

Belgium: Fiscal Developments

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 074; 10.5089/9781451803235.002.A001

Source: IMF, WEO.
Table 3.

Belgium: Operations of the General Government, 1998–2004

(In percent of GDP, unadjusted for working days)

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Source: Data provided by the Belgian authorities.
Table 4.

Belgium: Fiscal Scenarios, 2002–10

(In percent of GDP, unadjusted for working days; unless otherwise indicated)

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Sources: Data provided by the authorities; and IMF staff projections.

Excluding the effects of the UMTS auctions and the capital transfer resulting from the takeover. Other nonstructural items and one-off factors have not been excluded, in line with the WEO convention.

Excluding the effects of the UMTS auctions only.

Assuming in addition that 2006 one-off measures are eliminated gradually over 2007–10.

14. The staff noted that medium-term fiscal surplus objectives had been allowed to slip from earlier ambitions. Up to 2003, stability program updates aimed for a surplus of ½ percent of GDP by 2005, and a further buildup of about 0.3 percentage point of GDP per year thereafter. Based on a comprehensive analysis of the aging problem, the High Finance Council (HFC) had set a budget surplus target of 1.5 percent of GDP by 2011, which the staff found appropriate. The current stability program update envisages a slower buildup of the surplus, while subsequent preliminary estimates of the EU’s aging working group show a slight increase in Belgium’s cost of aging. The HFC, which experienced a lapse in its functioning last year, was unable to publish its 2005 medium-term assessment of public finances and compliance with the internal stability pact, even though its technical work continued.

15. Divergent revenue performance and spending pressures among the different entities of government pose a potential obstacle to overall fiscal consolidation. Decentralization was designed to leave the central government in charge of public debt and social security and of executing the strategy of funding the rising costs of aging from the declining interest bill. Subsequent policies have eroded the revenue base and increased spending pressures for the central government and done the opposite for the regions, at least ex ante. Thus, in 2005, to reach overall budget objectives, the central government had to obtain a commitment from the regions to temporarily save some of their revenues. In addition, while budgets of the autonomous regions and communities are jointly expected to be in balance in the medium term, there are underlying divergences between regions. The region with systematic surpluses may not continue to run surpluses as it has no compelling reason to do so.

16. The authorities are taking steps to set the social security system on a sound financial footing. With pensions and social assistance indexed only to prices, there is a concern that some groups of society will fall into poverty traps. Hence, consistent with the assumptions underlying the long-term aging projections, the budget provides 0.06 percent of GDP per year for real increases in such benefits. The contribution base to fund social security is being broadened beyond labor and will include some indirect taxes and 15 percent of the taxation of savings income.

17. At the same time, health care spending growth is expected to be curbed. Expenditure on health care is being allowed to increase by 4.5 percent per year in real terms through 2007 in order to catch up with modern technology and changing needs. Thereafter, the authorities plan to reduce it to 3.1 percent per year, in line with long-term aging projections. Structural measures are being taken, including benchmarking to best practices, increasing copayments, and promotion of the use of a referring doctor. If approved health spending growth exceeds the increase in revenue from social security contributions, other sources of revenue will be tapped to avoid increases in the labor tax wedge.

18. While budget objectives and tax reduction programs have been set in a medium-term context, the staff noted that overall fiscal policy implementation lacked such an orientation:

  • The pursuit of nominal annual budget targets has led to continuing reliance on one-off measures, which is even being slightly stepped up in the 2006 budget. Consequently, while at the current cyclical juncture a balanced budget would imply an appreciable structural surplus, it does not do so once adjusted for one-off measures. More importantly, most of these one-offs (e.g., the takeover of pension fund assets of public enterprises, sale and lease-back arrangements for real estate, tax securitization operations, and compression of public investment) imply future outlays and do not constitute gains in net present value terms.

  • Medium-term programs to reduce taxes and social security contributions are not being matched with similar medium-term plans to curb expenditure or raise revenues. The absence of such a framework masks, for example, that achieving surplus targets beyond 2006 without one-off measures would require discretionary spending to fall by ¾ percent per year in real terms (Table 4). In addition, cuts in social security contributions have been used to help reach wage agreements among social partners. Consequently, (i) tax reductions have absorbed a considerable amount of interest savings, thus eroding the primary surplus; and (ii) ad hoc increases in taxes have been increasing uncertainty about the tax system.

19. To compensate for ongoing tax reduction, balancing the budget in 2006 requires tight spending restraint and additional new tax measures. Broad-based spending restraint and slower public investment are expected to limit spending growth at the federal level (excluding pensions) to 0.3 percent in real terms. However, the final stage of the 2001 income tax reform and ongoing reductions in social security contributions will lower revenues by about 0.8 percentage point of GDP. Hence, tax increases yielding 0.5 percentage point of GDP are being implemented. About half of this will come from taxes levied on certain types of life insurance policies and mutual funds invested in government securities, hitherto exempt. A securitization of VAT tax arrears and an income tax regularization will provide the other half.7 Concurrently, the tax administration and sanctions for tax evasion are being strengthened. Any windfall revenues from higher-than-projected growth will be saved.

20. Achieving a balanced budget in 2006 is not yet in hand. While the staff is confident that further measures will be taken as needed to reach budget balance in 2006, its projections indicate that under current policies, a deficit of 0.4 percent of GDP remains to be filled (Text Table 3). Very tight spending guidelines remain to be backed by specific actions. If these measures are not structural, the underlying balance will deteriorate by more than ½ of one percentage point of GDP in 2006.

Text Table 3.

Belgium: Budget Indicators, 1999–2006

(In percent of GDP)

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Sources: National Bank of Belgium; and IMF staff calculations.

Nonstructural measures pertain to the sale of land and property, the receipts from the UMTS auctions (2001), the takeover of the Belgacom pension fund (2003), the tax amnesty (2004), the securitization of tax arrears (2005–06) (see ¼19), timing shifts in the tax collection and the payments to the railways, and various smaller items.

Jobs and economic growth

21. Social partners and the authorities have agreed on a “Generation Pact” to boost employment of the young, low-skilled, and older workers. The Pact, whose implementation starts in 2006, includes: (i) additional cuts in employer’ social security contributions targeted at young and older workers and shift and night work for up to about 0.4 percentage point of GDP; (ii) reform of early retirement regimes, inter alia by raising the eligibility age from 58 to 60 years and the minimum career length to 35 years; (iii) tightening job search requirements for older workers; (iv) strengthening training; and (v) a better accompaniment of laid-off workers, including bonuses for a rapid return to work. People working beyond age 60 will see their pensions topped up. The public sector will help lower youth unemployment by allowing more of its vacancies to be filled with first-time jobs.

22. Taxes on labor are being reduced, and awareness is being built that wage moderation will be essential to preserve competitiveness. During 2002–10, the tax burden on labor is expected to be lowered by the equivalent of nearly 3 percentage points of GDP. With limited budgetary room, revenue is being raised from other sources. To ensure an effective decline in labor costs and import the wage moderation ongoing in trading partners, further tax cuts are to be made contingent on equivalent wage moderation. The staff and authorities agreed that the current level of competitiveness was adequate but should not be allowed to deteriorate. Social partners have been asked to discuss ways to claw back some of the expected competitiveness losses as a result of the implementation of the 2005–06 wage agreement. Labor unions agree with the need for structural reforms to boost competitiveness but anticipate difficulties in convincing their membership to moderate wage demands so soon after reforms of the early retirement regime, unless additional job creation can be guaranteed.

23. The staff emphasized that the ongoing cuts in taxes and social security contributions and the implementation of the Generation Pact will raise employment but not enough to pay for themselves. Simulations by the Federal Planning Bureau and the National Bank (NBB) show that cuts in employer’ social security contributions (SSC) lower labor costs and generate employment, and that targeted cuts are more effective. Nonetheless, to increase employment rates substantially, e.g., by 5 percentage points, such cuts would need to be large, leading to an annual fiscal cost of about 1.5 percent of GDP in the current wage-bargaining framework, if targeted (Text Table 4). Even if gross wages could be kept unchanged, the steady state budgetary cost would still be at least 1 percent of GDP. SSC cuts implemented so far, mostly on the employer side, and those envisaged in the Generation Pact total about 2 percent of GDP and can be expected to raise employment by 1½ percentage points in steady state. Personal income tax cuts will reach 1 percent of GDP with the last stage of the reform in 2006, without significant effects on employment. Alternatives within the budget, such as financing SSC cuts from other revenue sources or through spending restraint have limitations. With targeted cuts to raise the employment rate by 5 percentage points, the latter would imply a real decrease of discretionary spending (outlays excluding social security spending) by 2½ percent per year over 2007–10.

Text Table 4.

Belgium: Fiscal Cost of Cutting Social Security Contributions to Raise the Employment Rate by 5 Percent

(Deviation from baseline in the long run; in percent of GDP)

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Sources: Federal Planning Bureau, National Bank of Belgium; and IMF staff calculations.

Employees’ contributions would have to be cut by much more than their current yield.

24. The current wage-setting framework impedes the beneficial effects of reform on job creation and the ability of the economy to respond to pressures from outsourcing. As the unemployed and persons outside the labor force have little voice in discussions between social partners, cuts in the tax wedge on labor are mostly being used for higher take-home pay.8 With wage increases in trading partners expected to remain low owing to competitive pressures and structural reforms and indexation placing a floor under domestic wage increases, the wage-bargaining framework does not allow a swift correction of erosion in competitiveness. In addition, tying wage increases to those of key trading partners that have lower labor costs and significantly higher employment rates on average is not conducive to catching up with the latter.

25. The business environment is being made more attractive. To promote investment, a notional interest rate deduction has been introduced for equity capital, equalizing its fiscal treatment with that of debt financing. Administrative simplification has yielded considerable results: the authorities estimate that the associated costs of doing business in Belgium have declined from 3.4 percent of GDP in 2002 to 2.6 percent of GDP in 2004. The backlog of adopting EU directives has been eliminated, and liberalization of network industries, in particular electricity and postal services, is continuing. The competition authority has been strengthened, while public spending is being reallocated to foster a knowledge-based society and encourage research and development. On overall product market regulation, Belgium is ahead of its neighbors (Figure 5.) and at the EU average following recent progress (¶6). As noted by the OECD, a further reduction in state control and barriers to entrepreneurship would be desirable.


26. The authorities and social partners acknowledged the need for further reform while preserving the main features of Belgium’s social model. They emphasized that the Generation Pact constituted a milestone, with its focus on the need to work longer, improve job search assistance, and tighten enforcement of job search requirements to address the consequences of aging. They felt that the existing wage-bargaining model could be refocused on job creation by explicitly taking into account developments in the employment rate in setting the room for wage increases. More widespread use of “all-in” agreements, which set nominal wage growth regardless of subsequent inflation, would be considered, but not before the 2007–08 wage round. On fiscal issues, the authorities emphasized that they would take further measures to balance the 2006 budget. To reach surplus targets in 2007 and beyond, they believed that sufficient spending restraint could be achieved and saw further scope to broaden nonlabor taxation. They agreed that the HFC should continue to play its key role as independent assessor of public finance developments.

B. Financial Sector Issues and Financial System Stability Assessment

27. Building on the economic recovery in 2004 and the low-risk environment, the performance of the financial sector has been improving. Overall vulnerability declined as financial soundness indicators and bank profitability picked up (Figure 7 and Tables 5 and 6). The increase in bank profits stemmed mainly from rising noninterest income and lower provisioning, while interest income was squeezed by stiffer competition for savings deposits and mortgage loans. With deleveraging by enterprises, mortgage lending and expansion abroad became the key drivers of bank activity, though recently, domestic corporate borrowing has perked up. Banks reported that their preparation for Basel II was on track. Both nonlife and life insurance posted higher profits, the former because of premium growth and the latter largely due to a rise in investment income (Table 7). However, in the current low interest rate environment, relatively high guaranteed rate of return contracts continue to curb the life sector’s profitability.

Figure 7.
Figure 7.

Belgium: Financial Sector Indicators 1/

Citation: IMF Staff Country Reports 2006, 074; 10.5089/9781451803235.002.A001

Source: Data provided by the authorities.1/ 2005 based on September data; 2005 growth rates based on September 2004 over September 2005 growth.
Table 5.

Belgium: Indicators of External and Financial Vulnerability, 2000–05

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Sources: Data provided by the authorities; IMF, IFS; and IMF Research Department.

September 2005 data.

Capital account data cover the definition of the Belgium-Luxembourg Economic Union (BLEU).