Belgium: Staff Report for the 2006 Article IV Consultation
Author: International Monetary Fund
Publication Date:
05 Mar 2007
eISBN:
9781451803273
Language:
English
Keywords:
ISCR; CR; fiscal policy; IMF staff projection; surplus; interest rate hike; labor market; unemployment rate; product market; headline inflation; debt ratio; early retirement; Global
Download PDF (2.6 MB)

This 2006 Article IV Consultation highlights that the economic upturn that started in mid-2005 in Belgium has remained on track. On the heels of a catch-up in private investment, the revival of private consumption and the cyclical expansion in neighboring countries have broadened the recovery to all sectors of the economy. Underlying inflation has been stable and broadly in line with the euro area average. Despite some real exchange rate appreciation and interest rate hikes, monetary conditions have remained accommodating. On other structural issues, the upward trend in employment rates is set to continue.

Abstract

This 2006 Article IV Consultation highlights that the economic upturn that started in mid-2005 in Belgium has remained on track. On the heels of a catch-up in private investment, the revival of private consumption and the cyclical expansion in neighboring countries have broadened the recovery to all sectors of the economy. Underlying inflation has been stable and broadly in line with the euro area average. Despite some real exchange rate appreciation and interest rate hikes, monetary conditions have remained accommodating. On other structural issues, the upward trend in employment rates is set to continue.

I. Introduction1

1. Fiscal consolidation, job creation, and further strengthening of financial supervision are policy priorities for Belgium. They correspond to the challenges of dealing with rising aging costs and fiscal federalism, taking full advantage of the global expansion, and adapting supervision to an increasingly complex and internationally-oriented financial sector. Overall, the economy has performed well, and policy objectives have been in line with Fund recommendations, but implementation has lacked determination in some key areas (Box 1). Hence, following the mid-2007 elections, a decisive strengthening of policies will be crucial to preserve high living standards and an adequate social security system.

Effectiveness of the Policy Dialogue

The authorities agree that policies should focus on raising employment rates and achieving fiscal consolidation. Implementation of Fund recommendations has been slow and remains incomplete, partly because the scope and speed of reform are constrained by the long-standing tradition of consensus-building and the complex federal structure of government. The authorities see continuous and comprehensive engagement of the Fund as key to its effectiveness.

Fiscal policy

Fund recommendations: reduce primary spending growth durably to achieve the authorities’ twin objectives of fiscal consolidation and tax reduction; adopt a multi-year expenditure-based framework to lock in fiscal adjustment; revise the fiscal federalism arrangements and reinforce fiscal institutions, including the internal stability pact and the High Council of Finance (HCF).

Policy developments: the budget has been balanced or in surplus since 20001 with public debt steadily falling as a share of GDP. However, interest savings have been used for tax cuts and spending hikes, leading to an erosion of the primary surplus. Primary spending growth remains too high for consolidation. The authorities continue to focus on achieving nominal balance targets. The HCF has resumed its work.

Labor and product market reforms

Fund recommendations: phase out early retirement arrangements, modify the wage-bargaining framework, shorten the duration of unemployment benefits, and enforce job search requirements; in product markets, continue deregulation and liberalization.

Policy developments: reforms have relied mostly on active labor market programs, but recently, employment services have been strengthened. The Generation Pact set out measures to raise employment of the young and old. Social partners prefer maintaining the central wage-bargaining framework, but some flexibility has become acceptable. Product market reforms are proceeding along EU timelines, and the administrative burden was reduced appreciably.

Financial sector

Fund recommendations: the 2005 FSAP recommended adapting supervisory arrangements to changing market developments, enhancing macro-prudential supervision and cooperation between the central bank and supervisors, upgrading insurance supervision, and strengthening pension supervision earnestly. Policy developments: most of the recommendations have been implemented.

1 Though this is disputed by Eurostat for 2005.

II. Economic Developments and Outlook

2. The economic upturn that started in mid-2005 has remained on track. On the heels of a catch-up in private investment, the revival of private consumption and the cyclical expansion in neighboring countries have broadened the recovery to all sectors of the economy and allowed growth to become more balanced in 2006 (Table 1).2 Owing to more robust private and public consumption, growth has been exceeding that of key trading partners (Figure 1), and the economy is now operating near capacity.

Table 1.

Belgium: Basic Data, 2001–07

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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.

Based on national accounts data, economy-wide.

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.

Includes the effect of the restructuring of the national railway company in 2005 as presented by Eurostat. According to the authorities, the fiscal balance should be 0.1 percent of GDP in 2005 and the public debt 91.5 percent of GDP. Other elements of the accounts, e.g., total expenditure, would also differ.

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.

Figure 1.
Figure 1.

GDP Growth remains robust, falling in line with the euro area, after faster growth.

(Percent change, annualized, seasonally adjusted)

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Sources: Belgostat; and Haver Analytics.1/ France, Germany, and the Netherlands.

3. Underlying inflation has been stable and broadly in line with the euro area average. Deviations have been due to administrative price changes and recently to a methodological revision (Figure 2).3 Headline inflation has been more volatile, reflecting the higher weight of energy prices, with the decline in the latter pushing it toward 2 percent at end-2006. Inflationary pressures from widespread wage indexation have been muted: the relevant index rose by only 1.7 percent in 2006, as it largely excludes energy prices and benefited from the correction of a previous upward bias.

Figure 2.
Figure 2.

Headline inflation declined sharply as energy price increases waned.

(Percent change over same period of previous year)

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Source: Cronos.

4. Monetary conditions have been supportive, while fiscal policy turned procyclical in 2006 (Figure 3). Despite some real appreciation and interest rate hikes, monetary conditions have remained accommodating, only recently reaching their long-run average. With the cycle typically well attuned to the euro area average, interest rates set by the ECB have been suitable from Belgium’s perspective. Guided by nominal targets, fiscal policy imparted an impulse of almost 1 percentage point of GDP in 2006, as growth surprised on the upside. While acknowledging the small fiscal multiplier, owing to the highly open nature of the economy, and the confidence-enhancing effect of sustained achievement of fiscal targets, the staff saw this as a key factor underpinning the strength of activity. The authorities, though, felt that their policy of tax cuts in a balanced budget environment had been more important.

Figure 3.
Figure 3.

Policy conditions have supported growth.

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Source: IMF staff estimates.1/ The monetary conditions index is a weighted average of the REER and short-term interest rate.

5. Buoyant house prices have bolstered residential investment and supported household spending (Figure 4). Residential real estate prices registered double-digit growth in 2005, for the second consecutive year, but the market has cooled since then, with realtor associations expecting the pace of increases to be halved in 2006.4 While a strong housing market is a feature common to many euro area countries, domestic factors have been adding exuberance: the 2004 fiscal amnesty led to a repatriation of assets that were invested in secondary residences, and reduced transaction costs and strengthened fiscal incentives for first-home purchases boosted family house prices from 2005 onward. Some indicators (e.g., the ratio of disposable income over monthly mortgage payments) suggest a slight overvaluation of the market since end-2005, but the price level remains below that of neighboring countries. The impact on activity has been felt through residential construction and mortgage refinancing, as the household savings rate has remained stable for the past three years.

Figure 4.
Figure 4.

Residential investment and house prices remain strong.

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Sources: WEO; and Haver Analytics.1/ Average of France, Germany, and the Netherlands

6. At odds with developments elsewhere in the euro area, the unemployment rate has not declined significantly (Figures 5 and 6). Comparatively faster labor force growth, high relative labor costs, and less wage moderation seem to be the underlying culprits, though labor unions saw a lack of training and a less dynamic structure of production as equally important factors. All job creation since mid-2005, which has not lagged much compared to previous cycles, has been in the nontradable sectors, with losses in industry not quite matched by gains in construction. More labor hoarding and the fitful start to the current recovery appear to have dampened the cyclicality of unemployment. Finally, a recent tightening of job search requirements—which has reduced the administrative unemployment rate slightly—seems to have spurred more people into active job search, but the authorities agreed that it was too early to declare success.

Figure 5.
Figure 5.

Employment grew more than in neighboring countries.

(Percentage changes from previous month, seasonally adjusted)

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Sources: WEO; and Haver Analytics.1/ Average of France, Germany, and the Netherlands.
Figure 6.
Figure 6.

Unemployment did not decline significantly during the upswing so far.

(Percent of labor force, seasonally adjusted)

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Sources: National Bank of Belgium; and OECD.

7. While judging its current level to be appropriate, all agreed that competitiveness should not be allowed to erode further (Figure 7). As the authorities underscored, developments in relative unit labor costs and market share volumes were similar to elsewhere, except in Germany. Current account and trade surpluses had been sustained, with their recent decline mainly the result of adverse terms of trade effects. The economy has remained attractive to foreign investors because of progress in reducing business regulation and corporate income taxation. In addition, model-based estimates suggest that the current exchange rate is not overvalued. Nonetheless, with labor costs (and productivity) among the highest in the world, and several manufacturing sectors wilting under competitive pressure, the authorities and social partners agreed that wage moderation would be essential going forward.

Figure 7.
Figure 7.

Real exchange rate appreciation signals eroding competitiveness.

(ULC-based REER index, total economy)

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Source: WEO.

8. Export volume shares have fallen appreciably, but value shares have held up well (Figure 8). Even though exporters do not seem to have comparatively greater pricing power, given the preponderance of standardized products, price deflators for exports (and to a lesser extent, imports) appear to be consistently outpacing those of trading partners (Figure 9). There is also no evidence that the product structure has been shifting toward higher value-added products. This raises suspicions of a statistical bias in the price-volume breakdown of trade, whose correction would, however, not materially alter the assessment of overall performance.

Figure 8.
Figure 8.

Export market shares have fallen in volume but hardly in value.

(Percent of partner imports, NA-based)

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Sources: Belgian authorities; and WEO.1/ Average of France, Germany, and the Netherlands.
Figure 9.
Figure 9.

Export prices suggest suspiciously strong pricing power.

(Export deflator, NA-based, 2001=100)

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Sources: Belgian authorities; and WEO.

9. Against this background, economic growth is expected to slow but maintain a robust pace. The authorities and the staff project GDP growth to decline from nearly 3 percent in 2006 to 2.2 percent in 2007, as rising interest rates dampen demand, residential construction eases from its recent sustained vigorous pace, the fiscal stance turns restrictive, and the global environment softens. With good profitability and high capacity utilization rates, private investment should remain strong, but—after its substantial catch-up during 2004–05—will register slower growth. There was agreement that abrupt euro appreciation associated with a disorderly resolution of global imbalances and a sharper-than-expected U.S. slowdown constitute key downside risks, and that the German economy could go either way from the baseline projecting a slowing associated with an increase in the VAT rate.5 On the domestic front, residential construction could surprise on the upside. Inflation is projected to reach nearly 2 percent in 2007, in part due to mid-year indirect tax increases.

III. Financial System

10. Households are benefiting from the ongoing financial deepening. They are adding about 2 percent of GDP per year to their large stock of net financial assets, which are generally viewed as retirement savings since specific third pillar pension savings vehicles are only beginning to emerge. In search of return, households have been increasing their claims on institutional investors. This shift has been accompanied by a rise in the risks borne by households and fostered by a larger supply of more flexible mutual fund and insurance products, and a rise in the taxation of income from securities. On the liability side, mortgage credit, the largest household source of credit, has been steadily growing since the late 1980s, recently boosted by low interest rates and the booming house market (Figure 10). Banks have allowed households to swiftly take advantage of changes in the level and term structure of interest rates (Figure 11). They have introduced new instruments with different risk and price profiles, but there is no evidence of any loosening of lending standards.

Figure 10.
Figure 10.

Household indebtedness is on the rise led by mortgage financing.

(Household liabilities, in percent of GDP)

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Source: National Bank of Belgium.
Figure 11.
Figure 11.

Mortgage financing flows have moved back to fixed-rate products.

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Source: National Bank of Belgium.

11. Corporate deleveraging is continuing, with the financial sector intermediating the shift toward equity finance (Figure 12). As elsewhere, profit margins of nonfinancial corporations have risen, generating the internal funds needed to finance the upswing in investment. Concurrently, recourse to external financing has increasingly taken the form of equity issues, slightly more than in other countries, as a duty on new equity issues was eliminated and an allowance for corporate equity (ACE) instituted. Consequently, debt financing turned negative in 2005 for the first time in several years, and equity issuance skyrocketed in 2006. Venture capital seems to be in sufficient supply but remains undersized as the economy is insufficiently geared toward innovation and small entrepreneurship.

Figure 12.
Figure 12.

Corporate financing has continued to switch from debt to equity.

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Source: National Bank of Belgium.

12. The trend toward internationalization of financial institutions has been accelerating, while banks are expanding in nontraditional areas. No doubt, the fact that two of the four largest banks are cross-border institutions is a driving factor, but other banks are also raising their exposures abroad, especially to Central and Eastern Europe. The share of domestic customers has fallen to about one third of bank assets, and lending to non-euro area residents has been one of the fastest growing activities (Figure 13). At present, half of the corporate loans are to residents outside of the euro area. In addition, banks have branched out into energy trading and have been engaging increasingly with hedge funds, mostly on behalf of clients and with transfer of collateral so that their capital at risk in these operations has remained limited.

Figure 13.
Figure 13.

Destination of bank lending is shifting abroad, in search of higher yields.

(Credit destination as a percent of total lending)

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Source: National Bank of Belgium.

13. The financial system has remained stable and highly profitable, liquid, and solvent (Figure 14, Tables 2–4). Benefiting from a benign risk environment, low interest rates and effervescent equity markets, bank-insurance groups are experiencing high returns on assets and equity, in part due to historically low levels of provisioning and nonperforming loans. Banks remain well capitalized with risk asset ratios reaching close to 12 percent in mid-2006. Solvency and coverage ratios of insurance companies and pension funds have been increasing due to exceptional growth in premiums in 2005, in anticipation of higher taxation, and rising equity valuations. Stress tests conducted by the Financial Stability Committee show the system to be resilient to plausible shocks, confirming the findings of the 2005 financial stability assessment by the IMF (FSAP).6

Figure 14.
Figure 14.

Bank profitability has continued to recover and is approaching historical highs.

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Source: National Bank of Belgium.1/ Since 2006, data based on new IAS/IFRS compliant reporting.
Table 2.

Belgium: Indicators of External and Financial Vulnerability, 2000–06

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

IMF staff projection for 2006.

Data before 2002 cover the definition of the Belgium-Luxembourg Economic Union (BLEU).

2006, October; reserves and foreign liabilities refer to the Belgian central bank, both before and after EMU.

Belgian francs (BEF) per dollar until 1998, euro per dollar thereafter. The fixed BEF/euro conversion rate is 40.3399.

Latest data.

Data for 2006 are for official data for period January 2006 to June 2006. Nonannualized growth rates.

Table 3.

Belgium: Financial Soundness Indicators of the Banking Sector, 1999–2006 1/

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Sources: CBFA; and NBB.

Data on a consolidated basis, unless otherwise stated.

June 2006 data. Annualized data for ROAA and ROAE.

BIG covers the four main banking groups.

Simple ratio of capital-to-total assets, without risk weighting.

Since 2006, data based on new IAS/IFRS-compliant reporting scheme; provisional sector-aggregate for June 2006 based on six largest credit institutions.

Territorial data; excluding government, interbank and nonresident loans.

Unconsolidated (solo/company) data from the Corporate Credit Register.

Nonperforming loans refer to loans classified as substandard, doubtful, or loss.

Unconsolidated (solo/company) data.

RIR-survey. Difference between lending rate on loans <= 1 year and deposit rate on term deposits >= 1 month and <= 1 year.

MIR-Survey. Difference between lending rate on loans <= 1 year and deposit rate <= 1 year.

Up to 2005, liquid assets consist of cash, short-term interbank claims (maturity < 1 month) and the total securities portfolio; as from 2006, liquid assets include cash and debt instruments issued by central government and financial institutions.

Up to 2005, short-term liabilities consist of short-term interbank debt (< 1 month) and sight, savings and short-term deposits (< 1 month) of nonbank clients; as from 2006, they consist of wholesale deposits.

Core and encouraged set of indicators.

Table 4.

Belgium: Financial Soundness Indicators of the Nonbanking Sectors, 1999–2006

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Sources: CBFA, NBB, Stadim, UPC.

June 2006 data.

Available solvency marging over required solvency margin.

Data for 2005 based on a sample of already available annual accounts in the Central Balance Sheet Register.

Earnings before interest and tax as a percentage of interest and principal expenses.

Percent change in house price index (1953=100).

Mortgage loans after deduction of deposits related to mortgage loans; consolidated basis (new IAS/IFRS-compliant reporting scheme since 2006).

Encouraged set of indicators.

14. In line with the FSAP recommendations, the unified supervisor (CBFA) and the central bank (NBB) have been substantially improving the quality of supervision, from an already high level. In particular, regulations and supervision in banking, insurance, securities, payments, and settlement have been fully aligned with international standards, pension fund and insurance supervision upgraded, and internal controls and operation of the CBFA and cooperation between the CBFA and the NBB improved. The staff urged the authorities to accelerate the envisaged on-site exams of pension funds and conduct more outreach on the new pension law. The authorities acknowledged these points as well as the need to further exploit the synergies between the CBFA and the NBB.

15. Looking ahead, it was agreed that supervisors need to adapt to the changing systemic risk profile of the bank-insurance groups. Given resource constraints, the staff called for a risk-based approach to the allocation of management and staff resources at the CBFA. The authorities saw merit in this suggestion but felt that reputational and legal considerations required a continuous and comprehensive engagement with firms of lesser systemic importance. Beyond improving international cooperation through memoranda of understanding with foreign supervisors, the authorities argued for the establishment of an international tier to supervision for regionally and globally systemic institutions. In this context, they remain committed to addressing the international dimension of crisis management, including solvency issues, and to proactively securing a high level of engagement with international partners on the Euroclear payments and settlement system.

IV. Dealing With Aging and Globalization7

16. The authorities and the public generally recognize that meeting the challenge of aging in the context of globalization requires a comprehensive strategy, but in the staff’s view, speed, depth, and specificity of policy implementation are lagging. The key components of the authorities’ strategy consist of fiscal consolidation to benefit from interest savings associated with a declining public debt burden, and a sharp increase in employment rates. On both counts, the authorities have made good progress, but success is still distant, and key opportunities have not been exploited (Box 2). Achieving balanced budgets or small surpluses for seven years in a row has established fiscal credibility, but interest savings have been used for spending and tax reductions (Table 5). The authorities felt that this strategy had been necessary to secure the recent good performance of the economy. Similarly, while the labor market reforms of the Generation Pact represent a breakthrough in awareness, they will not significantly lift employment rates above demographic trends. All agree with the need for further reforms, but the authorities anticipate a lengthy process of consensus-building and gradual action.

Table 5.

Belgium: Operations of the General Government, 1999–2005 1/

(In percent of GDP, unadjusted for working days)

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Source: Data provided by the Belgian authorities.

Includes the effect of the restructuring of the national railway company in 2005 as presented by Eurostat. According to the authorities, the overall balance should be 0.1 percent of GDP in 2005 and the public debt 91.5 percent of GDP. Other elements of the accounts, e.g., total expenditure, would also differ.

17. Addressing the projected rise in aging-related costs requires a mix of fiscal adjustment, growth-enhancing policies, and entitlement reforms (Box 3). Without these reforms or with only the fiscal adjustment as envisaged in the 2006 Stability Program Update, public debt dynamics are unsustainable. Indeed, aging-related expenditure is projected to increase by 5.8 percent of GDP by 2050, even with the employment rate rising by 7.5 percentage points.

A. Fiscal Policy and Institutions

18. After being strongly procyclical in 2006, fiscal policy will tighten in 2007, arresting the trend decline in the primary surplus. With higher-than-expected growth and substantial one-off measures, balancing the budget in 2006 represents a structural weakening by about 1 percent of GDP. Conversely, the 2007 budget aims for a structural improvement of 0.6 percent of GDP, and recourse to one-off measures is being reduced. However, with revenue projections somewhat optimistic, the staff sees a remaining gap of about 0.3 percent of GDP (Text Table), which it urged the authorities to close with durable measures. The authorities disputed this assessment while emphasizing their intention to take any necessary additional measures in the context of the quarterly reviews of budget implementation. General government spending is set to grow marginally slower than GDP, while federal government expenditure is much tighter. Conversely, regional authorities, which have little or no debt and an increasing share of revenue, are set to ramp up spending.

Belgium: General Government Fiscal Indicators, 2000–07

(In percent of GDP, unless otherwise indicated)

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Sources: National Bank of Belgium; and IMF staff.

Excludes the effect of the restructuring of the national railway company in 2005.

According to Eurostat, the debt transfer of the national railway company to the Railway Infrastructure Fund should be accounted as expenditure in 2005.

The 2005 public debt figure is consistent with Eurostat’s treatment of the national railway company debt transfer. According to the authorities, the public debt figure should be 91.5 percent of GDP.

Aging and Fiscal Sustainability

Between 2005 and 2050, total net aging costs are expected to rise by 5.8 percent of GDP. To deal with this issue, the authorities plan to build up fiscal surpluses and implement growth and productivity-enhancing reforms. Four scenarios detailed below illustrate that (i) without growth-enhancing structural reforms, fiscal sustainability cannot be secured; (ii) the reform scenario implied in the analysis of the Study Committee on Aging (SCA) combined with the fiscal policy assumptions in the 2006 Stability 50 Program Update does not ensure a stable steady-state debt; and (iii) achieving steady-state debt through additional structural reforms only is likely to be a tall order. In particular, annual labor productivity growth would need to be 0.4 percent permanently higher than in the baseline macroeconomic scenario. However, further direct pension and health care reforms that yield a decline in aging costs of 0.5 percent of GDP by 2030 would also do the job.

uA01fig02

Public Debt Scenarios

(Percent of GDP)

Citation: IMF Staff Country Reports 2007, 089; 10.5089/9781451803273.002.A001

Source: IMF staff estimates.

Staff baseline. Annual labor productivity growth is assumed to average 1.5 percent during 2005–5 0, in line with the average productivity growth over the past two decades. Employment is expected to remain constant, reflecting an increase in the employment rate by about 5 percentage points, which is feasible on the basis of cohort effects. Balanced budgets are assumed over the medium term, allowing a reduction of the public debt-to-GDP ratio to 65 percent, but rising costs of aging are not offset in the long run. Under this scenario, the public debt-to-GDP ratio would increase without bound.

Belgium: Macroeconomic Assumptions

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Sources: Committee on Aging’s 2006 Report; and IMF staff.

Period average, percent change.

Change in percentage points.