2009 Article IV Consultation: Staff Report; and Public Information Notice on the Executive Board Discussion

The 2009 Article IV Consultation highlights that the near-term outlook for Belgium is challenging, with real GDP expected to drop by about 3 percent in 2009 and a gradual recovery projected for 2010. The unemployment rate will continue to rise in 2010, and inflation pressures are expected to remain subdued. Uncertainty to the outlook is high but risks appear broadly balanced. The crisis will have a considerable downward impact on potential growth, in addition to that of demographic factors, in 2009–11.


The 2009 Article IV Consultation highlights that the near-term outlook for Belgium is challenging, with real GDP expected to drop by about 3 percent in 2009 and a gradual recovery projected for 2010. The unemployment rate will continue to rise in 2010, and inflation pressures are expected to remain subdued. Uncertainty to the outlook is high but risks appear broadly balanced. The crisis will have a considerable downward impact on potential growth, in addition to that of demographic factors, in 2009–11.

I. Executive Summary and Staff Appraisal1

1. The authorities’ actions have helped to stabilize the financial sector and halt the economic downturn. The Belgian economy was hit hard by the global financial crisis and economic downturn. In response, the authorities took measures to support the financial sector and let the automatic fiscal stabilizers operate freely while implementing a moderate stimulus plan. But the recovery is expected to be slow and fragile. At the same time, ground has been lost in addressing the high public debt and public spending pressures related to population aging, and in strengthening competitiveness and labor market participation. The political situation remains complex and the June 2009 regional elections have strengthened political parties that are not part of the federal coalition. With a crowded election calendar over the next years, this complicates the authorities’ efforts to tackle the medium-term challenges facing the country in the areas of public finances and structural reforms.2

2. The near-term outlook is challenging. Real GDP is expected to have dropped by about 3 percent in 2009, and only a gradual recovery is projected for 2010. The unemployment rate would continue to rise in 2010 and inflation pressures are expected to remain subdued. Uncertainty to the outlook is high but risks appear broadly balanced. The dislocation from the crisis lowered potential growth in 2009-11, in addition to the downward impact due to demographic factors.

3. The main post-crisis challenges faced by the Belgian authorities are to prepare for an orderly exit from the crisis measures as the recovery gains strength while at the same time laying the ground for high and sustained growth over the medium term. It is particularly important to take early action to strengthen financial stability, restore fiscal sustainability, and improve the functioning of labor and product markets to boost competitiveness and economic growth.

4. Helped by massive public intervention, the banking sector has stabilized but its financial situation remains fragile and its supervision needs to be strengthened. Bank recapitalization and balance sheet repair remain important while targeted liquidity support needs to continue in the near future. Moreover, Belgian banks remain vulnerable to potential spillovers from mature markets and emerging Europe. The risk of a creditless recovery is a cause for concern although this is mitigated by the public support and ongoing bank restructuring. Hence, credit to the economy should be closely monitored. Exit from the emergency support to the financial sector should take place gradually to avoid adverse market reactions and a credit squeeze. The initiated reorganization of the Belgian supervisory authority is welcome and the authorities should continue to strongly support enhanced international cooperation in regulatory reform and coordination of exit policies.

5. The financial crisis and the economic downturn threaten the medium-term sustainability of public finances already under pressure from a rapid rise of aging-related spending. The government’s new Stability Program aims appropriately to achieve a balanced budget by 2015 to avert unsustainable public debt dynamics. The intergovernmental burden-sharing agreement for 2009-10 and the planned agreement for 2011-12, along with the first multi-year fiscal framework are welcome first steps but leave important decisions, including a comprehensive fiscal federalism reform, open until after the 2011 federal elections. While the 2010 budget strikes the right balance between initiating the fiscal consolidation and supporting the recovery, additional measures are needed to achieve the deficit targets for 2011 and beyond, including by reversing most of the fiscal stimulus measures after 2010. Post-crisis fiscal consolidation will require efforts at all government levels and social security. The adoption of a rule-based fiscal framework would help to increase the credibility of the consolidation efforts.

6. Structural reforms remain crucial to improve competitiveness and boost growth. In view of declining export shares, there remains a need to moderate wage increases, strengthen competition and enhance the mobility of resources across sectors. There is also a pressing need to raise the low Belgian employment rate, by both reabsorbing the unemployed and raising labor market participation, especially among senior workers.

7. It is proposed that the next Article IV consultation be held on the regular 12-month cycle.

II. Deep Recession and Challenging Outlook

A. Severe Recession in 2009

8. Hit by the financial crisis and the collapse in world trade, the Belgian economy experienced an abrupt and severe contraction in the last quarter of 2008 and the first half of 2009. Sizeable financial wealth losses of households and non-financial corporations contributed to plummeting consumer confidence and business sentiment. The serious problems in the financial sector also led to a tightening of credit conditions. Private consumption fell despite gains in real disposable income, the latter in part due to lower inflation. Exports contracted rapidly, reflecting the sharp drop in world trade and, given the importance of intra-EU trade, spillover effects from the slump in the Euro area. As a result, private investment was significantly scaled down and firms sharply reduced their inventories.

Industrial production fell by a cumulative 10 percent over the first three quarters of 2009, reflecting both falling domestic demand and the deteriorating global environment. While confidence indicators have started to recover from the second quarter onward, they remain largely below their pre-crisis levels. Real GDP started to increase again in the third quarter as the recession in partner countries is bottoming out, financial market conditions were improving, and firms began rebuilding some of their depleted inventories. For 2009 as a whole real GDP is expected to have contracted by about 3 percent.

Sources: Haver Analytics; WEO; and IMF staff estimates.

9. Unemployment is heading upwards. The recession has brought an end to the continuous decline in unemployment since 2005. The unemployment rate has thus far risen by over 1 percent since its cyclical trough in May 2008 and exceeded 8 percent in October 2009. This relatively modest increase also reflects the impact of measures to encourage firms to use reduced working-time arrangements to respond to the drop in activity. However, employment has steadily contracted during the year and the unemployment rate would continue to rise in the near future as recovery prospects are feeble and there is a considerable time lag between higher activity levels and job creation.

Sources: WEO; and IMF staff estimates.

B. Outlook and Risks

10. The recovery is expected to be gradual and tepid, with real GDP growth forecasted at slightly above 1 percent in 2010 and to increase to almost 2 percent over the medium term. Exports are likely to pick up in 2010 as global activity would gain strength, although the expansion in Belgium’s main trading partners is likely to remain sluggish while relatively high wage costs and supply rigidities remain a constraint on export performance. In addition, as the level of inventories has fallen sharply, some further restocking could take place. However, a rebound in private consumption and investment will take some time. The considerable wealth losses due to the financial crisis, the ongoing rise in unemployment, and the deterioration in the fiscal position are likely to induce a further increase in the households’ savings rate and slow consumption.3 Also, the very low rate of capacity utilization and tightened financing conditions would induce firms to postpone new investments. The authorities project a stronger recovery with growth exceeding 2 percent by 2012, mostly driven by a stronger rebound in domestic demand. In light of the fiscal consolidation program (see Section IV), staff considers this rather optimistic. Unemployment would increase to above 9 percent in 2010. The gradual strengthening of domestic demand would raise GDP growth above its potential rate while staff expects the output gap to narrow gradually over the medium term.

11. Lower energy and food prices since mid-2008 have brought inflation sharply down with a modest inflation risk going forward. Headline inflation dipped into negative territory in early 2009 due to the base effects from substantial declines in energy prices. Annual core inflation remained above 1 percent and is higher than in the Euro area, partly reflecting the impact of automatic wage indexation. Inflation pressures are expected to remain subdued in the period ahead, even once the energy and food price base effects dissipate, due to the weak outlook for growth and employment.

Sources: WEO, and IMF staff estimates.

12. The outlook is unusually uncertain and risks are broadly balanced. On the upside, the global monetary easing, fiscal stimulus, and the waning of financial market turbulence would strengthen foreign demand. Stronger recoveries in partner countries, in particular in the Euro area, would speed up Belgian economic growth. On the downside, the public support of the financial sector and the fiscal impact of the downturn have significantly increased the public debt ratio, which could trigger adverse market reactions and dampen growth. Moreover, a backlash from the financial crisis cannot be ruled out because of the still strained capital positions and risky exposures in the banking sector. Although thus far the slowdown in lending appears in line with lower demand, credit may not be able to fully expand with the demand from firms and households as the recovery gains strength.

Source: WEO and IMF staff estimates.

13. The risk of a further house price correction remains considerable but the impact on the real economy will likely be limited. Real house prices doubled over the past decade and were estimated to have been overvalued by some 15-20 percent compared to fundamentals in 2007.4 House prices stabilized in 2008 and have fallen by about 8 percent in 2009. The proportion of household wealth invested in housing has increased since 2000, but remains considerably less than that in France, the U.K., and the Netherlands. The impact of a further price correction on the real economy is likely to be mitigated by the relatively low indebtedness of households and conservative lending practices.5 Mortgages tend to be fixed rate and have conservative loan-to-value ratios, diminishing the risk of foreclosures. Refinancing products are uncommon making a significant adverse impact on consumption less likely. In addition, while construction activity has fallen in 2009, the sector’s share in GDP has been stable at around 5 percent, below the European average.

Sources: Haver Analytics, and IMF staff estimates.

C. External Developments and Competitiveness Issues

14. The small current account deficits in 2009-10 are expected to be temporary. Belgium’s highly open economy has been significantly affected by the global downturn and the sharp drop in net exports during 2008-09 came on top of an already weakening export performance. Accordingly, the national saving-investment balance turned negative, reflecting a large increase in the overall government deficit that is partly offset by a rise in net savings of the private sector. Exports are expected to pick up again from 2010 onwards, in line with the recovery in global trade. With a more sluggish expansion of domestic demand and imports, the foreign contribution to growth would become positive again. In view of the persistent fiscal deficits, however, the current account surpluses projected over the medium term would be smaller than during the pre-crisis period.

Belgium: Saving-Investment Balances, 2002-2015

(In percent of GDP)

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

15. Competitiveness issues remain a constraint on the export performance of the Belgian economy. Estimates based on the CGER methodologies suggest that the real exchange rate is broadly in equilibrium. However, developments in real effective exchange rates based on unit labor costs (ULC) continue to point to a competitiveness gap with respect to the key trading partners, especially Germany. This gap is due, in part, to the relatively high wage growth in Belgium—owing to the automatic wage indexation mechanism—that is not offset by higher productivity growth. Belgian exporters have been losing market shares over the past decade, although some sectors (mainly chemicals) have gained in market share. Accordingly, there is need for some wage moderation that needs to be supported by measures to increase competition and facilitate movement of resources (especially labor) within and across sectors.

Belgium: CGER Competitiveness Assessment

(In percent)

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D. Consequences of the Crisis for Potential Growth

16. The financial crisis and the economic recession will have a significant adverse impact on the Belgian economy’s growth capacity. The banking crisis and the collapse of global trade will compound the long-term slowdown of potential growth reflecting the impact of demographic factors, notably population aging. Trade and financial sector developments will affect potential growth in Belgium both directly and through indirect effects on the production capacity of other sectors that depend on external finance and/or foreign demand. To evaluate the path of potential output going forward, staff has used historical data on the evolution of potential output following recessions of the early 1990s in Belgium and in Scandinavian countries that experienced banking crises (see Analytical Note 1). The results indicate that in 2009-11 potential growth would be about 1 percent lower than its trend rate, which is itself declining due to demographic factors. Potential growth is projected to recover gradually to its trend rate of about

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percent by 2015.

Sources: WEO; and IMF staff estimates.

III. The Financial System: Post-Crisis Assessment and Exit Strategies

A. Financial Sector Conditions have Stabilized but Challenges Remain

17. Since the worst of the financial crisis in the latter part of 2008, the financial situation of the Belgian banking sector has stabilized but risks remain elevated. Decisive government support and a gradual improvement in investor confidence have resulted in a decline in CDS spreads and stabilization in equity prices.6 As a result, liquidity conditions and access to financing have improved, while interbank rates have steadily come down from their peak in October 2008. The government interventions and improved market conditions have enabled the banks to raise their capital ratios and to de-leverage. In addition, Belgian banks benefit from relatively low risks in the domestic residential real estate market and lower household debt and non-financial companies’ leverage than the Euro area average. However, risks to the loan portfolio are expected to rise and possible additional losses and write-downs over the next few quarters remain a concern. While Belgian banks have very few activities in Greece, all three major banks are still highly exposed to mature markets and impaired structured asset classes, and one bank is quite vulnerable to developments in Central and Eastern European (CEE) markets.

18. Public support has boosted capital ratios but banks may face additional capital charges. The government interventions have kept the regulatory capital ratios of the main Belgian banks in line with the European average (Tier 1 ratios rose to above 10 percent in 2009) but banks remain highly leveraged. However, as market participants increasingly focus on a more stringent capital definition, Belgian banks will need to boost their capital to maintain market confidence and support the financing of the economy.

Solvency Ratios of Belgian Banks

(In percent)

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Sources: Companies reports; Moody’s; and IMF staff calculations.Leverage ratio defined as Tier1 capital divided by total capital–goodwill and intangibles

19. The uncertain profitability outlook constrains the banks’ capacity to rebuild a high-quality capital base through internal capital generation. The profitability of Belgian banks improved gradually over 2009 because of rising net interest income. The improvement in interest margins mainly reflected significantly lower funding costs in the current monetary policy environment which, however, may not last. At the same time, the banks continued to face impairments on their investment portfolio, notably through their remaining exposure to structured assets, and lower revenues from asset management activities reflecting the sizable wealth losses in the economy. This suggests that the banks may have to continue to rely on external sources of capital, either public or private, for an extended period and that the repair of balance sheets remains important and needs to be accompanied by asset disposal.

B. Macro-Financial Linkages and Cross-Border Spillovers

20. A negative feedback loop between the financial sector and the real economy has led to an increase in counterparty risk and deteriorating asset quality.7 Although the risks of impairments on the banks’ domestic consumer and mortgage loan portfolio appear relatively modest due to low household indebtedness and conservative lending practices, the share of non-performing loans in the total loan portfolio has risen significantly and impairment costs have more than doubled compared to their pre-crisis levels (see Analytical Note 2). In particular, credit risks on corporate loans and international loans are on the rise. Further losses could be expected given the usual lag between an economic downturn and credit defaults.

21. Bank lending to the private sector has shrunk since the beginning of the crisis. The recession and declining producer confidence have dampened credit demand. At the same time, lending conditions to the private sector for all types of loans, including mortgages, have been tightened over the course of 2009, reportedly reflecting lingering difficulties in tapping funding markets and ongoing deleveraging pressures. Growth of credits granted to resident non-financial corporations of all sizes slowed down to 3.5 percent year-on-year in August 2009 from a maximum of about 15 percent in the course of 2008. However, while the balance between credit demand and supply factors remains unclear, lending conditions in Belgium appear marginally less restrictive than in other European countries according to recent European Central Bank’s surveys (see Analytical Note 2).

22. Credit to the economy should be closely monitored as risks of a creditless recovery are a cause for concern even though mitigating factors are at play. Staff estimates, based on the results of a cross-country analysis, that Belgium has a relatively high probability of experiencing a creditless recovery.8,9 An additional shock to the financial sector could reduce credit and particularly affect sectors that are dependent on external financing, potentially leading to a suboptimal allocation of resources. This points to the need to ensure that exit strategies from support programs are carefully designed, in order to avoid a credit squeeze. At the same time, the public support to the banks and their restructuring with the banks’ increased focus on lending activities in the core home markets would limit the risk of a creditless recovery.

23. Belgian banks remain vulnerable to potential spillovers from both mature markets and CEE. All main Belgian banks have major cross-border operations and Belgium has a relatively high exposure to debtor countries. In particular, Belgian banks are highly exposed to France, the US, the UK and the Netherlands. The breakdown of the Belgian loan portfolio by countries shows that exposure is relatively high in some countries where nonperforming loans have increased particularly rapidly such as Ireland and Spain. In addition, one bank is quite vulnerable to developments in CEE.


Belgium: Monetary and Financial Sector Developements

Citation: IMF Staff Country Reports 2010, 063; 10.5089/9781451980547.002.A001

Sources: Haver; IMF, IFS; ECB; and Eurostat.1/Weighted average of changes in interest and exchange rates relative to their average values in a base period. An increase (decrease) indicates a monetary tightening (loosening).2/Credit growth to households in 2008 and 2009 was largely affected by securitization operations. Excluding these operations, the underlying credit growth decelerates but remains positive in 2008 and 2009.

Belgium: Vulnerability of the Belgian Banking System to Cross-Border Contagion

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Sources: Bankscope; and IMF staff estimates.

A positive number indicates a deterioration in asset quality.

C. Preparing for Exit from Government Support

24. Most of the government support schemes do not have built-in sunset clauses but the restructuring plans of banks that benefitted from state aid are subject to the European Commission’s approval and include the gradual withdrawal from the emergency public support (see Analytical Note 2). The Belgian authorities agreed that reducing the large public support in a timely manner is needed to reduce the distortions created by public interventions and to lessen the moral hazard problems associated with bailout operations, while exit needs to be well-organized to avoid market disruptions and support credit.

Preparing for a timely and orderly exit

25. Flexibility and clear communication are crucial for a successful exit strategy. The authorities indicated that the pace of exit from the financial sector would be gradual in order to test whether the financial system and financial markets can function on their own again. Communicating exit plans in conjunction with the decision of the European Commission on state aid will help anchor expectations and assuage lingering market fears.

26. Public capital injections into financial institutions should be withdrawn only when the capital adequacy of Belgian banks is satisfactory and the financial stability of the banks is ensured. While the banks are implementing restructuring programs, it will most likely take some time for their financial health to improve enough for the authorities to be able to sell their shares or for the banks to reimburse the state directly. The authorities considered that appropriate policies could provide incentives for the private recapitalization of banks, including through restrictive compensation and dividend policies. In the meantime, the government should actively safeguard the public’s investment in financial institutions and maintain a level playing field across institutions.

27. The unwinding of state refinancing guarantees is being done gradually and in a targeted manner to avoid a backlash in market expectations. Staff supports the amended one-year extension of refinancing guarantees offered to Dexia with a gradual reduction in the level of coverage of the guarantees.10 The authorities indicated that that associated costs and restriction on dividend and coupon payments should minimize moral hazard and induce the bank to cease using the guarantees when they are no longer needed. Dexia already waived, from October 16, 2009, the benefit of the guarantee for all new contracts with a maturity below one month, and all new contracts with no fixed maturity, and is committed to end all new guaranteed funding by mid-2010.

Strengthening the regulatory framework

28. Staff welcomes the initiated reorganization of the Belgian supervisory authority. While there is no first-best model of financial supervision, the current crisis has highlighted the important role of adequate macro-prudential supervision in order to prevent banks from undertaking excessively risky activities with large externalities. The creation by early 2011 of a new unified structure for the supervision of financial institutions, as in Germany and the Netherlands, entails the merger as soon as feasible of the authorities vested in the central bank and in the Banking, Finance and Insurance Commission (CBFA). The CBFA will henceforth focus on surveillance of financial markets and the protection of consumer interests. This reform should effectively combine the supervision of individual institutions and of the system as a whole. The authorities agreed with staff that the transition period should be carefully handled and have set up a transition committee to ensure that control activities are not interrupted. They have also prepared a draft crisis law that would establish a rule-based resolution framework for failed financial institutions while preserving their systemic functions. It allows the authorities to transfer property and business lines from a troubled financial institution to another private bank or public entity when the institution enters resolution proceedings.

29. Given the cross-border orientation of Belgian banks, the authorities should continue to strongly support enhanced international cooperation in regulatory reform and coordination of exit policies. Belgium should play an important role in implementing the new European financial stability arrangements based on the recommendation of the de Larosière group.11 In addition, there is a need to enhance information flows among national supervisors and create a body that could settle potential conflicts arising from home-host supervision issues and the complex nature of cross-border banking. International coordination of financial sector exit strategies is needed to avoid destabilizing financial flows, particularly as regards liquidity support, the maximum coverage of deposit insurance and bank/asset guarantees across the European Union.

IV. Restoring Fiscal Sustainability is a Priority

30. The economic and financial crisis and the necessary public interventions have led to a significant deterioration in the public finances. The cost of letting the automatic stabilizers operate freely, the fiscal stimulus plan, and shoring up the financial sector have significantly worsened the overall fiscal situation. The overall deficit jumped to about 6 percent of GDP in 2009 from 1.2 percent in 2008, and the public debt rose to close to 100 percent of GDP in 2009. The crisis has undone the gradual debt reduction achieved during the last decade and has further hampered the planned pre-funding of the impending rise in aging-related public expenditures. High debt raises the risk of sizeable increases in interest expenditures, especially once interest rates increase from their currently subdued levels or as markets begin to reassess sovereign risks in the Euro area.

31. Recognizing the risk of unsustainable public debt dynamics, the government has announced an appropriate fiscal consolidation strategy that aims to achieve a balanced budget by 2015, in order to start reducing debt after 2011. The associated deficit objectives and burden sharing path that was adopted by the government in the fall of 2009 had to be further strengthened to reflect the recent ECOFIN Council recommendation to bring Belgium’s overall deficit below the 3 percent Stability and Growth Pact (SGP) threshold already in 2012. On this basis, the authorities have prepared a new Stability Program for the period 2009-12.

A. Fiscal Outlook and Economic Stimulus

32. The 2010 budget strikes the right balance between initiating the much-needed fiscal consolidation and supporting the recovery. The budget is based on the intergovernmental burden-sharing agreement for 2009-10 and the first multi-year fiscal framework covering 2010-11, both welcome first steps in the consolidation strategy. The 2010 budgets at every level of government aim at streamlining spending and boosting revenue in order to reduce the overall deficit to 5.1 percent of GDP (the new Stability Program for 2009-12 aims at a deficit of 4.8 percent of GDP in 2010). The total fiscal effort of about ¾ percent of GDP reflects the burden-sharing agreement allocating 65 percent of the adjustment effort to the federal government and social security, and 35 percent to the regions, linguistic communities, and local governments.

33. In view of the signs of an incipient economic recovery and the strong need for medium-term fiscal consolidation, most of the fiscal stimulus measures should be reversed after 2010. In line with other European Union countries, the Belgian authorities reacted to the crisis by adopting a stimulus package for 2009-10.12 The size of the stimulus package is broadly appropriate given the large negative output gap and the limited fiscal space in Belgium, but its composition raises concerns as some measures are neither temporary nor targeted.13 While the reduction in the (very high) tax wedge on labor is a welcome measure, it is important to reverse all other measures that entail a permanent increase in expenditure or revenue losses.

B. Challenges of a Credible Medium-Term Fiscal Adjustment

34. The government’s medium-term consolidation strategy should be enhanced by a more formal institutional framework. Recent experience indicates that structural deficit reductions are challenging to implement in Belgium. Key factors in this regard are the lack of adequate incentives to keep real spending increases in line with trend economic growth and the off-loading on the federal government of revenue shortfalls, higher social security outlays, and some spending decided at regional and local government levels. The current approach identifies the necessary structural fiscal efforts of at least 0.75 percent of GDP that are required every year to achieve the balanced budget target by 2015. However, especially for the period beyond 2012, it does not articulate the measures or mechanism to help ensure the credibility of this commitment.

35. Moreover, pressing aging-related costs cannot be ignored any longer. For the period until 2014 it is estimated that the fiscal costs of aging will increase by more than 3 percent of GDP. The need for front-loaded fiscal tightening for intergenerational equity purposes is largely accepted by the public and the authorities alike but the necessary adjustment has been continuously postponed. The 2009 Sustainability Report of the European Commission concludes that aging-induced structural adjustment in Belgium should be at least 0.6 percent of GDP per year as opposed to the loosening fiscal stance over the recent years.

Belgium: Projections of the Fiscal Costs of Aging, 2008–60

(In percent of GDP)

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Source: High Finance Council’s Study Committee on Aging 2009 Report.

36. The new Belgian Stability Program for 2009-12 represents a significant effort in the right direction. The Program is based on the intergovernmental burden-sharing agreement for 2009-10 and the planned agreement for 2011-12. It builds on the deficit reduction targeted for 2010, and aims to reduce the overall deficit to 3 percent of GDP by 2012. The consolidation strategy contains a balanced package of revenue measures, steps to discourage the use of early retirement schemes in the private sector, and measures to strengthen fiscal responsibility at the regional and local levels. Any better-than-expected fiscal performance at every level of government is to be directed towards debt reduction over the coming years. However, part of the sharp consolidation results from rather optimistic macroeconomic and revenue assumptions for 2011-12. Under more realistic assumptions, additional fiscal efforts starting in 2011 will be needed to achieve the deficit targets.

Sources: Belgian authorities; and IMF staff projections.

37. In view of the need to credibly commit to medium-term fiscal consolidation amid considerable political uncertainty, the adoption of a rule-based framework would help cement and reinforce the planned consolidation efforts. Under current fiscal federalism arrangements the federal government is responsible for servicing most of the general government debt while controlling only a fraction of general government revenue and spending. In order to address the large existing imbalances it will be important to build on the existing burden sharing agreements by framing them into a more credible multi-year fiscal framework rather than having to resort to periodic renegotiations. Since a very sizeable adjustment is needed to bring the public debt back to sustainable levels, the need to reach a new consensus on deficit objectives anytime the fiscal situation deteriorates is very costly and severely limits the potential scope of consolidation. Often, the consolidation objectives are delayed, as was the case with the intergovernmental agreement for 2009-10 that was signed on December 15, 2009, and based on already voted budgetary objectives of each level of government. The agreement, while an important and welcome step, is still insufficient to ensure deficit reduction efforts beyond 2010.

38. Staff recommends introducing a cap on total expenditure growth for each level of government and the social security administration while also considering additional revenue measures. Overall spending limits could be set on a multi-annual basis and translated into expenditure growth caps for each level of government. The implementation could come either under a reinforced multi-year budgetary framework or evolve into a fiscal rule, and should in both cases be based on realistic macroeconomic assumptions. Analytical Note 3 compares the Swiss debt-brake rule to the recently adopted German fiscal rule and discusses the applicability of this type of rule to Belgium. In view of the considerable growth in healthcare spending and pensions expected in the coming years, it is important to take measures to increase the effective retirement age and to reduce healthcare costs.14 At the same time, regional governments should tighten their fiscal control over local governments by strictly enforcing the existing golden rule and by ensuring the feasibility of the local investment programs. Revenue measures should focus on broadening the tax base and improving revenue collection. Significant gains can also be achieved by streamlining the existing large number of tax expenditures.

39. The government has expressed its support for continuing to implement part of the fiscal consolidation by taking advantage of the age structure of the civil service, but no specific decisions have been taken thus far. Over the next 10 years, about a third of the public servants are scheduled to retire. The table below analyzes potential savings from indicative scenarios of non-replacing every second or every fourth retiring public sector employee. Depending on the scope of adjustment considered appropriate, each scenario will have to be matched to the desired level of efficiency of the public services. At the same time, the efficiency of public services in Belgium can be significantly improved, especially at sub-national levels of government.15

Belgium: Projections of Civil Servants Retirement, 2010-20

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Sources: ITINERA Institute (2009); and IMF staff calculations.

V. Structural Reforms: Restoring Potential Growth

40. Pushing ahead with structural reforms in the labor and product markets is important to restore growth in the aftermath of the recession. The adverse effect of the crisis on potential output compounds the negative impact of demographic factors. In this context, further labor and product market reforms are especially urgent, as they can help prevent a rise in structural unemployment and limit productivity losses. Now that the worst of the recession seems to have passed, the time is ripe for ambitious action on the structural front that would support the budding recovery, strengthen competitiveness, and durably improve living standards.

Source: OECD, and IMF staff estimates.

41. Further labor market reforms are essential for increasing the labor supply and potential output, as well as for supporting job creation during the recovery. The low employment rate in Belgium reflects in large part a high share of the long-term unemployed and a low rate of labor force participation, notably for both younger and older workers. Lifting the Belgian employment rate (currently at 61.5 percent of the working-age population) to the Euro area average (65 percent) by reducing long-term unemployment and raising labor force participation could increase potential output growth by about ½ percent per year, on average, over the next five years. In this regard, and in broad agreement with the authorities, staff recommends to focus on the following reform priorities:

  • Support re-absorption of the unemployed. With a further rise in cyclical unemployment expected in 2010, the extension of the temporary unemployment programs until the middle of the year is welcome. However, to avoid lasting damage to employment incentives, such programs need to be phased out once the recovery takes hold. At the same time, active labor market policies need to be stepped up, while efforts to reduce the long-standing rigidities stemming from distortionary labor taxes need to be continued. Further action is needed to enhance monitoring of job search activities, apply penalties for refusal of suitable jobs, and increase job counseling and training opportunities. In addition, limiting the level of unemployment benefits over time or their duration would be effective in strengthening incentives for job search.

  • Improve labor market participation. To counter demographic pressures on potential output and promote the creation of new jobs in the economy, labor market participation needs to be increased for both older and younger workers. This would involve raising the effective retirement age by further limiting pathways into early retirement, as well as extending activation programs to older workers. In this regard, the system spelled out in the Stability Program 2009-12 that links the pre-pension age with the benefits payable by employers is a step in the right direction. For younger workers, this calls for reconsidering employment protection legislation, including for workers on temporary contracts. For both groups, expanding job counseling and training opportunities would help ease their way into the labor force.

42. Further product market reforms are key to facilitate the necessary post-crisis restructuring and to raise productivity and potential output over the medium term. Staff recommends further strengthening the independence of the Competition Authority and ensuring that it is provided with adequate resources. The Competition Authority should be able to conduct independent sectoral analyses and issue specific recommendations regarding policy changes that could improve competition. At the same time, the role of sectoral regulators needs to be clearly defined and effective cooperation among the regulators needs to be established. In the service sector, the EU Services Directive provides an opportunity for further liberalization that should be fully seized.

Figure 1.
Figure 1.

Belgium: Financial Indicators

Citation: IMF Staff Country Reports 2010, 063; 10.5089/9781451980547.002.A001

Source: Thomson Financial/DataStream and Bloomberg.
Figure 2.
Figure 2.

Belgium: Bank Lending Survey 1/

Citation: IMF Staff Country Reports 2010, 063; 10.5089/9781451980547.002.A001

Source: National Bank of Belgium.1/ Data above the zero line are looser conditions and below the zero line are tighter
Figure 3.
Figure 3.

Belgium: Labor Market Indicators

Citation: IMF Staff Country Reports 2010, 063; 10.5089/9781451980547.002.A001

Sources: Belgian authorities; Global Insight; OECD; and IMF, WEO.1/ Unemployment benefits are measured in percent of previous earnings. Data are for 2007.2/ Labor taxes are for a single person without children, at 100 percent of the average wage, measured in percent of labor costs.
Table 1.

Belgium: Selected Economic Indicators 2005-14

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

Contribution to GDP growth.

Table 2.

Belgium: High-Frequency Financial Indicators

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Sources: Bloomberg; Datastream.

Euros; change in percentage points.

Basis points, 5 Yr CDS.

Index; change in percentage points.

Percent; change in percentage points.

Basis points; 3-month interbank rate minus 3-month Treasury Bill.

Table 3.

Belgium: Fiscal Scenarios, 2005-15

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

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Sources: IMF staff projections; Belgian Stability Programme 2009-12; data provided by authorities.

Excludes one-off measures including the restructuring of the national railway company in 2005 and part of the fiscal stimulus 2009.

Source: High Finance Council, 2010.

Table 4.

Belgium: Financial Soundness Indicators of the Banking Sector, 2003-09 1/

(In percent)

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Sources: CBFA and NBB.

Consolidated data. Since 2006, the data are based on the IAS/IFRS reporting Scheme.

Data for the first 6 months of 2009. The flow data are annualised.

Deposits booked at amortised cost only.

As of 2006, liquid assets include cash and debt instruments issued by central government and financial institutions.

Unconsolidated data.

Table 5.

Belgium: Financial Soundness Indicators of the Non-Banking Sectors, 2003-09

(In percent)

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Source: NBB, Stadim, UPC.

Unconsolidated data.

Provisional data for first 9 months of 2009, unless mentioned otherwise.

Provisional 2009 figure for first 9 months (annualised).

2009 data are for the first half of the year.

Analytical Note 1: The Effect of the Crisis on Potential Output in Belgium1

1. Measuring potential output is difficult even when the economic environment is fairly stable, and it is especially challenging in times of crises. Potential output is usually understood as the productive capacity of an economy, or the highest level of output that can be attained without inflationary pressures. As such, it is of importance for both monetary and fiscal policy makers, with implications for the sustainability of public finances, especially in a country like Belgium. Alas, potential output is not directly observable and its estimates are never precise, with uncertainty rising tremendously in times of crises.

2. The current crisis is likely to have a large negative effect on potential output through several channels, although some positive effects are also possible. Potential output can be viewed as a product of potential, or “normal,” labor input (often defined in terms of hours) and “normal” labor productivity. The effects on labor arise as a result of: (i) growth in structural unemployment caused by crisis-related dislocations and the damage to human capital from prolonged unemployment; (ii) declines in labor force participation, because unemployment tends to discourage some workers from seeking jobs; and (iii) increases in labor force participation, in particular of second-income earners, in response to income and wealth losses. Turning to the effects on labor productivity, these may arise due to: (i) reductions in capital-labor ratios reflecting slower capital accumulation as a result of investment declines and obsolescence of parts of the pre-crisis capital stock; (ii) a deterioration in total factor productivity associated with crisis-related dislocations and impaired funding systems—including for efficiency-enhancing innovation—that can slow resource reallocation; and (iii) an improvement in total factor productivity driven by expulsion of inefficient activities and increased incentives for restructuring prompted by the crisis.

3. The effects of the crisis on potential output can be exacerbated or mitigated by domestic policy measures and by external developments. In particular, failures to reverse short-term crisis-related measures, such as unemployment support programs, as well as a crisis-related rise in the recourse to early retirement could further depress potential output. Conversely, certain fiscal stimulus measures—such as infrastructure investment—and additional structural reform efforts spurred by the crisis are likely to have lasting positive effects on potential output. At the same time, an accelerated build-up of public debt could be a serious drag on potential output, because of the possible upward pressure on interest rates and the higher tax burdens going forward. Finally, external developments—changes in potential output in trading and financial partners—could have important effects on domestic potential output, especially in very open economies, such as Belgium.

4. The common methods of estimating and forecasting potential output are not well suited to the inherently unstable crisis environment. Potential output is typically estimated by isolating trend components in total GDP or its supply-side determinants—usually within a Cobb-Douglas production function framework—and projecting these into the future.2 Beside the well-known issues associated with filtering, such as end-point problems and substantial revisions of recent estimates, these trend-based projections cannot adequately reflect sudden shifts in potential output that may occur in a crisis. These estimates can, however, provide helpful information about potential output dynamics in past crises, for which the end-point and revision problems are much smaller. Specifically, historical potential output estimates (based on the production function approach) can be used as a benchmark for evaluating a current crisis-driven deviation of potential output from its pre-crisis path—the approach adopted below.

5. The dynamics of potential output during the recessions and banking crises of the early 1990s can provide a useful benchmark for potential output in Belgium. During the early 1990s, many advanced European economies, including Belgium, simultaneously experienced recessions, making that episode somewhat similar to the ongoing global downturn. Although Belgium did not have a banking crisis at that time, the early 1990s saw major banking crises in two other European economies—Finland and Sweden—that offer a convenient proxy for Belgium. Of course, the crises are different: the current crisis in Belgium was triggered by external financial spillovers, while the crises in Finland and Sweden followed financial liberalization carried out without adequate policy adjustments.3

Yet, the current recession in Belgium is similar in severity to the early 1990s’ recessions in Finland and Sweden, on average, and markedly more severe than the concurrent Belgian recession that was not associated with a banking crisis (Figure 1-1).

Figure 1-1.
Figure 1-1.

Actual Output Growth Rates - 1990-93 and Current Recession

Citation: IMF Staff Country Reports 2010, 063; 10.5089/9781451980547.002.A001

Sources: Haver Analytics; Eurostat; and IMF staff calculations.

6. The effects of financial crises on potential output may be similar across Belgium, Finland, and Sweden, while the effect of trade developments is larger in Belgium. The current crisis is likely to affect potential output through its long-lasting effects on the financial and the export sectors, as well as other sectors that are dependent on bank financing and/or external demand. Table 1-1 compares the importance of these sectors in Belgium with that in Finland and Sweden. It shows that although the weight of the financial sector in GDP is somewhat higher in Belgium, it is not out of line, especially when compared to Sweden. This observation supports the idea that financial sector disruptions may have broadly similar effects in these economies. That said, the share of exports in GDP in Belgium is about twice that of Finland and Sweden, hence external developments are likely to have larger effects on Belgium. Although the growth dynamics of the financial sector in Belgium are now similar to that in Finland and, especially, Sweden in the early 1990s, the recent slowdown in exports is much bigger (Figures 1-2 and 1-3).

Table 1-1.

A Comparison of Output Composition in Belgium to Finland and Sweden

(In percent of GDP)

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Sources: Haver Analytics; Eurostat; and IMF staff calculations.
Figure 1-2.
Figure 1-2.

Financial Sector Growth Rates - 1990-93 and the Current Recession

Citation: IMF Staff Country Reports 2010, 063; 10.5089/9781451980547.002.A001

Sources: Haver Analytics; Eurostat; and IMF staff calculations.
Figure 1-3.
Figure 1-3.

Export Sector Growth Rates - 1990-93 and the Current Recession

Citation: IMF Staff Country Reports 2010, 063; 10.5089/9781451980547.002.A001

Sources: Haver Analytics; Eurostat; and IMF staff calculations.

7. Banking crises in Finland and Sweden were associated with large slowdowns in potential output, unlike the concurrent Belgian recession. According to the production function estimates of the European Commission, potential growth began to decline in 1990 in all three economies, a year before the banking crises hit Finland and Sweden in 1991 (Figure 1-4). In these two latter countries potential growth fell about 1.5 percentage points below its pre-crisis rate in 1992-93, before recovering over the next three years. The fairly rapid recovery was likely associated with the relatively timely resolution of the banking crisis and successful restructuring of the manufacturing sectors. In Belgium, potential growth slowed less dramatically in the early 1990s, but remained below its pre-recession rate over the medium term. Table 1-2 shows average deviations of potential growth from the pre-crisis (1989) rates in Belgium, Finland, and Sweden over the period following the crises of 1991. The “baseline scenario” assigns the weights of ½ to Belgium and ¼ each to Finland and Sweden, while the “alternative scenario” assigns equal weights to all three countries in the calculation of average potential growth. The “baseline scenario” generates the pattern of a more gradual slowdown and recovery in potential growth, while the “alternative scenario” produces the pattern of a deeper decline followed by a stronger rebound.4

Figure 1-4.
Figure 1-4.

Potential Output Growth Rates - 1990-93 Recessions

Citation: IMF Staff Country Reports 2010, 063; 10.5089/9781451980547.002.A001

Sources: European Commission; and IMF staff calculations.
Table 1-2.

Benchmark Declines in Potential Growth

(In percentage points)

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Sources: European Commission; and IMF staff calculations.Note: 1991 is crisis year; three-year moving averages.

8. The historical benchmarks combined with the effects of demographic changes indicate that a significant slowdown in potential growth in now likely in Belgium. Potential growth has begun to weaken prior to the current recession because of moderating migrant inflows, with ageing-related declines of the labor force expected to deepen the slowdown in the coming years. This slowdown can be approximated by a no-crisis path based on a linear interpolation of potential growth rates between the pre-crisis (2007) and post-crisis (2014) points, using the production function estimates of the European Commission (Figure 1-5, the dashed line). Accordingly, demographic pressures—notably ageing—are expected to be responsible for a decline in potential growth in Belgium of about 0.4 percentage points between 2007 and 2014. Applying benchmark discounts based on the experiences of Belgium, Finland, and Sweden in the early 1990s to this no-crisis path yields potential growth rates shown in Figure 1-5 and Table 1-3. Overall, potential growth is expected to slow considerably from about 1.9 percent in 2007 to between 0.7 and 0.8 percent in 2010, depending on the scenario, before gradually returning to its no-crisis trend rate of 1.5 percent. These losses in potential output are broadly in line with the losses observed in OECD countries following financial crises in the post-World War II period.5 That said, given Belgium’s sensitivity to external developments, the recovery of potential growth will depend a lot on the strength of the global economy going forward.

Figure 1-5.
Figure 1-5.

Estimates of Potential Growth Rates in Belgium

Citation: IMF Staff Country Reports 2010, 063; 10.5089/9781451980547.002.A001

Sources: European Commission; and IMF staff calculations.
Table 1-3.

Potential Growth With and Without the Crisis Effect

(In percent)

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Sources: European Commission; and IMF staff calculations.Note: no-crisis path based on a linear interpolation.


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  • Furceri D., and A. Mourougane (2009),The effect of financial crises on potential output: New empirical evidence from OECD countries,OECD Economics Department Working Paper 699.

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