2018 Article IV Consultation - Press Release; Staff Report


2018 Article IV Consultation - Press Release; Staff Report

Context—A Healthy Recovery and Renewed Reform Efforts

1. The government is making another reform push ahead of an upcoming election period. Several important reforms have been implemented in recent years, including reductions in the labor tax wedge, the temporary suspension of wage indexation, and pension reform. The reform momentum slowed in 2016, particularly with respect to fiscal policies, but fiscal consolidation accelerated in 2017, and the governing center-right coalition agreed on a new package of tax and labor market measures. The centerpiece of the agreement was a reform of the corporate income tax system. These are important achievements as Belgium heads into local elections this year and regional and federal elections in 2019.

2. The economic recovery has contributed to healthy employment growth. Real GDP is estimated to have increased to 1.7 percent in 2017 from 1.5 percent in 2016. The recovery has been driven by strong business investment and solid private consumption growth, and aided by a combination of improving labor market conditions and favorable financial conditions supported by continued monetary accommodation by the ECB. The unemployment rate fell to 7.3 percent, approaching pre-crisis levels, and employment expanded by an estimated 1.2 percent, thanks in part to previous reforms to reduce taxes on labor (the “tax shift”), contain wage growth (the “index jump,” a one-time suspension of wage indexation), and increase the effective retirement age.1 Inflation rose to 2.2 percent, owing to higher domestic energy prices. Core inflation, at 1.5 percent, remained higher than the euro area average, partly reflecting price dynamics in service sectors such as restaurants, cafes, and telecommunications, where competition is relatively limited.


GDP and Employment Growth

(Percent y-o-y growth)

Citation: IMF Staff Country Reports 2018, 071; 10.5089/9781484346051.002.A001

Sources: Eurostat, IMF World Economic Outlook and IMF staff calculations.

3. The current account is estimated to have remained close to balance in 2017, moderately weaker than implied by medium-term fundamentals. After recording consistent surpluses prior to the global financial crisis, the current account has hovered around balance in recent years. Over 1999–2015, Belgium’s share of world goods exports fell by 22 percent (from a 3.3 percent share to 2.6 percent) versus an average decline of 15 percent in high-income OECD countries. This trend is partly explained by the fact that Belgium’s exports are concentrated in a European market that has become relatively less important in size. In addition, unit labor costs have risen more rapidly than in some peer countries, although wage moderation since 2013 has helped narrow the competitiveness gap. The ULC-based REER appreciated 13 percent from 2000 to 2013 before declining sharply in 2014 and 2015. Since end-2015, however, the ULC-based REER has been on an appreciating trend once again. The external balance assessment (EBA) model yielded a cyclically adjusted current account norm of 1.8 percent of GDP in 2017 compared to an estimated actual surplus of 0.1 percent, implying a real effective exchange rate overvaluation of about 3 percent (Annex II).

4. The fiscal deficit decreased significantly thanks to a mix of cyclical, structural, and one-off factors. The headline deficit halved from 2.5 percent of GDP in 2016 to an estimated 1.2 percent in 2017, surpassing the target of 1.6 percent in the April 2017 Stability Program (Table 1). Corporate income tax revenues surged due to the cyclical recovery and measures taken by the government to encourage advanced payments. Spending on wages and unemployment benefits declined, reflecting the job-rich recovery and the payoff from previous reforms. Lower spending was also the result of large windfall savings from low interest rates and a significantly smaller contribution to the EU budget. Public debt, which stabilized at 106 percent of GDP in 2016, declined to an estimated 103 percent in 2017.

Table 1.

Belgium: Budget and Projected Outturns

article image
Sources: Haver Analytics, Belgian authorities, and IMF staff calculations.

Draft Budgetary Plan, submitted to the European Commission in October preceding the budget year.

Stability Program submission, consistent with revised budget submitted in May.

Figure 1.
Figure 1.

Belgium: Macroeconomic Context

Citation: IMF Staff Country Reports 2018, 071; 10.5089/9781484346051.002.A001

Sources: Haver Analytics, Eurostat, national statistical authorities, and IMF staff calculations.

Outlook—Recovery Gaining Momentum but Risks Down the Road

5. The recovery is gaining pace, but the medium-term outlook remains subdued. Staff projects growth to increase to close to 2 percent this year. Business investment should remain strong, supported by the improving economic outlook, rising capacity utilization in the manufacturing industry, and continued low interest rates. Private consumption growth is expected to increase as further tax reductions in 2018 and 2019 under the tax shift boost disposable income. Net exports, on the other hand, are not expected to contribute to growth, reflecting continued competitiveness challenges, which are partly related to weak productivity growth. Over the medium term, real GDP growth is expected to fall back to about 1½ percent. Potential output growth is currently estimated at around 1.4 percent, and projected to increase gradually as past and ongoing reforms and investment lead to higher potential employment and labor productivity growth. Headline inflation is projected to decline to 1½ percent in 2018 as energy prices recede while core inflation should increase gradually to over 2 percent as the output gap turns positive.

6. Risks to the outlook include potential external shocks and domestic political developments (Annex III). As a small, open economy highly dependent on external demand, Belgium is vulnerable to growth shocks in Europe. While the impact of the Brexit referendum has been limited so far, a “hard” Brexit would be detrimental given Belgium’s close economic ties with the United Kingdom.2 Geopolitical shocks or monetary policy normalization in advanced countries could lead to volatility and higher financing costs. A combination of lower growth and higher interest rates could result in adverse debt dynamics and eventually undermine investor confidence (Annex IV). On the domestic side, stock market valuations have risen substantially (albeit in line with other major European stock markets when abstracting from one large company), and sustained increases in housing prices coupled with pockets of high household leverage have increased risks. Reform momentum could slow in the run-up to federal elections in 2019, and the elections themselves could lead to a protracted period of uncertainty if the winning parties are unable to form a new coalition government.

Policy Discussions—Maintaining the Reform Momentum

7. The current recovery is an opportunity to strengthen the resilience and growth potential of the Belgian economy. The government’s ability to deal with future shocks will depend on whether it implements the right policies now while the economy continues to recover.

  • First, with public debt above 100 percent of GDP and only starting to come down, Belgium still has a long way to go to rebuild buffers and achieve a more sustainable fiscal position. This will require following through on plans to gradually move toward structural balance.

  • Second, with real GDP growth projected at only around 1½ percent for the foreseeable future, further labor and product market reforms are needed to increase productivity growth, raise potential output, and integrate vulnerable groups into the labor market.

  • Third, although the financial sector has recovered since the crisis and is generally sound, cyclical vulnerabilities are rising and new challenges are emerging, suggesting the need for vigilance and proactive policies.3

8. The government agreed last summer on a new package of measures related to taxation, the labor market, and social benefits (Table 2 and Box 1). The most notable reform was a reduction in Belgium’s corporate income tax (CIT) rate from 34 percent to 25 percent, to be phased in over the next three years (SMEs will benefit from a reduced rate of 20 percent starting in 2018). To compensate for the resulting revenue loss, the notional interest rate deduction (NID) was modified to apply only to incremental corporate equity rather than to the total stock, and new anti-tax avoidance measures were introduced consistent with Belgium’s EU obligations.4 Together, the measures are designed to enhance Belgium’s competitiveness while preserving revenue neutrality.

Table 2.

Belgium: Reform Agenda

article image

9. Policy discussions focused on the importance of maintaining the reform momentum and not yielding to complacency. Achieving the balanced budget goal will require efforts at all levels of government to make spending more efficient and safeguard revenues (Section A). A combination of policies and reforms could help raise productivity growth, including increasing investment in infrastructure and enhancing competition in services (Section B). To fully realize Belgium’s employment potential, it will be critical to address the severe fragmentation of the labor market (Section C). To preserve financial stability, the authorities should address vulnerabilities in the mortgage market and carefully navigate the transition toward a European Banking Union (Section D).

A. Rebuilding Fiscal Buffers

10. Fiscal consolidation remains a priority. Prior to the crisis, Belgium had a solid track record of running primary surpluses and reducing public debt. Post-crisis fiscal adjustment, however, has been weak, causing debt to climb back above 100 percent of GDP. Real primary spending growth has been at the root of the problem, driven mainly by social spending and the public sector wage bill. Tax revenues as a share of GDP, meanwhile, remain high by European standards despite a downward trend since 2013 linked to the tax shift.

11. The strong fiscal performance in 2017 is encouraging, but further measures are needed to achieve a balanced budget in the medium term. Approximately a third of the decline in spending in 2017 (as a share of GDP) was due to windfall interest savings; future interest savings are expected to be more modest and are subject to considerable uncertainty. The spike in advanced payments boosted CIT revenues in 2017 but should not affect future CIT revenues, which are projected to decline modestly. Meeting the government’s medium-term objective of structural balance is further complicated by the fact that the next phases of the tax shift, to take effect in 2018–20, will likely lead to revenue losses. In addition, the government will need to gradually reorient public expenditure from current to investment spending in order to deliver on its plans to increase public investment in the coming decade.5 The package of reforms agreed last summer contained some new taxes but noticeably lacked expenditure reforms. In the absence of further measures, the structural deficit is projected to remain at around 1½ percent over the medium term.

12. The CIT reform will help boost investment and should be complemented with additional measures to safeguard revenues while reducing distortions in the tax system. The CIT reform appropriately lowers the high statutory rate while broadening the tax base to offset the revenue losses. However, a reduced rate for SMEs could create a disincentive for companies to grow, and the changes to the NID regime will reintroduce bias toward debt financing. The CIT reform should be complemented by measures that further broaden the tax base and address remaining distortions in the tax system. Environmental taxation could be strengthened and certain deductions and exemptions, including on VAT and company cars, could be eliminated. To create a more level playing field across business and investment activities, it would be useful to review other aspects of the tax system, including the taxation of interest, dividends, and capital gains; the targeting of profit tax deductions; the preferential tax treatment of rental income and real estate; and tax preferences on savings accounts.6

13. Staff reiterated the need for efficiency-oriented spending reforms, and for a gradual shift from current to investment spending. The high levels of public spending in Belgium have not necessarily translated into better services or social outcomes. Previous analytical work by staff suggests that there is significant scope to make spending more efficient.7 Reducing the wage bill to the EU average (for example, by streamlining the civil service) would yield 2½ percent of GDP in savings.8 Subsidies are 1½ percent of GDP higher than the EU average and 1½ percent of GDP higher than the average in France, Germany, and the Netherlands. Further savings could be achieved by containing growth in health care costs, better targeting social benefits to the most vulnerable, and improving administrative efficiency and coordination across levels of government. Achieving a significant reduction in current spending is all the more important as Belgium’s growth prospects depend critically on making up for years of underinvestment in public infrastructure (Box 2 in Section B).

Authorities’ Views

14. The authorities agreed that reducing spending was the key to achieving their medium-term objective of structural balance. They argued that many of the reforms already put in place will continue to pay dividends, including reforms to contain health care spending, encourage later retirement, and tighten requirements for the unemployed to accept job offers. They are working to improve the integration of workers with disabilities and better target social benefits. They emphasized that Belgium’s federal structure, whereby all levels of government are on equal footing, makes coordination more complicated. They expect the CIT reform to be revenue neutral, and pointed out that the dynamic effects of the reform (i.e., the favorable effects on investment) could even lead to net revenue gains. They maintained that a reduced rate for SMEs made sense given the prominent role that SMEs play in Belgium’s economy. They acknowledged that the next phases of the tax shift will require offsetting measures to safeguard revenues.

Corporate Income Tax Reform

The corporate income tax reform reduces the standard CIT rate from 33 percent to 29 percent in 2018, and to 25 percent in 2020, compared to an average CIT rate of 24 percent in the euro area in 2017. The 3 percent austerity surcharge (imposed since 1991) falls to 2 percent in 2018 and to zero in 2020. SMEs, which were previously subject to a progressive rate structure, henceforth benefit from a single reduced rate of 20 percent on the first €100,000 of their tax base. The CIT reform includes other advantages for companies, including (i) an increase in the dividend received deduction (ii) a temporary increase in the investment deduction for investments made by SMEs and independent workers; and (iii) the possibility for companies belonging to the same group to consolidate their tax results starting in 2020.

To compensate for the resulting revenue loss, the reform broadens the tax base through a series of measures. This includes important changes to the NID scheme. Whereas the NID previously applied to the entire equity stock, it will now apply only to incremental equity, defined on a 5-year moving average basis. In addition, a limit on the NID and other deductions is established, equal to €1 million plus 70 percent of the balance after the investment deduction is applied. The reform further broadens the tax base by introducing various measures against tax avoidance, such as interest deduction limitations, controlled foreign company (CFC) rules, and exit taxes. These measures are consistent with Belgium’s obligation to comply with the EU’s Anti-Tax Avoidance Directive (ATAD). Because the effects of the base-broadening measures will not be felt immediately, the reform includes some administrative measures—for example, increasing the penalty for insufficient advanced payments—designed to boost revenues in the interim and render the reform revenue-neutral in all years.

Staff assessment: The reduction in the headline CIT rate should help improve Belgium’s competitiveness and attract foreign investment. However, the increased gap between the CIT rate and personal income tax rates, combined with the lack of capital gains taxes, could create incentives for individuals to register as a corporation, which can lead to organizational inefficiencies, revenue losses, and misallocation of capital. The narrowing of the NID, while serving as an important revenue compensating measure, reintroduces a degree of debt bias into the tax system by increasing the cost of equity capital, while interest deductions remain in place. Moreover, the CIT reform does not address inefficiencies related to preferential treatment of income from intellectual property.

Estimated Budgetary Impact of CIT reform

(EUR millions)

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Source: National Bank of Belgium.

Analysis by the National Bank of Belgium (NBB) finds the reform to be broadly revenue neutral, though with some degree of uncertainty. The revenue effects of narrowing the NID depend on the reaction of companies and on the evolution of the notional interest rate, which is tied to the rate on Belgian government bonds.

Figure 2.
Figure 2.

Belgium: Fiscal Context

Citation: IMF Staff Country Reports 2018, 071; 10.5089/9781484346051.002.A001

Sources: Haver Analytics, IMF World Economic Outlook, Eurostat, OECD, and IMF staff calculations.

B. Boosting Productivity

15. Productivity growth in Belgium has lagged peers. While many advanced economies have experienced a slowdown in productivity growth over the past two decades, the trend has been more pronounced in Belgium, with respect to both labor and total factor productivity growth. The literature has identified several common structural headwinds, including aging societies, slowing global trade, and a waning ICT boom.9 In addition, continued deindustrialization of advanced economies has implied a reallocation of resources to sectors where productivity growth is generally slower and declining. Policy distortions, including regulations that limit competition in services, have also been identified as potential culprits.10 Belgium faces many of these features common among advanced countries.


Evolution of Real GVA per Hour Worked

(Index 1996=100)

Citation: IMF Staff Country Reports 2018, 071; 10.5089/9781484346051.002.A001

*Note: Difference between productivity growth in Belgium and the average of Germany, France, and the Netherlands.Source: Eurostat

16. Sectoral reallocation effects explain part of the productivity gap with neighboring countries. Productivity developments have been heterogeneous across economic sectors: while industry, construction, and finance are performing at or above the regional average in terms of value-added per hour worked, service subsectors with large employment shares—including trade, travel, accommodation, public administration, education, and science—have seen subdued productivity growth. Labor productivity growth in ICT services has been particularly poor compared to peer countries and might have negatively affected TFP in the rest of the economy. The adverse productivity trend is amplified by the growing employment share of sectors with low labor productivity growth. Staff has performed a “shift-share analysis” to assess how shifts in the relative economic weight of different sectors affect overall labor productivity growth. The comparison with neighboring countries indicates that these sectoral reallocation effects, including deindustrialization, explain about half of the cumulative productivity growth gap with peers since 1996.11

17. An aging workforce and slower human capital accumulation are additional constraints on productivity growth. Demographic changes and increased participation rates have resulted in high employment growth of older workers. The share of 55+ workers in Belgium has increased twofold from 6.5 percent in 2000 to 15 percent in 2017. While increased participation by older workers is a positive development in general, it may have had an impact on labor productivity growth, with several studies linking workforce aging to declining labor productivity.12 Possible explanations include age-related changes in physical capability, knowledge depreciation (which could in some cases outweigh positive experience accumulation effects), and insufficient propensity to upgrade skills and adopt innovation.

18. Underinvestment in public infrastructure and its deteriorating quality are likely to be significant factors constraining productivity growth in Belgium. Public investment as a share of GDP has declined by half since 1970. At 2.2 percent in 2016, it stood significantly below the EU average of 3.9 percent. In real terms, public investment is barely at its level in 1980, whereas current primary spending has more than doubled. The decline in the 1980s was mainly the result of fiscal consolidation efforts that targeted public investment rather than current expenditures. Because of low investment, the stock of general government fixed assets amounts to only 36 percent of GDP, well below peers.13 Empirical studies show that improving infrastructure quality can have a significant positive impact on firms’ productivity. Staff has modeled the impact of a budget-neutral shift from current to capital spending that brings Belgium’s capital stock in line with its neighbors, demonstrating the significant positive effects on productivity growth and GDP (Box 2).


General Government Fixed Assets

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 071; 10.5089/9781484346051.002.A001

Source: Eurostat

Simulating an Increase in Public Investment

Staff used the IMF’s Global Integrated Monetary and Fiscal Model (GIMF) to simulate the effects of an increase in public investment in transport infrastructure.1 GIMF is a large-scale dynamic stochastic general equilibrium (DSGE) model that considers the implications of policy changes for the demand and supply sides of the economy. It was calibrated using Belgian macroeconomic data.

The simulation assumes a gradual expenditure-neutral shift from current spending towards public investment (peaking at 2 percent of GDP after 5 years). This causes the public capital stock to increase gradually, from 36 percent of GDP initially to 51 percent of GDP by 2029, undoing the deterioration since 1995 and bringing it in line with the average public capital stock level in neighboring countries. The higher capital stock increases productivity and thereby lowers prices, leading to a gradual real exchange rate depreciation and increase in net exports. Higher productivity also creates a wealth effect that boosts private consumption.

Overall, the model predicts a cumulative GDP increase of around 6 percent in the long run. While this magnitude is broadly in line with similar simulations using DSGE models, it should be interpreted with caution in the Belgian case, given country-specific characteristics that were not modeled.2

1 See Voigts, S., 2018, “Simulating an Increase in Public Investment in Belgium,” accompanying IMF Selected Issues Paper.2 While the model is comparatively detailed, it remains stylized and does not account for all relevant factors. For instance, it does not consider Belgium’s (relatively high) import share of exports, which implies that the growth impact of public investment via export demand could be significantly less pronounced in practice than modeled.
Figure 3.
Figure 3.

Belgium: Productivity

Citation: IMF Staff Country Reports 2018, 071; 10.5089/9781484346051.002.A001

Sources: Eurostat, World Economic Forum, OECD, ORBIS and IMF staff calculations.

19. Limited competition in service sectors appears to have had both direct and indirect effects on productivity. While Belgium’s overall product market regulation score is not worse than the OECD average, many service sectors, including telecommunications, retail, legal and accounting, and land transportation, face comparatively high barriers to entry and competition. Cross-country analysis by staff using firm-level data shows that high levels of sectoral regulation are associated with lower productivity growth, as regulatory protection reduces firms’ incentives to innovate and raise efficiency. While the direct effects on total productivity are limited by the small share of these sectors in the economy, large spillovers to all the sectors using inputs from the business services make the total drag on productivity significant. Staff econometric analysis indicates that reducing the degree of regulation to the best practices in the EU could raise annual TFP growth by 1 percentage point, largely due to reducing the adverse regulation spillover effect.14

20. These findings suggest that lifting Belgium’s productivity growth requires a combination of reforms. Efforts should focus on: (i) increasing public investment in critical infrastructure, especially energy and transport, which is an important constraint on Belgium’s growth potential; (ii) boosting competition in services by enhancing institutional capacity to foster competition and lowering regulatory barriers closer to the level of best practice observed in the EU; (iii) fostering innovation through the appropriate design of planned tax reforms, including by reforming the innovation income deduction;15 (iv) strengthening lifelong learning, especially in ICT. Boosting productivity growth through such reforms could help improve external competitiveness and mitigate the impact of population aging on potential growth.

Authorities’ Views

21. The authorities are concerned about slow productivity growth and agreed that upgrading infrastructure and strengthening competition would help. They observed that slow productivity growth is a common problem in advanced economies and pointed to the recently created National Productivity Council, which will focus on this issue. They agreed that some sectors (professional services, telecommunications, construction, retail) would benefit from more competition and said the legal and regulatory framework could also be improved. They highlighted recent reforms in the energy sector that have helped increase competition, as well as a new telecommunications law that facilitates switching carriers (“easy switch”). They drew attention to new tax incentives in the CIT reform aimed at boosting investment and R&D expenditures (e.g., a temporary increase in the investment deduction for SMEs and the self-employed, a broader exemption from withholding tax for researchers, tax incentives for growth financing, and the development of a tailor-made financial ecosystem for growth companies). They also noted plans to increase investment in mobility, energy transition, digitalization, education, health and security under the Strategic Investment Pact.

C. Addressing the Fragmentation of the Labor Market

22. The labor market is improving, reflecting the positive impact of reforms. Pension reforms in 2013 and 2015 have contributed to a significant increase in the participation rates of the older workers. Recent reforms to reduce taxes on labor and contain wage growth have also paid off, resulting in strong employment growth and declining unemployment rates, with older workers accounting for much of the employment increase.

23. However, fragmentation of the labor market remains high. Youth unemployment, at 20 percent in 2016, remains above the EU average and could have long-lasting effects on young people’s productivity and incomes, as well as their social prospects.16 Large regional disparities in unemployment rates persist. Employment rates among the low-skilled and immigrants born outside the EU remain very low, and skills mismatches are growing (Figure 4). Staff analysis using micro census data to examine the relative likelihood of being employed conditional on belonging to a certain socioeconomic group confirms that there are significant disadvantages for the young, the low-skilled, and especially non-EU immigrants when controlling for other individual characteristics. The limited progress in integrating these vulnerable groups into the labor market is not only a social and fiscal issue but also an important constraint on potential growth in Belgium.

Figure 4.
Figure 4.

Labor Market Fragmentation

Citation: IMF Staff Country Reports 2018, 071; 10.5089/9781484346051.002.A001

Source: Eurostat.

24. Recent labor market measures will help, though more could be done to unlock Belgium’s large untapped labor market potential. The 2017 summer agreement included some new measures to reduce the tax wedge for younger workers and increase labor market flexibility (Table 2). To better integrate vulnerable groups into the labor market, it will be crucial to address educational gaps including in languages, improve the supply of and demand incentives for vocational training, develop apprenticeship programs, and reduce barriers to geographical mobility.17 The wage setting process, guided by the revised 1996 law, has recently supported wage moderation. To ensure that it supports growth and employment, it should reflect not only comparator country wages but also productivity developments as well as regional and sectoral labor market conditions. The new National Productivity Council could play a useful role in informing social partners in this respect. Moreover, ensuring an adequate degree of flexibility for labor agreements at the enterprise level would support employment and competitiveness.

Authorities’ Views

25. The authorities highlighted recent progress in addressing labor market challenges while acknowledging that more efforts are needed. Past reforms to moderate wage growth and reduce the labor tax wedge have contributed to the current job-rich recovery. The authorities also pointed to several measures in the 2017 summer package that could help integrate vulnerable groups into the labor market, including shorter notice periods during the first six months of employment, “flexi- jobs” in retail industries, more working-hour flexibility in the e-commerce industry, tax advantages for employers hiring young workers, and “mystery calls” to combat discrimination in the hiring process. They acknowledged that increasing productivity without reversing gains in the integration of low-skilled workers was a key challenge. Another challenge is to ensure that older workers who extend their careers receive the training necessary to keep their skills up to date.

D. Preserving Financial Stability

26. The soundness of the Belgian financial sector has improved significantly since the crisis. Capital buffers have increased, with Tier I capital ratio rising by about 300 basis points since 2009 to 16.2 percent. Non-performing loans have fallen to 2.4 percent of gross loans. Profitability has recovered, and banks’ migration to the new Basel III standards is well underway. The banking sector is now more focused on traditional financial activities and markets, while the insurance sector has restructured itself in response to a protracted period of sluggish growth and low interest rates. Stress tests on banks and insurance companies conducted in the context of the 2017 FSAP confirm that they can absorb credit, sovereign, and market losses in the event of a severe deterioration in macro financial conditions.18

27. Nevertheless, cyclical vulnerabilities are rising. Whereas household debt in the euro area has been falling since the crisis, household debt in Belgium continues to increase and currently stands at 60 percent of GDP, with mortgage debt accounting for 90 percent of the total. Although the aggregate financial position of households remains strong thanks to a very high level of assets, households have become net borrowers (on a flow basis) for the first time in nearly a decade. Consolidated non-financial corporate (NFC) debt has increased to 129 percent of GDP (as of June 2017), well above the euro area average of 79 percent. However, nearly half of this amount consists of intragroup debt with small residual exposures for the Belgian financial system. The increases in household and corporate leverage have coincided with a steady increase in housing and equity prices in the context of low interest rates and low risk premia. Price-to-earnings (P/E) ratios exceed P/E ratios in the euro area and the United States (as of September 2017).19

28. The housing market appears to be only moderately overvalued, but pockets of vulnerability exist. Having grown rapidly in the 2000s, residential housing prices did not experience a sharp decline during the crisis, and have since risen by about 20 percent in nominal terms. The price-to-rent and price-to-income ratios stand well above their historical averages. More sophisticated measures, however, indicate only a moderate overvaluation.20 Since 2015 there has been a reversal in the tightening of mortgage lending standards, as evidenced by a growing share of loans with high loan-to-value (LTV) and/or high debt service-to-income (DSI) ratios.21 Risks are mitigated to some extent by the fact that Belgian households generally hold considerable financial assets. Nevertheless, nearly a third of outstanding mortgage debt is held by households whose liquid financial assets cover less than six months of debt service.22


Price-to-Rent Ratio

(Percent deviation from historical mean; 1995Q1–2017Q3)

Citation: IMF Staff Country Reports 2018, 071; 10.5089/9781484346051.002.A001

Source: OECD and IMF staff calculations.

29. It will be important to stand ready to tighten macroprudential conditions further if balance sheet risks were to grow significantly. To address growing risks in the housing market, the NBB in 2014 introduced a 5 percent risk weight add-on for banks using internal ratings models to determine their minimum regulatory capital requirements for mortgage loans. In 2017, the NBB proposed a tightening of macroprudential policies through a targeted increase in capital charges linked to the riskiness of exposures, proxied by LTV ratios. However, as this proposal was not accepted by the government, the NBB subsequently proposed a new macroprudential measure requiring banks with riskier mortgage portfolios to hold more capital. This measure should be enacted promptly. Looking ahead, it will be important to strengthen the NBB’s ability to deploy cyclical macroprudential measures in the financial sector in a timely manner.

30. Belgium’s banks need to continue adapting their business models to an evolving economic and technological environment. Although profitability has recovered since the crisis, it has more recently come under pressure from persistently low interest rates. Should rates remain low, profitability could suffer further, particularly as mortgages continue to be refinanced. Thus, staff stressed the need for banks to further reduce operating costs and diversify revenue sources to boost profitability. More broadly, the financial sector will need to adapt to the growing digitalization of finance and step up protections against cyber security risks. Banks were also encouraged to carefully manage their interest rate risk, particularly against an abrupt increase in market rates that could put downward pressure on their interest margins if their liabilities were to reprice faster than their assets.

Figure 5.
Figure 5.

Belgium: Financial Sector Developments

Citation: IMF Staff Country Reports 2018, 071; 10.5089/9781484346051.002.A001

Source: Haver Analytics.

31. Carefully navigating the transition to a European Banking Union poses important institutional challenges. Completion of Banking Union is a central objective for Europe, with significant potential benefits. Progress is being made, especially with respect to the resolution framework. Close cooperation between the NBB, the ECB, and the Single Resolution Board is necessary to address challenges arising from the key role subsidiaries of euro area banks play in Belgium’s banking sector. These systemically important euro area subsidiaries should continue to be closely supervised under the Single Supervisory Mechanism, and they should maintain sufficient capital and loss absorbing capacity until the completion of the Banking Union.

Authorities’ Views

32. The Belgian authorities broadly shared staff’s assessment. They agreed that cyclical vulnerabilities were rising while stressing that risks are currently not elevated. Risks associated with increasing household leverage were to some extent mitigated by the high level of assets combined with a relatively low share of variable rate loans, while the level of NFC debt was not too high when adjusted for the high share of intragroup lending. The authorities do not believe the residential housing market is strongly overvalued, but agreed that systemic risk is building and that some segments pose heightened risks. The NBB is addressing these risks through macroprudential measures. They confirmed their determination to work toward a European Banking Union and help ensure that in the transition period the systemically important subsidiaries of euro area banks hold sufficient loss absorbing capacity.

Staff Appraisal

33. The strengthening recovery is an opportunity to boost the resilience and long-term growth potential of the Belgium economy. The government has made important progress in delivering on its reform agenda. With the economic recovery strengthening, the government should maintain the reform momentum and lay the foundation for stronger, more inclusive growth in the future. Fiscal consolidation remains a priority, and further labor and product market reforms are needed to increase productivity growth, raise potential output, and integrate vulnerable groups into the labor market. Such reforms will not happen overnight, but it is important not to yield to complacency.

34. Given the high level of public debt, Belgium should continue pursuing gradual fiscal consolidation based on deeper reforms to make public spending more efficient. The sharp decline in the budget deficit in 2017 is encouraging and at least partly reflected the payoff from previous reforms. Nevertheless, more efforts will be needed to achieve the government’s objective of structural balance in the medium term and create fiscal space for more public investment. Further adjustment should be driven by reforms to make spending more efficient, in particular by reducing subsidies, making the division of labor between levels of government more efficient, accelerating ongoing reductions in public employment, and better targeting social benefits. Coordination and participation across all levels of government will be essential.

35. The welcome reform of corporate income and labor taxation should be complemented by additional measures to safeguard revenues and promote economic efficiency. The reform of the corporate income tax system appropriately lowers the high statutory rate and broadens the tax base, including through anti-tax avoidance measures. Additional tax reform should focus on addressing distortions in the current system while safeguarding revenues, particularly given the expected revenue losses from the next phases of the tax shift. There is scope to further broaden the tax base by eliminating certain deductions and exemptions. Restoring balance between different forms of business income and limiting tax arbitrage would make the system more efficient.

36. Raising the low rate of productivity growth would help improve external competitiveness and mitigate the impact of population aging on potential growth. While the decline in productivity growth partly reflects deindustrialization and sectoral shifts toward services common to many advanced countries, Belgium has lagged its peers in part due to a long period of underinvestment and limitations to competition in some service sectors. It will thus be important to step up efforts to upgrade infrastructure, particularly transport and energy, coordinated among all levels of government. There is also scope to enhance competition in services by lowering regulatory barriers and to foster innovation through tax reforms and support for education and training. Faster productivity growth could help improve Belgium’s external position, which is moderately weaker than implied by medium-term fundamentals.

37. To fully realize Belgium’s employment potential, it is critical to address the fragmentation of the labor market. Older workers account for much of recent employment gains, whereas less progress has been made integrating immigrants born outside the EU, the young, and the low-skilled. Moreover, significant regional disparities persist. Further reforms are needed to address educational gaps, improve the supply of and demand incentives for training, and reduce barriers to geographical mobility. The wage setting process, guided by the revised 1996 law, should not only reflect comparator country wages but also productivity developments as well as local and sectoral labor market conditions.

38. The resilience of the financial sector has improved considerably since the crisis, but cyclical vulnerabilities are rising and new challenges are emerging. Household and corporate leverage is increasing, partly reflecting the low interest environment. It will be important to stand ready to tighten macroprudential conditions further if balance sheet risks were to grow significantly, which could be facilitated by enhancing the NBB’s ability to deploy macroprudential measures in a timely manner. The transition to a full European Banking Union needs to be carefully navigated, including by continued close supervision of systemically important subsidiaries of euro area banks operating in Belgium. Banks should further reduce operating costs and diversify revenue sources to adapt to a changing economic, technological, and regulatory environment.

39. It is proposed that the next Article IV consultation take place on the standard 12-month cycle.

Table 3.

Belgium: Selected Economic Indicators, 2014–23

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Sources: Haver Analytics, Belgian authorities, and IMF staff projections.

Contribution to GDP growth.

As of December 2017.

Table 4.

Belgium: Balance of Payments, 2014–23

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Sources: Haver Analytics, Belgian authorities, and IMF staff projections.
Table 5.

Belgium: General Government Statement of Operations, 2014–23

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Sources: Haver Analytics, Belgian authorities, and IMF staff projections.

Excludes the 2012 Dexia recapitalization.

Table 6.

Belgium: General Government Consolidated Balance Sheet, 2009–16

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Sources: Haver Analytics and IMF staff calculations.
Table 7.

Belgium: Financial Soundness Indicators for the Banking Sector, 2009–161

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Sources: National Bank of Belgium.

Consolidated data. Data are based on the IAS/IFRS reporting scheme.

Only loans to households as of 2014

Excluding saving certificates as of 2014

Deposits booked at amortized cost only.

Only household deposits as of 2014

Unconsolidated data.

Annex I. Main Recommendations of the 2017 Article IV Consultation and Authorities’ Response

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Annex II. External Sector Report

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Annex III. Risk Assessment Matrix

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