Statement by Mr. De Lannoy, Executive Director for Luxembourg and Mr. Jost, Senior Advisor to the Executive Director May 8, 2019

2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Luxembourg


2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Luxembourg

The Luxembourg authorities thank Mr. Stavrev and his team for the constructive cooperation during the Article IV consultation and the thorough assessment presented in their report. They broadly agree with staff’s appraisal and will, as in previous years, carefully consider the policy recommendations.

Luxembourg’s economy remains strong with sound employment and economic growth prospects. Public debt levels are low compared to peers and are projected to decline further. Public investment and social spending remain high. A stable political and social environment, a skilled international labor force, a long-standing track record of fiscal prudence and a robust and predictable legal and regulatory framework, including in the financial sector, are key factors supporting growth. A continuous triple-AAA credit rating confirms the market’s confidence in the country. The recently re-appointed Government is fully committed to prudent economic and fiscal policies supporting the country’s competitiveness and resilience, while increasing its efforts to reduce the economy’s ecological footprint and promoting inclusiveness.

The authorities concur with staff regarding mostly external downside risks, including a retreat from cross-border integration, and policy uncertainty at European and global level. On the national level, sustained increases in population, notably as a result of strong economic growth, lead to structural challenges including pressures on infrastructure and the housing market. The authorities continue to actively monitor and manage the existing risks, fully aware of the open nature of Luxembourg’s economy, as, for instance, the preparations for a possible disorderly exit of the United Kingdom from the European Union show. Challenges arising from changes in international taxation are considered to be balanced, as the more level global playing field could also bring other traditional strengths of Luxembourg’s socio-economic context to the fore.

Macroeconomic outlook

Economic growth is expected to remain strong. Despite lower growth expectations in the Euro Area, the Luxembourg economy is set to grow at 3.0 percent in 2019 and 3.8 percent in 2020, according to the national statistical agency. Similarly, employment growth, measured at 3.7 percent in 2018, is also projected to remain strong at 3.4 percent in 2019. Financial and business services, healthcare and ICT remain among the most dynamic sectors for job creation. Unemployment is expected to further trend down from 5.5 percent in 2018 to 4.8 percent in 2020, to reach post-crisis lows.

The current declining trend in unemployment is due to both the Government’s targeted active labor market policies and favorable growth dynamics. In particular, the employment agency has devised personalized programs tailored to the needs of, often long-term, unemployed, in a high-skilled and rapidly evolving labor market. Examples include the reform of the Revenu d’Inclusion Sociale which aims at combating inactivity traps, or the novel Digital Skills Bridge program designed to provide technical and financial assistance to companies upskilling their employees even before their jobs may be digitized. The authorities remain committed to closely working with the private sector and adapting policies to the challenges posed by digitalization.

Public finances

Luxembourg’s fiscal position remains structurally sound. The projected drop of the general government nominal surplus from +2.6 percent of GDP in 2018 to +1.0 percent in 2019 and +1.4 percent in 2020, primarily reflects a prudent approach in estimating fiscal revenues. It also reflects the Governments’ strong commitment to the socio-economic resilience of the country and its focus on high levels of public investment to prepare the country for future challenges, notably by investing in climate- and ecologically-friendly infrastructure. At the same time, the authorities continue to set aside substantial amounts to a dedicated pension reserves fund, whose assets have accumulated to around 33 percent of GDP by the end of 2018. Reserves are destined to finance future pension obligations and would contribute to mitigating potential challenges arising from population ageing. Debt levels remain low at 21.4 percent of GDP in 2018 and are projected to decline to 20.2 percent and 19.9 percent in 2019 and 2020 respectively.

Low and declining public debt levels, a budget in surplus, the continued full respect of EU fiscal rules as well as its self-set public debt limit of 30 percent of GDP, demonstrate the Government’s longstanding commitment to sound fiscal policies. The authorities are aware of the existing revenue risks and stand ready to actively address them, as past years have shown. Examples include fiscal remedies in response to the change to the EU VAT regime applicable to electronic commerce activities, or continued policy adjustment in the context of ongoing BEPS-related developments. In this vein, maintaining fiscal room for maneuver acts as a countercyclical fiscal buffer and adds to the economy’s resilience to potential shocks. This prudent approach is in line with past and present IMF recommendations, notably for small and open economies.

While the short- and medium-term fiscal position remains favorable, the authorities agree that population ageing could pose challenges in the long-run, while noting that cost of ageing projections are subject to volatile assumptions on demographic and economic developments. The authorities thank staff for their thorough assessment and providing sensitivity analyses, which can help frame a policy debate. As noted by staff, past reforms have introduced a parametric framework that facilitates adjustments, but political economy considerations remain key. The authorities place strong emphasis on discussing possible reforms with social partners. Finally, a dedicated pension reserve fund provides a significant buffer, with assets amounting currently to some 33 percent of GDP, which allow to sustain pension expenditures over a substantial period into the future, even under a no-policy change scenario.

Economic policy

The Government remains committed to high levels of public investment, in both tangibles and intangibles, in line with IMF recommendations. Going forward, public investment spending is scheduled to amount to over 4 percent of GDP annually and aims at addressing infrastructure needs, including in housing and public transportation, and at preparing the economy for technological change, while continuing efforts to diversify the financial sector and the economy as a whole. Investments in ICT infrastructure and e-Government remain key. In addition, the Government’s policies aim at making growth more socially inclusive and beneficial for all. Reducing the carbon footprint of the economy and supporting R&D are other areas of priority. The Government remains committed to the emission targets agreed under the Paris agreement. The planned increase in fuel taxation, among other measures, illustrates this commitment. The authorities look forward to working with staff to further improve public investment efficiency.

As the staff report highlights, Luxembourg has fully embraced the international tax transparency agenda. Over the last five years, the Government has taken and continues to take decisive actions to align its tax framework to international standards, including those set by the OECD, such as the BEPS action plan. Luxembourg is participating in the automatic exchange of information in the field of taxation and has put into place a BEPS-compliant IP box regime. In addition, in 2018 and 2019 respectively, parliament transposed the Anti-Tax Avoidance Directive (ATAD) I, as well as the Multilateral Instrument (MLI). The authorities expect to transpose the ATAD II by the end of 2019. This is in addition to earlier steps, such as the introduction of regulations aimed at neutralizing hybrid mismatches or the introduction of the arm’s length principle into national law.

Reflecting some of these efforts, the 2019 peer review report by the OECD Global Forum on Transparency and Exchange of Information for Tax Purposes found Luxembourg to be “largely compliant” with the international standard of transparency and exchange of information on requests. The Government remains committed to staying actively engaged in all relevant fora and to aligning the tax framework to international developments. Recent efforts at the OECD level are a powerful example of a successful global consensus-based approach, which Luxembourg continues to fully support. In this sense, the authorities welcome staff’s analysis of BEPS actions implemented in Luxembourg.

The authorities are aware of the challenges stemming from a changing international tax environment. They are monitoring the developments closely and stand ready to adapt where necessary. At the same time, the authorities stress the importance of a global level playing field, which would also bring about opportunities, considering Luxembourg’s various other comparative advantages such as its political and social stability, prudent policies and an effective governance framework.

Financial sector

The financial sector remains sound. As staff points out, banks are profitable and maintain high levels of capital, liquidity and asset quality. NPLs are very low, both in absolute levels and compared to peers. Banks remain resilient to shocks as stress tests indicate. The fund industry, distributing to a diverse pool of investors both in the European internal market and globally, remains an important component of the financial industry in Luxembourg. The authorities continue to closely monitor existing and emerging risks, in both the fund industry and banking sector, including at the level of the Systemic Risk Committee (CdRS).

The authorities remain committed to implementing robust financial policies, notably by continuously adjusting the national regulatory framework and macroprudential surveillance to evolving international standards and best practices. Authorities are thereby also following up on IMF recommendations, as staff rightly highlights. As such, the frequency of on-site inspections for investment funds and banks has increased, engagement with authorities of other jurisdictions has been strengthened even further, revised early warning indicators under the Solvency II regime are used, and steps to standardize reporting of borrower-related indicators have been taken. The authorities are contributing to the development of consistent leverage measures, guidance for liquidity stress testing by investment fund managers, and standardized stress testing for money market funds.

Similarly, the authorities took a number of steps to continue to strengthen the AML/CFT framework. Luxembourg transposed the 4th EU AML Directive (AMLD4), and the transposition work relating to the AMLD5 is on schedule. In addition, the authorities conducted a National Risk Assessment (NRA), in line with OECD best practices and are in the process of implementing a strategy to ensure that measures to prevent or mitigate money laundering and terrorist financing are commensurate with the risks identified in the NRA. A Register of Beneficial Owners of corporate and other legal entities was established in January 2019 in conformity with AMLD4 provisions.

The authorities believe that these efforts will further strengthen the robust and effective supervisory framework. In the same vein, the authorities are tracking evolving international regulatory standards and developments, and are actively engaged in discussions in all relevant fora such as ESMA, ESRB, FSB, IOSCO, SSM and SRM. The authorities also remain attached to the objective of further risk reduction in the banking sector at EU level to further strengthen financial stability in order to facilitate the completion of the banking union. At the same time, it is and remains crucial that institutions, including subsidiaries, maintain sufficient levels of own funds and eligible liabilities in order to allow for a smooth operationalization of resolution strategies.

Housing market

Economic developments and related population growth generate strong demand in the housing market. The Government has made alleviating housing supply constraints a priority, focusing in particular on increasing the availability of social housing. Accordingly, and in line with 2018 Article IV recommendations, the Government intends to change urban planning laws, boost the construction of social housing, and reform real estate taxation to reduce speculation. On the financial side, the authorities continue to actively monitor and manage potential risks, including within the Systemic Risk Committee (CdRS). The introduction of macro-prudential measures contributes to the build-up of capital buffers in the banking system. A draft enabling bill extending the macroprudential toolkit by including tools allowing for borrower-based mortgage lending measures is in the legislative process.

Diversification efforts

Despite the positive economic outlook, and in order to increase the economy’s resilience to shocks and facilitate employment across sectors, the Government maintains its efforts to diversify the financial sector itself and the economy as a whole.

Fostering innovation in the fields of financial technology and promoting climate finance, including in the form of public-private partnerships, remain priorities. The inception of the Luxembourg House for Financial Technology (LHoFT) and the International Climate Finance Accelerator Luxembourg showcase the ambitions of the Government to contribute to the continued development of the internationally oriented financial center, and to the mobilization of capital supporting climate change mitigation in Europe and beyond.

In addition to the efforts to further develop the ICT sector by providing first-class infrastructures and telecommunication, Luxembourg has implemented a legal and regulatory environment aimed at enabling private investors and companies to explore and use space resources via the initiative. More generally, the Government continues to pay careful attention to developing a climate conducive to business, investment and innovation, as reflected in the 2019 Budget.