Country Report Belgium
While the escalation of the European debt crisis has led to negative GDP growth in Belgium in 2012, the government still seems committed to fiscal austerity. Weaker growth prospects and political hurdles, however, make significant budget cuts and the implementation of unpopular yet necessary pension and labor market reforms challenging. That said, the solid financial position of the private sector, while not neglecting potential risks, and Belgium’s institutional strength suggest that the country’s underlying economic fundamentals remain strong.
In 2012, the slowdown of world trade and the escalation of the European debt crisis took its toll on the Belgian economy and GDP growth turned negative (-0.1%). Tighter financial conditions, persistent uncertainty, increasing unemployment, and fiscal consolidation tempered domestic demand, while a deceleration of global demand hampered exports. Going forward, we do not expect GDP growth to rebound strongly in 2013. Domestic demand will be suppressed by a weak labor market, tight credit conditions, low capacity utilization, and sizeable fiscal austerity measures. The recent drop in inflation will not substantially increase households’ purchasing power because of automatic wage indexation. As far as external demand is concerned, the expected pick up in world trade can lead to a modest increase in net trade’s contribution to GDP growth. But exports alone cannot push the wider economy into the growth territory.
Large debt ratio demands for a committed government…
The harsh austerity measures implemented by the government last year are necessary given the country’s weak public finances. Although during the last two decades the government was very successful in bringing down public debt (from 138%-GDP in 1993 to 88%-GDP in 2007), since the financial crisis government indebtedness increased again (100%-GDP in 2012). The European Commission requires that Belgium brings its debt ratio below 100% this year and to implement structural budget cuts amounting to around 1% of GDP. The government has paved the way to achieve this adjustment so that it can safeguard debt sustainability and maintain market calm. Recent experience has, however, shown that it is very difficult to generate budget surpluses in a weak growth environment. Refinancing needs are relatively large but government bond yields are low (around 2% at the time of writing) and despite its large debt ratio Belgium has never lost access to the bond market during the crisis. Downside risks remain, however, since if sentiment changes, the large gross financing needs may rapidly develop into a real problem. In addition to the currently elevated government debt level, there exist significant contingent liabilities due to bank restructuring and guarantees provided to Belgian banks (together worth almost 15% of GDP). These contingent liabilities could further threaten debt sustainability if balance sheets of financial institutions were to deteriorate. Against this backdrop, a continuation or deepening of the European debt crisis should be considered as a significant downside risk to Belgian’s fiscal sustainability.
…also in the medium to long-run
Next to short-term fiscal consolidation, medium and long term reforms are inevitable to increase potential economic growth and to enhance the sustainability of public finances. This is especially important given the impact of aging on public spending alongside a relatively low effective retirement age (61.4 years) and labor force participation rate (69%). Pension and labor market reforms implemented and agreed upon since end 2011, such as reduced pension and unemployment benefits, increased minimum early retirement age (from 60 to 62 in 2013) and stricter eligibility requirements for early retirement and unemployment benefits, are steps into the right direction but insufficient.
In order to keep public debt sustainable, achieving higher nominal GDP growth is key. It is, therefore, crucial to reverse the deterioration of Belgian firms’ competitiveness, since exports are an important driver of GDP growth. Measures introduced in the 2013 budget bill to reduce wage and (energy) price growth are very welcome but insufficient to bolster competitiveness. Agreement on necessary reforms is hard to reach given the broad spectrum of parties in government and wide (both social and economic) differences between Flanders and Wallonia. Furthermore, the large debt ratio in combination with the weak growth outlook provides little room for (potential) growth enhancing public spending and measures to incentivize the private sector to invest in R&D.
Wealthy private sector to face high debt and elevated house prices
Private sector credit growth, while slowing since 2010, has been significant in the past two decades, almost doubling in 15 years to a level of 237% of GDP in 2012. Factors mitigating the risk of this fast growth are a low level of household debt compared to eurozone peers and very high household financial assets (in 2011 household net financial assets amounted to 212%-GDP and 515% of disposable income). It should be noted that more than 80% of debt held by households comprises mortgage debt and, while slowing since 2010, real house prices have risen significantly in the past decade. Between 2000 and 2011 real house prices rose by 62%-points and the price-to-income ratio was 47% above its long-term historical average in 2011. Although financial savings are large, a fall in house prices and/ or a rise in unemployment pose a risk to households’ solvency. The housing market, therefore, contains potential risks for financial stability. As far as the corporate sector is concerned, the debt-to-financial asset ratio is low and net debt levels are moderate (around eurozone average). Both gross liabilities and assets are, however, far above eurozone average, and small and medium enterprises (SMEs), which are vulnerable to a weakening macro-environment, make up for a large part of the loan portfolios of Belgian banks. For that matter, a deteriorating economic landscape should be considered a downside risk for the financial sector. That said, in recent years much deleveraging has taken place in the financial sector and as of end-2012 banks are well capitalized and loan-to-deposit ratios are low. We therefore believe the financial sector is relatively healthy, though not immune to risks.