DBRS Assigns AA (high) Rating to the Kingdom of Belgium, Trend Negative

DBRS Inc. (DBRS) has today assigned ratings of AA (high) to the Kingdom of Belgium’s long-term foreign and local currency debt. The trend on both ratings is Negative. The ratings balance Belgium’s strong private savings rate, positive net international investment position, high level of productivity and healthy household balance sheets with high public debt and large contingent liabilities in support of the financial sector. The trends are Negative as increased uncertainty in financial markets could result in funding pressures for the sovereign given its comparatively high public debt-to-GDP ratio and significant contingent liabilities.

Belgium’s small, open economy was exposed to the global financial crisis, with a financial sector that suffered substantial losses from holdings of securitised assets. Renewed funding pressures led to the recent dismantling of Dexia SA, which relied heavily on market funding, requiring a continuation of guarantee support from the public sector. However, the recovery has been relatively strong as the country is one of the few Euro Area economies whose first quarter 2011 GDP exceeded its pre-crisis peak.

The Kingdom of Belgium has undergone a deep political crisis. However, an agreement has been reached that will likely allow for the formation of a new government. Elections were held in June 2010 and only in October 2011 did negotiations appear to be moving decisively toward a conclusion. The issues that separated the political parties included demands for greater fiscal devolution from the Flemish region and the electoral reform of the Brussels-Halle-Vilvoorde (BHV) district. This stalemate was even more of a concern in an environment characterised by a slowdown in growth across Europe, including Belgium’s three main trading partners – France, Germany and The Netherlands – and a sharp increase in uncertainty in financial markets.

The recession of 2009 brought an end to the successful fiscal consolidation that reduced public debt from 134% of GDP in 1993 to 84% in 2007. The subsequent deterioration in public indebtedness was due equally to the fiscal effects of the recession and to the support given to the financial system. Public debt worsened less in Belgium than in other Euro Area economies, but nonetheless remains one of the highest in Europe at 96.2% of GDP in 2010, which is well above the 60% Maastricht ceiling.

Despite the significant challenges posed by high public debt, fiscal adjustment has been on track. With the strength of the recovery, the government exceeded its fiscal deficit target for 2010 and will likely meet this year’s target of 3.6% of GDP. However, to reach the target of 2.8% of GDP in 2012, a significant effort will likely be required, particularly in light of the reduction in growth projections. DBRS takes comfort in Belgium’s history with fiscal consolidation and in the relatively good performance of the economy, which makes debt stabilisation and reduction less difficult.

Belgium has been a substantial provider of savings to the rest of the world, driven by a high national savings rate, which averaged 25% of GDP in the period 1999-2010. This has supported a high investment rate domestically and the acquisition of foreign assets, delivering a positive net international investment position of 78% of GDP in 2010. This strong external position is accompanied by a positive income balance, and shields the country from the effects of a disruption in external finance. Furthermore, with moderate household debt at 55% of GDP in 2010, there has been limited deleveraging, and loan growth appears supportive of the recovery.

As a relatively small country, Belgium has a very open economy to trade and direct investment, with high labour productivity. Exports of goods and services accounted for 78% of GDP in 2010, while Belgian foreign direct investment (FDI) stood at 63% of GDP and inflows of FDI reached 145% of GDP in 2009. Trade has played an important role as a driver of growth, although, as is the case with some other advanced economies, its share of world exports has fallen. Its output per hour worked is high and estimated to be at a similar level to that of The Netherlands and the United States of America. While measured productivity growth appears stagnant, real income per capita has grown moderately at an average of 1.8% for the period 1998-2007, slightly above the rates seen in France and Germany.

The large Belgian banking system suffered extensive losses from its holdings of securitised assets. As a result, it required extensive support from the public sector balance sheet, accounting for an increase in government debt of 5.9% of GDP and a rise in public contingent liabilities of 15.8% of GDP as of the end of 2010. The recent dismantling of Dexia SA, with the renewed stresses in funding markets, has led to the continuation of the support commitment, with a new public guarantee programme of up to EUR 54.4 billion, or 15% of GDP, for Dexia SA. Furthermore, the Belgian State has purchased Dexia Bank Belgium for EUR 4 billion.

Expenditure on pensions, health and old age care is a common concern among economies that are advanced in their demographic transition as fertility rates drop and life expectancies rise. A recent report by the Belgian High Council of Finance Study Committee on Ageing projects a rise in pension, health and old age care costs, at 1.3% of GDP by 2016 and 5% of GDP by 2030 under their benchmark scenario. On a medium-term horizon, the evolution of the economic recovery with the presence of significant downside risks to growth in Europe will be important in determining the impact on the financial sustainability of public pensions and health care.

Differences between the Flemish and Walloon regions, have led to demands for political reform and greater regional autonomy, particularly from the wealthier region of Flanders. The difficulties in reaching a broad consensus on devolution and political reform have deprived Belgium of a government since the elections of June 2010. In spite of the deep regional differences, DBRS believes that there is a wide political consensus on the need for debt stabilisation and reduction. As fiscal devolution deepens, however, the balance between central government and social security revenues and the evolution of their financial obligations, especially with respect to ageing-related costs, will be key for long-term fiscal sustainability.

In spite of the political challenge posed by the differences between the Flemish and Walloon regions, there has been significant willingness to reduce public debt in the past, with persistent large primary fiscal surpluses. With the heightened uncertainty in financial markets and lower growth expected in 2012, the implementation of a credible fiscal plan to meet the 2011-2014 Stability Programme fiscal targets and ensure debt reduction will be key to supporting the ratings. Stress on the public sector balance sheet from the support of the financial system, especially if the contingent liabilities were to be realised, or a significant deterioration in sovereign funding conditions, could place downward pressure on the ratings.

Notes:
All figures are in Euros (EUR) unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the National Bank of Belgium, Belgium Stability Programme 2011-2014, Belgian Debt Agency, Federal Planning Bureau, High Council of Finance, Statistics Belgium, OECD, Eurostat, Haver Analytics and IMF. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This credit rating has been issued outside the European Union (EU) and may be used for regulatory purposes by financial institutions in the EU.

This is the first DBRS rating on the Kingdom of Belgium.

Lead Analyst: Pedro Auger
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 11 November 2011
Most Recent Rating Update: 11 November 2011

For additional information on this rating, please refer to the linking document under Related Research.