DBRS Confirms Belgium at AA (high) with Negative Trend

DBRS Ratings Limited (DBRS) has today confirmed its ratings on the Kingdom of Belgium’s long-term foreign and local currency debt at AA (high) with Negative trends, and on the short-term foreign and local currency ratings at R-1 (high) with Stable trends. The ratings reflect Belgium’s high GDP per capita, high productivity levels, and strong household balance sheet. Belgium’s ratings are also supported by a sound track record of fiscal consolidation and the benefits associated with membership of the Euro area. However, Belgium’s ratings continue to be constrained by: (i) the country’s large stock of public sector debt and its relatively high funding needs, (ii) a weakened financial sector with large government guarantees, and (iii) weak growth prospects and waning competitiveness. The ratings are further constrained by low employment rates and an ageing population, and by the prevalence of a marked political and economic regional divide that could undermine political stability and the country’s ability to reduce its high stock of debt.

DBRS assigned a Negative trend to the ratings in November 2011 as a result of tension in financial markets that could result in funding pressures for the sovereign given its high public debt ratio and significant stock of contingent liabilities. DBRS believes that the formation in December 2011 of a six-party coalition government after an 18-month stalemate is credit positive. However, DBRS is maintaining the Negative trend on the long-term ratings because of the continued pressure on the debt ratio driven by: (i) the deterioration in the growth outlook since the last DBRS review, (ii) the potential for further capital transfers to the country’s financial institutions, and (iii) the sovereign’s exposure to refinancing risk.

After a period of 18 months with only a caretaker administration in place, Belgium formed a six-party coalition government in December 2011. The new government included a series of consolidation measures in the 2012 Budget amounting to EUR 11.3 billion (3% of GDP) in spending cuts and tax increases, plus a spending freeze of about 0.4% of GDP. In March 2012, the authorities adopted a further round of consolidation measures worth 0.3% of GDP. According to estimates by the National Bank of Belgium (NBB) these measures resulted in a 1.7 percentage point increase in revenues as a share of GDP, from 49.4% in 2011 to 51.1% in 2012, involving almost all revenue categories. In addition, revenues benefited from an extra EUR 0.5 billion from a tax amnesty programme that will run until 2014. As a result, the deficit for 2012 is expected at approximately 3.0% of GDP, 0.2 percentage points above the target but down from 3.7% of GDP in 2011.

Despite this progress, Belgium’s debt is expected to increase to 100.6% of GDP in 2012, slightly higher than the 99.4% estimate in the 2012-15 Stability Programme. The increase in the debt ratio in 2012 reflected the costs associated with the recapitalisation of Dexia SA, which added 0.77 percentage points to the debt ratio, and the contributions to the European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM), which added a further 1.5 percentage points to the country’s debt. Going forward, the government expects the debt (inclusive of the Dexia SA recapitalisation costs) to fall to 92.3% of GDP by 2015. However, this projection was based on an assumption of an average annual growth of 1.6% over the 2013-15 period. The growth outlook has since deteriorated, with the latest assessment by the NBB pointing to a contraction of real GDP by 0.2% in 2012 and 0.0% in 2013. DBRS thus sees downside risks to the government’s debt projections.

DBRS also sees material risks to European Commission estimates for potential growth of 1.6% per annum. This is because 90% of the growth in potential output is expected to come from productivity growth, which has, in recent years, been weak and has turned negative in recent months. Were potential growth to underperform expectations, reducing the stock of debt would likely take longer than anticipated.

Belgium’s stock of contingent liabilities also presents risks to the fiscal consolidation programme. At the end of March 2012, contingent liabilities were estimated at EUR 54 billion (15.7% of GDP), of which 90% relates to the financial sector. Moreover, and despite recent progress in reforming the pension system, the country faces high contingent liabilities associated with its ageing population. In addition, with 17.2% of GDP in financing needs in 2013 and 40% of GDP worth of debt to be rolled over in the next 5 years, Belgium is exposed to refinancing risks.

Waning competitiveness is also materialising in a deteriorating current account, as Belgian exports to emerging markets remain subdued as a result of the country’s export mix and unfavourable developments in unit labour costs relative to the country’s main trading partners and the Euro area.

Going forward, the evolution of the ratings will depend on the trajectory of the debt ratio and developments affecting rollover risk. Triggers for a downgrade would include (i) a budgetary performance which falls significantly short of the targets outlined in the latest Stability Programme, (ii) a materialisation of contingent liabilities through the calling of sovereign guarantees and a deterioration in financial institutions, which results in an increase in government support. Conversely, DBRS may change the trend to Stable in case of (i) stronger GDP growth than anticipated coupled with the adoption of measures aimed at boosting the country’s growth potential and competitiveness, (ii) a reduction in refinancing risk, and (iii) a material improvement in the resilience of the country’s financial institutions.

Notes:
All figures are in EUR unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include the Belgian Debt Agency, Ministry of Finance, National Bank of Belgium, National Institute of Statistics, Federal Planning Bureau, IMF, OECD, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Carla Clifton
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 11 November 2011
Most Recent Rating Update: 16 November 2012

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