DBRS Confirms Belgium at AA (high), Changes Trend to Stable from Negative

DBRS Ratings Limited (DBRS) has today confirmed the Kingdom of Belgium’s long-term foreign and local currency issuer ratings at AA (high) and changed the trend from Negative to Stable. DBRS has also confirmed the short-term foreign and local currency issuer ratings at R-1 (high) and maintained the Stable trend.

The rating confirmation reflects Belgium’s sound track record of fiscal consolidation, its wealthy and resilient economy and a sound net foreign asset position. The coalition government has already made substantial progress on fiscal consolidation and the 2014 budget aims to reduce the deficit further. Positive developments on the fiscal side have been accompanied by improving macroeconomic conditions. However, these supportive factors are balanced by significant challenges: the country’s large stock of public sector debt, high ageing costs, waning competitiveness and political fragmentation. The change in trend to Stable from Negative reflects two key drivers: (1) DBRS’s assessment that fiscal consolidation will support a reversal in government debt as reflected in a debt to GDP ratio expected to peak in 2015 as the primary fiscal balance approaches its debt-stabilizing threshold, and (2) diminished risks of contingent liabilities stemming from the banking sector following significant deleveraging.

DBRS sees risks to the ratings as being broadly balanced. If sustained improvement in the primary fiscal balance were to lead to a material reduction in the debt stock over the medium term, the ratings could experience upward pressure. On the other hand, weakened political commitment to fiscal consolidation, or a material downward revision to growth prospects, either due to adverse external shocks or weak domestic demand, could lead to a change in the trend to Negative from Stable. A further deterioration in the country’s competitiveness position and in trend growth prospects, as reflected in the failure to adopt credible measures aimed at boosting potential output, could also put downward pressure on the rating. DBRS emphasises the country’s strong net investment position, its strong fiscal framework and sound economic structure as key factors supporting the rating.

Belgium’s wealthy economy, with GDP per capita 20% higher than the EU average, has demonstrated considerable resilience. Healthy private sector balance sheets, as reflected in a modestly indebted non-financial sector and a high level of savings, and the successful restructuring of the banking sector, have supported the flow of credit to the economy. GDP is expected to expand by 1.4% and 1.7% in 2014 and 2015, respectively, driven by rising net exports and household consumption. Unemployment is set to rise further from 8.4% in 2013 to 8.5% in 2014 as job creation is projected to lag the recovery in GDP. DBRS expects however that the strong households' balance sheets will support private consumption despite the adverse labour market dynamics. Despite some recent weakening in the balance of payments, Belgium continues to benefit from a strong external balance as reflected in a net foreign asset position of 47% of GDP in 2013.

Belgium has a strong track record of fiscal consolidations both prior to the crisis when it brought its debt to 84% of GDP in 2007, down from 138% in 1993, and also more recently, as reflected in contained fiscal deficits. In 2013 the general government deficit declined to an estimated 2.7% of GDP from 4.1% in 2012, while its primary balance returned to surplus, at 0.5% of GDP, following four years of deficit. DBRS expects the deficit to remain below the 3% threshold in 2014-2017. However, the possibility of a renewed political deadlock following the May elections cannot be completely discounted and it increases risks of fiscal slippage. Belgium's experience of care-taker governments suggests that whilst an adverse market reaction to an unstable political environment is a real possibility, fiscal slippages would be mostly contained.

Risks stemming from the banking sector are gradually receding. The ongoing restructuring in the sector has reduced financial vulnerabilities whilst preserving the ability of the banks to provide credit to the economy. Deleveraging has reduced the balance sheet of banks to 268% in 2013Q2 from 410% of GDP in 2008. Capital injections have strengthened capital ratios but profitability is still low. Contingent liabilities from the banking sector remain high, yet they have declined to 12% of GDP in 2013 from 15.7% in 2012. In particular, KBC Group repaid EUR1.75 billion of state aid in 2013, and the Belgian government sold its 25% share of BNP Fortis for EUR 3.25billion (0.8% of GDP), allocating the full sale proceeds to the reduction of government debt. Over the near term DBRS does not expect additional capital injections into Dexia. Nonetheless, the group still has a sizeable portfolio of loans and government bonds in run-off mode and further write-downs cannot be ruled out over the medium term.

Despite this progress, several challenges weigh on the ratings. Belgium’s public debt remains high at 99.8% of GDP in 2013. The debt ratio stabilised in 2013 as a result of the positive impact of the reimbursement of the KBC loan (0.5% of GDP) and the sale of government assets (1.3% of GDP), partly offset by the contributions to the European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM), which added a further 0.7 percentage points to the country’s debt. Going forward, the debt is expected (excluding the costs of the Dexia recapitalisation) to rise again in 2014, to just above 100% of GDP. This increase will be mostly due to stock-flow adjustments associated with contributions to the EFSF and ESM.

Demographic and productivity trends pose a significant challenge to Belgium’s potential growth prospects. The government undertook important reforms in recent years to increase incentives to work, with the objective of raising the employment rate to 73% by 2020. At the same time, total factor productivity growth has slowed significantly over the past decade, undermining real wage growth prospects. Waning competitiveness is materialising in a deteriorating current account, as Belgian exports to the EU and 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. The ratings are further constrained by the prevalence of a marked political and economic regional divide that could undermine political stability and the country’s ability to make headway in reducing its high debt stock.

Notes:
During the rating committee, the main points discussed were the issuer's fiscal position, including the sustainability of its debt trajectory, the susceptibility of public finances to debt shocks, and the medium-term growth outlook. The committee concluded that the issuer has become less vulnerable to risks emanating from the banking sector and that the debt trajectory is expected to stabilize. Other factors discussed included the issuer's economic structure and performance, including its economic resilience, the implementation of structural reforms and the political environment.

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. These can be found on www.dbrs.com at: http://www.dbrs.com/about/methodologies.

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.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

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

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

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Giacomo Barisone
Rating Committee Chair: Roger Lister
Initial Rating Date: 11 November 2011
Most Recent Rating Update: 15 February 2013