DBRS Confirms Belgium at AA (high), Stable Trend

DBRS Ratings Limited (DBRS) has confirmed the Kingdom of Belgium’s Long-Term Foreign and Local Currency – Issuer Ratings at AA (high) and its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings remains Stable.

The Stable trend reflects DBRS’s view that risks to the ratings are balanced. The improvement in the fiscal position and higher growth offset the vulnerability arising from high public debt, even though additional efforts to limit the growth of current fiscal spending look less certain. Nevertheless, reform efforts, including the wage moderation strategy and the tax shift from labour to consumption, have started to yield results. The improvement of cost competitiveness has been accompanied by lower taxes on labour encouraging job creation. Against this background, total employment is projected to continue to grow in 2018-2019.

Belgium’s ratings are supported by its productive, open and wealthy economy, strong external position, and sound private sector balance sheets. GDP per capita is 29% higher than the European Union (EU) average and total exports account for more than 80% of GDP. Moreover, the country benefits from a strong net external creditor position, estimated at around 50.0% of GDP on average over the last five years, which reflects healthy private-sector balance sheets. Household net financial wealth-to-GDP ratio estimated at around 245% of GDP is one of the highest in Europe.

Notwithstanding these strengths, Belgium faces important challenges, including a high level of public debt, which constrains the fiscal space and makes the country vulnerable to shocks. A fragmented labour market and rising age-related spending are additional challenges. These features reflect a labour market characterised by low employment and participation rates, caused by structural inactivity among certain groups, including immigrants and low-skilled individuals, combined with a low effective retirement age.

THE BUDGET POSITION HAS IMPROVED BUT PUBLIC DEBT REMAINS HIGH
Despite the positive fiscal outturn achieved in 2017, further progress in fiscal consolidation looks less certain. After modest progress in recent years, the budget deficit declined substantially in 2017 to 1.2% of GDP from 2.5% on average in 2015 and 2016. Last year’s better-than-expected fiscal position was mainly the result of labour market improvements as well as buoyant economic activity, which translated into an exceptional flow of corporate tax revenues increasing by 0.4% of GDP. Strong revenues were also accompanied by reductions in primary spending and interest costs, of 0.3 ppt and 0.4 ppt, respectively. However, the fiscal position is expected to deteriorate slightly over the next few years, with the National Bank of Belgium (NBB) projecting an annual fiscal deficit of 1.4% of GDP on average in 2018-19. This is because further fiscal spending savings should only partially offset both the small increase in public investment and lower tax revenues flow as a result of the multiannual tax shift.

In addition, part of the flow of corporate tax revenues collected last year is likely to have been temporary, because of a one-off effect in the timing of tax collections. Despite this, the corporate tax reform, which lowers the rate from 33% to 29% in 2018, and further to 25% from 2020 onwards, entails also a broadening of the tax base and it is expected to be budgetary neutral by the Belgian authorities. However, it remains to be seen if the government will make additional efforts to limit the growth of current spending, especially during the cycle of local, regional and federal elections.

Further fiscal consolidation efforts could accelerate the decline in the public debt-to-GDP ratio. Despite a fall from the peak of 106.8% in 2014, public debt estimated at 103.3% of GDP in 2017 by the NBB, remains high. However, the combination of sound GDP growth and falling interest costs, which are projected to drop to 2.3% of GDP in 2018 from 2.9% in 2016, bodes well for further debt reduction. The government has taken advantage of low interest rates and extended the average maturity to 9.3 years, one of the highest in Europe. Moreover, the downward trend in the public debt ratio could accelerate if the government continues to limit fiscal spending and to divest its equity stakes in financial institutions. Following the 25% sale of the government’s stake in BNP Paribas last summer, the potential privatisation of part of Belfius, likely up to 0.6% of GDP, may contribute to decrease the public debt ratio below 102% of GDP, the lowest level since 2011.

THE ECONOMY GAINED MOMENTUM AND THE FINANCIAL SYSTEM IS RESILIENT
Structural reforms have started to pay off. Job creation remains sustained with the unemployment rate falling below 7% of the working force for the first time since May 2011, supporting Belgian private consumption. This reflects in part the structural reforms implemented in recent years, including those aimed at moderating wage gains and shifting taxes from labour to consumption, helping Belgium’s competitiveness. Moreover, with the revival of global trade and the strengthening of Eurozone GDP, activity gained momentum in 2017 following years of subdued economic performance. In DBRS’s view, momentum should persist in 2018, when GDP is expected to accelerate slightly to 1.8% from 1.7% estimated last year. Nevertheless, a gradual slowdown is projected from 2019 onwards, as growth potential remains constrained by barriers to competition in the service sector, weak public investment, high labour taxes and a fragmented labour market.

The current low interest rate environment represents a challenge for the profitability of insurance companies and banks. Moreover, rising household gross debt-to-income ratio in light of high valuation in the residential property market and strong credit growth remains a concern. The NBB, however, continues to be vigilant on the housing and commercial real estate dynamics, and has proposed a new measure for domestic residential real estate exposures consisting of a 5 ppt risk weight add-on and a second more targeted component linked to the risk profile of the loan portfolio. Furthermore, the relatively high level of banks’ capitalisation and good asset quality, along with one of the highest household net financial wealth positions in Europe, makes the financial system resilient to adverse shocks.

THE NET EXTERNAL ASSET POSITION REMAINS STRONG
Belgium enjoys a strong net external creditor position which, coupled with a balanced current account, provides an important buffer against external shocks. Robust private-sector balance sheet supports the net international investment position, which at around 50% of GDP over the last five years is one of the highest in Europe. Following years of slight but persistent deficits, the current account shifted into a surplus of 0.1% of GDP in 2016, related to improved cost competitiveness. Looking ahead, a slight deterioration in cost competitiveness seems likely, as the effect of the wage moderation peters out. Nevertheless, in DBRS’s view, the healthy support of the service sector and the primary income surplus might offset the deterioration in the goods balance, maintaining the current account broadly in balance in the 2018-2019 period. However, weaker demand from the UK could adversely affect Belgium’s current account; UK is one of Belgium’s largest trading partners and the terms of its departure from the European Union are unknown.

GOVERNMENT STABILITY SUPPORTS THE REFORM AGENDA
The country has a history of contentious politics, characterised by frictions between the two main linguistic groups (Flemish and Walloon) and the distribution of power between federal and regional levels. Nevertheless, the current ruling coalition, with a majority of 85 out of 150 seats in Parliament, is expected to serve its full term. The coalition is composed of three Flemish parties, including the separatist New Flemish Alliance (N-VA), the Christian Democratic and Flemish Party, the Open Flemish Liberals and Democrats as well as the Liberal Reformist Movement – the only francophone party. Despite internal friction among the different parties, the government has implemented several reforms, with the N-VA party supporting the reform agenda instead of pursuing further devolution.

RATING DRIVERS

Although DBRS foresees limited upside potential in the near term, the ratings could be upgraded if fiscal consolidation results in a significant reduction in the public debt-to-GDP ratio over time. On the other hand, (1) a sharp deterioration in growth prospects and/or (2) a substantial reversal in fiscal progress due to a weaker commitment to consolidation, either of which leading to a material worsening in the public debt trajectory, could put negative pressure on the ratings.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA – AA range. The main points discussed at the Rating Committee include: The Belgian government’s fiscal consolidation effort, public debt-to-GDP ratio trajectory, labour market, GDP potential growth, contingent liabilities, household financial assets.

KEY INDICATORS

Fiscal Balance (% GDP): -2.5 (2016); -1.2 (2017F); -1.3 (2018F)
Gross Debt (% GDP): 105.7 (2016); 103.3 (2017F); 102.1 (2018F)
Nominal GDP (USD billions): 423.0 (2016); 438.2 (2017F); 453.3 (2018F)
GDP per capita (USD thousands): 37,365 (2016); 38,583 (2017F); 39,709 (2018F)
Real GDP growth (%): 1.5 (2016); 1.7 (2017F); 1.8 (2018F)
Consumer Price Inflation (%, eop): 1.8 (2016); 2.2 (2017F); 1.6 (2018F)
Domestic credit (% GDP): 231.7 (2016); 223.4 (Sept-2017)
Current Account (% GDP): 0.1 (2016); 0.0 (2017F); 0.1 (2018F)
International Investment Position (% GDP): 51.3 (2016); 50.4 (Sept-2017)
Gross External Debt (% GDP): 273.9 (2016); 259.4 (Sept-2017)
Governance Indicator (percentile rank): 86.5 (2016)
Human Development Index: 0.90 (2015)

Notes:

All figures are in euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include National Bank of Belgium, Belgian Debt Agency, Ministry of Finance, OECD, ECB, European Commission, Eurostat, IMF, World Bank, UNDP, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

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.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

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

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

Lead Analyst: Carlo Capuano, Assistant Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: 11 November 2011
Last Rating Date: 18 August 2017

DBRS Ratings Limited
20 Fenchurch Street
31st Floor
London
EC3M 3BY
United Kingdom
Registered in England and Wales: No. 7139960

Information regarding DBRS ratings, including definitions, policies and methodologies, is available on www.dbrs.com.