DBRS Confirms Belgium at AA (high), Stable Trend

DBRS Ratings Limited (DBRS) 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.

KEY RATING CONSIDERATIONS

Belgium’s ratings are supported by its productive, open and wealthy economy, with a GDP per capita level that is almost 30% higher than the European Union (EU) average. Moreover, the country benefits from a strong net external creditor position, at around 50% of GDP on average over the past five years, reflecting healthy private-sector balance sheets. Household net financial wealth, which is estimated at around 240% of GDP, is one of the highest in Europe.

The Stable trend reflects DBRS’s view that risks to the ratings are balanced. Reform efforts, including the wage moderation strategy and the tax shift from labour to consumption, have started to yield results. The improvement in cost competitiveness has been accompanied by higher job creation and further measures agreed in July are a first step to address labour market rigidities. Moreover, the fiscal deficit declined substantially in 2017 to 1.0% of GDP from 2.5% in 2016, and a similar figure to last year is projected for this year. Although additional efforts to limit the growth of current fiscal spending look less certain in the coming years, lower interest cost and very long maturity offset the vulnerability arising from high public debt.

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. Conversely, a sharp deterioration in growth prospects and/or a substantial reversal in fiscal progress as a result of weaker commitment to consolidation, either of which that lead to a material worsening in the public debt trajectory, could put negative pressure on the ratings.

RATING RATIONALE

The Budget Position Has Improved, but Public Debt Remains High

After a positive fiscal outturn in 2017, the budget position is expected to be maintained this year. The headline deficit declined substantially last year to 1.0% of GDP from 2.5% on average in 2015 and 2016. This result overperformed the government’s expectation envisaged in the April 2017 stability programme by around 0.6% of GDP. The improvement in the labour market was one of the main drivers along with buoyant economic activity. In addition, there was an exceptional flow of corporate tax revenues, which increased by 0.6% of GDP, mainly related to rise of the basic rate of the tax surcharge imposed in cases of insufficient advance payment. Strong revenues were also accompanied by reductions in primary spending and interest costs. Another deficit of 1.0% of GDP is projected for this year.

However, the fiscal position is likely to deteriorate over the next few years, unless further cuts are implemented. The National Bank of Belgium (NBB) is projecting the fiscal deficit to rise to 1.8% of GDP in 2019. This is mainly because of a more moderated flow of corporate tax revenues after a large tax collection since 2017. In addition, some fiscal slippage might also occur ahead of the federal elections. This would increase the risk of a further delay in reaching a structural budget balance, which was already postponed from 2019 to 2020.

Public debt is trending downwards but remains high at 103.4% of GDP in 2017. A combination of sound nominal growth and a further reduction in interest costs, which are projected to drop to 2.2% of GDP in 2018 from 2.9% in 2016, bodes well for debt sustainability. The government has taken advantage of low interest rates and extended the average residual public debt maturity to around 9.6 years, one of the highest in Europe. According to the International Monetary Fund (IMF), the public debt-to-GDP ratio is likely to fall below 100% in the next two years. Moreover, a more pronounced reduction might occur should further divestment of the government equity stake in financial institutions materialize. The government has planned to privatize close to 30% of its equity stake in Belfius, which may generate proceeds of around EUR 2 billion (0.5% of GDP), even though the timing is not clear. In the medium-term, additional fiscal consolidation efforts are likely to be needed to accomplish a further decline in the public debt-to-GDP ratio. This is because economic growth seems moderating towards its potential, while interest costs are expected to bottom out at around 2% of GDP in the coming years, as monetary policy from the European Central Bank (ECB) starts to normalize.

Labour Market Remains Supportive of Economic Growth Even Tough Risks are Tilted to the Downside

Structural reforms have started to pay off, but economic growth momentum is moderating. The government has focused its agenda on addressing both Belgium’s international competitiveness and domestic demand, by implementing a set of reforms that have been accompanied by strong job creation. These include, those aimed at moderating wage gains and shifting taxes from labour to consumption, as well as a reduction in the corporate tax rate. Recently the government showed its commitment to further improving the labour market, which despite a rapid increase in total employment (2.7% over the last two years) remains constrained by rigidities and skills mismatch. A set of new measures agreed in July, including special training budgets for the unemployed are positive, although additional efforts might be needed. Inactivity and high unemployment rate among certain groups, including immigrants, youths and low-skilled individuals appear to be structural. This, together with a low effective retirement age, which puts pressure on public finance in the long-term, translates into low employment and participation rates, constraining Belgium’s GDP potential. Against this background, barriers to competition in the service sector and still high labour taxes represent additional elements that limit productivity gains.

Growth momentum appears to have eased slightly in line with the Eurozone. The NBB projects real GDP to expand by 1.5% in 2018 following a modest first half of 2018, which resulted from a slowdown in private investment and a fall of inventories. A similar rate is also forecast for 2019 as export growth is expected to weaken and as the corporate investment cycle recedes. In DBRS’s view, further escalation of trade tensions add some uncertainty to the export outlook. The country is well integrated in global value chains, which are currently threatened by lower export demand from the US and the UK’s departure from the EU.

Financial System is Resilient Despite Some Risks Arising from the Housing Market

The current low interest rate environment poses a challenge for the profitability of insurance companies and banks. Moreover, a rising household debt-to-income ratio in light of high valuation in the residential property market and strong credit growth, represent another vulnerability. In May 2018, the government, however, endorsed a new macro-prudential measure proposed by the NBB. This entails a 5% increase in the risk weighting coefficients on mortgage portfolio in continuation with a similar measure implemented in 2013 but foresees on average an additional 3% of capital surcharge targeting more risky real estate sub-segments. 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 Large Net External Asset Position is a Credit Strength

Belgium enjoys a strong net external creditor position which, coupled with a balanced current account, provides an important buffer against external shocks. At 56% of GDP in 2017, Belgium’s net international investment position (NIIP) is one of the highest in Europe and reflects a robust private-sector balance sheet. Following years of modest, but persistent deficits, the current account has remained broadly balanced over the past few years, primarily reflecting improved cost competitiveness. Looking ahead, given that the wage moderation is petering out, labour cost are set to rise generating a slight deterioration in cost competitiveness. Nevertheless, in DBRS’s view, the healthy support of the service sector and the primary income surplus might offset a potential deterioration in the goods balance, maintaining the current account in small surplus in the 2018-2019 period. However, escalating trade tensions and weaker demand from the UK could adversely affect Belgium’s current account. The UK is the fourth-largest trading partner receiving around 8% of total Belgium’s merchandise exports. The pharmaceutical, automotive, transport and logistic sectors could be the most vulnerable to the UK’s departure from the EU.

Progress with the Reform Agenda Continues Despite a Divisive Environment

Belgium 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 comprises 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 frictions among the different parties, the government has implemented several reforms, with the N-VA party supporting the reform agenda instead of pursuing further devolution. Local elections in October 2018 will likely provide an indication of the political sentiment ahead of regional and federal elections next year. The 2019 elections could potentially entail the risk of a complex process of government formation, which might affect shorter term progress on structural reforms and fiscal consolidation.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA – AA range. The main points discussed during the Rating Committee include: Fiscal outlook, public debt sustainability, potential higher political uncertainty post-election and labour market developments.

KEY INDICATORS
Fiscal Balance (% GDP): -1.0 (2017); -1.0 (2018F); -1.8 (2019F)
Gross Debt (% GDP): 103.4 (2017); 100.1 (2018F); 99.0 (2019F)
Nominal GDP (EUR billions): 437.2 (2017); 453.4 (2018F); 469.0 (2019F)
GDP per capita (EUR thousands): 38,640 (2017); 39,749 (2018F); 40,913 (2019F)
Real GDP growth (%): 1.7 (2017); 1.5 (2018F); 1.5 (2019F)
Consumer Price Inflation (%, eop): 1.6 (2017); 1.5 (2017F); 2.0 (2018F)
Domestic credit (% GDP): 225.2 (2017); 225.4 (Mar-2018)
Current Account (% GDP): -0.2 (2017); 0.3 (2018F); 0.2 (2019F)
International Investment Position (% GDP): 56.0 (Dec-2017)
Gross External Debt (% GDP): 273.9 (2016); 256.7 (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: 16 February 2018

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