DBRS Morningstar Confirms the Kingdom of Belgium at AA, Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Kingdom of Belgium’s Long-Term Foreign and Local Currency – Issuer Ratings at AA. At the same time, DBRS Morningstar confirmed Belgium’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS

The Stable trend reflects DBRS Morningstar’s view that Belgium’s credit fundamentals remain solid, despite large projected fiscal deficits over the medium term. The National Bank of Belgium (NBB) forecasts the general government budget deficit to widen to 4.7% of GDP in 2023 from 3.9% in 2022 and to remain elevated at 4.6% in 2024 and 4.7% in 2025. The deterioration of the fiscal balance in the current year is driven by rising spending pressures, as the indexation of public wages and social benefits to inflation and the increase in certain social benefits have pushed up nominal spending levels. In the medium-term, rising aging-related budgetary costs constitute the most important structural fiscal challenge. While the projected deficits are forecast to raise the government debt ratio to 107.9% of GDP in 2025, debt affordability over the next years will continue to benefit from a still moderate interest burden. The general government’s interest expenditure is projected to increase gradually from 1.5% of GDP in 2022 to 2.2% in 2025. The pass-through of higher borrowing costs is attenuated by comparatively long debt maturities.

Belgium’s AA ratings are supported by its wealthy and diversified economy, its strong net external asset position, large household savings and high institutional quality. These credit strengths counterbalance the challenges associated with high public sector debt, the economy’s exposure to external shocks given its small size and openness and the fragmentation of the political landscape between the main linguistic groups and across the political spectrum. This fragmentation has delayed government formation in the past and impeded the adoption and implementation of fiscal consolidation measures and structural reforms in recent years.

CREDIT RATING DRIVERS

An upgrade of the ratings could occur if the government narrows its budget deficit in a structural manner and the public debt ratio starts to follow a clear downward path. A downgrade could occur if growth prospects or the budgetary outlook deteriorate markedly and the public debt ratio rises more than currently expected.

CREDIT RATING RATIONALE

Government Budget Deficit Projected to Widen in 2023 and to Remain Elevated Over the Next Years

After benefitting from temporary factors in 2022, fiscal balances have started to deteriorate again this year. In 2022, the general government budget deficit narrowed to 3.9% of GDP from 5.5% in 2021 as COVID-19-support measures were scaled back markedly and tax revenues were boosted by high inflationary pressures and strong employment growth. Budgetary dynamics, however, are projected to reverse this year notwithstanding a further decrease in COVID-19 support measures and a lower net cost of energy support measures. The NBB projects the general government budget deficit to widen to 4.7% of GDP in 2023. This deterioration is driven by an upswing in primary current expenditure which rose by a large 8.8% year-on-year in Q1 2023 as the indexation of public sector wages and social benefits to inflation, increases in certain social benefits and rising age-related costs have pushed up nominal spending levels. Moreover, fiscal pressures in 2023 have been aggravated by a slowdown in tax revenue growth which partly results from the indexation of personal income tax brackets to high inflation last year.

Budgetary pressures are projected to remain elevated over the next years. The NBB forecasts the general government budget deficit at a large 4.6% of GDP in 2024 and 4.7% in 2025. Fiscal pressures emanate particularly from demographic developments. The High Council of Finance projects aging-related budgetary costs (e.g. pensions, health care) to increase by 1.8% of GDP between 2022 and 2028. While the coalition agreement of the current seven-party government commits to an annual fiscal consolidation effort of 0.2% of GDP, a lasting reduction of the large structural deficit would require the implementation of additional fiscal consolidation measures. DBRS Morningstar currently views the adoption of more far-reaching consolidation measures on the expenditure and the revenue sides prior to the parliamentary elections in spring 2024 as unlikely given the lack of consensus on the future path of fiscal policy within the heterogenous government coalition.

High Public Debt Stock Is Important Credit Weakness but Debt Affordability Benefits From Still Moderate Interest Burden

Government debt is high and projected to increase moderately over the next years. The NBB forecasts general government debt to rise from 105.1% of GDP at end 2022 to 107.9% at end 2025 on the back of large government budget deficits and as nominal GDP growth is projected to decelerate owing to a slowdown in inflation. At the same time, debt affordability continues to benefit from a moderate interest burden. While the recent increase in nominal interest rates is projected to raise interest expenditures to a still moderate 2.2% of GDP in 2025 from 1.5% in 2022, the interest burden is forecast to remain lower than during much of the past decade, as interest expenditures averaged 2.7% of GDP between 2010 and 2021. The pass-through of the recent increase in government borrowing costs on interest payments is attenuated by a comparatively long average tenor of government debt. The average maturity of the central government debt was 10.6 years in June 2023 up from 8.0 years in December 2015 as the government extended debt maturities in previous years in order to lock in historically low rates.

Wage Indexation Supports Private Consumption but Weakens Price Competitiveness of Export Industries

Economic growth dynamics have decelerated moderately in recent months. According to a flash estimate by NBB, real GDP expanded by 0.2% (quarter-on-quarter) in Q2 2023, down from 0.4% in Q1 2023. On an annual basis, the NBB projects real GDP to increase by 1.4% in 2023. Economic growth in the current year is driven by a strengthening in private consumption whereas export activity is likely to soften. Household purchasing power has increased markedly in 2023 due to the (time-delayed) indexation of wages to the health index, a measure of consumer price inflation. The EC forecasts real per capita compensation of employees in Belgium to increase by 5.3% in 2023 after contracting by 1.3% in 2022 compared to no change in 2023 and a contraction of 2.3% in 2022 for the total Euro area. In addition, private consumption is supported by still strong labour markets which have weathered the COVID-19 and the energy shocks well. At the same time, wage indexation has led to a comparatively large increase in labour costs for Belgian exporters which, in turn, weakens their external price competitiveness. Therefore, net exports are likely to be a drag on growth over the next few years. In contrast, private investment particularly in green technologies and automation is projected to pick up from next year onwards. Taking into account the latter and a projected softening of private consumption, the NBB projects a modest deceleration of real GDP growth to 1.3% in 2024 and to 1.2% in 2025.

High Institutional Strength but Fragmentation of Domestic Political Landscape Impedes Structural Policy Changes

Belgium’s ratings are supported by a high institutional strength as the country is characterised by a high rule of law, low levels of corruption and stable political and economic institutions. At the same time, the domestic political landscape is fragmented between the main linguistic groups (Flemish and Walloon) and across the political spectrum. This fragmentation has delayed government formation in the past. The current seven-party coalition government, which comprises parties from a broad range of the political spectrum, was formed in October 2020, 17 months after the May 2019 federal elections. The heterogenous political composition of the government has impeded the implementation of structural reforms in the past, particularly with regard to fiscal policy (e.g. tax reform, fiscal consolidation). Overall, the deep and structural political divisions in the country, leading to lengthy processes of government formation and a gridlock in certain policy areas, weigh negatively on DBRS Morningstar’s qualitative assessment of the ‘Political Environment’ building block.

Financial Stability Supported by Good Financial Condition of Banking Sector and Large Household Savings

The current financial condition of the domestic banking sector is good. The banking sector has strong capital buffers with the average Tier 1 capital ratio standing at 18.1% in March 2023. Furthermore, asset quality is good. The sector-wide NPL ratio stood at a low 1.5% in March 2023. At the same time, DBRS Morningstar notes that the stock of Stage 2 loans towards non-financial corporates has increased to 19.1% of total gross loans in March 2023 from 13.0% in December 2019. These loans could present a risk to asset quality as part of these loans could translate into NPLs in the future. This applies particularly in view of the recent increase in interest rates and the upswing of companies’ wage bills on the back of wage indexation, as these factors might weaken the repayment capacity of some companies. DBRS Morningstar takes a conservative approach to the financial risks faced by the banking sector and applies a negative qualitative assessment to the ‘Monetary Policy and Financial Stability’ building block.

In DBRS Morningstar’s view, financial stability risks emanating from the housing sector are lower than in most other advanced economies, as the increase in Belgian housing prices has been less pronounced. According to the OECD, residential housing prices in Belgium rose by 40.9% between March 2015 and March 2023 compared with an average growth of 74.5% among OECD countries. Furthermore, the repayment capacity of most household borrowers is supported by large household assets. The aggregate net worth of households in Belgium stood at a large 205% of GDP in March 2023 compared to an average of 145% for the Euro area.

External Finances Benefit From a Large Net External Asset Position

External finances have started to recover from the energy price shock last year. NBB forecasts the current account deficit to narrow to 0.5% of GDP in 2023 from 3.6% in 2022 as the decline in global energy prices has lowered the economy’s energy import bill. Furthermore, external finances benefit from rising inflows of investment incomes as the increase in global interest rates – in tandem with the economy’s large net external creditor position - has raised primary income surpluses. Over the next two years, however, NBB forecasts the current account deficit to widen to a still moderate 1.0% of GDP in 2024 and 1.2% in 2025 as the comparatively strong increase in Belgian labour costs is projected to impair the international price competitiveness of the Belgian export sector. Despite the projected moderate deterioration in the current account balance, DBRS Morningstar continues to view Belgium’s external position as strong due to its large net external creditor position. Belgium’s net international investment position amounted to 53.6% of GDP in March 2023, which is one of the highest among EU countries. Belgium’s net external creditor position results primarily from large net assets in portfolio investment (34.6% of GDP) and direct investment (26.1%). While Belgium is a small economy, its extensive trade linkages throughout Europe continue to support DBRS Morningstar’s positive qualitative assessment of the ‘Balance of Payments’ building block.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

There were no Environmental, Social or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (4 July 2023) at https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/418851.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (29 August 2022) https://www.dbrsmorningstar.com/research/401817/global-methodology-for-rating-sovereign-governments. In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (4 July 2023) at https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

The sources of information used for these credit ratings include Belgium Ministry of Finance (Belgium’s Stability Programme 2023-2026, April 2023; National Reform Programme 2023, April 2023), Belgian Debt Agency (Economy & Public Finances Debt Management Strategy in 2023), National Bank of Belgium (Economic Projections for Belgium – June 2023; Financial Stability Report 2023), High Council of Finance (Study Committee on Ageing: Annual Report 2023, July 2023), Statbel, Eurostat, European Commission (Council Recommendation on the 2023 National Reform Programme of Belgium and delivering a Council opinion on the 2023 Stability Programme of Belgium, 24 May 2023; European Economic Forecast, Spring 2023), European Central Bank, OECD (Housing Prices), BIS, IMF (World Economic Outlook April 2023; International Financial Statistics; Belgium: 2022 Article IV Consultation, March 2023; Belgium: Selected Issues, March 2023), World Bank, International Energy Agency, European Environment Agency (EEA Effort Sharing Decision Dataset, October 2022), Social Progress Index, Global Peace Index, Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

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

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and credit ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication/. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/418850.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Yesenn El-Radhi, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: November 11, 2011
Last Rating Date: February 03, 2023

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.