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

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Kingdom of Belgium's Long-Term Foreign and Local Currency - Issuer Ratings at AA. At the same time, Morningstar DBRS 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 Morningstar DBRS' view that Belgium's credit fundamentals remain solid. The Belgian economy demonstrated a high degree of resilience against recent shocks, supported by robust domestic demand. Real GDP levels in Q1 2024 stood 5.5% above its Q4 2019 level compared to an increase of 3.5% for the entire Euro area. At the same time, fiscal balances have deteriorated markedly. The general government budget deficit rose to 4.4% of GDP in 2023, up from 3.6% in 2022, as the indexation of public wages and social benefits to inflation and increases in several social benefits have pushed up nominal spending levels. Looking ahead, the fiscal deficit is projected to widen further on current policy settings, driven by gradual, albeit steady, increases in interest expenditure and ageing costs. Therefore, reversing the unfavourable fiscal trajectory stands out as an important challenge for the incoming new federal government. While the new federal government coalition is yet to be formed, the government formation process after the June 2024 national elections has so far proceeded at a much faster pace than after previous elections with the formation of the new government targeted for autumn 2024. The most likely future government coalition is a five-party coalition spanning centre-left to centre-right parties. In terms of future fiscal policy, Morningstar DBRS takes the view that the reinstatement of European Union (EU) fiscal rules is set to raise pressure on the government to step up fiscal adjustment efforts over the next years. This, in turn, should contain budgetary pressures and the increase in the public debt ratio in the medium-term.

Belgium's AA credit 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 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. While high public debt is an important credit weakness, debt affordability continues to benefit from a still moderate, albeit rising, interest burden as the pass-through of higher borrowing costs has been attenuated by comparatively long debt maturities.

CREDIT RATING DRIVERS
An upgrade of the credit 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. The credit ratings could be downgraded if growth prospects or fiscal balances deteriorate markedly and the increase in the public debt ratio is not contained over the medium-term.

CREDIT RATING RATIONALE

Economic Growth Is Driven By Robust Domestic Demand

The Belgian economy grew at a stronger pace than most other Euro area economies over the past year. Real GDP expanded by 1.4% in 2023 compared to a growth rate of 0.6% for the Euro area. This comparatively strong growth dynamic can be ascribed to robust domestic demand. Private consumption held up better than in most other Euro area countries as household purchasing power was bolstered by the (time-delayed) indexation of wages to the health index, a measure of consumer price inflation. Furthermore, notwithstanding a decrease in housing investment, gross fixed capital investment rose by 3.6% as domestic businesses stepped up investments in automation and green technologies.

Looking ahead, the National Bank of Belgium (NBB) forecasts real GDP growth to decelerate moderately to 1.2% both in in 2024 and in 2025. While investment activity is likely to normalize, private consumption is projected to continue to expand at a robust pace. In contrast, net exports are likely to be a drag on growth as robust domestic demand bolsters import demand. In addition, wage indexation has led to a comparatively large increase in labour costs for Belgian exporters which, in turn, has weakened their external price competitiveness. This wage gap, however, is expected to shrink over the next years, driven by catch-up of wage growth in trading partner economies. In general, the credit profile is supported by the wealthy and diversified nature of the Belgian economy. At the same time, Belgium faces important structural challenges such as raising the economy's comparatively low labour force participation rate which is essential for mitigating the detrimental impact of population ageing on labour supply.

Reinstatement of EU Fiscal Rules Raises Consolidation Pressure

Fiscal balances deteriorated over the past year with the general government budget deficit widening to 4.4% of GDP in 2023 from 3.6% in 2022. This deterioration was driven by an upswing in primary current expenditure as the indexation of public sector wages and social benefits to inflation, increases in several social benefits and rising age-related costs have pushed up nominal spending levels. Even though remaining energy support measure amounting to 0.4% of GDP are planned to be phased out in 2024, fiscal pressure are projected to continue to increase over the next years on current policy settings. The NBB forecasts the general government budget deficit to widen to 4.8% of GDP in 2024 and to 5.3% in 2025 related to rising interest expenditures and increasing ageing costs. The High Council of Finance projects ageing-related budgetary costs (e.g. pensions, health care) to increase by 1.8% of GDP between 2022 and 2028.

Maintaining the current path of fiscal policy is impeded by the reinstatement of EU fiscal rules from 2024 onwards. In July 2024, the European Commission proposed to open an excessive deficit procedure for Belgium which is yet to be adopted by the European Council. Belgium's fiscal adjustment needs for complying with new EU fiscal rules are very large both from a cross-country and a historical perspective. Morningstar DBRS takes the view that the large fiscal adjustment needs under EU fiscal rules are set to raise pressure on the incoming Belgian government to adopt far-reaching consolidation measures.

High Public Debt Stock Is An Important Credit Weakness

Government debt is high and - based on current policy settings - projected to increase over the next years. NBB forecasts general government debt to rise from 105.2% of GDP at end 2023 to 110.7% at end 2026 stemming from large government budget deficits and a deceleration in nominal GDP growth owing to a slowdown in inflation. However, debt affordability continues to benefit from a moderate interest burden. While the recent increase in nominal interest rates is projected to raise interest expenditure to a still moderate 2.4% of GDP in 2025 from 1.6% in 2022, the interest burden is forecast to remain lower than during much of the past decade, as interest expenditure averaged 2.8% of GDP between 2010 and 2020. 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 2024 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.

Government Formation Process Has So Far Proceeded Much Faster Than After Previous Elections

The federal parliamentary elections in June 2024 have triggered a change in government. The outgoing Prime Minister Alexander de Croo announced his resignation in the aftermath of the election as some parties of his seven-party "Vivaldi" government coalition encountered strong losses. While a new government coalition is yet to be formed, the most likely scenario is currently a coalition between five centre-right and centre-left parties (New Flemish Alliance, Vooruit, CD&V, Mouvement Réformateur, Les Engagés). The government formation process has so far proceeded at a much faster pace than has been the case after previous elections. By mid-July, the five parties had already concluded their exploratory talks and started official coalition negotiations with several party leaders stating their intention to form a coalition government until September 2024. In contrast, the government formation process after the May 2019 elections lasted 18 months. At the same time, Morningstar DBRS continues to view the fragmentation of the domestic political landscape between the main linguistic groups (Flemish and Walloon) and across the political spectrum as an obstacle for reaching consensus in important policy areas and for the adoption of structural reforms. The deep and structural political divisions in the country weigh negatively on Morningstar DBRS' qualitative adjustment in the `Political Environment' building block assessment. In general, Belgium's credit 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.

Current Financial Condition of Banking Sector is Strong But Asset Quality Risks are Tilted to the Downside

The current financial condition of the domestic banking sector is strong. Banks benefit from strong capital and liquidity buffers. According to NBB data, the average Tier 1 capital ratio of credit institutions amounted to 17.1% at end-March 2024. Furthermore, asset quality metrics are good with the current stock of the sector-wide NPL ratio standing at a low 1.6% at end-March 2024. Looking ahead, pockets of vulnerability for asset quality might arise from the increase in interest rates and the accompanying cooling in real estate markets. The exposure of Belgian banks to commercial and residential real estate is higher than in most other Euro area economies. This, however, is partly mitigated by the fact that the increase in Belgian housing prices has been less pronounced over the past years than in several other countries. Furthermore, the repayment capacity of most mortgage borrowers is supported by a still strong condition of the domestic labour market and large household assets. The aggregate net worth of households (excl. pension entitlements) in Belgium stood at 186% of GDP in December 2023 compared to an average of 122% for the Euro area. In terms of bank loans to non-financial corporates, Morningstar DBRS takes the view that the strong increase in interest rates as a risk factor for future asset quality might strain the repayment capacity of some borrowers. The average interest rate on outstanding loans to non-financial corporates rose to 3.7% in May 2024 from just 1.5% two years earlier. Morningstar DBRS takes a conservative approach to the financial risks faced by the banking sector and applies a negative qualitative adjustment to the `Monetary Policy and Financial Stability' building block assessment.

External Finances Benefit From a Large Net External Asset Position

While the decrease in energy prices lowered the energy import bill last year, the current account deficit remained unchanged at 1.0% of GDP in 2023. The improvement in the goods balance was offset by a widening deficit in the services balance (primarily travel, other business services). Looking ahead, the NBB forecasts the current account deficit to widen moderately to 1.1% of GDP in 2024 and 1.6% in 2025 on the back of robust domestic demand and as the international price competitiveness of the Belgian export sector export continues to be impaired by the comparatively strong increase in Belgian labour costs. Despite the projected moderate widening of the current account deficit, Morningstar DBRS 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 64.5% of GDP in March 2024, which is one of the highest among EU countries. This creditor position results primarily from large net assets in portfolio investment (37.4% of GDP) and direct investment (28.2%). While Belgium is a small economy, its extensive trade linkages throughout Europe continue to support Morningstar DBRS' positive qualitative adjustment of the `Balance of Payments' building block assessment.

ENVIRONMENTAL, SOCIAL, AND 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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/436763.

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 (15 July 2024) https://dbrs.morningstar.com/research/436000/global-methodology-for-rating-sovereign-governments. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/427030 in its consideration of ESG factors.

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

The sources of information used for these credit ratings include Belgium Ministry of Finance (Draft Budgetary Plan Belgium 2024, October 2023), Belgian Debt Agency (Investor Presentation, July 2024), National Bank of Belgium (Economic Projections for Belgium - June 2024; Financial Stability Report 2024), High Council of Finance (Study Committee on Ageing: Annual Report 2023, July 2023), Statbel, Eurostat, European Commission (Commission Opinion on the Existence of an Excessive Deficit in Belgium, 8 July 2024; European Economic Forecast, Spring 2024), European Central Bank, OECD (Housing Prices), BIS, IMF (World Economic Outlook April 2024; International Financial Statistics; Belgium: 2023 Article IV Consultation, December 2023; Belgium: Selected Issues, December 2023), World Bank, International Energy Agency, European Environment Agency (EEA Effort Sharing Decision Dataset, October 2023), Social Progress Index, Global Peace Index, Haver Analytics. Morningstar DBRS 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

Morningstar 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.

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

For further information on Morningstar DBRS 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 Morningstar DBRS 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/436762.

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, Global Sovereign Ratings
Initial Rating Date: November 11, 2011
Last Rating Date: January 26, 2024

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