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 notwithstanding fiscal challenges. On an unchanged policy basis, the National Bank of Belgium (NBB) forecasts the general government budget deficit to widen from 4.6% of GDP in 2024 to 4.8% in 2025 and 5.5% in 2026. As a result, general government debt is projected to rise from 104.6% of GDP to 109.6% in 2026. Therefore, reversing the unfavourable fiscal trajectory stands out as an important challenge of the yet-to-be-formed new federal government. While the formation of a new government coalition has so far been complicated by diverging views on fiscal consolidation measures across different political parties, Morningstar DBRS takes the view that the opening of an excessive deficit procedure by the European Union (EU) against Belgium is set to raise pressure on the incoming government to step up fiscal adjustment efforts over the next years. Economic growth is moderate and continues to be driven by robust domestic demand. During the first three quarters of 2024, real GDP expanded by 0.9% on a year-on-year basis. Looking ahead, real GDP growth is likely to strengthen gradually as monetary easing is projected to aid investment activity. At the same time, similar to other EU countries, the growth outlook is exposed to external downside risks such as an escalation of geopolitical or global trade tensions.

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.

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 the increase in the public debt ratio is not contained over the medium-term due to a deterioration in growth prospects or an unfavourable fiscal trajectory.

CREDIT RATING RATIONALE

Government Formation Process Is Still Ongoing

Policy uncertainty is currently high as the government coalition negotiations following the federal parliamentary elections in June 2024 have not yet succeeded in forming a new government. The most likely scenario is the formation of an "Arizona" government coalition between four centre-right parties (New Flemish Alliance, CD&V, Mouvement Réformateur, Les Engagés) and one centre-left party (Vooruit). While government formation talks between these parties initially proceeded at a much faster pace than had been the case after previous elections, negotiations in more recent months have been complicated by diverging views on fiscal consolidation measures on both the expenditure and revenue sides. Nevertheless, party leaders have stated their aim to conclude government coalition negotiations by the end of January 2025. In general, 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, therefore, 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. At the same time, Belgium's credit ratings are supported by a high institutional strength as the country is a strong performer on the World Bank's Governance Indicators reflecting a high rule of law, low levels of corruption and stable political and economic institutions.

Compliance with EU Fiscal Rules Necessitates Large Fiscal Consolidation Measures

The NBB estimates that the general government budget deficit widened to 4.6% of GDP in 2024 up from 4.2% in 2023. This deterioration was driven by strong expenditure growth. During the first nine months of 2024, general government expenditure rose by 5.5% on a year-on-year basis, exceeding the 5.1% increase in general government revenues. This increase resulted largely from an upswing in primary current expenditure as the indexation of public sector wages and social benefits to inflation and rising age-related costs have pushed up nominal spending levels. Furthermore, capital expenditure rose by 8.1%. On the revenue side, fiscal accounts benefitted from rising income taxes from households and corporations and higher social security contributions whereas nominal indirect taxes remained broadly unchanged. Looking ahead, fiscal deficits are projected to widen on an unchanged policy basis. NBB forecasts the general government budget deficit to rise to 4.8% of GDP in 2025 and to 5.5% in 2026 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 2.0% of GDP between 2023 and 2029.

The yet-to-be-formed government coalition faces large fiscal consolidation needs to reverse this unfavourable fiscal trajectory. The European Council initiated an excessive deficit procedure for Belgium in July 2024. NBB estimates that compliance with new EU fiscal rules would require an average annual structural improvement of 0.71 percentage points (pps) of GDP under a four-year period or of 0.47 pps over a seven-year period. An extension to seven years can only be approved if Belgium commits to the implementation of growth-enhancing structural reforms and investments. Furthermore, in view of higher geopolitical tensions, Belgium is likely to face rising defence spending pressures over the next years. According to NATO estimates, total defence expenditure amounted only to a comparatively low 1.3% of GDP in 2024. 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. This, in turn, should contain budgetary pressures and the increase in the public debt ratio in the medium-term. Nevertheless, until the new government is formed, uncertainty will remain about Belgium's fiscal plans. We will assess the fiscal policy measures of the incoming government once presented.

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 104.6% of GDP at end 2024 to 112.8% at end 2027 stemming from large government budget deficits and a deceleration in nominal GDP growth owing to a slowdown in inflation. While debt affordability currently continues to benefit from a still moderate interest burden, the relative size of the interest burden is projected to gradually increase over the next years owing to large budget deficits and the expectation that interest rates are unlikely to return to the very low levels of pre-pandemic years. NBB forecasts public interest expenditure to increase from 2.2% of GDP in 2024 to 2.8% in 2027. In comparison, the general government interest burden averaged 3.0% of GDP between the years 2010 and 2019 and 5.0% between 2000 and 2009. The pass-through of changes 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 10.4 years in December 2024.

Economic Growth Is Driven by Domestic Demand

Economic activity expanded at a moderate pace over the past year. The NBB estimates real GDP to have grown by 1.0% in 2024, down from a growth rate of 1.3% in 2023. Growth over the past year was largely driven by strong private consumption and a step-up in public spending. While the growth rate of real disposable household income decelerated, private consumption was bolstered by a decrease in the savings rate. A large negative contribution from changes in inventories and, to a lesser extent, a contraction in housing investment weighed on economic growth. Looking ahead, NBB forecasts a gradual strengthening of real GDP growth to 1.2% in 2025 and to 1.4% in 2026 based on the expectations that private consumption will be supported by a further drawdown in household savings particularly in 2025 and that investment activity will gradually strengthen. Net exports are forecast to be a moderate drag on economic 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.

Similar to other open EU economies, Belgium's outlook is exposed to downside risks such as an escalation of geopolitical or global trade tensions. 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.

Banks Have So Far Weathered Asset Quality Risks Well

Financial stability is supported by the good capital and liquidity buffers of domestic banks. According to NBB data, the average Tier 1 capital ratio of credit institutions amounted to 15.9% at end-September 2024. Moreover, banks have so far weathered potential asset quality risks such as the sharp increase in interest rates for corporate borrowers reasonably well. The NPL ratio amounted to 1.7% in September 2024, up from 1.6% in December 2023. In terms of household mortgages (34.3% of total loans in September 2024), the pass-through of higher interest rates has been contained by long interest rate fixation periods of most mortgages. Furthermore, the repayment capacity of most mortgage borrowers is supported by large household assets. The aggregate net worth of households (excl. pension entitlements) in Belgium stood at 186% of GDP in June 2024, compared to an average of 130% for the Euro area. Pockets of vulnerability might arise from banks' exposure to commercial real estate. In September 2024, 10.1% of total loans were collateralised by commercial real estate. Commercial real estate borrowers face repricing risks over the next years and segments such as retail and office are exposed to structural challenges such as a rising importance of remote work and e-commerce. In view of the asset quality risks emanating from banks' exposure to commercial real estate, Morningstar DBRS 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

NBB estimates the current account balance to have turned into a modest surplus of 0.5% of GDP in 2024 from a deficit of 0.7% in 2023. The goods balance benefitted from improving terms of trade and the higher investment income led to a rising surplus in the primary income balance. Looking ahead, the NBB forecasts the current account balance to turn into deficits of 0.2% of GDP in 2025 and 0.9% in 2026 on the back of robust domestic demand driving up imports 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 deterioration of the current account balance, 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 57.3% of GDP in September 2024, which is one of the highest among EU countries. This creditor position results primarily from large net assets in portfolio investment (32.8% of GDP) and direct investment (19.9%). 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 Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.

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. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 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 Belgian Debt Agency (Investor Presentation, January 2025), National Bank of Belgium (Economic Projections for Belgium - December 2024; The new European Fiscal Framework: Implications for Fiscal Policy in Belgium, October 2024; Financial Stability Report 2024, May 2024), High Council of Finance (Study Committee on Ageing: Annual Report 2024, July 2024), Statbel, Eurostat, European Commission (Council Decision on the Existence of an Excessive Deficit in Belgium, 23 July 2024; European Economic Forecast, Autum 2024), European Central Bank, OECD (Housing Prices), BIS, IMF (World Economic Outlook October 2024; International Financial Statistics; Belgium: 2023 Article IV Consultation, December 2023; Belgium: Selected Issues, December 2023), World Bank, NATO (Defence Expenditure of NATO Countries 2014-2024, June 2024), International Energy Agency, European Environment Agency (EEA Effort Sharing Decision Dataset, October 2024), Social Progress Index, Global Peace Index and Macrobond. 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 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. Morningstar DBRS' outlooks and credit 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://dbrs.morningstar.com/research/446360/.

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: 11 November 2011
Last Rating Date: 26 July 2024

DBRS Ratings GmbH
Neue Mainzer Straße 75
60311 Frankfurt am Main Deutschland
Tel. +49 (69) 8088 3500
Geschäftsführer: Detlef Scholz
Amtsgericht Frankfurt am Main, HRB 110259

For more information on this credit or on this industry, visit dbrs.morningstar.com.