Public Information Notice No. 12/28

Public Information Notice: IMF Executive Board Concludes 2011 Article IV Consultation with Belgium

March 20, 2012

On March 9, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Belgium.¹

Background

Growth momentum has slowed since early 2011. As confidence weakened, growth began to falter in tandem with a marked slowdown in the rest of the euro area. The labor market has so far remained resilient, partly because of a series of employment support programs. Annual average inflation remained around 3½ percent in 2011, and will trigger the automatic wage indexation mechanism for public sector employees in early 2012. Private sector lending stabilized as bank deleveraging slowed in 2011. The recent tendency of inflation and nominal unit labor costs to increase more than in Belgium’s main trading partners is a concern for competitiveness.

As the euro area crisis unfolded, Belgian sovereign and bank spreads have come under pressure. Drying up of liquidity in euro area financial markets since the summer of 2011 eventually led to the restructuring of Dexia. Dexia’s Belgian retail operations were broken out of the group and nationalized at a cost of 1 percent of GDP. The remainder of the group was provided with guarantees by the governments of Belgium, France, and Luxembourg. The contingent liabilities arising from this operation and previous bank support, combined with an already high stock of public debt, contributed to rising bond yields and CDS spreads on Belgian sovereign debt during the financial market turmoil of late 2011.

Continued uncertainty about the evolution of the euro area crisis and slow growth in Europe weigh on the outlook for Belgium. Real GDP growth is expected to stall in 2012 and resume gradually from 2013. Risks to the outlook are slanted to the downside. They arise from the high public debt; from the financial sector’s exposure to countries with weak growth prospects, fragile sovereign debt markets and stressed financial markets; from the strong interplay between the banking sector and the Belgian sovereign; and from Belgium’s high degree of trade openness. The economy is thus vulnerable to financial turmoil across the euro area and to cyclical developments in Europe.

A new federal government was formed in December 2011. The new government program appropriately aims at achieving fiscal sustainability over the medium-term, containing risks in the financial sector, and increasing employment and growth. The Sixth Reform of the State substantially increases the degree of fiscal federalism by devolving additional spending responsibilities to subnational governments and reforming their funding. The 2012 budget includes a sizeable fiscal consolidation package of 2½ percent of GDP, in order to reduce the fiscal deficit below 3 percent of GDP in 2012. The authorities continue to strengthen banking supervision and are committed to implement the Basel III and Solvency II regulatory frameworks. The government program details structural reforms aimed at raising the employment rate (for 20–64 year olds) by 5 percentage points. Key measures include greater degressivity in unemployment benefits; stricter enforcement of job search requirements and a gradual limitation of pre-pension benefits for older workers; and a stepwise increase in the minimum age for early retirement from 60 to 62 years by 2016.

Executive Board Assessment

Executive Directors welcomed the new government’s efforts to achieve fiscal sustainability over the medium term, contain financial sector risks, and increase employment and growth. Directors cautioned, however, that the euro area turmoil and the strong linkages between financial institutions and the sovereign continue to pose downside risks to the outlook. In this context, a steadfast and full implementation of the government’s economic program remains crucial.

Directors stressed that medium-term fiscal consolidation is key to mitigating pressures in the sovereign debt market. They welcomed the sizable adjustment in the 2012 budget and the government’s commitment to take additional measures as needed to achieve structural balance by 2015. With revenues at almost 50 percent of GDP, Directors agreed that the consolidation strategy should focus on expenditure containment, particularly in pensions, health care, and public sector employment. Most Directors noted that a rationalization of wage and benefit indexation could also generate budgetary savings. More broadly, Directors recommended a rules-based framework and a burden-sharing agreement between all levels of government to strengthen the credibility of the consolidation effort. In light of weak growth prospects, most Directors recommended allowing automatic stabilizers to operate freely around the consolidation path, although a few Directors noted the importance of safeguarding the achievement of fiscal targets.

Directors welcomed the steps taken to address financial sector distress in 2011. They noted, however, that the financial system remains vulnerable to market pressures in the euro area and that the interplay with the Belgian sovereign has intensified. With greater domestic competition and a deteriorating economic outlook likely to depress profits, Directors argued that pushing ahead with the bank restructuring under way and strengthening capital buffers remain important priorities. Accordingly, they encouraged the authorities to stand ready to provide the necessary backstop if private capital cannot be tapped. Directors also stressed the need to strengthen bank supervision and implement the Basel III and Solvency II regulatory frameworks. They further agreed that Belgium’s experience during the global financial crisis has underscored the need for more effective crisis management and cross-border resolution in Europe.

Directors welcomed the labor and pension reforms recently launched by the authorities as first steps toward raising employment and growth. Nevertheless, they noted that additional efforts are needed, in particular to increase the effective retirement age to its statutory level. Directors stressed the need to push ahead with reforms in labor and product markets, with most Directors noting that a reform of the wage indexation scheme would help boost competitiveness. Directors observed that a job-friendly tax reform could increase trend growth. With severely limited fiscal space, they considered that any reduction in the high labor taxes would have to be offset by an increase in indirect taxes revenues.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.