Public Information Notice No. 08/40

Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with Belgium

March 28, 2008

On March 21, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Belgium.¹

Background

With a supportive external environment and buoyant domestic demand, GDP is estimated to have grown by 2.7 percent in 2007 and unemployment declined to its lowest level since 2002. Rapid job creation contributed to rising households' net disposable income and private consumption. Meanwhile, business investment firmed up, boosted by strong net revenue growth in the first half of 2007. However, headwinds from a worsening international environment, combined with domestic political tensions, contributed to a slowdown of activity toward the end of the year.

Looking ahead, the spike in oil prices, euro appreciation, the spillovers from the global financial turmoil, and dimmer economic prospects in partner countries will exert a drag on activity. Hence, the staff projects output growth to weaken to 1.4 percent in 2008. Greater economic uncertainty and less favorable financing conditions will lower business investment and consumption will decelerate in response to more sluggish real disposable income growth and a slower pace of job creation. Moreover, concerns about the depth and persistence of the ongoing financial market turmoil and its effects on growth constitute downside risks.

Headline inflation has risen to 3.5 percent in January 2008 with the surge in food and energy prices. Partial wage indexation will boost wages and shield purchasing power,

but it will drive up hourly labor costs in excess of what was envisaged in earlier wage agreements. These agreements contained moderate wage increases to help preserve competitiveness. The authorities have responded to the energy price spike by raising targeted income support for the energy needs of low-income households.

The ongoing financial turbulence has so far had only a limited impact on the financial system and the economy. Banks' exposure to the U.S. subprime market is small, bank capitalization is strong, and liquidity shocks have been absorbed. Nonetheless, recent volatility in equity prices as well as a widening of credit default spreads indicates continuing market concerns about asset valuations and their implications for banks' earnings and capital. Meanwhile, the cross-border dimension of the financial system has gained further importance with a partial merger between a Belgian and Dutch bank.

With political tensions following the June 2007 elections, federal policy making has been at a standstill, delaying fiscal consolidation and structural reforms. The 2007 general government outcome is estimated to show a small deficit, short of the planned surplus of 0.3 percent of GDP. The stance of fiscal policy was broadly neutral, with the structural balance remaining close to balance. The authorities agreed on resuming fiscal consolidation and balancing the 2008 general government budget. Current fiscal federalism arrangements have led to unsustainable fiscal imbalances, both between the federal and regional entities and between the regions, but lack of consensus about a new allocation of competencies between federal and regional governments has delayed their reform.

Demographic trends are projected to dampen long-term growth, as population aging curbs labor supply and sharply raises dependency ratios. Despite recent increases, employment rates remain among the lowest in the industrialized world. At the same time, skill mismatches and geographical differences in growth and income persist, amid limited labor mobility.

Executive Board Assessment

Executive Directors welcomed the upswing of recent years with robust growth continuing in 2007 that brought unemployment down to a low level. Directors noted, however, that the economy now faces headwinds, largely due to external factors. They commended the authorities for their prudent 2008 budget and the well-targeted approach to addressing the consequences of the spike in inflation. Looking forward, Directors noted the need to address population aging, and encouraged the authorities to adopt a program of medium-term fiscal consolidation and implement reforms to raise employment rates and productivity.

Directors noted that prudent domestic policies are called for to meet the challenge of the near-term outlook. With protracted global financial turmoil and the slowdown in partner countries, GDP growth is expected to weaken in 2008 and remain subdued in 2009. This combined with a sharp rise in inflation presents significant policy challenges. They encouraged the authorities to allow fiscal stabilizers to operate fully around a medium-term consolidation path and avoid recourse to one-off measures to achieve nominal budget objectives. Given the widespread practice of wage indexation and the increase in targeted support for low-income households, they felt that purchasing power is adequately protected and called for continued wage moderation to prevent a further erosion in competitiveness.

Directors noted that the financial system had been only moderately affected by the recent financial market turbulence, but cautioned that its resilience was likely to be tested further. They supported the authorities' encouragement of early and transparent disclosure and saw the need to ensure that financial institutions maintain adequate capital buffers to deal with further risks. Directors welcomed the authorities' continuing efforts to further enhance already high-quality supervision, and noted that**--**with ongoing cross-border consolidation modifying the financial landscape considerably**--**deeper coordination with host country authorities will be needed.

Recognizing that the political situation had caused delays in policymaking, Directors encouraged the new government to take decisive and medium-term oriented action. They welcomed the intention to achieve a balanced budget for the general government in 2008, underpinned by the regional authorities' efforts to aim for a larger-than-planned surplus. Nonetheless, Directors felt that the credibility of the authorities' strategy to deal with aging will depend on promptly adopting the structural expenditure restraint needed to return the fiscal consolidation path to that recommended by the High Finance Council, and on making up for recently lost ground over the medium term.

Directors welcomed the authorities' intention to revise fiscal federalism arrangements to address fiscal imbalances among different levels of government. They underscored that any new agreements should be neutral from a consolidated budget perspective, provide incentives for regions to narrow income differences, and be transparent about the intergovernmental solidarity mechanisms. Directors noted that further devolution of competencies would need to be accompanied by strengthened accountability and stronger coordination among federal and sub-federal entities of economic policies, for which existing fiscal institutions may need to be strengthened.

Directors saw labor and product market reforms as vital to raise growth, reduce unemployment, increase employment rates, and boost productivity. They recommended comprehensive reforms that would involve a further streamlining and coordinating of labor market policies across regions, an improvement in training and education, a revision of the tax-benefit system, and phasing out early retirement schemes. Directors felt that the wage bargaining framework ought to be made more conducive to achieving higher employment rates.

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.