- Luxembourg's prosperous economy is backed by an effective institutional framework, robust economic growth, and a large net asset position.
- Net services exports' contribution drives current account surpluses, in turn supporting the large net asset position, while low government debt levels reflect persistent fiscal surpluses.
- We expect pressure from changing international tax regulation will be effectively managed.
- We are therefore affirming our 'AAA/A-1+' ratings on Luxembourg, and keeping the outlook stable.
On Sept. 14, 2018, S&P Global Ratings affirmed its 'AAA' long-term and 'A-1+' short-term foreign and local currency sovereign credit ratings on Luxembourg. The outlook is stable.
The stable outlook reflects our expectation that, over the next two years, Luxembourg will maintain strong credit metrics while effectively managing changing international fiscal regulation. We could consider a negative rating action if the economic and financial effects of tighter regulation of Luxembourg's financial services sector or corporate taxation framework were more pronounced than we expected. This would likely weaken the country's economic growth prospects and fiscal performance, and could weigh on sovereign creditworthiness. The ratings could also come under pressure if credit growth accelerated to levels that would risk undermining Luxembourg's economic and financial stability by, for example, encouraging unsustainable acceleration in asset valuations.
Our ratings on Luxembourg reflect its prosperous economy, transparent and effective institutional framework, prudent budgetary policies, and recurrent external surpluses. The financial and business services sectors are Luxembourg's key industries, supporting its role as a financial hub and contributing to its prosperity. At the same time, however, they expose Luxembourg to changing international financial regulations and potential external shocks. Those potential shocks are somewhat mitigated by the diversity of activities within the financial sector and by the government's efficient policy responses, which are consistent with a 'AAA' rating.
Institutional and Economic Profile: Strong institutions underpin effective policy-making and robust economic growth
- Luxembourg is adapting to changes in the international tax environment.
- Financial sector exports and increasingly, domestic demand, drive robust economic growth.
- The main risks to growth are a hard landing in housing prices and reduced attractiveness to foreign companies in a context of stricter international tax regulation.
The ratings on Luxembourg benefit from the institutional framework, which, in our view, supports economic policies oriented toward sustainable economic growth. The state has promoted growth of the financial sector (27% of GDP in 2016) and continues to identify areas for its expansion, while at the same time aiming to diversify the economy into nonfinancial sectors. Luxembourg's GDP per capita--estimated at $116,000 in 2018--is one of the highest among the sovereigns we rate. Its economy has enjoyed strong growth compared with other developed economies. We expect real GDP growth to average 3.3% per year in 2018-2021, against 3.5% in 2013-2017. This favorable growth outlook is supported by the recent expansionary tax reform and the automatic wage indexations triggered in 2017 and 2018, which should continue boosting consumption. In addition, growth in financial services exports (63% of commercial services exports in 2017) should stay vigorous throughout the period, in part because some financial institutions are relocating European headquarters to Luxembourg from London following Brexit, as well as continued expansion of the eurozone. Employment growth, favorable financial conditions, and the expanding population have pushed up house prices. A limited supply in the rental market, and tax incentives for house purchases have also contributed to price increases. Although we expect population growth to continue, the rate of increase could somewhat diminish as lending conditions become more restrictive and as the government continues to take measures in order to increase the supply of affordable housing. Nevertheless, if the affordability of housing deteriorates, it could undermine consumption growth and reduce Luxembourg's attractiveness for foreign labor, while overvaluation could create risks of financial instability. Risks to growth are related to the external environment. Were Brexit to have a significant negative impact on the eurozone economy as a whole, Luxembourg's economy could also slow. Nonetheless, in the short term, Brexit also represents an upside risk in view of financial institutions' decisions to move their operations totally or partially from the U.K. to Luxembourg. International and European anti-tax avoidance initiatives, as well as the recent U.S. corporate tax reform, which incentivizes U.S. companies to repatriate their offshore profits, could also represent a downside risk, but the impact is not likely to be felt in the near term.
Flexibility and Performance Profile: Low debt and a large net asset position
- Luxembourg has a history of budget surpluses, which supports its low level of debt.
- Changes in the international tax environment are a challenge to Luxembourg's budgetary position, but large general government assets and low debt represent a significant buffer if risks materialize.
- Large current account surpluses support the country's large external net asset position.
Luxembourg has mostly posted general government surpluses since 1995, in part owing to surpluses in the social security system. More recently, Luxembourg's e-commerce revenues from value-added tax (VAT) gradually eroded in the wake of the EU's measures to reduce VAT competition in the EU, which reduced the incentive for e-commerce companies to locate themselves in member states with low rates of VAT. However, Luxembourg's budgetary measures, including the 2% VAT rate increase and the spending containment plan, helped absorb this shock and limit the impact on the central government balance. We expect the general government balance will remain in mild surplus over our forecast horizon through 2021, at 1.1% of GDP in 2018 and averaging 0.7% over 2019-2021. Social security surpluses will keep offsetting gradually increasing deficits at the central government level, as the government pursues the expansionary tax reform--with the headline corporate income tax rate being lowered further to 18% in 2018, from 19% in 2017. Luxembourg raises about 18% of tax revenues from the financial services industry, in particular from banks, holding companies, and investment funds, in part thanks to a competitive tax environment. As in other EU countries, the tax regime is subject to change as a result of various international initiatives, such as the recently adopted EU-wide Anti-Tax Avoidance Directive, which will be incorporated into Luxembourg law by the end of the year. Moreover, several of Luxembourg's tax rulings have been or are currently under investigation by the European Commission (EC) under EU State Aid rules. In this context, changes to the headline corporate tax rate is part of the government's changing approach to international tax competition, with a greater focus on headline tax rates than on tax exemptions. Luxembourg is thus adjusting to the changes in the international tax environment. This does not insulate the country from further risks stemming from international regulations, but such changes are likely to be gradual, and we expect the government to respond to them proactively to maintain a sound budgetary position over the medium term. The recent changes to the U.S. tax system could also represent a downside risk to tax receipts, but we do not expect any near-term impact. We regard Luxembourg's 2013 pension reform as an important step toward increasing the long-term sustainability of the system. However, we find that the current framework is not sufficient to contain the long-term budgetary pressure. Early retirement schemes are still widespread and the retirement age is below the EU average. Under our 2018-2021 forecasts, we expect that gross general government debt as a percentage of GDP will average 21% of GDP, excluding guarantees related to the European Financial Stability Facility (see "S&P Clarifies Its Approach To Accounting For EFSF Liabilities When Rating The Sovereign Guarantors," published Nov. 2, 2011). We expect the cost of debt to remain low, at around 0.8% of revenues. We also forecast that general government assets will remain relatively high, ensuring an overall net asset position for the government. This represents a significant buffer in light of the challenges highlighted above. We expect Luxembourg to continue posting large current account surpluses in 2018-2021, supported by strong service surpluses and offset by negative net income. Luxembourg's financial account flows reflect its role as a financial hub. These flows amount to significant gross assets and liabilities on the international investment position. These could represent an economic risk, rather than a balance-of-payments risk. For example, a reduction of inflows into special-purpose vehicles or funds would be matched by a reduction of corresponding outflows, but the service exports associated with these activities would also decline, undermining growth and current account performance. As a member of the eurozone, Luxembourg's monetary policy is managed by the European Central Bank (ECB). We view the ECB's policy-setting as broadly appropriate for Luxembourg, in synchronization with its policies and those of major members of the area, such as neighboring France and Germany. That said, given relatively high growth in Luxembourg, as well as the ongoing rise in house prices, the ECB continuing its loose monetary policy may become less appropriate for Luxembourg in the medium term.
|Luxembourg Selected Indicators|
|ECONOMIC INDICATORS (%)|
|Nominal GDP (bil. LC)||44||46||50||52||53||55||58||62||65||68|
|Nominal GDP (bil. $)||57||62||66||58||59||63||70||77||81||85|
|GDP per capita (000s $)||108.0||115.0||120.8||102.7||101.8||105.9||115.9||124.5||127.4||130.5|
|Real GDP growth||(0.4)||3.7||5.8||2.9||3.1||2.3||3.7||3.4||3.3||3.0|
|Real GDP per capita growth||(2.8)||1.3||3.3||0.4||0.7||(0.2)||1.2||0.9||0.8||0.5|
|Real investment growth||6.1||1.2||4.3||(8.0)||0.5||1.9||1.7||1.9||2.0||2.0|
|Real exports growth||2.8||5.3||14.0||6.9||2.7||3.9||4.4||4.0||3.7||3.5|
|EXTERNAL INDICATORS (%)|
|Current account balance/GDP||5.6||5.5||5.2||5.1||5.1||5.0||5.2||5.3||5.3||5.3|
|Current account balance/CARs||0.9||0.8||0.9||0.8||1.0||1.0||1.1||1.2||1.2||1.2|
|Net portfolio equity inflow/GDP||305.4||242.6||387.1||352.6||218.4||444.3||303.0||295.0||300.0||300.0|
|Gross external financing needs/CARs plus usable reserves||410.3||408.9||454.3||535.6||574.6||574.4||562.6||545.0||544.8||529.5|
|Narrow net external debt/CARs||191.1||199.5||294.3||325.8||373.8||405.6||387.5||368.4||367.1||357.0|
|Narrow net external debt/CAPs||192.9||201.2||296.9||328.5||377.5||409.8||391.9||372.8||371.6||361.4|
|Net external liabilities/CARs||(6.5)||(8.1)||(3.6)||(1.6)||(8.1)||(7.4)||(8.0)||(8.6)||(9.6)||(10.3)|
|Net external liabilities/CAPs||(6.5)||(8.1)||(3.6)||(1.6)||(8.2)||(7.5)||(8.1)||(8.7)||(9.7)||(10.4)|
|Short-term external debt by remaining maturity/CARs||312.4||310.7||356.3||437.8||477.1||477.3||465.2||447.6||447.4||432.0|
|Usable reserves/CAPs (months)||0.0||0.0||0.0||0.0||0.0||0.0||0.0||0.0||0.0||0.0|
|Usable reserves (mil. $)||991||963||863||771||973||879||879||879||879||879|
|FISCAL INDICATORS (%, General government)|
|Change in net debt/GDP||(0.7)||0.3||(2.7)||(1.7)||(3.8)||1.5||(1.4)||0.5||(0.8)||(0.5)|
|MONETARY INDICATORS (%)|
|GDP deflator growth||2.6||1.7||1.6||1.3||(1.3)||2.1||1.7||1.9||1.9||2.0|
|Exchange rate, year-end (LC/$)||0.76||0.73||0.82||0.92||0.95||0.83||0.82||0.79||0.80||0.80|
|Banks' claims on resident non-gov't sector growth||3.1||6.4||4.9||15.7||8.7||9.5||6.0||6.0||5.0||5.0|
|Banks' claims on resident non-gov't sector/GDP||83.9||84.7||82.6||91.7||98.0||102.7||103.2||103.8||103.6||103.5|
|Foreign currency share of claims by banks on residents||8.8||8.5||9.7||9.3||8.9||7.9||8.0||8.0||8.0||8.0|
|Foreign currency share of residents' bank deposits||N/A||N/A||N/A||N/A||N/A||N/A||N/A||N/A||N/A||N/A|
|Real effective exchange rate growth||(1.9)||1.6||2.6||(1.9)||2.3||2.4||N/A||N/A||N/A||N/A|
|Savings is defined as investment plus the current account surplus (deficit). Investment is defined as expenditure on capital goods, including plant, equipment, and housing, plus the change in inventories. Banks are other depository corporations other than the central bank, whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial-sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. LC--Local currency. CARs--Current account receipts. FDI--Foreign direct investment. CAPs--Current account payments. The data and ratios above result from S&P Global Ratings' own calculations, drawing on national as well as international sources, reflecting S&P Global Ratings' independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.|
Ratings Score Snapshot
|Luxembourg Ratings Score Snapshot|
|Key rating factors|
|Fiscal assessment: flexibility and performance||1|
|Fiscal assessment: debt burden||2|
|S&P Global Ratings' analysis of sovereign creditworthiness rests on its assessment and scoring of five key rating factors: (i) institutional assessment; (ii) economic assessment; (iii) external assessment; (iv) the average of fiscal flexibility and performance, and debt burden; and (v) monetary assessment. Each of the factors is assessed on a continuum spanning from 1 (strongest) to 6 (weakest). S&P Global Ratings' "Sovereign Rating Methodology," published on Dec. 18, 2017, details how we derive and combine the scores and then derive the sovereign foreign currency rating. In accordance with S&P Global Ratings' sovereign ratings methodology, a change in score does not in all cases lead to a change in the rating, nor is a change in the rating necessarily predicated on changes in one or more of the scores. In determining the final rating the committee can make use of the flexibility afforded by §15 and §§126-128 of the rating methodology.|
- Criteria - Governments - Sovereigns: Sovereign Rating Methodology, Dec. 18, 2017
- General Criteria: Methodology For Linking Long-Term And Short-Term Ratings , April 7, 2017
- General Criteria: Methodology For Rating Sukuk, Jan. 19, 2015
- General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009
- General Criteria: Methodology: Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009
- Sovereign Ratings List, Sept. 5, 2018
- Sovereign Ratings History, Sept. 5, 2018
- Sovereign Ratings Score Snapshot, Sept. 4, 2018
- Global Sovereign Rating Trends Midyear 2018, July 16, 2018
- Sovereign Risk Indicators, July 5, 2018. A free interactive version is available at http://www.spratings.com/sri.
- Default, Transition, and Recovery: 2017 Annual Sovereign Default Study And Rating Transitions, May 8, 2018
- Sovereign Debt 2018: Global Borrowing To Remain Steady At US$7.4 Trillion, Feb. 22, 2018
- Why Are Sovereign Foreign And Local Currency Ratings Converging? Jan. 10, 2018
In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision. After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts. The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above. The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria And Research').
Ratings Affirmed Luxembourg Sovereign Credit Rating AAA/Stable/A-1+ Transfer & Convertibility Assessment AAA Senior Unsecured AAA Luxembourg Treasury Securities SA Senior Unsecured AAA
Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at www.standardandpoors.com for further information. Complete ratings information is available to subscribers of RatingsDirect at www.capitaliq.com. All ratings affected by this rating action can be found on S&P Global Ratings' public website at www.standardandpoors.com. Use the Ratings search box located in the left column. Alternatively, call one of the following S&P Global Ratings numbers: Client Support Europe (44) 20-7176-7176; London Press Office (44) 20-7176-3605; Paris (33) 1-4420-6708; Frankfurt (49) 69-33-999-225; Stockholm (46) 8-440-5914; or Moscow 7 (495) 783-4009.
|Primary Credit Analyst:||Ghita Lamriki, Paris (33) 1-4420-6709;|
|Secondary Contact:||Marko Mrsnik, Madrid (34) 91-389-6953;|
|Additional Contact:||EMEA Sovereign and IPF;|
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