Finance minister Yuriko Backes (DP) has achieved her goal, stated categorially ahead of the draft budget she delivered in October, as DBRS Morningstar confirmed Luxembourg’s AAA rating status. DBRS Morningstar said that in its view “the credit fundamentals of Luxembourg remain solid notwithstanding the adverse impact of the energy price shock on economic growth and fiscal accounts” and that the ratings reflect “Luxembourg’s very strong public finances.”

The ratings agency acknowledged that economic growth dynamics have weakened in recent months as the strong increase in global energy prices has weighed on consumer and business sentiment and reduced the purchasing power of households.

Furthermore, the government budget balance is expected to deteriorate moderately in 2022 and 2023 on the back of fiscal support measures which seek to cushion the impact of high energy prices on households and businesses. “These risks, however, are mitigated by Luxembourg’s ample fiscal space for absorbing a temporary increase in budgetary pressures which results from a comparatively low level of public debt and a large stock of government assets,” the report states. Indeed, the budget presented by Backes confirmed the government’s commitment to keep public debt below 30% of GDP.

Backes feels vindicated

“I am particularly pleased with this confirmation of the AAA rating, as it is the first that comes after the Tripartite last September and following the presentation of the draft  2023 budget,” Backes said. “This decision is a testament to the merits of successive packages of measures in favour of households and businesses and reminds us at the same time that a responsible and far-sighted policy continues to remain in place to preserve favourable prospects for the future.”

DBRS Morningstar also said that believes that the overall financial condition of the economy’s large banking sector is sound. Banks have comfortable liquidity positions and benefit from good capital buffers, which are sufficient to absorb some potential weakening of asset quality in the future, the report’s authors stated.

The stock of non-performing loans is currently low with regard both to banks’ total domestic and foreign loan exposures (NPL ratio Q1 2022: 1.0%) as well as to loans to domestic households (1.4%) and non-financial corporations (1.5%).

Domestic housing prices

However, looking ahead DBRS Morningstar views a potential correction of domestic housing prices in tandem with rising interest rates as a risk factor for banks’ asset quality. “Housing prices have increased markedly over the past years, clearly exceeding the increases in rents and incomes,” the report states.

It notes that around 46% of the total new mortgage loans which have been extended to households since 2012 have fixed the initial interest rate only up until one year, “exposing these mortgage borrowers to increases in interest rates.” At the same time, DBRS Morningstar  says, “repayment capacity of most households is supported by large household assets.”