POLITICS & INSTITUTIONS - ECONOMY

Outbreak impact on Lux “will be temporary”: Moody’s



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Steffen Dyck, a vice president and senior credit officer at Moody’s Investors Service, stated in a report issued on 8 April 2020:“We believe that the impact from the coronavirus outbreak on the economy and Luxembourg’s government finances and debt metrics will be temporary.”Photo credit: Moody’s Investors Service 

The grand duchy’s economy will contract sharply this year, but should bounce back next year, while government will begin to reduce its rising debt load starting in 2022, a major credit ratings agency has forecast this week.

Steffen Dyck, lead author of the Moody’s Investors Service report, said:

“Taking into consideration the support measures announced so far, both from the national government and European institutions such as the European Central Bank and the European Commission, we forecast a sharp contraction in Luxembourg’s real GDP by around 4% in 2020. The largest impact will be felt from the second half of March throughout the second quarter, before the economy begins to recover in the third quarter, assuming that the restrictions on public life and economic activity are gradually lifted from early May.”

Dyck also said:

“We expect that real GDP growth will rebound relatively strongly and reach around 3% in 2021.”

For comparison, according to Statec, the national statistics bureau, Luxembourg’s economy grew by 2.3% in 2019 and earlier this year had been forecast to expand by 2.8% in both 2020 and 2021.

Government balance sheet

Luxembourg’s government has so far pledged to spend €8.8bn to prop up the country’s economy and could borrow €3bn this year to pay for the stimulus package.

In its report this week, Moody’s maintained its AAA top-notch rating on the grand duchy’s debt, with a “stable” outlook, meaning it does not anticipate downgrading Luxembourg bonds within the next 6-12 months.

The report noted the Luxembourg “government’s very sound finances and strong balance sheet.” Moody’s said government debt was about 18% of GDP in 2019, one of the lowest proportions among advanced economies. And Moody’s pointed to the country’s flush reserves, including those of its social security funds. Nevertheless, the agency predicted government debt would rise by around 6% of GDP.

From the Moody’s report:

“We forecast that government revenues will decline by about 3% in 2020 compared to 2019, mainly driven by the sharp contraction in economic activity during the lock-down period, which leads to sharply lower direct and indirect tax revenues. Together with increased government spending, this will lead to a fiscal deficit of around 2% of GDP in 2020, down from our expectation of a sizable surplus of more than 3% in 2019. As the economy recovers in the second half of 2020 and into 2021, the deficit will narrow to about 1% of GDP next year. As a result, Luxembourg’s government debt burden will increase temporarily to around 22% of GDP this year and peak below 24% in 2021.”

Risk factors

Moody’s did warn of several potential “factors that could lead to a downgrade” of its credit rating. One is the relatively small size of the country, which could possibly make it more difficult to issue “significant quantities” of bonds. Political disputes within the euro area could destabilise the bloc and thus the country’s growth prospects.

Luxembourg remains highly reliant on the financial sector, which represents roughly 25% of the country’s economy and 11% of its workforce, Moody’s observed. Any meltdown in global markets would hit Luxembourg’s cross-border financial industry (and the country’s tax revenues) hard.

Generally speaking, a higher credit score leads to cheaper interest rates for borrowers on global capital markets.

Moody’s published its credit opinion on 8 April.