Over the coming months, the International Monetary Fund (IMF) expects growth in Luxembourg to pick up to 1.5%, with inflation continuing to fall without dropping below 3%. “The moderately expansionary fiscal stance is broadly appropriate to boost growth, but more targeted and temporary measures would have been more effective,” comments Emil Stavrev, head of the IMF delegation. “In the medium term, given ageing costs and fiscal risks, gradual fiscal consolidation--mainly by improving spending efficiency and streamlining tax expenditures--would free up space to invest in the digital and green transition while stabilising debt.”
Call for structural reforms
Competitiveness figures largely in the analysis of the Washington-based institution. “Key reforms are needed to maintain the country’s competitiveness,” says the IMF. “The authorities should consider more ambitious reforms to break the self-perpetuating spiral between wages and living costs. These would include correcting imbalances between housing supply and demand by reducing the use of demand-side policies and stimulating supply; increasing the flexibility of the wage indexation system; and continuing efforts to increase labour market participation, reduce skills mismatches and remove barriers to foreign workers.”
The institution added: “In this context, the reforms announced by the authorities in favour of the transition to individual taxation are welcome and could be complemented by a means test for family benefits.”
More targeted tax measures
Taxation was one of the first major projects of ’s (CSV) government, which aims to reduce the tax burden on households and ultimately on businesses, even if it means increasing the deficit.
“The moderately expansionary fiscal stance is broadly appropriate, but more targeted and temporary measures would have been preferable,” say the IMF experts, for whom certain permanent measures “worsen the medium-term budget outlook.” The organisation also suggests that a more prudent fiscal policy would stabilise debt in the medium term. This debt is expected to increase by 6 to 7 percentage points of GDP between now and 2029.
In concrete terms, then, the IMF recommends a gradual fiscal consolidation: “Consolidation of around 0.2% of GDP per year over the next five years would keep the debt at around 30% of GDP by 2029.” They didn’t come out against adjusting tax brackets to inflation, but neither did they recommend it, at least not without “compensatory measures.” Nor did they recommend a planned reduction in the rate of corporation tax: “This could potentially lead to a fall in revenue, without necessarily attracting new businesses.”
The IMF also recommends rationalising spending. With the largest item of expenditure being social spending, pension insurance and health insurance, the institution advocates an early reform of pensions that would ensure the long-term sustainability of the system as well as generational equity. “The planned public consultation on this issue is therefore welcome, as it will help to ensure ownership of a reform. Measures are also needed to remedy the rapid deterioration in the balance of the National Health Fund (CNS).”
Stravrev concedes, however, these are sensitive measures and will not necessarily be easy to implement.
Property sector as a risk
Apart from geopolitical risks, the main short-term risks for the Luxembourg economy are linked to the housing sector and the fear, according to the IMF, of a “potentially disorderly” correction in asset prices, particularly overvalued property prices. For years, the institution has been pointing to the imbalance between supply and demand in the property sector and the resulting risk of a bubble.
Along with taxation, the property sector has been another priority for the Frieden government, whose policies of support are well received by the IMF delegation. “These measures could help to restore confidence and ease the pressure on the construction sector,” say the experts. “However, given the supply constraints, the increase in demand is likely to lead to a further deterioration in household indebtedness and affordability. Over time, these measures may lead to moral hazard and encourage risk-taking.” They recommend concentrating public investment in social and affordable housing in a cost-effective way, with greater involvement of the private sector. “Projects aimed at cutting red tape are welcome and should be accelerated.”
Real estate is also a vulnerability for the financial sector, one highlighted by the rise in interest rates. “Macroprudential policy should aim to preserve the resilience of banks and avoid the accumulation of vulnerabilities, particularly in the property sector,” says the IMF. “Bank capital buffers should be used to increase minimum macroprudential capital requirements to absorb unexpected losses on real estate exposures, preferably through sectoral systemic risk buffers. The risk of limited credit supply resulting from such a measure would be mitigated by banks’ profitability and a comfortable capital margin. At the same time, supervisors should continue to monitor real estate risks, focusing on valuation and concentration, and ensure adequate provisioning and sound lending practices.”
This article in Paperjam. It has been translated and edited for Delano.