DBRS Confirms the Kingdom of Belgium at AA (high), Stable Trend

DBRS Ratings Limited (DBRS) confirmed the Kingdom of Belgium’s Long-Term Foreign and Local Currency – Issuer Ratings at AA (high). At the same time, DBRS confirmed the Kingdom of Belgium’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings remains Stable.

KEY RATING CONSIDERATIONS

The confirmation of the Stable trend reflects DBRS’s view that risks to the ratings are balanced. The Belgian economy continues to grow, and employment has reached high levels. The fiscal deficit remains small and the government debt-to-GDP ratio continues to decline gradually, projected at close to 100% in 2019. While on a downward path, the still high public debt ratio leaves Belgium with limited capacity to respond to adverse shocks. Moreover, economic growth is forecast to remain modest around 1.4% in 2019. The coming Belgian federal and regional elections, set to be held on 26 May 2019, have added some degree of uncertainty to the fiscal outlook and the reform progress of the government.

The ratings are supported by Belgium’s wealthy and diversified economy, its strong net external asset position reflecting healthy private sector balance sheets, and its robust and credible institutional framework. These credit strengths counterbalance the challenges associated with high public sector debt, relatively low growth of potential output, and the economy’s exposure to external shocks given its small size and openness.

RATING DRIVERS

Although DBRS foresees limited upside pressure in the near term, the ratings could be upgraded if an improved budget position and stronger economic growth lead to a significant reduction in the public debt ratio. Conversely, a sharp deterioration in growth prospects or a substantial reversal in fiscal consolidation, bringing about a material worsening in the public debt trajectory, could put negative pressure on the ratings.

RATING RATIONALE

The Electoral Cycle Has Put A Temporary Brake on Policymaking

Belgium’s institutions are robust, but politics can be contentious given frictions between the main linguistic groups (Flemish and Walloon) and the distribution of power between federal and regional levels. Coalition governments are common. After more than four years in power, Prime Minister Charles Michel resigned in December 2018 after failing to obtain parliamentary support for his now minority government. This followed the departure of the nationalist New Flemish Alliance (N-VA) from the four-party centre-right ruling coalition over its opposition to a United Nations migration agreement. The Prime Minister and his minority government have stayed on as caretaker government. Another coalition government seems likely after the elections, currently scheduled for May. The N-VA is leading the opinion polls, but its lead is not enough to indicate a majority of seats in Parliament.

The current political situation is delaying additional progress on fiscal consolidation and reforms. During its term, the government managed to implement several structural reforms, with the N-VA party supporting the reform agenda instead of pursuing further devolution. However, the 2019 budget and the labour market measures (the “jobs deal”) have not been passed yet. Some agreed measures might be legislated, but a formal budget is only expected after a new government is in place. Given the fragmented political structure in Belgium, a protracted process of government formation after the elections could be likely. In the meantime, the budget will operate under the “provisional twelfths” system, limiting expenditure and the impact on public finances. Despite the policy uncertainty, DBRS does not envisage major disruptions from the electoral cycle and expects the next government to maintain prudent economic policies.

The Budget Position Is Set to Deteriorate, But the Public Debt Ratio Is Expected to Continue Falling

The fiscal deficit remains small, but it is projected to widen again. In 2018, the deficit is estimated at below 1% of GDP, after a substantial reduction in 2017. However, over the next two years, the deficit is set to deteriorate to some extent, unless further spending cuts are implemented. The National Bank of Belgium (NBB) is forecasting a deficit of 1.6% in 2019. The deterioration will come from the last phase of the five-year “tax shift” reform (a tax relief already legislated), and the fading one-off effects on corporate revenues. The deterioration would increase the risk of a further delay in reaching a structural budget balance, which has already been postponed from 2019 to 2020.

The high government debt-to-GDP ratio is trending downwards gradually. Down from a recent peak of 107.6% in 2014, the debt ratio is estimated at 102.3% in 2018, still among the highest in the euro area. This leaves public finances vulnerable to shocks, particularly an adverse growth shock and a materialisation of contingent liabilities. Nevertheless, a combination of GDP growth and lower interest costs, projected at below 2% of GDP in 2019 down from over 3% in 2014, bodes well for debt dynamics. Government debt is projected to fall below 100% of GDP over the medium term. Additional fiscal consolidation efforts might be needed to achieve a faster decline in debt. A sharper debt reduction could also result from further divestment of the government equity stake in financial institutions. The government still has a 100% participation in Belfius.

A favourable public debt profile helps mitigate the risks from high debt. 90% of debt is fixed rate, reducing risks from sharp rises in interest rates. The government has taken advantage of low interest rates and extended debt maturities to an average of 9.6 years, one of the highest in Europe. A buy-back programme has also helped smooth the debt redemption profile. Moreover, borrowing requirements for 2019 are the lowest since 2009.

Belgium’s Economic Growth Is Moderating, While Its Net External Asset Position Remains Large

Growth remains steady, but has lost momentum, in line with the trend in Europe. The central bank (NBB) has estimated real GDP at 1.5% in 2018, below the euro area average. A slightly lower growth rate is forecast for 2019, as export growth is expected to soften and as the business investment cycle normalises. Some downside risks to the outlook are external. The country is well integrated into the global value chains, and thus exposed to lower external demand. The UK’s departure from the EU could adversely impact Belgium’s external sector, as the UK is the fourth-largest trading partner, accounting for almost 8% of Belgium’s merchandise exports. The pharmaceutical, automotive, and transport sectors appear the most vulnerable. An intensification of global trade tensions would also be negative for exports.

Structural reforms adopted in recent years have yielded some results. The government’s reform agenda focused on addressing both Belgium’s weak trade competitiveness and high tax burden, by implementing a set of reforms aimed at moderating wage gains, shifting taxes from labour to consumption (the “tax shift”), and reducing the corporate tax rate. Strong job creation followed the implementation of these reforms. Nevertheless, the labour market remains constrained by some rigidities and skill mismatches. Inactivity and unemployment are high among non-EU immigrants, youths and low-skilled individuals. This, together with a low effective retirement age, translates into relatively low employment and participation rates, constraining Belgium’s GDP potential. Barriers to competition in the services sector and still high labour taxes represent additional elements that limit productivity gains.

Nevertheless, Belgium continues to benefit from a wealthy economy, with a GDP per capita level that is close to 20% higher than the euro area average. The level of private sector savings is also sizeable. Household net financial wealth, estimated at around 240% of GDP, is one of the highest in Europe. The aggregate net worth of Belgian households is above 700% of net disposable income, among the highest of OECD countries, comparable to Dutch households. Aggregate high incomes and savings provide the Belgian economy with an important degree of resilience.

Belgium is also a strong external creditor, which provides a buffer against external shocks. Averaging 50.4% of GDP over the past five years, Belgium’s net international investment position is one of the highest in Europe. Following years of persistent, but modest deficits, the current account remained broadly balanced over the past two years, largely reflecting improved cost competitiveness. With wage moderation now petering out, competitiveness could be affected to some degree, impacting the goods trade deficit, but the surpluses in the service and income balances are set to persist.

The Financial System is Sound Despite Some Risks Arising from Stronger Credit Growth

Risks to financial stability are moderate, although private sector debt and house prices are rising. Low interest rates have led to stronger credit growth, while banks have also loosened lending standards. Increasing household demand for loans is also leading to a steady, albeit moderate, rise in house prices. This all has resulted in higher household debt, estimated at close to 110% of disposable income. In response to the potential build-up of vulnerabilities, the government in May 2018 adopted a new macroprudential measure proposed by the NBB. This entails a 5% increase in the risk weighting coefficients on mortgage portfolios, with an additional capital surcharge targeting riskier real estate sub-segments, leading to an additional 3pp risk weight add on.

The current low interest rate environment has also affected banks’ interest margins. Nevertheless, Belgian banks are profitable, well capitalised, have liquidity levels above the minimum requirements and their asset quality is good, comparing favourably against the average of European banks. The sound position of the banking sector, together with one of the highest household net financial wealth positions in Europe, supports the resilience of the financial system to adverse shocks.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA – AA range. The main points discussed during the Rating Committee include the current political situation and implications, coming federal elections, fiscal performance and outlook, public debt trajectory, macroeconomic performance and exposure to shocks, financial stability risks and position of the banking sector.

KEY INDICATORS

Fiscal Balance (% GDP): -0.9 (2017); -0.8 (2018E); -1.6 (2019F)
Gross Debt (% GDP): 103.4 (2017); 102.3 (2018E); 101.4 (2019F)
Nominal GDP (EUR billions): 439.1 (2017); 455.4 (2018E); 471.1 (2019F)
GDP per Capita (EUR): 38,686 (2017); 39,915 (2018E); 41,086 (2019F)
Real GDP Growth (%): 1.7 (2017); 1.5 (2018E); 1.4 (2019F)
Consumer Price Inflation (%): 2.2 (2017); 2.4 (2018E); 2.0 (2019F)
Domestic Credit (% GDP): 227.3 (2017); 229.4 (Sept-2018)
Current Account (% GDP): 0.7 (2017); -0.1 (2018E); -0.4 (2019F)
International Investment Position (% GDP): 52.6 (2017); 51.4 (Sept-2018)
Gross External Debt (% GDP): 258.5 (2017); 250.4 (Sept-2018)
Governance Indicator (percentile rank): 85.1 (2017)
Human Development Index: 0.92 (2017)

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in euro (EUR) unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Fiscal balance (NBB), Gross debt (NBB), Nominal GDP (NBB/European Commission), GDP per Capita (NBB/European Commission), Real GDP Growth (NBB), Inflation (NBB), Domestic Credit (NBB), Current Account (NBB), International Investment Position (NBB), Gross External Debt (NBB). Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include Belgian Debt Agency, Ministry of Finance, National Bank of Belgium (NBB), Statbel, OECD, ECB, European Commission, Eurostat, IMF, World Bank, UNDP, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Adriana Alvarado, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Financial Institutions Group and Sovereign Ratings
Initial Rating Date: November 11, 2011
Last Rating Date: August 17, 2018

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