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 modestly, projected closer to 100% in 2019. Nevertheless, while on a downward path, the still high public debt ratio leaves Belgium with limited capacity to respond to adverse shocks. Economic growth is also forecast to remain modest around 1.2% in both 2019 and 2020. Moreover, after the Belgian elections in May 2019, the domestic political landscape is more fragmented, adding some degree of uncertainty to the reform progress and the medium-term fiscal outlook.

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 Belgian Political Landscape is More Divided and Policymaking Is On Pause

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. The outcome of the federal and regional elections held in May 2019 led to a more fragmented political structure. At the federal level, the right-wing New Flemish Alliance (N-VA) remains the largest party in parliament, but with its seats down to 25 of the total 150 seats of the federal parliament. The far-right Flemish Interest (VB) had higher-than-expected gains, taking 18 seats. Smaller parties on the far left also gained seats. At the same time, the regional divide was clear, with the Flemish-speaking voters on the right and the French-speaking voters on the left of the political spectrum. Talks for the formation of regional government are ongoing. DBRS expects the federal government formation to take several months. In the meantime, the former minority government remains as caretaker government.

The current political situation is delaying additional progress on fiscal consolidation and reforms. The 2019 budget and some of the previously agreed labour market measures (the “jobs deal”) have not been passed yet. Until a new federal government is in place, the budget is operating under the “provisional twelfths” system, limiting expenditure and the impact on public finances. Given Belgium’s degree of decentralisation, the regions carry out a significant share of public sector functioning, and their fiscal positions are sound. Despite policy uncertainty, DBRS does not envisage major disruptions during the period of government formation and expects the next government to maintain prudent economic policies. (For further details, please see DBRS commentary entitled “Belgium: More Fragmented Election Results Bring Challenges for Federal Government Formation”, available at www.dbrs.com).

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 came in lower than expected at 0.7% 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 1.3% in 2019. The deterioration is the result of the last phase of the five-year “tax shift” reform (a tax relief already legislated), and the fading one-off effects on corporate revenues in 2018. The deterioration would increase the risk of a further delay in reaching a structural budget balance, which has already been postponed twice from 2019 to 2021.

The high government debt-to-GDP ratio is declining gradually. From a recent peak of 107.6% in 2014, the debt ratio was 102.0% 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 stakes in financial institutions. The state has, among others, a 100% participation in Belfius.

A favourable public debt profile helps mitigate the risks from high debt. 91.3% 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 10 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 and projected to be even lower in 2020 .

Belgium’s Economy Is Moderating, But Household Income Remains High and The Net External Asset Position Large

Growth remains steady but has lost momentum, in line with the trend in Europe. After slowing to 1.4% in 2018, real GDP growth is forecast at 1.2% in 2019 and 1.1% in 2020 by the NBB. The slowdown reflects weaker export growth and the normalisation of the business investment cycle. Private consumption is set to be the main growth driver. Downside risks to the outlook have risen and are largely 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 about 9% of Belgium’s merchandise exports. The pharmaceutical, automotive, and transport sectors appear the most vulnerable. A deterioration in euro area growth and an intensification of global trade tensions would also be negative for exports and sentiment.

Structural reforms adopted in recent years have yielded results. The previous government’s reform agenda focused on addressing both Belgium’s weak trade competitiveness and high tax burden, by implementing measures aimed at moderating wage gains, shifting taxes from labour to consumption (the “tax shift”), and reducing the nominal 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 are additional factors that limit productivity gains.

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 48.8% of GDP over the past five years, Belgium’s net international investment position is one of the highest in Europe. After several years of current account surpluses, Belgium’s current account has been mostly in deficit since 2008, but the deficit is small averaging 0.6% of GDP in the past five years. Improved cost competitiveness led to a reduction in the current account deficit in recent years. But, with wage moderation now petering out, competitiveness could be affected, impacting the goods trade deficit. The surpluses in the service and income balances, nevertheless, are set to persist.

The Financial System is Sound Despite Some Risks from Strong 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 loosened lending standards. Rising household demand for loans is contributing 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.

To address the potential build-up of vulnerabilities, the NBB adopted a macroprudential measure in May 2018. This entails a 5% increase in the risk weighting coefficients on mortgage portfolios, with an additional capital surcharge on riskier real estate sub-segments, resulting in an additional 3pp risk weight add-on. Moreover, in response to strong credit growth and to enhance the resilience of banks in Belgium, the NBB activated the countercyclical capital buffer at the end of June 2019, raising it to 0.5% of risk weighted assets, with a one-year implementation period.

Low interest rates have also weighed on 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, fiscal performance and outlook, public debt trajectory and risks, macroeconomic performance and prospects, and financial stability risks.

KEY INDICATORS

Fiscal Balance (% GDP): -0.7 (2018); -1.3 (2019F); -1.7 (2020F)
Gross Debt (% GDP): 102.0 (2018); 101.4 (2019F); 101.3 (2020F)
Nominal GDP (EUR billions): 450.6 (2018); 463.1 (2019F); 476.0 (2020F)
GDP per Capita (EUR): 39,507 (2018); 40,409 (2019F); 41,330 (2020F)
Real GDP growth (%): 1.4 (2018); 1.2 (2019F); 1.1 (2020F)
Consumer Price Inflation (%): 2.3 (2018); 1.5 (2019F); 1.6 (2020F)
Domestic Credit (% GDP): 224.7 (2018); 225.2 (Mar-2019)
Current Account (% GDP): -1.3 (2018); -1.6 (2019F); -2.0 (2020F)
International Investment Position (% GDP): 43.7 (2018); 49.4 (Mar-2019)
Gross External Debt (% GDP): 241.3 (2018); 248.8 (Mar-2019)
Governance Indicator (percentile rank): 90.2 (2016); 89.2 (2017)
Human Development Index: 0.92 (2016); 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 (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), the Belgian statistical office (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: Thomas R. Torgerson, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: November 11, 2011
Last Rating Date: February 15, 2019

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