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Fitch Affirms Luxembourg at 'AAA'; Outlook Stable
October 13, 2017 / 8:14 PM / 2 months ago

Fitch Affirms Luxembourg at 'AAA'; Outlook Stable

(The following statement was released by the rating agency) LONDON, October 13 (Fitch) Fitch Ratings has affirmed Luxembourg's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'AAA' with a Stable Outlook. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS Luxembourg's ratings reflect the sovereign's high income per capita, strong governance indicators, high growth potential and sound public finances, balanced against higher macroeconomic volatility partly due to economic openness and heavy reliance on the financial services sector. Public finances are a key strength for Luxembourg's ratings. Luxembourg has the lowest gross public debt among 'AAA' sovereigns at 20.8% of GDP in 2016. The general government had a budget surplus of 1.6% of GDP, compared with the 0.2% 'AAA' median. Furthermore, social security reserves reached 33.5% of GDP in 2016 and the government expects the reserves to continue increasing until the mid-2020s. The public finances also benefit from declining interest expenditure. Luxembourg issued a new 10-year bond in January 2017 with a 0.625% coupon. The average maturity of the sovereign's entirely euro-denominated debt is 6.3 years, and the structure of the debt insulates the country from a significant increase in borrowing costs. Against this solid background the government implemented some fiscal easing in 2017 through personal and corporate income tax cuts. The fiscal impact is estimated at 0.8% of GDP, according to the European Commission (EC). The share of VAT revenue Luxembourg can retain from e-commerce transactions originated in Luxembourg to non-resident customers has declined to 15% in 2017 from 30% in 2016, equivalent to an additional 0.3% of GDP loss of tax revenue. On the expenditure side the wage indexation mechanism triggered a 2.5% increase in the wage bill in 1Q17 and public investments are projected to grow 16%. Fitch forecasts the budget to be broadly balanced in 2017, taking into account second round effects on revenues from the fiscal stimulus and wage indexation, and the balanced position to be maintained next year. Fitch forecasts economic growth to remain buoyant, averaging 4.1% over 2017-2019 notwithstanding short term volatility, as illustrated by the weak quarterly growth in 1H17. GDP grew 3.1% in 2016 according to the recently revised estimates by the Luxembourg statistical office and average growth over the last five years was 3%, compared with the 'AAA' median of 1.9% and eurozone growth of 1.1% over the same period. The combination of fiscal easing, higher nominal wages triggered by the indexation and robust employment growth will boost domestic demand, household consumption in particular. Favourable external developments, including the pick-up in eurozone growth and global trade, also help the Luxembourg economy. Nevertheless due to its high openness (exports are more than 2x GDP) the economy remains sensitive to global risks, such as a disorderly Brexit or protectionist measures by major global economies. In light of the robust growth performance, strong cyclical position and the nominal rigidities illustrated by the automatic wage indexation mechanism, the combination of fiscal easing and the ECB's ultra-loose monetary conditions could lead to overheating risks or asset price misalignments in the domestic economy. However, Fitch judges these risks, for example in the real estate market, to be limited, due to a strong domestic banking sector and resilient mortgage market. Potential growth is estimated by the EC to be around 3% over the medium term. Despite the strong growth potential, especially compared with most eurozone members, the composition reveals that productivity growth has been persistently weak in Luxembourg since the global financial crisis. Fitch expects productivity growth to improve in Luxembourg based on the economy's structural strengths and comparative advantages. Luxembourg has a strong external balance sheet, although its gross debt and asset position is volatile as it is inflated by the financial sector. Its net international investment position was 23% of GDP in 2016. The current account has been in surplus for more than two decades, at around 5% of GDP since 2013. Luxembourg has a very large financial sector, comprising international banks, domestically-oriented banks, and investment funds. Total banking sector assets amounted to approximately 14x GDP at end-2016, while the aggregate financial sector accounted for 11% of total employment and 27% of gross value added in 2016. Domestic lending and retail operations are concentrated in five domestically-oriented banks, while these banks' exposure to international banks is limited to their use of interbank funding. The banking sector is resilient with a strong Tier 1 capital adequacy ratio of 24.1% at end-2016, and one of the lowest non-performing loan ratios across EU countries, at 0.2% of total loans. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Luxembourg a score equivalent to a rating of 'AAA' on the Long-Term Foreign-Currency (LT FC) IDR scale. Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that the downside risks to the 'AAA' rating are currently not material. However, the following factor could put downward pressure on the ratings: A severe sudden contraction of financial sector activity in Luxembourg could have adverse consequences for the real economy, negatively impacting Luxembourg's labour market conditions and public finances. KEY ASSUMPTIONS Fitch assumes that structural reforms to the pension system will be enacted over the medium- to long-term to offset the fiscal costs of Luxembourg's ageing population, which are currently projected to increasingly weigh on public finances over the long term. Fitch assumes that the sovereign will not extend support to the internationally-oriented financial institutions, even in the event of a systemic shock to the wider financial sector. Fitch believes that in a severe financial crisis, some losses to the domestically-oriented Luxembourg banks (whose assets amount to 190% of GDP at end-2016) could still materialise on the sovereign's balance sheet. The full list of rating actions is as follows: Long-Term Foreign- and Local-Currency IDR affirmed at 'AAA'; Outlook Stable Short-Term Foreign- and Local-Currency IDR affirmed at 'F1+' Country Ceiling affirmed at 'AAA' Issue ratings on long-term senior unsecured local-currency bonds affirmed at 'AAA' Contact: Primary Analyst Gergely Kiss Director +44 20 3530 1425 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Eugene Chiam Director +44 20 3530 1512 Committee Chairperson Charles Seville Senior Director +1 212 908 0277 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Country Ceilings Criteria (pub. 21 Jul 2017) here Sovereign Rating Criteria (pub. 21 Jul 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. DIRECTORS AND SHAREHOLDERS RELEVANT INTERESTS ARE AVAILABLE here. 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