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Fitch Affirms Luxembourg at 'AAA'; Outlook Stable
July 18, 2014 / 8:18 PM / in 3 years

Fitch Affirms Luxembourg at 'AAA'; Outlook Stable

(The following statement was released by the rating agency) LONDON, July 18 (Fitch) Fitch Ratings has affirmed Luxembourg's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'AAA'. The Outlooks are Stable. The issue ratings on Luxembourg's senior unsecured foreign and local currency bonds have also been affirmed at 'AAA'. The Country Ceiling has been affirmed at 'AAA' and the Short-term foreign currency IDR at 'F1+'. KEY RATING DRIVERS Luxembourg's 'AAA' IDRs reflect the following key rating drivers: Luxembourg is a small, very high-income, ultra-open economy with strong macroeconomic dynamics compared to other eurozone countries. Despite a sharp 5.6% GDP contraction in 2009 and a mild 0.2% contraction in 2012, the economy has had one of the strongest recoveries in the euro area. GDP growth in 2013 was 2.1%, recently surpassing its 2007 pre-crisis level, and is forecast to accelerate to 2.3% in 2014. By contrast, growth in the eurozone as a whole fell by 0.4pps in 2013 and is forecast to grow by a more muted 1.2% in 2014. However, Luxembourg's growth tends to be more volatile than other 'AAA' economies due to its small size and the importance of its financial sector. Luxembourg's fiscal position is strong, but faces several challenges in the medium and long term. General government debt was 23.1% of GDP in 2013, well below the 'AAA' median and the EU's 60% threshold level. Large social security reserves amounting to 27% of GDP provide additional financing flexibility. In the near term, the loss of e-commerce VAT revenues (1.5%-2.0% of GDP from 2015) would cause the deficit to widen in the absence of offsetting consolidation measures. In the longer term, ageing-related expenditure would rise significantly in the absence of further pension reforms. At 0.1% of GDP in 2013, the general government balance outperforms its 'AAA' peers, but is likely to face some downward pressure across the forecast horizon due to the loss of e-commerce VAT revenues. Fitch forecasts a budget balance of 0.1% for 2014, before declining to -0.8% and -0.5% in 2015 and 2016 respectively, as the consolidation measures partially offset the loss of revenue. So far, only a rise in the VAT rate has been announced, accounting for one-third of the required adjustment gap by 2018. Fitch expects further adjustment measures to be announced in the 2015 budget. The presence of large international banks and investment funds in Luxembourg's small economy brings non-negligible macroeconomic, and ultimately fiscal, risks. Notwithstanding the strength of Luxembourg's business model and comparative advantages the country has built up over the past decades, for example in fund management, finance is a risky and often volatile industry, exposed to exogenous shocks, especially in a monetary union undergoing structural changes. The large financial sector (70x GDP) accounts for 24% of gross value added and 11% of employment, making the outlook for the sector an important driver of the economy's prospects. Luxembourg has a strong external balance sheet, although its gross debt and asset position are inflated by the financial sector. Its net international investment position was 204% of GDP in 2013, with the current account in surplus for more than two decades, largely due to its large financial service exports. Luxembourg's governance indicators are consistent with 'AAA' medians, and its institutional strengths foster confidence in its ability and willingness to honour its public debt commitments. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that downside risks to the 'AAA' rating are currently not material. However, future developments that could individually or collectively result in a negative rating action include: - The systemic domestically-oriented banks are moderate in size relative to the sovereign and fairly insulated from the internationally-oriented banks and investment funds. Nevertheless, a sudden, deep fall in financial sector activity overall could lead to a significant adverse macroeconomic impact, including on the labour market, with knock-on effects on public finances. KEY ASSUMPTIONS Fitch assumes that the consolidation programme laid out in the new government's 2014 budget and 15th Stability and Growth Programme will be adhered to. Fitch expects the bulk of the remaining necessary consolidation measures will be announced in the 2015 budget. Fitch assumes that sovereign support for the financial sector in Luxembourg would be limited to the large domestically-oriented banks even in the event of a large systemic shock to the sector. The aggregate balance sheet of the three largest domestically-oriented banks is roughly 2x GDP. Fitch assumes that the gradual progress in deepening fiscal and financial integration at the eurozone level will continue; key economic imbalances within the currency union will be slowly unwound; and eurozone governments will tighten fiscal policy over the medium term. Fitch assumes the eurozone will avoid long-lasting deflation, such as that experienced by Japan from the 1990s. It also assumes that the risk of fragmentation of the eurozone remains low. Throughout the global financial and sovereign crises, Luxembourg has built up the largest cross-border claims (Target2 balance) within the Eurosystem. The exposure was 240% of GDP at end -2013 and would only materialise in the extreme scenario of a full break-up of the monetary union. Contact: Primary Analyst Eugene Chiam Associate Director +44 20 3530 1512 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Amelie Roux Director +33 1 44 299282 Committee Chairperson Richard Fox Senior Director +44 20 3530 1444 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available on Applicable criteria, 'Sovereign Rating Criteria' dated 13 August 2012 and 'Country Ceilings' dated 09 August 2013, are available at Applicable Criteria and Related Research: Sovereign Rating Criteria here Country Ceilings here Additional Disclosure Solicitation Status 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 WEBSITE '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. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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