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Fitch Affirms Luxembourg at 'AAA'; Outlook Stable
April 14, 2017 / 8:10 PM / in 3 months

Fitch Affirms Luxembourg at 'AAA'; Outlook Stable

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(The following statement was released by the rating agency) LONDON, April 14 (Fitch) Fitch Ratings has affirmed Luxembourg's Long-Term Foreign- And Local-Currency Issuer Default Ratings (IDRs) at 'AAA'. The Outlooks are Stable. The issue ratings on Luxembourg's senior unsecured local-currency bonds have also been affirmed at 'AAA'. The Country Ceiling has been affirmed at 'AAA' and the Short-Term Foreign- and Local-Currency IDRs at 'F1+'. KEY RATING DRIVERS Luxembourg's 'AAA' IDRs reflect strong governance metrics, high income per capita, and solid growth potential and public finances, which offset the weaknesses from high structural unemployment and heavy concentration of the economy in the financial services sector. Public finances are a key strength for Luxembourg, with a five-year average fiscal surplus of 1.2% of GDP compared with a 0.3% of GDP deficit for the 'AAA' median. The general government surplus for 2016 improved marginally to 1.6% of GDP in 2016 (2015:1.5%) due to under-spending, partly due to the later than expected triggering of the automatic wage indexation, and technical delays in public investments. Fitch forecasts the fiscal surplus will fall to 0.1% of GDP in 2017 and 2018 as this underspending reverses, and owing to the government's 2017 tax reform measures that were approved by parliament in December 2016. Tax reform will benefit households by abolishing a 0.5% temporary tax from the 2014 fiscal consolidation package, and increasing tax credits and deductions. This is only partly offset by an increase in taxes for the highest earners, a rise in the tax on savings interest, and measures to combat tax fraud. Businesses also benefit from a reduction in the corporate income tax rate to 19% (from 21%) and further to 18% in 2018, and a rise in investment tax credits. Fiscal policy for 2017-18 is designed to utilise fiscal space to achieve some redistribution towards households and to improve the business environment in the lead up to the October 2018 elections. Luxembourg has the lowest public debt/GDP amongst 'AAA' rated sovereigns at 20.6%, with the entire debt stock euro-denominated. Debt is forecast to rise to 23.0% of GDP in 2017 and 2018 following the issuance of EUR2 billion in central government debt in January 2017 to refinance maturing debt. A potential recapitalisation of the Central Bank of Luxembourg is still pending and could add 1% of GDP to the government's debt according to Fitch's estimates., The projected long-term increase in fiscal costs due to population ageing remains one of the highest across EU countries, despite reforms to the pension system in 2013, and would result in a gradual decline in the country's pension reserves. Proceedings by the European Commission (EC) on potential state aid received by Fiat-Chrysler, McDonalds and Amazon could lead to these companies having to repay Luxembourg taxes retrospectively, resulting in one-off boosts to fiscal revenues. Luxembourg is appealing the Fiat-Chrysler decision. Luxembourg's potential growth is estimated by STATEC to be strong at 3.2%. The five-year average real GDP growth of 3.5% significantly outperforms the 'AAA' median primarily driven by strong net exports driven by the financial services sector. Revised figures for 2014 and 2015 showed stronger growth in real GDP at 5.6% and 4.0%, respectively, resulting in real GDP improving by 1.5pp over 2013-15 after the revision. The full year estimate for Luxembourg's real GDP growth in 2016 was 4.2%, with growth driven mainly by net exports, and to a lesser extent public and private consumption. Fitch forecasts growth to pick up slightly to 4.4% in 2017 and 4.5% in 2018 and to be more broad-based as domestic demand is boosted by the government's tax cuts for households and businesses, and private consumption is supported by low interest rates, robust employment growth (2016: 3.2% yoy) and wage growth (2016: 3.5% yoy). Risks to the growth outlook are roughly balanced. There is potential for stronger growth if private consumption and investments perform better than expected, particularly if the economy benefits from financial corporations shifting some operations to Luxembourg following the UK's Brexit vote. Conversely, weaker global trade and growth as a result of protectionist measures from the world's largest economies and disorderly Brexit trade negotiations impacting EU trade and growth would likely affect financial market performance and Luxembourg's small and trade-dependent economy. Luxembourg's external finances are robust, with a large net creditor position of 2,181% of GDP, supported by large external assets of international banks, investment funds and multi-national corporations. The country has benefited from more than two decades of large current account surpluses, driven by a large net services surplus. Luxembourg has a very large financial sector, comprising international banks, domestically-oriented banks, and investment funds. Total banking sector assets amounted to 1,409% of GDP at end-2016, while the aggregate financial sector accounts for 11% of total employment and 25% of GVA in 2016. Domestic lending and retail operations are concentrated amongst five domestic banks, while domestic 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 23.9% 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 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 current Outlook is Stable. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a material likelihood of leading to a downgrade. 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 the changes to the international corporate tax framework across the EU would not result in a large-scale migration of operations out of Luxembourg by multinational corporations. Fitch assumes that new structural reforms to the pension system will be enacted to offset the fiscal costs of Luxembourg's ageing population, which are currently projected to increasingly weigh on public finances over the next decade. 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 189% of GDP at end-2015) could still materialise on the sovereign's balance sheet. Contact: Primary Analyst Eugene Chiam Director +44 20 3530 1512 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Marina Stefani Associate Director +44 20 3530 1809 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 (pub. 16 Aug 2016) here Sovereign Rating Criteria (pub. 18 Jul 2016) 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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Users of Fitch’s ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed. The information in this report is provided “as is” without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. 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