Washington, D.C., 24 May 2023
On May 17, 2023, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Luxembourg.1
Luxembourg has shown resilience in the aftermath of the war in Ukraine and accelerated tightening of global financial conditions, partly helped by fiscal support. That said, despite robust labor market, GDP growth slowed. Soaring energy prices sent inflation to a multi-decade high, prompting the Government to support households and firms by introducing price controls and tax cuts. Although costly, the measures have helped temporarily keeping inflation below the levels in most euro area peers and limiting the number of wage indexations. Tighter financial conditions have started to impact the financial sector, with heterogeneity across segments. The financial sector, overall, remains resilient, though there are some pockets of vulnerabilities, especially in the real estate sector and non-bank financial institutions.
Growth is expected to slow to about 1 percent in 2023, before gradually recovering to its potential percent over the medium term. Headline inflation is likely to moderate further but core inflation is expected to remain persistent. The near-term outlook is highly uncertain. Risks are tilted to the downside and stem from a deeper global slowdown, a de anchoring of inflation expectations, and systemic financial instability at the global level.
Executive Board Assessment2
Executive Directors agreed with the thrust of the staff appraisal. They noted that the Luxembourg economy has remained resilient in the face of successive shocks, supported by solid fundamentals and a strong policy response. However, uncertainties and risks have risen, including from Russia’s war in Ukraine and global financial tightening, as well as high domestic real estate prices and household indebtedness. In this context, Directors encouraged the authorities to continue pursuing policies targeted at addressing inflationary pressures and maintaining macro-financial stability, while implementing structural policies to promote economic resilience.
Directors urged the authorities to maintain a broadly neutral fiscal stance to help contain persistent inflation. They stressed the need for better targeted and less price distortionary energy support measures, while continuing efforts to promote energy security. Given the increased uncertainty over the near term, Directors saw scope for a flexible fiscal policy, including by allowing automatic stabilizers to operate fully. They also emphasized the need for prudent spending to preserve buffers, including by expediting pension reforms. Directors welcomed the recent adjustment of the tax brackets and called for more frequent, budget-neutral adjustments in response to inflation, alongside a comprehensive review of the tax-benefit system.
Directors noted that while financial risks have risen, banks’ strong capital and liquidity buffers should help absorb potential shocks. They encouraged continued close monitoring of financial sector risks and pockets of vulnerabilities, especially in real estate. They saw merit in introducing income-based limits and considering targeted capital measures to strengthen banks’ resilience. Directors welcomed the strengthening of the supervision and stress-testing capacities for investment funds, while calling for continued monitoring of liquidity and leverage and further proactive participation in international fora to strengthen investment fund regulation. While welcoming the authorities’ plans, they encouraged further enhancements to the AML/CFT framework.
Directors stressed that structural reforms should primarily focus on real estate and labor markets. Improving housing affordability should remain a top priority, with further actions necessary on the supply side, including through front-loaded public investment, while avoiding demand support. Directors encouraged consideration of enhancing the automatic wage indexation framework, including by indexing wages to a measure of core inflation, while striking a balance between distributional and competitiveness concerns. Directors commended the authorities’ progress in reducing gender gaps and encouraged additional measures to further reduce them. Seniors’ labor market participation should also be improved.
It is expected that the next Article IV consultation with Luxembourg will be held on the standard 12-month cycle.
1 Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
2 The Executive Board takes decisions under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussions.
Source – IMF