For the detailed rating report, click here.

Scope Ratings GmbH has today assigned AAA long-term issuer and senior unsecured local- and foreign-currency ratings to the Grand Duchy of Luxembourg, along with a short-term issuer rating of S-1+ in both local and foreign currency. All Outlooks are Stable.

Rating drivers

Luxembourg’s AAA rating reflects its wealthy economy and robust economic growth, sound public finances, euro area membership and effective institutional framework as well as its strong external position. However, unfavourable demographics, exposure to developments in the external environment, and imbalances in the housing market remain challenges. The Stable Outlook reflects our assessment that the risks faced by Luxembourg are balanced.

Luxembourg benefits from an exceptionally wealthy economy, with a GDP per capita estimated at around EUR 96,000 for 2018, the highest among the sovereigns rated by Scope, and high labour productivity, which exceeds the euro area average by more than 50%. Over the past five years Luxembourg’s economy has been growing considerably faster than the euro area average (3.5% compared to 1.5% for the euro area in 2013-17) supported by strong trade surpluses in the services balance, reflecting Luxembourg’s importance as a global financial centre. In line with the IMF’s forecast, Scope expects growth to remain strong at 4% in 2018 and 3.5% in 2019 due to a sturdy performance in both domestic and external demand, before converging to its medium-term potential of 3%.

Sound public finances and a low debt burden are key strengths underpinning Luxembourg’s AAA ratings. The government has strengthened the fiscal framework, complying with the medium-term objective of the Stability and Growth Pact in its budgetary strategy and keeping debt as a share of GDP below 30%. As a result, during 2011-17 the budgetary surplus averaged around 1% of GDP. Going forward, Scope expects higher spending for infrastructure and the tax reform to reduce the headline surplus to 1% of GDP over 2018-19, partly offset by a rise in revenues led by a strong economic performance.

Luxembourg benefits from highly liquid capital markets, and a favourable debt profile, reflected in low refinancing risks as well as no foreign exchange risks as all debt is issued in euro.

Furthermore, Luxembourg’s AAA rating is supported by the country’s euro area membership, affording the advantages of a large common market, a strong reserve currency, the independent European Central Bank (ECB) effectively acting as a lender of last resort, and an economic governance and macroprudential framework sustaining credible macroeconomic policies.

The rating is also supported by favourable external surpluses which reflect the country’s key role in global capital flows, underpinned by its favourable business environment, effective institutional framework and economic stability. The large financial sector has consistently generated strong surpluses in services trade, at 35% of GDP on average in 2010-17, in part counterbalanced by net outflows of primary income, reflecting the large number of foreign companies and employees. Over the medium-term Scope expects the current account balance to average around 5% of GDP, mostly reflecting the large sustained surpluses in financial and business services. Compared to end-2016 Luxembourg’s net international investment position remained almost unchanged at a high 47% of GDP at end-2017. 

Despite the relative strengths of Luxembourg, challenges remain. The financial sector’s exposure to developments in the external environment remains an important risk. The sector generates around 27% of gross value-added in the economy, and the direct tax contribution of the funds industry amounts to about 2% of GDP. Against this backdrop, international tax transparency initiatives, including the European anti-tax avoidance agenda and the US tax reform, which incentivise the repatriation of funds held overseas, could affect Luxembourg’s growth and fiscal revenues. This risk, however, is mitigated by proactive government policies and Luxembourg’s favourable business environment. In addition, while Brexit adds to medium-term uncertainties given the UK’s major role in the trade of financial services (the UK share of assets under management is around 18%), it could, on the other hand, also result in financial institutions moving business to Luxembourg.

While the medium-term public debt dynamics of Luxembourg are sound – a very low debt level of 23% of GDP at end-2017, one of the lowest in the euro area, and sizable government assets exceeding liabilities, including pension fund reserves, about 33% of GDP – long-term challenges remain due to adverse demographics. Measured by net present value of future pension and healthcare obligation changes, Luxembourg ranks fourth among the 30 advanced economies, with a ratio of 128% of GDP, above that of the Netherlands (109%), Belgium (95%) and Germany (88%), but below the USA (154%) and Switzerland (132%).

Rising household debt, which amounted to 65% of GDP in Q1 2018, and strong growth in house prices, by 5.7% each year since 2015, driven by a structural supply-demand mismatch, are sources of financial imbalances. Mortgages account for more than 80% of total household debt. The Central Bank of Luxembourg estimates the average overvaluation in house prices between Q1 2012 and Q1 2017 at 6.85%. On a positive note, the government has submitted to parliament a bill on regulatory measures aimed at strengthening the macro-prudential framework by capping several ratios (loan to value, loan to income, debt to income, and debt-service to income) and a loan’s initial maturity.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, signals an indicative ‘AAA’ (‘aaa’) rating range for Luxembourg. This indicative rating range can be adjusted by up to three notches on the Qualitative Scorecard (QS) depending on the size of relative credit strengths or weaknesses versus peers based on analysts’ qualitative findings.

For Luxembourg, the QS signalled relative credit strengths for the following analytical categories: i) growth potential of the economy; ii) market access and funding sources; and iii) banking-sector oversight and governance. Relative credit weaknesses were signalled for: i) macro-economic stability and sustainability; ii) vulnerability to short-term external shocks; and iii) financial imbalances and financial fragility. The combined relative credit strengths and weaknesses generate no adjustment and signal a sovereign rating of AAA for Luxembourg. A rating committee has discussed and confirmed these results.

For further details, please see Appendix II of the rating report.

Environmental, social and governance factors

Scope considers sustainability issues (ESG) during the rating process, as reflected in its sovereign methodology. Governance-related factors are explicitly captured in Scope’s assessment of ‘Institutional and Political Risk’, for which Luxembourg has one of the highest scores as measured by the World Bank’s Worldwide Governance Indicators.

Socially related factors captured in CVS are Luxembourg’s very high per-capita income, somewhat elevated unemployment rate, and low albeit increasing old-age dependency ratio. Furthermore, income inequality as calculated by the Gini coefficient is moderately lower than the average for OECD economies.

According to the global Green Finance Index, which measures sustainable development in the world’s financial systems, Luxembourg ranks among the top international financial centres. The Luxembourg Stock Exchange (LuxSE) listed the world’s first green bond in 2007, issued by the European Investment Bank. Furthermore, in 2016 Luxembourg launched the Luxembourg Green Exchange (LGX), the first worldwide platform to list sustainable financial instruments. Currently it is the world’s leading exchange of its kind, listing over USD 100bn bonds. More than 50% of the world’s green bonds are listed in Luxembourg. In addition, Luxembourg accounts for around 40% of all assets managed by European responsible-investment funds. Finally, environmental factors are considered during the rating process but did not have an impact on this rating action.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s assessment that the risks faced by Luxembourg are balanced.

The Outlook could be changed if: i) the changing international tax environment adversely impacts growth and fiscal revenues; and/or ii) the build-up of vulnerabilities in the housing market becomes unsustainable, weighing on financial stability.

Rating committee

The main points discussed were: i) Luxembourg’s growth outlook; ii) recent developments in the financial sector and its exposure to changes in international tax environment; iii) debt dynamics and sustainability; iv) current account performance; v) the housing market; vi) the financial sector’s macro-prudential framework; vii) recent political developments; and viii) peer considerations.

Methodology

The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com. Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com. The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information

The rating was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party. The following substantially material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: Central Bank of Luxembourg, STATEC, IMF, ECB, Eurostat, BIS, OECD, WB, and Haver Analytics.

Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures

This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Rating prepared by Levon Kameryan, Lead Analyst
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director
The ratings/outlook were first released by Scope on 19 October 2018.
As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on Luxembourg are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar 2018" published on 21.09.2018 on www.scoperatings.com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the deviation from Scope’s published calendar was due to the first-time release of the ratings.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2018 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin.

Scope Ratings GmbH, Lennéstrasse 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Director: Torsten Hinrichs.