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Rating action

Scope Ratings GmbH has today affirmed Belgium’s long-term issuer and senior unsecured local- and foreign-currency ratings at AA and revised the Outlook to Negative. The short-term issuer rating has been affirmed at S-1+ in both local and foreign currency with a Stable Outlook.

Summary and Outlook

The affirmation of Belgium’s AA rating is supported by a wealthy and diversified economy, a favourable debt profile and market access, macroeconomic stability, and a strong external position. However, these supportive factors are counterbalanced by the challenges of increasing fiscal slippage, still-high public debt levels and weakening economic prospects.

The Outlook change to Negative of Belgium’s long-term ratings reflects: i) increasing fiscal slippage and vulnerabilities, characterised by high public debt, widening structural deficits, and continuously rising social expenditures; and ii) deteriorating economic prospects, driven by declining productivity, a lack of structural reforms and the weak external environment.

The Negative Outlook reflects Scope’s view that the risks to the ratings are tilted to the downside over the next 12 to 18 months. The ratings could be downgraded if: i) policy inertia weakens public finances further; ii) productivity growth remains negative due to a lack of structural reform; and/or iii) the external position deteriorates further. Conversely, the Outlook could be revised back to Stable if: i) a reversal back to fiscal consolidation places the public debt-to-GDP ratio on a steady downward path; ii) potential growth increases on the back of structural reforms; and/or iii) the economy benefits from a significant recovery in external demand.

Rating rationale

The first driver of Scope’s revision of Belgium’s Outlook to Negative is the structural deterioration in the economy’s fiscal fundamentals, which if left unaddressed, poses a considerable risk to the country’s medium-term public finances. Belgium’s consolidated general government gross debt in 2019 is estimated at 99.1% of GDP, above levels for peers such as France (98.9%) or the UK (84.2%). Similarly, the country’s projected gross financing needs at 14.6% of GDP and structural deficit of 2% of GDP for 2020 are among the highest in the euro area. These metrics reflect persistent risks to Belgium’s public debt sustainability and constrain the economy’s ability to respond effectively in downturns. While previous governments improved Belgium’s budgetary performance and gradually reduced its general public debt levels over 2014-18 by 7pp, to 100% of GDP, upcoming budgetary pressures are likely to reverse some of the achieved consolidation, which, in Scope’s opinion, may constrain the economy’s ability to respond effectively in crises.

Scope notes that the fiscal loosening has been mostly structural, despite a marked decline in interest expenditure in recent years. Tax revenues declined from 52.5% of GDP in 2014 to 50% in 2018, partly resulting from corporate tax reform. Social expenditure, which represents around half of public spending in Belgium, is a key factor weighing on fiscal dynamics. The latter is expected to increase by 0.9% of GDP over 2018-21 and accelerate significantly over the long term due to population ageing. According to the IMF, adding the net present value of changes in healthcare and pensions spending to the 2018 debt level results in a debt-to-GDP ratio of 187% for Belgium, well above that of France (140%) and the UK (148%). On this basis, Belgian public finances are set to deteriorate over the medium-term. After a post-crisis low at 0.7% of GDP in 2018, the 2020 Draft Budgetary Plan projects the budget deficit to widen considerably to 1.7% of GDP in 2019 and to reach 2.3% of GDP in 2020, well above targets set out in the 2019 Stability Programme of 0.8% in 2019 and 0.2% in 2020. In the absence of policy changes, authorities risk a significant deviation from the requirements of the Stability and Growth Pact’s preventive arm in both 2019 and 2020, with a structural adjustment gap averaging 0.6% of GDP and debt reduction gaps of 1.5% and 2.7% in the two years.

Given the above-mentioned fiscal vulnerabilities, policy action is required to support fiscal consolidation and reverse an adverse trajectory in Belgium’s public finances. The current caretaker government envisages a no-policy change budget for 2020, leaving structural budgetary pressures unaddressed. At the same time, newly elected regional governments expect regional deficits to increase in order to finance new policies or investments. The Negative Outlook on the AA rating thus captures the rising risk to the fiscal trajectory arising from fiscal slippage at the central government level alongside Brussels’ inability to coordinate regional budgets. Current fiscal projections are exacerbated by downside risks to economic growth, which could lead to worse-than-expected fiscal performance in the near term.

The second driver for the Negative Outlook reflects Belgium’s deteriorating growth prospects, which pose additional downside risks to the abovementioned fiscal challenges. Growth is projected at 1% in 2020, down from an estimated 1.4% in 2019 and 1.46% in 2018. While Scope expects economic growth to benefit from robust growth contributions from private (0.6pp) and public consumption (0.28pp) growth over the course of this year, contributions from the external sector remain negative (-0.34pp). The gradual shift from supply-side-driven growth towards consumption-led expansion will be accompanied by low growth in total factor productivity, totalling just 2% in cumulative terms since 2010, markedly below peers such as France (3.5%) and the UK (6.7%). Total factor productivity growth turned negative in 2018 and is projected to decline by another 0.63% in the period to 2021. Under Scope’s view, these developments could adversely affect potential growth, currently estimated at 1.5%, higher than that of France (1.2%), but on a weakening trajectory.

The measures implemented in past structural reform programmes with regards to the labour market and tax system are insufficient to keep Belgium’s economy on a stable growth path. The country’s employment rate of 70%, despite an increase of 3.5 percentage points since 2015, remains among the lowest in the euro area and only higher than that of Italy and in line with that of Greece. Having the highest tax wedge in the euro area, at 46.1% of labour costs in 2018, moreover prevents Belgian households from taking up more work. Furthermore, the lack of policy coordination alongside language barriers between regions constrain labour mobility. Regulatory impediments contribute to economic disparities between the three large regions of Flanders, Wallonia and Brussels. Moreover, structural challenges impede the creation of a more competitive business environment, reflected in a high share of zombie firms and low entry rates of new businesses compared to in peer countries. Scope expects a continued delay in reform implementation to adversely affect labour supply over the medium term as the share of the population of working age is projected to decline from 65.6% to 64.6% between 2017 and 2021, in line with demographic trends also present in many peers.

Finally, the weak external environment continues to weigh on one of the most open economies in the world, with goods and services trade accounting for an 80% share of GDP between 2016 and 2018. After five consecutive years in surplus, the country’s current account turned negative in 2018 (-1% of GDP) and has remained negative since then (-1.1% in Q3 2019). Belgium’s export performance has been a major growth driver since the global financial crisis, reflecting successive gains in competitiveness thanks to moderate wage costs and high productivity. This trend is currently being reversed, however, with higher compensation of employees (3.1% year-on-year in 2019) despite the decline in productivity. Ongoing trade tensions, Brexit, and increasing import demand add to an adverse trajectory of the trade balance. Belgian exporters face a greater exposure to Brexit-related risks than exporting peers in other countries, with around 3.8% of Belgium’s GDP affected by direct or indirect trade links with the UK. Scope anticipates that weak external demand, together with a further deterioration in the wage-productivity gap, will continue to hamper economic growth.

Despite these negative developments, Belgium’s ratings remain supported by its key credit strengths:

First, Belgium benefits from relative macroeconomic stability as reflected in exceptionally low GDP volatility, a diversified economy, and high wealth levels. High productivity, as measured in real output per person employed of EUR 90,840 in 2018, supports economic stability and exceeds the levels in France (EUR 82,240) and the UK (EUR 85,670). A diversified industrial structure shields Belgium’s small, open economy from adverse external shocks to an extent, demonstrated in the economy’s comparatively stable economic performance after the financial crisis. Macroeconomic stability is also ensured by a relatively low unemployment rate of 5.4% (Q3 2019) and stable net private investments of 4.7% of GDP. In addition, Belgium benefits from high net household wealth (950% of GDP in 2019 compared with 650% in France), which could mitigate risks in the event of financial market distress or a major correction in real estate markets.

Second, Belgium’s AA rating is underpinned excellent market access and a strong debt profile. Belgium’s debt is characterised by a long average maturity, which stood at 9.8 years as of year-end 2018. Similarly, around 90% of public debt is long term with no foreign-currency debt outstanding. Furthermore, financing conditions for Belgium are very supportive, with the 10-year sovereign bond yielding just -0.08% at the time of writing, close to that of France (-0.14%) and below that of the UK (0.57%). Belgium’s favourable market access was reflected in the latest 15 January benchmark issuance of a EUR 6bn 10-year bond with an annual coupon of only 0.1%. This robust debt profile and excellent market access mitigates risks stemming from high public debt levels.

Third, external sustainability supports the ratings, as shown in high net international investment assets of 48.8% of GDP and very low net external debt levels of 5.4% of GDP as of Q3 2019. Belgium’s exporting companies benefit from diversified destination markets across Europe, which also mitigates risk related to Brexit. Trade with the UK has mainly affected exporters’ intensive margins, with the number of products and companies involved in the export sector remaining broadly stable to date. It is Scope’s view that the innovativeness of key exporting industries (minerals, pharmaceuticals and chemicals) continues to shield Belgium’s external accounts from sudden shifts in the presently volatile external environment.

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

The rating committee reviewed Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, and assigned an indicative ‘A’ (‘a’) rating range for the Kingdom of Belgium. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis. For the Kingdom of Belgium, the following relative credit strengths have been identified: i) growth potential of the economy; ii) economic policy framework; iii) macro-economic stability and sustainability; iv) market access and funding sources; v) current account vulnerability; vi) external debt sustainability; vii) vulnerability to short-term external shocks; viii) banking sector performance; ix) banking sector oversight and governance; and x) financial imbalances and financial fragility. No credit weaknesses relative to peers were identified beyond the CVS assessment. The combined relative credit strengths and weaknesses generate a positive three-notch adjustment and indicate a sovereign rating of AA for the Kingdom of Belgium. A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope considers sustainability issues during the rating process as reflected in its sovereign methodology. Governance factors are explicitly captured in Scope’s assessment of ‘institutional and political risk’ under its methodology, on which the Kingdom of Belgium has high scores on a composite index of six World Bank Worldwide Governance Indicators in line with the performance of its AA rated peers.

Social factors are reflected in Belgium’s comparatively high GDP per capita, moderate unemployment rates, and relatively low wealth and income inequality levels relative to the EU average. However, Scope observes an increasing skills mismatch, youth unemployment rates above the EU average and a persistent inequality of opportunities for the children of disadvantaged families, resulting in a heightened risk of poverty due to social background (62.1% against a EU average of 53.4% in 2017). Finally, environmental factors were considered during the rating process, including the challenges for Belgium of meeting energy and climate targets by 2030. New measures, such as higher environmental taxation and more substantial actions on energy efficiency, are needed, however, to comply with targets. Scope’s environmental assessments did not play a direct role in this rating action.

Rating committee
The main points discussed by the rating committee were: i) economic growth potential; ii) fiscal policy framework; iii) external economic risks; and iv) peers.

Methodology
The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on http://www.scoperatings.com. The historical default rates used by Scope Ratings can be viewed in the rating performance report on 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 and 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 in which a rating may change within the next 12 to 18 months. A rating change is, however, not automatically a certainty.

Solicitation, key sources and quality of information
The rating was initiated by Scope and 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 material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: National Bank of Belgium (NBB), Belgian Debt Agency, National Statistical Office (StatBel), International Monetary Fund, European Commission, Eurostat, OECD, 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 publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon 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 Bernhard Bartels, Associate Director
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director
The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The ratings/outlooks were last updated on 18 May 2018.

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
© 2020 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: Guillaume Jolivet.