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Rating action

Scope Ratings GmbH (Scope) has today downgraded the Kingdom of Belgium’s long-term local and foreign currency issuer and senior unsecured ratings to AA- and has revised the Outlook to Stable, from Negative. Belgium’s short-term issuer ratings were affirmed at S-1+ in local and foreign currencies, with Outlooks Stable.

Rating drivers

The downgrade of Belgium’s sovereign credit ratings to AA- from AA reflects:

1. A lasting impact the Covid-19 crisis will have on Belgium’s fiscal fundamentals. This crisis has led to a sharp increase in public debt ratios, which are projected to continue increasing over the forecast horizon, exacerbating pre-existing debt sustainability challenges.
    
2. Structural economic weaknesses in the form of declining productivity growth, lagging business dynamism and labour market bottlenecks. These issues have gone largely unaddressed by a lack of structural reform in recent years with adverse implications for longer-run growth and fiscal consolidation prospects.

The Stable Outlook represents Scope’s view that risks to the ratings over the next 12 to 18 months are balanced. The ratings could be downgraded or the Outlooks revised once more to Negative if, individually or collectively: i) Belgium fails to successfully implement a credible consolidation strategy, with associated risk for debt sustainability; ii) a further shock to economic growth, fiscal dynamics and/or financial stability results in a sudden significant increase in government debt ratios; and/or iii) political instability emerges, weighing upon governance and the government’s capacity to implement credit-enhancing structural reform.

Conversely, the ratings/Outlooks could be upgraded if, individually or collectively: i) Belgium places public debt on a firm downward trajectory; and/or ii) structural reforms accelerate and successfully strengthen the medium-term growth outlook; and/or iii) further advancements in the EU institutional architecture provides additional support to Belgium’s credit profile.

Rating rationale

The first driver of the rating downgrade to AA- reflects the lasting impact of the Covid-19 shock on Belgium’s fiscal fundamentals. In response to the public health crisis, Belgium adopted necessary countermeasures to contain the spread of the virus. It also implemented a large fiscal support package to mitigate the adverse impact of lockdown on the domestic economy. This fiscal support included, among other areas, increases of health spending and hospital funding, funding of temporary unemployment schemes as well as other support measures for households and corporates. The budget impact of these measures was EUR 17.5bn (3.9% of GP) in 2020¹ and has resulted in a significant budget deficit of 9.4% of GDP. The government’s economic recovery plans foresee continued fiscal support short- to medium- term, with EUR 6bn to be mobilised in coming years. While this continued government support is appropriate to support the recovery, it will also further weigh on fiscal metrics. Scope expects the general government deficit to gradually narrow to around 4% of GDP by 2026 as the stimulus is withdrawn and economic activity picks up. Under this scenario, public debt continues rising to around 120% of GDP in 2026, slightly better than figures under IMF forecasts but nonetheless almost 22pps above 2019 levels. This highlights the materiality of the Covid-19 shock on Belgium’s fiscal fundamentals, which has exacerbated long-standing credit weaknesses that are only partly mitigated by the ECB monetary policies and EU funding support programmes.

The Belgian government has outlined a medium-run budgetary strategy under the Stability Programme of 2021-24². The government’s fiscal objectives include a 0.2% of GDP budget adjustment each year from 2022 on, mostly driven by increasing revenues as a share of GDP while expenditures stabilise. While Belgium has managed to successfully consolidate public finances in the past, such as during the 1990s or, to a somewhat lesser extent, over the 2014-19 period, future budget consolidation may be more difficult to achieve. This reflects structural fiscal pressures Belgium faces in way of ageing-related costs as well as the absence of a stable, strong government more recently with the capacity to implement critical difficult reforms. Belgium is among the EU countries that will see the largest increase in ageing costs over coming years. The Study Committee on Ageing projects these costs to increase by 5pps of GDP between 2019 and 2040. Ageing pressures are reflected within IMF forecasts for the country’s structural deficit, which is expected to widen from 3.5% of GDP in 2020 to 5% of GDP 2026, the second widest among peers after the United States (5.1% of GDP; France: 3.5%; United Kingdom: 3.2%).

The second driver of the ratings downgrade to AA- reflects Belgium’s structural bottlenecks impacting the economy, which weigh on growth potential and present additional downside risks to outstanding fiscal challenges, existing within a fragmented political landscape that constrains policy makers’ capacities to address said structural challenges. Belgium exhibits constrained productivity growth relative to peers due to limited progress in addressing weak business dynamism, a lack of competition in product and service markets, and ineffective public R&D spending. According to OECD data, labour productivity growth averaged 0.3% over 2015-19 in Belgium versus a 0.8% OECD average. In addition, multifactor productivity, which is more closely linked to innovation, has been flat on average over the same period, below growth rates in the United Kingdom (0.1%), France (0.4%) and the United States (0.6%). Furthermore, reforms are needed to raise labour-force participation and address skills shortages. Such structural economic bottlenecks weigh on growth potential (estimated at around 1.3%) and have been left unaddressed at the national level in recent years due to the political stalemate following the breakup of the coalition in December 2018 and the May 2019 elections.

In this context, Scope notes that the Belgian recovery plan is a constructive step in partially alleviating these challenges, for instance via increasing public investment and committing to a structural reform agenda. However, policy making at the national level is likely to be constrained by political polarisation and fragmentation, which have led to a decline in mainstream parties and increase in political support for regionalist, green and anti-establishment groups in regional and federal parliaments. Belgium’s policy making framework is characterised by coalition building and consensus-based decision making. This tends to slow and complicate the decision-making process around crucial reforms. Difficulty in forming a coalition government following the fall of the Charles Michel I government coalition in December 2018, which required until October 2020 to form a workable governing majority, is only the most recent example of hindrances in governance. Looking ahead, Scope expects policy making in Belgium to remain constrained given the fragile coalition government of seven political parties.

Overall, the two drivers for the downgrade highlight the difficulties Belgium’s government faces in reversing the fiscal degradation resulting from the Covid-19 crisis over the coming years. The fiscal and economic pressures have been exacerbated by the crisis in a politically fragmented environment that constrains policymakers’ ability to address these challenges effectively.

Despite these credit weaknesses, Belgium’s AA- ratings remain supported by its key credit strengths:

Firstly, Belgium benefits from its wealthy and diversified economy. High income per capita, as measured in GDP per capita in power purchasing parity terms of USD 54,265 in 2019, supports economic resilience and exceeds the per-capita GDP levels of France (49,696) and the United Kingdom (48,603). High wealth levels are also reflected in the very large net financial assets of Belgian households of EUR 1.1trn (254% of GDP), which mitigate risk in event of financial system distress or a major correction in real estate markets. Belgium’s diversified industrial structure also partially shields its small, open economy from adverse external shocks to an extent. The country ranks 18th globally according to the Economic Complexity Index and 22nd on the World Economic Forum’s 2019 Global Competitiveness Index although these rankings have deteriorated in somewhat in recent years. High wealth levels and a diversified economy underpin macroeconomic stability as has been demonstrated in comparatively more resilience economic performance after the financial crisis as well as the relatively lesser contraction in GDP in 2020 of 6.4% versus that of several peers (8.2% in France and 9.9% in the United Kingdom).

Secondly, Belgium’s AA- rating is underpinned by strong market access and a favourable debt profile. The government debt is characterised by a long average maturity, which stood at 10.3 years as of May 2021. Around 92% of public debt is long term with no foreign-currency exposures after accounting for swap agreements. Furthermore, financing conditions for Belgium are highly accommodative, with the 10-year sovereign bond yielding only 0.3% at the time of writing, in line with that of France but below that of the United Kingdom (0.8%). Belgium’s favourable market access is reflected in the recent February 2021 launch of a syndicated benchmark issuance of a EUR 5bn 50-year bond with an annual coupon of only 0.7% and oversubscription of EUR 41bn³. This robust debt profile and strong market access, also supported by the ECB’s highly accommodative monetary policy stance, partially mitigates risks stemming from high public debt levels.

Lastly, a sound external position supports the ratings, as displayed in high net international investment assets of 45.1% of GDP versus a net international investment position of -116% for the United States, -66% for the United Kingdom, and -26% for France. Belgium’s exporting companies benefit from diversified destination markets across Europe. This helps to mitigate risks related to Brexit. Although the worst-case scenario of a no-deal Brexit has been averted, Scope still expects a reduction in trade between the United Kingdom and the EU, which affects Belgium more adversely compared to other member states. Nevertheless, the innovativeness of key exporting industries (minerals, pharmaceuticals and chemicals) continues to support Belgium’s external accounts from any sudden deterioration amid presently volatile external conditions. Still, Belgium’s external position faces a number of challenges related to adverse developments in competitiveness. The National Bank of Belgium expects that Belgian exports will see some decline in their market shares in the coming years, reflecting long-term competitiveness trends⁴. This also is reflected in IMF forecasts which project the Belgian current account balance to remain negative over the 2021-26 period.

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, provides a first indicative rating of ‘a+’ for Belgium. Belgium receives a one notch uplift to this indicative rating via the reserve currency adjustment under the methodology. As such, the ‘aa-’ indicative rating can be adjusted under the Qualitative Scorecard (QS) by up to three notches depending on the size of relative qualitative credit strengths or weaknesses against a peer group of countries.

For Belgium, the following QS relative credit strength has been identified: i) Macro-economic stability and sustainability; ii) Debt profile and market access. The following QS relative credit weaknesses have been identified: i) Growth potential of the economy; and ii) Institutional and political risks.

The QS generates no notch adjustments and indicates AA- long-term ratings for Belgium.

A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope explicitly factors in ESG sustainability issues during the ratings process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 20% weighting under the quantitative model (CVS) as well as in the qualitative overlay (QS). Under governance-related factors in the CVS, Belgium’s performance is strong and in line with that of sovereign peers, such as France and the United Kingdom, as assessed by the World Bank’s Worldwide Governance Indicators. Belgium has a record of policy inertia over recent years given difficulties in formation of robust government coalitions at federal level, leaving structural weaknesses partially unaddressed. This reflects long-term trends in political polarisation, which has been exacerbated by a complex political structure, with high degrees of autonomy for federated entities and limited formal hierarchy between government tiers.

Socially related credit factors are similarly captured under Scope’s CVS, as designated via increasing old-age dependency ratios and low labour force participation rates. These quantitative factors weigh on the ratings. The CVS score, however, also reflects supportive contributions from Belgium’s comparatively low income inequality. The qualitative assessment of social factors is reflected in the ‘social risks’ evaluation category of the QS, under which Belgium is assessed as ‘neutral’ compared with its sovereign peers, balancing strong social safety nets with skills mismatches as well as regional inequalities.

Environment-related credit risks of Belgium are balanced in Scope’s assessment. The economy is more carbon intensive than those of France or the United Kingdom with limited emissions reductions in recent years. Belgium also faces risks linked to storms and flooding but overall displays more limited natural disaster risk vulnerability within an international context. The European Commission has assessed the final national energy and climate programmes of Belgium as ‘unambitious’ in respect to the national energy contribution from renewables and ‘low’ as regards the ambition of energy efficiency enhancements⁵. Still, the climate plans are in line with requirements under the Effort Sharing Regulation. In addition, the current economic recovery plan specifically includes a climate and sustainability pillar and foresees large investment in the energy efficiency of buildings and in low-carbon energy systems, which support the green transition.

Rating Committee
The main points discussed by the rating committee were: i) fiscal developments and consolidation prospects; ii) structural economic pressures; iii) political and institutional factors; iv) constraints on reform progress; and v) external position.

Rating driver references
1. Kingdom of Belgium Debt Agency – May 2021 Investor Presentation
2. Programme de Stabilité de la Belgique 2021-24
3. Kingdom of Belgium Debt Agency – New 50-year OLO deal summary
4. National Bank of Belgium – December 2020 Economic Review
5. European Commission (2020) – Assessment of final national energy and climate plan of Belgium

Methodology
The methodology used for these Credit Ratings and/or Outlooks, ‘Rating Methodology: Sovereign Ratings’ 9 October 2020, is available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party Participation    NO
With Access to Internal Documents                                 NO
With Access to Management                                           NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks is/are UK-endorsed.
Lead analyst Thibault Vasse, Senior Analyst
Person responsible for approval of the Credit Ratings: Dr. Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on January 2003. The Credit Ratings/Outlooks were last updated on 7 February 2020.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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