By Thomas Gillet and Tom Giudice, Sovereign and Public Sector

The outcome of the election in Belgium (AA-/Negative) points to a still-higher degree of political fragmentation and polarisation, complicating the formation of the next government following the resignation of prime minister De Croo. Any coalition agreement likely depends on how hard the conservative nationalists (New Flemish Alliance) and far-right Flemish separatists (Vlaams Belang) insist on their electoral promise of Flemish autonomy, if not independence, to which other parties are opposed.

Moreover, any caretaker administration, as Belgium experienced for an extended period in 2020, will have little legitimacy to implement policies, let alone cut fiscal deficits. This is also because none of the main political parties put fiscal consolidation on top of their agenda, suggesting that even a well-balanced government may be unable to implement reforms to better balance the budget and tackle rising debt-to-GDP.

Lengthy coalition talks and uneven progress on reform are likely to result in continued high fiscal deficits, set to average more than 5% of GDP until 2029. General government debt is thus set to remain on an upward trajectory, increasing from 105% of GDP in 2023 to 116% by 2029, about 18-percentage-points above its pre-Covid level.

Without new impetus for fiscal consolidation, we expect Belgium’s deficits to remain above the euro-area average and its public debt to be among the highest in the euro area, below that of Greece (BBB-/Stable) and Italy (BBB+/Stable), but surpassing that of France (AA/Negative) and Spain (A-/Positive). This elevated public debt stock is a key credit risk as it durably limits the government’s fiscal space to respond to the next shock.

Fiscal trajectory vulnerable to a no-policy-change scenario…

Since federal elections in 2019, the fiscal record of the seven-party coalition formed in September 2020 has been weak, acknowledging the dual shocks of the pandemic and energy crisis. Still, compared to peers, the government has not implemented major reforms addressing Belgium’s key credit challenges.

Although the Belgian parliament passed a pension reform in April, the gains for public finances are modest. Savings are estimated at 0.4% of GDP by 2070. Plans for the simplification of the tax system were cancelled in 2023.

Continued lack of political consensus at the federal level about ambitious reforms could impede progress to rebuild fiscal buffers and prolong the steady deterioration of public finances since the pandemic. Compared to the government’s indicative stability programme, we project a fiscal consolidation gap growing from 1% of GDP in 2025 to 3% of GDP by 2027, in line with the IMF.

The federal government’s fiscal challenges will become even more acute as costs from the country’s ageing population increase. Belgium will have one of the highest costs of ageing by 2035 (28% of GDP in 2035), below that of France (29%, the highest in the EU) but above that of Spain (26%).

…increasing the risk of entering an excessive deficit procedure

In a no-policy-change scenario of persistently wide deficits, Belgium is likely to enter an excessive deficit procedure under the EU’s fiscal framework. Closer scrutiny might incentivise the federal government to reduce fiscal deficits under revised EU rules provided the government reaches political consensus for spending cuts.

Lower inflation, projected at 2.2% in 2025, down from 3.9% in 2024, could ease pressure on public deficits related to the country’s inflation-indexed pensions and social benefits, particularly if complemented by the complete phasing out of energy-related subsidies.

Wealthy and diversified economy, favourable debt profile, and robust external position remain credit strengths

Despite significant fiscal challenges captured through the Negative Outlook assigned in September 2023, Belgium’s credit ratings are supported by a high per capita GDP (EUR 62,500 in purchasing power terms), which is among the largest in the EU, and a wealthy and diversified economy. We expect real GDP growth to average 1.3% between 2024 and 2029, in line with the country’s growth potential.

Belgium has also a robust public debt profile, with a high average duration of the government debt portfolio (10.8 years), providing a cushion against higher interest rates and a potential shift in market sentiment. Belgium will continue to benefit from a very gradual increase of net interest payments, projected to exceed 2% of GDP only in 2027, compared to 2.7% for the UK and France, and 2.8% for Spain. Similarly, the country’s international competitiveness has resulted in a positive net international investment position while its euro-area membership supports the economy strong resilience against external shocks.

Scope’s next calendar review date is on 2 August 2024.