Reuters: US Dollar Report: Fitch Affirms Luxembourg at 'AAA'; Outlook Stable

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Fitch Affirms Luxembourg at 'AAA'; Outlook Stable Aug 9th 2013, 15:36 Fri Aug 9, 2013 11:36am EDT LONDON, August 09 (Fitch) Fitch Ratings has affirmed Luxembourg's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AAA'. The Outlooks on the IDRs are Stable. Fitch has simultaneously affirmed Luxembourg's Country Ceiling at 'AAA' and Short-term foreign currency IDR at 'F1+'. KEY RATING DRIVERS Luxembourg is a very high-income economy with favourable macroeconomic dynamics compared with other eurozone countries. Despite the slowdown GDP growth in Luxembourg outperformed the eurozone by almost 1 pp in 2012. The year-on-year growth rate in Q113 was 1%, while most eurozone members, including Germany, registered negative rates. However, Luxembourg's growth is more volatile than 'AAA' peers, reflecting its small size and the importance of the financial sector. The dominance of the international-oriented financial sector in a small open economy has non-negligible macroeconomic, and ultimately fiscal, risks. Notwithstanding the strength of Luxembourg's business model and comparative advantages the country has built up over the past decades, for example in fund management, finance is a risky and often volatile industry, exposed to exogenous shocks, especially in a monetary union undergoing structural changes. While the total balance sheet of the financial sector including banks and investment funds, at 70x GDP is not in itself a relevant indicator of the potential risks, the broader financial sector's share of GDP, including advisory and auxiliary services, exceeds 30% and its future development is important for Luxembourg's growth outlook. In light of recent developments, Fitch has lowered its estimates of medium-term potential growth rates to 1.5%-2%, mainly reflecting a weaker contribution from total factor productivity, while migration will keep labour supply on a positive trend. However, Fitch maintains its view that the Luxembourgian economy will grow faster than the eurozone over the medium term. Luxembourg has a strong public finance position. General government gross debt was 21% of GDP in 2012, including contributions of 1.2% of GDP to eurozone rescue schemes, the EFSF and ESM. In the short to medium term, social security reserves, equivalent to 28% of GDP in 2012, exceeding the gross debt level, provide the sovereign with extra financing flexibility. The projected rise in ageing-related expenditure to 2060 under current parameters remains among the largest in Europe, despite the pension reform measures adopted after a lengthy consultation period in December 2012. However, most of this projected fiscal shock takes place after 2030. The general government deficit was 0.8% of GDP in 2012, mainly due to a cyclical deterioration following the 0.2% deficit in 2011. Despite the government's fiscal consolidation measures equivalent to 2.1% of GDP, Fitch expects the deficit to remain broadly stable in 2013 due to the prolonged weakness of the economy. Luxembourg has a strong external balance sheet, although its gross debt and asset position is inflated by the financial sector. Its net international investment position was 76% of GDP in 2012. The current account has been in surplus for more than two decades, in the range of 5%-8% since 2008. Luxembourg ranks highly on all World Bank governance indicators, in line or exceeding 'AAA' medians. Its institutional strengths foster confidence in its ability and willingness to honour its public debt commitments. RATING SENSITIVITIES The Outlook is Stable. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a rating change. However, future developments that could individually or collectively, result in a downgrade of the ratings include: - Re-intensification of the eurozone crisis. The balance sheet of the Eurosystem increased substantially over the past three years and Luxembourg has built up by far the largest cross-border claim ('Target2 balance') relative to its economy in the eurozone. While the exposure has declined from its mid-2012 peak, it still exceeded 220% of GDP in May 2013. Fitch recognizes that direct losses would materialise only in an extreme scenario of full break-up of the monetary union. - Turbulence in the financial sector would pose limited direct risks through contingent liabilities to the sovereign as domestic-oriented institutions are fairly insulated from the internationally oriented banks and investment funds. Nevertheless, a sudden, deep fall in financial sector activity could lead to a significant adverse macroeconomic impact, including on the labour market, with knock-on effects on public finances as well. KEY ASSUMPTIONS The ratings and Outlooks are sensitive to a number of assumptions. Based on a modest eurozone recovery commencing in H213, Fitch forecasts GDP growth in Luxembourg to accelerate in 2013 to 0.6% from 0.3% in 2012. Growth can reach 1.3% in 2014 and 1.5% 2015, while unemployment is forecast to peak at 5.9% next year. Inflation will likely remain below the 2% eurozone price stability definition until 2014, not least due to the temporary tightening of wage indexation scheme,. Fitch assumes there will be progress in deepening fiscal and financial integration at the eurozone level in line with commitments by policy makers. It also assumes that the risk of fragmentation of the eurozone remains low. Fitch assumes that the new government to be formed following the general elections in autumn 2013 will maintain an economic policy consistent with the previous government and, in particular, the deficit targets of the Stability Programme will be met until 2015. To this end, the new government will have to clarify the measures to counterbalance the loss of e-commerce VAT revenues effective from 2015. Fitch assumes that the sovereign will not provide any support to the financial sector beyond the domestically active banks even in case of a large adverse shock to the financial sector. The total balance sheet of the three domestically active larger banks is less than 200% of GDP with a strong capital position and a loan portfolio benefiting from the healthy balance sheet position of the domestic sectors. Contact: Primary Analyst Gergely Kiss Director +44 20 3530 1425 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Amelie Roux Director +33 1 44 299282 Committee Chairperson Andrew Colquhoun Senior Director +852 2263 9938 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com Applicable criteria, 'Sovereign Rating Methodology', dated 13 August 2012 and 'Country Ceilings' dated 13 August 2012 are available at www.fitchratings.com. Applicable Criteria andALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE. Link this Share this Digg this Email Reprints

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