Estudios económicos
Luxembourg

Luxembourg

Population 0.6 million
GDP 115,839 US$ billion
A2
Country risk assessment
A1
Business Climate
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Synthesis

major macro economic indicators

  2018 2019 2020 (e) 2021 (f)
GDP growth (%) 3.1 2.3 -2.1 1.7
Inflation (yearly average, %) 2.0 1.6 0.2 1.3
Budget balance (% GDP) 3.1 2.4 -8.3 -3.9
Current account balance (% GDP) 0.0 2.2 0.6 1.1
Public debt (% GDP) 21.0 22.0 28.1 29.4

(e): Estimate (f): Forecast

STRENGTHS

  • Fiscal stability
  • Skilled multilingual workforce
  • High-quality infrastructure; business-friendly regulation
  • Major international financial centre
  • High standard of living

WEAKNESSES

  • Heavily dependent on a large financial sector
  • Economy vulnerable to eurozone economic conditions
  • Long-term budgetary impact of population ageing
  • International pressure for tax reform threatens to reduce the tax base

Risk assessment

Rebound in activity, driven by a resilient financial sector

Following a recession of unprecedented proportions, the economy is expected to rebound significantly in 2021, but without fully offsetting the previous year’s losses. Faced with the first wave of the pandemic in the spring of 2020, the government introduced a lockdown, closing all non-essential activities, but did not impose travel restrictions. While, as a result, the country recorded a substantial drop in GDP of around 8.5% in the first half of the year, it showed relative resilience in comparison to the rest of the Eurozone, and in particular compared to other countries in the region that had implemented similar lockdowns (average GDP loss of around 20% for France, Italy and Spain). Although household consumption and business investment collapsed in proportions comparable to those of the hardest hit countries, Luxembourg’s economy benefited during the crisis from the resilience of the financial sector, which accounts for 27% of GDP and whose jobs are conducive to teleworking. As the world's second-largest fund management centre (EUR 4.7 trillion in assets under management) behind only the United States, the Luxembourg economy is highly exposed to the volatility of the international financial markets, which were overall robust in 2020 after a collapse in the spring. The financial sector is mainly composed of foreign banks (subsidiaries of European banks) - of the 130 banks registered in 2019, only seven were domestically focused commercial banks - and alternative investment funds. Thanks to the diversity of the financial sector’s activities, profitability in the sector is less affected by very low interest rates. The end of the transition period following the UK's exit from the European Union will enable an influx of FDI from companies relocating from the UK, particularly in the insurance sector. Regarding financial stability, capitalisation is strong, and the authorities are taking measures to contain property risks (change to the rule on accelerated depreciation of rental property investments). Beyond finance, although Luxembourg has become a hub for scientific R&D, industry’s share in GDP is steadily declining (5% of GDP in 2019, with metals accounting for one-third, down from 6% in 2010 and 13% in 1995), replaced by real estate activities and business services (20% of GDP) and non-market services (19%).

 

Healthy public finances despite pandemic-related expenditure

While 2020 marked the end of a decade of budget surpluses, due to the fall in activity and support measures (unemployment, direct aid to companies, deferral of tax and social security payments), the public deficit is expected to fall significantly in 2021. The public accounts will nevertheless remain clearly in deficit due to the extension of some measures (short-time work scheme, business aid) amid the ongoing pandemic, and the increase in public investment, particularly in transport infrastructure, aimed at reviving activity (4.3% of GDP, up 0.6 points on 2019). Although a broader tax reform initially planned for 2021 was finally postponed due to health uncertainties, a carbon tax of
EUR 20/tonne of CO2 will be introduced in 2021 and increase by EUR 5/tonne per year through to 2023, and real estate income earned by investment funds will be taxed at a flat rate of 20%. Whatever happens, public debt, which was the lowest in the Eurozone before the crisis, will remain at a very low level.

Moreover, after falling sharply in 2020 mainly due to the collapse in the income balance resulting from social contributions paid to cross-border workers during the lockdown (partial unemployment scheme, extraordinary leave for family reasons), the current account surplus is expected to rebound in 2021. While trade is expected to grow, the trade deficit and the income deficit due to cross-border transfers will continue to be offset by a significant surplus in the balance of services, three-quarters of which is attributable to the financial sector (EUR 20 billion).

 

A government strengthened by its handling of the first wave

At the head of the country since 2013, Prime Minister Xavier Bettel of the centre-right Democratic Party (DP) remained in power following the 2018 legislative elections after reaching a deal, as he did in his previous term, with the Socialist Party (LSAP) and Déi Gréng (environmental), giving the coalition a narrow majority (31 seats out of 60). The Christian Social People's Party (CSV) came out top in the election with 28% of the vote, 11 points ahead of the DP, and is the main opposition party with 21 seats. While the DP has been forced to make concessions to its partners, notably the environmental party, the only one of the main parties to make gains in 2018, as evidenced by the green investment projects and the recent carbon tax, the coalition looks solid. According to a poll in June 2020, the prime minister's party was strengthened by its handling of the first wave of the pandemic, attracting increased voting intentions (21%), which would give the coalition a more comfortable majority (33 seats) in the event of early elections.

 

Last updated: March 2021

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