2015 marks the end of two consecutive years of above 4% GDP growth
Luxembourg found its success in economic and financial openness and a business-friendly and low tax environment. In 2015, real GDP growth is expected to reach 3%, mainly driven by net services exports. Private consumption has been hit by the VAT rate hikes at the start of 2015: +2pps in all VAT rates (with the main rate at 17%) except for the reduced 3% rate on basic goods (food, pharma, public transport etc). In 2016 and 2017, the economic activity is expected to continue to expand at a strong pace (GDP growth above 3%) supported by the execution of large public infrastructure projects, a pick-up in private consumption and dynamic exports. While goods exports will suffer from continued slow growth in advanced economies and emerging markets, services exports, mainly financial, will remain the main engine of growth. Although the traditional banking sector has been overall impacted by the low interest rate environment, the investment fund industry gained momentum and globally the contribution of the financial sector to the overall economy strengthened in 2015.
Low inflation, healthy public finances but high dependency on the financial sector
Headline inflation has trended downward since start of 2012 given increasing deflationary pressures in the Eurozone and the fall in oil prices since mid-2014. An uptick is expected for 2015 (+0.9%) following the VAT increases and the domestic economic recovery in addition to the lower euro is expected to support a further rise in inflation (+1.7% in 2016).
In addition to the VAT increases the government introduced a temporary personal income tax set at 0.5% of income. Further, a spending review – Zukunftspack – has been launced, amounting to 1.7% of GDP over the next five years. These measures are expected to fight the loss of VAT revenues following the entry into force of the new taxation regime on e-commerce. Hence, the fiscal balance will be almost neutral in 2015 (+0.1%), following a +0.6% of GDP in 2014. The debt-to-GDP ratio will hover around 23% in the short-medium term (2015-17), well below the 60% level of the Maastricht criteria. It is worth noting Luxembourg’s high dependency on the financial sector, including (i) a banking system with assets of roughly 16 times GDP and (ii) the second largest investment fund industry in the world. However, the international central securities depository is settled in Luxembourg – Clearstream Banking S.A. – and the overall banking system is sound.