On Tuesday, the European Commission proposed country-specific recommendations for a coordinated economic response to the coronavirus pandemic.
The short- to medium-term recommendations, outlined as part of the European Semester Spring Package, specifically look at areas such as public health investment and job retention through income support, assistance to companies and the fight against money laundering.
Concerning Luxembourg, the Commission recognised that the Grand Duchy is currently in the preventive stage of its Stability and Growth Pact. In its 2020 Stability Programme, the Luxembourg government expected the headline balance to deteriorate from a surplus of 2.2% of GDP in 2019 to a deficit of 8.5 % of GDP in 2020. The deficit is projected to fall to 3.0% of GDP in 2021. After having increased to 22.1% of GDP in 2019, the general government debt-to-GDP ratio is expected to increase to 28.7% in 2020 according to the programme. The Commission added that the macroeconomic and fiscal outlook have been affected by high uncertainty related to the coronavirus19 pandemic.
Looking at Luxembourg's response to the crisis, as part of a coordinated EU response, the Commission noted that the Grand Duchy has adopted budgetary measures to increase the capacity of its health system, contain the pandemic and provide relief to individuals and sectors that have been hardest hit. According to the 2020 Stability Programme, those budgetary measures amounted to 5.5% of GDP. Luxembourg also introduced measures aimed at supporting the liquidity of businesses, such as tax deferrals and loans to small and medium-sized enterprises in temporary financial difficulties. In contrast with the 2020 Stability Programme, the Commission has estimated a smaller impact of the package as it does not consider tax deferrals and the granting of refundable loans as discretionary measures with a budgetary impact. Overall, the measures taken by Luxembourg are considered in line with Commission guidelines.
Based on the Commission's 2020 spring forecast, Luxembourg’s general government balance is forecast at a deficit of 4.8% of GDP in 2020 and at a surplus of 0.1% in 2021. The general government debt ratio is projected to remain below 60% of GDP in 2020 and 2021. Compared to the Commission forecasts, the Stability programme is based on more prudent assumptions for both revenues and expenditures.
On 20 May 2020, the Commission also issued a report due to Luxembourg’s projected breach of the 3% of GDP deficit threshold in 2020. Overall, the analysis suggests that the deficit criterion as defined in the EU treaties is not fulfilled.
Although the Commission recognised that Luxembourg has one of the best performing health systems in the EU, the system is considered well above the critical vulnerability threshold since 49% of doctors and 62% of health workforce come from abroad. In this context, Luxembourg’s health system could be impacted by potential unilateral decisions by neighbouring countries at times of crisis. Indeed, the Commission stated that the country's health system could face rising challenges in the future, in addition to the growing number of vacancies of health workers in recent years.
Similarly, unemployment is expected to rise to 6.4% in 2020 before dropping to 6.1% in 2021. While Luxembourg has implemented several employment measures, such as partial unemployment, the Commission has recommended that special consideration be given to more vulnerable groups, such as older and low-skilled workers, in a context where the new minimum income scheme has already led to an increase of registered unemployed people with the public employment service.
The Commission added that the resilience of the banking sector should be considered when maintaining specific support measures for businesses in the recovery phase. To foster economic recovery, it will also be important to front-load mature public investment projects and promote private investment, including through relevant reforms, notably in digital and green sectors. Whilst Luxembourg has already launched initiatives to boost digitalisation and innovation, technological integration in the business sector and private investment, as well as the digitalisation of public services, remain low, according to the Commission.
In addition, the European Commission warned that Luxembourg faces significant money laundering risks in view of the high inflows of foreign direct investments and the presence of complex legal structures with foreign sponsors. Weaknesses in the application of the anti-money laundering framework by these professionals result in inadequate risk analyses and a low level of reporting of suspicious activities. The Commission maintained that the intensity of supervision of these professionals is inadequate to remedy these shortcomings. Tackling aggressive tax planning also remains key to improving the efficiency and fairness of tax systems, as acknowledged in the 2020 euro area recommendation. While Luxembourg has taken steps to address aggressive tax planning practices by implementing previously agreed international and European initiatives, the high level of dividend, interest and royalty payments as a percentage of GDP suggests that the country’s tax rules are used by companies that engage in aggressive tax planning.
As well as national responses, the Commission stressed that a coordinated EU economic response is essential to relaunch the economy. In this context, the EU institution concluded that Luxembourg should, as a Member State whose currency is the euro, ensure its policies remain consistent with the euro area recommendations and coordinated with those of the other euro area Member States.