On Wednesday 27 April 2022, Luxembourg's Minister of Finance, Yuriko Backes, presented details of the Stability and Growth Program (PSC) 2022, which provides an overview of the economic and budgetary prospects for Luxembourg in the current context marked by the war in Ukraine, to the Chamber of Deputies.

Minister Backes commented “The PSC that I presented today to the Chamber of Deputies for the year 2022 is part of a worrying and highly uncertain context. Despite the clarifications on the front of the pandemic, and following the recovery of public finances since last year, we are now facing a new crisis. The consequences of the Russian invasion of Ukraine not only risk breaking the momentum of the recovery, but with it, we can now expect a marked deterioration in public finances in the short term. The figures for the PSC 2022 show, however, that Luxembourg will be able to meet the challenges facing the country through a responsible and far-sighted budgetary policy.”

Following the parliamentary debates, the PSC 2022 is to be sent, together with the National Reform Programme, to the European Commission before the end of the month.

Growth forecasts revised downwards following the Russian invasion of Ukraine

Throughout the COVID-19 pandemic, the Luxembourg economy has shown resilience. Employees and companies have managed to adapt to an unprecedented situation and Luxembourg has returned to the economic and budgetary trends of before the pandemic. The economic recovery took hold at the end of 2020 and accelerated in 2021, thanks in particular to the various state aid measures put in place within the framework of the “Stabiliséierungspak” and the “Neistart Lëtzebuerg”.
Thus, real GDP growth is now estimated at +6.9% in 2021 and the labour market has proven to be just as dynamic, leading to a continuous decline in unemployment in recent months to 4.7% at the end of March 2022, the lowest rate for almost 15 years.

This recorded economic and budgetary improvement should have continued, as evidenced by the still positive figures in the 1st quarter of 2022. However, Russia's invasion of Ukraine from 24 February is deeply shaking the world economy, causing a further increase in energy prices, already high before the armed conflict, as well as food prices. The shock caused by recent events also threatens to undermine the confidence of consumers and business leaders and leads to increased volatility in financial markets.

According to the Finance Ministry, this is why Statec has revised Luxembourg's growth outlook down two percentage points, like the International Monetary Fund. Growth is now estimated at 1.4% in 2022. In the medium term, economic development is assumed to be between 2.5% and 3.0%.

The worsening inflationary trends and the resulting consequences for the Luxembourg economy have led the government to convene the social partners within the framework of the "Tripartite" coordination committee from 22 March 2022. In the spirit of solidarity which is specific to Luxembourg, an agreement was reached with the representatives of the UEL, the CGFP and the LCGB. The purpose of this agreement is in particular to shift the index tranche scheduled for August 2022 to April 2023, while compensating for the loss of purchasing power of low- or modest-income households.

In total, the measures decided within the framework of the “Solidaritéitspak” amount to some €750 million, or 1.0% of GDP. By including the state guarantees made available to companies, Luxembourg is mobilising a total of €1.3 billion or 1.7% of GDP to deal with the immediate consequences of this new crisis.

Taking into account the impact of the said measures, as well as those announced within the framework of the “Energiedësch”, the inflation rate is estimated at 5.2% for the whole of 2022, assuming a stabilisation or even a reduction in oil prices, inflation is estimated to drop to 1.6% in 2023.

Significantly deteriorated public finances in the short term

Luxembourg's public finances also experienced a remarkable recovery in 2021. After recording a historic deficit of around €-2.2 billion or -3.4% of GDP in 2020, public administrations closed the 2021 with a balance of €+650 million or +0.9% of GDP.

This improvement is attributable to the rigorous control of public funds at the level of the central administration, the deficit of which was able to be divided by ten, from €-3.1 billion in 2020 to some €-326 million in 2021. The public debt, for its part, was able to be reduced from 24.8% in 2020 to 24.4% of GDP in 2021.

The updating of the budget forecasts made for the PSC 2022 leads to a markedly deteriorated situation in the short term under the effect of the war in Ukraine. The general government balance goes from a surplus of +0.9% in 2021 to a deficit of -0.7% of GDP in 2022. Government revenue only increases by 4.3% (after an increase of 12.7% in 2021) and public spending increases by 8.3%.

The deterioration of the macroeconomic situation as well as the measures recently decided to mitigate the impact of inflationary pressures will thus have a significant impact on State finances. The central government would see its balance fall from €-326 million in 2021 to €-1.6 billion in 2022. Public debt is likely to increase again, to 25.4% of GDP in 2022.

In the medium term, the trajectory of public finances is gradually recovering thanks to the recovery of economic activity, to reach a balanced general government balance by 2026 and the public debt stabilizes at around 26% of GDP, is below the ceiling of 30% of GDP.

The improvement at the consolidated level of general government, however, masks contrary trends at the level of the sub-sectors: central government is once again heading towards a more balanced situation from 2023, while the Social Security surplus is reduced over the projection horizon.

A new MTO of 0% of GDP for the period 2023-2025

Following the extension of the general escape clause of the Stability and Growth Pact until 2022, the European budgetary rules are currently suspended. Like all the other Member States of the European Union, Luxembourg is therefore currently exempt from respecting the medium-term budgetary objective (MTO).

For the period 2020-2022, Luxembourg had set its MTO at +0.5% of GDP, i.e. at the same level as the minimum reference value determined at the time by the European authorities. The new minimum MTO calculated by the European Commission for the period 2023-2025 is 0% of GDP and Luxembourg is once again aligning itself with this minimum, setting its objective at this same level for the years to come.

With a structural balance above 0% for the next few years, the SGP 2022 also shows that Luxembourg respects its MTO, and would therefore be fully compliant with the rules of the Stability and Growth Pact, in case the derogation clause was deactivated from 2023 and that the rules of the said Pact came into force again