Belgium: Reducing debt remains the main challenge

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This post is a guest contribution by Olivier Bizimana of  Morgan Stanley.

Budget consolidation in Belgium is underway. The draft federal budget for 2011 passed the Belgian parliament last week. The caretaker government aims to cut the overall fiscal deficit to 3.6% of GDP in 2011 from 4.1% of GDP in 2010. In addition, Belgium’s Stability Program, published in April, aims to reduce the fiscal deficit to 0.8% of GDP, which should bring the debt-to-GDP ratio down to 92.2% in 2014. Our near-term view on Belgium has slightly improved, with the preparation of a comprehensive consolidation strategy by the caretaker government. However, the ongoing political impasse keeps us cautious, as Belgium remains vulnerable to a shift in market confidence, given its sizeable public debt and the uncertain market environment.

The key challenge for Belgium is to reach more sustainable debt levels in the medium term. Given the rising costs related to an aging population and high interest payments, additional structural efforts will likely be required to reduce public debt as a share of GDP over the longer term. We believe that for a country like Belgium, which has a high level of public debt, the priority is a relatively rapid reduction in debt, given its sensitivity to changes in interest rates and growth.

Market Concerns Have Eased for Now

Almost a year after the general elections, the political impasse in Belgium persists. The political parties have been unable to find sufficient common ground to start talks to form a coalition government. After several rounds of consultation, the King has appointed Mr. Elio Di Rupo, leader of the French-speaking Socialist Party, as ‘formateur’. He is in charge of forming a new coalition government and will be the Prime Minister if he succeeds. The appointment of Mr. Elio Di Rupo as a ‘formateur’ may not necessarily accelerate the formation of a coalition government, as there is as yet no agreement among the political parties on the main source of the political deadlock, state reform. The appointment of a ‘formateur’ is nevertheless an encouraging step towards the formation of a government. At the time of writing, whether Mr. Di Rupo will succeed where others have failed is unclear. Should the deadlock persist, new elections cannot be ruled out.

Meanwhile, the sovereign risk premium, measured either by the government bond spread versus the OIS over the same maturity or the sovereign CDS spreads, has shrunk since February. The reduction in market concern on Belgian sovereign debt is presumably due to the various initiatives taken by the caretaker government to consolidate public finances. However, general market concerns persist and volatility is still high – a reflection, in our view, of global uncertainty on the outcome of the sovereign debt crisis in the euro area periphery. The ‘hierarchy’ of sovereign risk premiums, ranking countries from the lowest perceived risk to the highest, is unchanged, though the spreads have widened.

Could Belgium Be Affected Again by Market Sovereign Debt Concerns?

In our view, the risk of a spillover of the sovereign debt crisis to Belgium, and other core countries in general, remains. Despite a comprehensive fiscal consolidation plan, the ongoing political impasse could weigh on investor confidence. Given the high uncertainty on the outcome of the crisis in the euro area periphery – in particular whether or not those countries perceived as most fragile (Greece, Ireland and Portugal) may have to restructure their public debts – markets are likely to remain in ‘contagion mode’, sensitive to the next ‘weakest link’. While we believe that the overall macroeconomic situation in Belgium is solid (strong external position, high household savings rate), as long as the political uncertainty persists, the trigger for renewed market tensions should remain.

Could Belgium’s Rating Be Downgraded?

Continue reading Belgium: Reducing debt remains the main challenge

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