Luxembourg Weathers Crisis

by Ulrika Lomas, Tax-News.com, Brussels

08 June 2010

Luxembourg's exceptionally open economy and internationally-integrated financial centre endured its worst economic performance in 30 years in 2009, with the economy contracting by 3.5%, according to the International Monetary Fund (IMF).

During 2009, the investment fund industry endured large redemptions, two systemically important banks were bailed out, and three smaller Icelandic banks failed.

Despite this, the IMF said a prompt and aggressive policy response safeguarded financial stability and mitigated adverse economic effects. "The authorities' decisive action in tackling troubled banks, combined with increases in deposit guarantees and substantial emergency liquidity provided by the European Central Bank, helped ameliorate financial contagion and restore market confidence. In addition, Luxembourg's enviable position of public finances at the outset of the crisis provided [the necessary space for the government] to extend fiscal support to the economy, boost social transfers, and protect household income,” the IMF said.

Looking to the future, the IMF noted that systemic financial stability risks have receded in line with international developments. In addition, growth, while still expected to be subdued compared to pre-crisis is expected to improve during 2010-11. In late 2009, the economy already showed signs of a rebound, led by improvements in manufacturing and the vitality of Luxembourg’s financial sector. In particular, new inflows to the investment fund industry resumed in the second quarter of 2009 with assets rebounding to close to their pre-crisis highs. In light of these indicators, the IMF has predicted growth of around 3% in 2010, reflecting improving conditions in global financial markets and trading partners as well as sustained fiscal stimulus.

Reflecting on the report, the IMF Executive Board welcomed in particular measures to strengthen banking supervision and emphasis on enhancing banks’ risk management practices. The Board urged, in light of the prevalence of foreign subsidiaries in Luxembourg’s banking system, that it remain actively engaged in European Union initiatives in the design of mechanisms for cross-border bank resolution and burden sharing. On banking regulation, the IMF said it looked forward to the timely implementation of the Financial Action Task Force’s recommendations, which govern practices to prevent money laundering and the financing of terrorism.

On fiscal policy, the IMF said that support provided in 2009 remains appropriate for 2010. While the IMF said the country should continue to support the economy in the coming year, it urged the government to continue its plans to introduce consolidation measures in 2011. While the Board considered the government’s plans to be "broadly appropriate," a few directors considered that additional adjustment may be needed to achieve fiscal balance. In order to support the review of government expenditure and fiscal policy, the Directors advocated the creation of a medium-term fiscal framework.

Concluding, the IMF observed that Luxembourg’s economic resilience going forward will depend on continued efforts to boost competitiveness and foster economic diversification.

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