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Outlook for Belgium

Recovery continues, but reform will need to go further

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1EY Eurozone Forecast December 2014 | Belgium

Highlights

• Belgium’s recovery continues, in spite of a temporary slowdown in Q2. We expect GDP growth of 1% in 2014, gathering pace to 1.2% in 2015 and about 1.8% a year in 2016–18. The recovery is unfolding broadly in line with the Eurozone average, reflecting both Belgium’s position in the European supply chain and also the fact that the economy faces similar structural challenges to those facing other member countries.

• In common with other Eurozone economies, Belgium’s recovery in late 2013 and early 2014 had been led by an improving external balance. Looking ahead, export growth seems likely to settle slightly higher than the 3.3% we expect in 2014. We see exports growing by 2.9% in 2015, but then by some 3.6% a year in 2016–18. This is one percentage point slower than in the decade to 2007, reflecting eroded Belgian competitiveness.

• Businesses have become more optimistic in recent months, and production in some sectors is approaching capacity. Together with low interest rates and easing lending criteria, this drove a spurt of investment through early 2014. We expect this to ease to a more sustainable pace from 2015 but, at 2%–3% a year, investment spending will be a key part of the recovery.

• Alongside this, businesses will start to pick up the pace of hiring, allowing unemployment — currently 8.5% of the workforce — to fall gradually and reach 8% by the end of 2016. Meanwhile, lower commodity prices will keep consumer price inflation to just under 1% in 2015, rising toward 2% thereafter. As a result, we expect consumption to grow 1.4% in 2015, and 1.6%–1.8% a year in 2016–18.

• Recovery could be boosted by more ambitious economic reform. The plans in the coalition’s accord are a starting point, but if Belgium is to regain competitiveness there should be further measures to increase wage flexibility. Additionally, the long-term public finance outlook would be much improved if pension ages were increased faster than proposed.

GDP growth

2014

1.0% GDP growth

2015

1.2%

Unemployment

2014

8.5%

Consumer prices

2014

0.6%

2 EY Eurozone Forecast December 2014 | Belgium

Recovery continues, but reform will need to go further

Belgium the bellwether recovers in line with the Eurozone

Belgium’s recovery continued into a sixth quarter in Q3 2014, with GDP growth picking up to 0.2% from 0.1% in the previous three months. An ongoing improvement in export performance since mid-2013 has been matched with a pretty sharp rebound in business investment (although part of this might reflect maintenance work at one of the country’s major power plants). And although the improvement in activity is yet to feed through into additional employment — the unemployment rate has remained broadly unchanged since mid-2013 — households have accelerated growth of their own spending modestly to around 0.3% a quarter over the first half of 2014.

As such, Belgium’s recovery so far looks much like the Eurozone’s as a whole. We expect GDP growth to pick up to 1% for 2014 — modest by historical standards perhaps, but a substantial improvement on the previous couple of years, when GDP growth overall was zero.

Exports benefit from Eurozone rebound

Due to a range of labor market rigidities, including a relatively high minimum wage, high employer social charges and a wage-price indexation mechanism, Belgian unit labor costs have risen substantially through the course of the Eurozone crisis — by around 15 percentage points from 2007 to 2013, compared with 10 percentage points in France, and falls in a number of peripheral Eurozone economies.

The recent coalition agreement sets out a number of measures that are designed to improve flexibility, but fall short of the scale needed to have a substantial impact on Belgian competitiveness. As such, we expect Belgium to continue to lose competitiveness over the coming years, particularly in lower value-added activities.

Export growth in Belgium has surprised a little in 2014, and as a result we now expect slightly slower growth in shipments during 2015. Nevertheless, at just below 3%, export growth in 2015 will remain consistent with a gradual recovery. In the longer term, as the Eurozone recovery continues to gather pace, we forecast that export growth will pick up to around 3.6% a year in 2016–18. However, this is around one percentage point slower than in the decade prior to the

Table 1

Belgium (annual percentage changes unless specified)

2013 2014 2015 2016 2017 2018

GDP 0.3 1.0 1.2 1.6 1.8 1.9

Private consumption 0.3 0.7 1.4 1.8 1.8 1.6

Fixed investment –2.2 3.2 2.1 2.4 2.8 2.7

Stockbuilding (% of GDP) 0.0 –0.6 0.0 0.1 0.0 –0.2

Government consumption 1.1 0.2 0.4 0.7 1.0 1.3

Exports of goods and services 2.9 3.3 2.9 3.3 3.7 3.8

Imports of goods and services 1.7 2.8 3.8 3.5 3.6 3.5

Consumer prices 1.2 0.6 0.9 1.6 2.0 2.0

Unemployment rate (level) 8.4 8.5 8.5 8.1 7.7 7.6

Current account balance (% of GDP) 0.1 –1.0 –1.0 –1.2 –1.2 –0.7

Government budget (% of GDP) –2.9 –2.1 –2.0 –1.9 –1.6 –1.3

Government debt (% of GDP) 104.5 107.5 110.1 111.3 111.8 111.7

ECB main refinancing rate (%) 0.5 0.1 0.1 0.1 0.2 0.8

Euro effective exchange rate (1995 = 100) 120.8 123.4 119.2 117.2 116.6 116.2

Exchange rate (US$ per € ) 1.33 1.33 1.24 1.21 1.20 1.19

Source: Oxford Economics.

3EY Eurozone Forecast December 2014 | Belgium

Table 2

Forecast for Belgium by sector (annual percentage changes in gross added value) 2013 2014 2015 2016 2017 2018

GDP 0.3 1.0 1.2 1.6 1.8 1.9

Manufacturing –0.8 2.0 1.5 2.2 2.2 2.1

Agriculture 1.6 0.7 0.4 0.6 0.7 0.7

Construction –1.3 –0.3 0.9 1.7 1.9 1.7

Utilities –2.9 1.0 1.3 1.7 1.8 1.6

Trade –0.9 0.2 0.7 1.3 1.7 1.7

Financial and business services 0.8 1.1 1.5 2.0 2.3 2.4

Communications 0.3 1.5 1.6 2.3 2.6 2.7

Non-market services 1.4 1.2 1.0 0.9 1.0 1.3

Source: Oxford Economics.

economic crisis — a reflection both of Belgium’s lost competitiveness and deleveraging constraining the medium-term pace of recovery around the Eurozone.

Capital investment driving rotation to higher-end activities

Firms in Belgium’s corporate sector have shown more willingness to invest than firms in the same sector elsewhere in the Eurozone. Belgian businesses have increased capital spending each quarter since the start of 2013. However, we suspect some of the strength in the first half of 2014 (when business investment grew especially sharply) might reflect power plant repairs after an outage, a development also felt in Belgium’s import bill through 2014.

Moreover, although confidence measures and capacity utilization also strengthened steadily during the first six months of the year, recent data suggests both have ebbed in the final few months of 2014. This might reflect uncertainty among Eurozone manufacturers more generally over future Chinese demand — and by extension, the chemicals and machinery sectors Belgium has key strengths in. Demand for loans among Belgian firms dipped in Q4 2014, also suggesting a pause in the pace of capital spending.

As such, after growing by an expected 3.2% in 2014, total fixed investment growth will ease to just over 2% in 2015, and gather pace gradually thereafter to around 2.7% by 2017–18. Moreover, it seems likely that with Belgium losing competitiveness in lower value-added sectors, but retaining key strengths in research and development and high value-added parts of the supply chain, there will continue to be a shift out of heavy industry toward hi-tech sectors in the years to come. While of course this is positive in many respects, it will pose challenges for Belgium in absorbing lower-skilled workers.

Household finances in good shape, but reform would boost job prospects

Households have enjoyed relatively good income growth by Eurozone standards in recent years, as unemployment has risen less notably than elsewhere (due at least in part to tighter employment protection legislation) and wage indexation has ensured real wage growth. Unemployment rose just 1.5 percentage points from trough to peak, compared with 2.5 percentage points in France despite similar growth performances. As such, we expect less job creation in the near term than in other economies, as firms continue to exploit spare capacity before hiring additional workers.

Figure 1GDP growth

Source: Oxford Economics.

% q-on-q

–0.4

–0.3

–0.2

–0.1

0

0.1

0.2

0.3

0.4

Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014

Figure 2Unit labor costs

Source: Oxford Economics.

2008 = 100

90

95

100

105

110

115

120

2008 2009 2010 2011 2012 2013 2014

Belgium

France

Germany

Spain

Netherlands

4 EY Eurozone Forecast December 2014 | Belgium

Recovery continues, but reform will need to go further

Figure 3Contributions to GDP growth

Source: Oxford Economics.

% year

–1.0

–0.5

0.0

0.5

1.0

1.5

2.0

2012 2013 2014 2015 2016 2017 2018

Private consumption

Net exports

InvestmentGovernment consumption

Forecast

Figure 4Government deficit and debt

Source: Oxford Economics.

% of GDP% of GDP

40

60

80

100

120

–9

–8

–7

–6

–5

–4

–3

–2

–1

0

1

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Forecast

Government debt(right-hand side)

Government deficit (left-hand side)

Looking ahead, in the interest of improved competitiveness the new coalition Government has agreed to postpone the wage indexation mechanism for one year. This will put an additional break on the recovery of real income in 2015, although with inflation seen at just under 1% this will be less of a blow to household finances than in a typical year. In subsequent years, we expect inflation to gather speed, reaching 2% by 2017. But since the coalition has made clear that wage indexation will remain intact in the longer term, these price increases should be met by income growth (albeit at the expense of competitiveness and job creation).

But nevertheless, with confidence recovering around the Eurozone and households benefiting from substantially lower energy prices than previously anticipated, the pace of consumer spending growth should pick up very modestly to 1.4% in 2015. With employment rising more vigorously from 2016, wage indexation active again, and Belgian households relatively unburdened by debt, consumer spending growth should accelerate to around 1.7% a year in 2016–18.

However, Belgium’s apparently strong labor market belies a number of vulnerabilities. At just 68% in Q2 2014, the participation rate is three percentage points lower than in the Netherlands and four percentage points lower than in France, largely as a result of structurally high youth unemployment (partly due to the high minimum wage) and generous incentives toward early retirement. If Belgium is to tackle its debt stock in the medium term, improving participation and boosting underlying trend growth will be crucial components. However, Belgium has done less to tackle labor rigidities than most other Eurozone economies, and measures outlined in the coalition’s plans are at best a step in the right direction, rather than an ambitious action plan.

Government constrained by high debt

At just over 90% of GDP in 2008, Belgium entered the economic crisis with a relatively high debt stock, even by Eurozone standards. The debt stock has since risen above 100%, and, like many other Eurozone economies, Belgium faces substantial fiscal pressures from an aging population.

Lower interest rates have helped a little in this respect (we estimate each percentage point fall in Belgium’s 10-year bond yield lowers interest payments by around €300m, or 0.1% of GDP) but nevertheless, substantial fiscal restraint is required in the years to come if Belgium is to ensure a sustainable public debt position. Current government spending is expected to grow by just 0.4% in 2015, climbing to 1.3% by 2018 — again, substantially lower than the pre-crisis trend.

Slow growth demands a more ambitious reform effort

Overall therefore, we expect Belgium to grow by just 1% in 2014, picking up to 1.2% in 2015, and gathering pace to 1.9% by 2018. But even this would be around 0.4 percentage points slower than the average over the decade to 2007. This will leave Belgium more vulnerable than most to shocks that have an impact on fiscal sustainability in the coming years. A more ambitious set of reforms, in particular to the labor market, but also in areas crucial to productivity, such as skills and regulation, could improve the underlying growth outlook.

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