statnews Studies and forecasts No. 16/2011 11/05/2011

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Medium-term macro-economic projections

Recovery set to strengthen gradually, with risks remaining high but evenly distributed throughout the main scenario

In Note de Conjoncture No. 1-2011, STATEC presents its macro-economic forecasts up to 2014. This medium-term forecasting is a new step for STATEC, as is the European semester, the political context in which it takes place. Growth in the Luxembourg is expected to strengthen over the next few years (approximating 4% at the end of the period) although it will not reach pre-crisis levels.

Note de conjoncture (NDC) No. 1-2011 includes medium-term macro-economic forecasts covering the period 2011-2014. This is the first time that STATEC is publishing a complete set of provisional macro- economic data covering such a long period as part of its NDCs. The forecasts relate mostly to the main macro-economic aggregates (such as GDP, , , and sectors), and to public finances. These simulations were used to draw up the 12th Stability and Growth Programme and the National Reform Programme as notified by the government to the European Commission on 29 April 2011.

NDC 1-2011 is wholly given over to forecasts and, in addition to the main scenario, contains a brief overview of the recent economic situation and a sensitivity analysis (of the main scenario to a changed global environment). There are a number of sections covering the following topics: the procedure used by the Forecasting committee to draw up forecasts, risks and uncertainties, an analysis of changes in the sliding scale since 2006, a comparison of potential growth rates for Luxembourg, and an of the macro-economic impact of economic and budgetary policy ("bipartite") measures determined in 2010.

1 Summary of the economic situation 2010-2014

1985-2010 2010 2011 2012 2013-14 2010 2011 Change as % (unless otherwise specified) Revisions4 GDP value (EUR Billions) … 41.60 43.69 46.14 … 1.29 1.50 Idem, evolution in % 7.5 9.3 5.0 5.6 6.4 3.3 0.4 Potential GDP (vol.) 4.7 2.9 2.7 2.6 2.5 0.4 0.3 GDP (en vol.) 4.8 3.5 3.2 3.5 3.9 0.3 0.2 Of which: final consumption of households 3.1 2.0 1.5 3.5 3.2 0.3 0.3 public consumption 4.6 2.9 0.5 3.1 2.0 0.2 -1.6 gross capital formation 6.0 2.6 13.7 5.9 4.2 -10.6 6.5 total export 7.3 6.3 6.2 6.0 7.2 -3.8 1.3 total import 7.1 6.8 7.1 6.6 7.5 -5.3 1.7 Total domestic employment2 3.2 1.5 1.9 1.9 2.5 -0.3 0.4 National employment 1.5 1.3 1.2 1.3 1.8 -0.3 0.1 Foreign cross border workers 9.3 1.8 2.9 2.8 3.3 -0.2 0.8 Unemployment rate1 2.8 6.0 6.0 6.1 5.6 -0.2 -0.5 Consumer price index (IPCN) 1.9 2.3 3.5 2.3 1.8 0.0 1.8 Moving scale 1.8 1.7 1.9 4.0 1.8 -0.4 Average nominal wage cost2 2.6 1.6 2.2 4.5 2.7 -0.6 0.2 Net lending/borrowing (public adm., % of GDP) 3 1.7 -1.7 -1.0 -1.5 -1.0 0.2 -0.3

Source: STATEC (1985-2010: actual national accounts; 2011-14: April 2011 forecasts) 1 Based on the registrations with the ADEM 2 National accounts concept 3 Forecasts of the STATEC, average 1990-2010 instead of 1985-2010 4 Compared to the NDC 2-10, published on 19 November 2010

Methodological aspects

In this Note de conjoncture, STATEC is for the first time publishing a medium-term macro-economic scenario that runs up to 2014. In the past, STATEC forecasts published in NDCs were limited to the current year and the subsequent year. The Europe 2020 Strategy, with a closer coordination of economic, social and structural policies, require a new macro-economic to be set up to incorporate STATEC's work.

The European semester covers the first six months of the year during which budgetary policy (Stability Programme) and structural policy (National Reform Programme) are drawn up by national authorities and examined at European level (by the Commission and the Ecofin Eurogroup) to detect any signs of imbalance and inconsistency and make remedial recommendations at a time when important budgetary decisions are still being drafted.

The macro-economic situation underlying the Stability Programme is identical to that set out in this NDC. These forecasts, which go up to 2014, were drawn up by STATEC and discussed by the Forecasting committee, which comprises public servants from the Ministry of Finance, the general inspectorate of finance (IGF), the social security authorities (IGSS), the PAYE tax authorities (ACD), the land registration and estates department (AED), customs and excise and STATEC.

The forecasts were drawn up using STATEC's Modux macro-econometric model, based on assumptions on the global environment taken from the main international organisations. The assumptions in terms of public spending are based on an "unchanged policy" approach which takes into account known political measures such as the 2011 budget, the multi-annual investment plan and all measures determined under the 2011 bipartite agreement. Variables not covered by known measures are extrapolated using previous trends. "Unchanged policy" in this case means "in the absence of any new economic policy measures". Revisions include, for example, the full reinstatement of the sliding wage scale system from autumn 2011.

2 The result in terms of public finances – receipts and balance – arising out of simulations using the Modux model was analysed and adjusted where necessary by the Forecasting committee. All the forecasts published in this NDC make up a balanced ("main") scenario, which is as likely to be overly optimistic as overly pessimistic. This is the most probable outcome for the economy over the next few years, given the international and budgetary assumptions and the econometric tools used. Alternative scenarios were tested using the Modux tool ("sensitivity analysis") to check the sensitivity of the main scenario against assumptions about the international environment.

Forecasts up to 2014

Global environment

Since the autumn of 2010, the economic situation in the eurozone has improved slightly, with growth rates in GDP in volume revised upwards by 0.5 percentage points (ppt) for 2010 and 2011 in all. However, with GDP growth below 2%, economic activity is set to remain sluggish throughout 2011 and 2012 although it will strengthen gradually. Therefore a true recovery, characterised by growth in GDP in volume of over 2% is not expected to materialise before 2013.

STATEC's main scenario provides for a slow, gradual rise in short-term interest rates in the eurozone, from 1.5% in 2011 to 2.4% in 2014. Oil prices and exchange rates were determined as follows (technical assumptions): price per barrel of oil at USD 113 and a USD/EUR exchange rate of 1.39 throughout the forecasting period. Thus, the price per barrel, expressed in EUR, is expected to exceed the maximum levels observed in 2008 by some 15% (annual averages).

Activity

The growth trend (or potential growth) for the Luxembourg economy has been falling for the last 20 years or so. Estimated at some 5% at the turn of the century, STATEC now puts this at about 2.5%. As regards instantaneous growth, after rising almost 3.5% in 2010, GDP in volume is set to slow slightly in 2011, with GDP in volume expected to rise 3.2%. From 2012, growth in GDP is expected to approximate 4%. In this upward part of the cycle, a familiar characteristic from recent years is resurfacing in Luxembourg, i.e. if the economic situation is favourable, GDP will rise above the European average whereas in "bad" years there is very little difference.

It is important to correctly interpret the projected 3.5-4% growth rates for 2012 and beyond. This is not a new trend or average growth but rather a growth forecast corresponding to a peak configuration, given the available information. This growth is above all dependent on the underlying European economic climate, where the rise in GDP in volume is expected to level off at some 2% over the medium term. This, therefore, is not an optimistic scenario but rather the most probable outcome of GDP trends over the next few years. This scenario also provides for future average growth in the financial sector about three times lower than in the past.

3 Comparison of the expansion of the main GDP growth (smoothed) and potential GDP aggregates, good times vs. current recovery

10 12 GDP in volume (moving average over 3 years) 9 10 8 8 7 6 6

5 % as Change 4

Change as % 4 Potential GDP 2 3 0 2

1 captital Public Private formation Gross fixed consumption Total exports consumption

0 imports Total

Average growth 97-00 and 04-07 Average growth 11-14 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 Source: STATEC Source: STATEC

Population, employment, unemployment

The population was again surprisingly dynamic in 2010, with the resident population rising 1.9% over the year (compared to 1.7% in 2009 and 2% in 2008), while positive net migration reached over 7,500 people, i.e. 1.5% of the total population. Over the next few years, STATEC expects population growth to tail off gradually, while remaining relatively high in view of economic growth.

The activity rate (working population compared to working-age population) has been falling since 2008, after peaking for a number of years. However, this trend is entirely due to the male working population and the rate of activity among women continues to rise. STATEC anticipates a (slight) additional fall-off in overall activity over the forecasting period, which is likely to stabilise in 2013/14 at 2002/03 levels. The rate of activity among women is expected to continue to rise, albeit at a more moderate pace.

The labour market has recovered relatively well from the impact of the crisis, with domestic employment rising 1.6% in 2010 (compared to 0.9% in 2009). Much of this was due to non-market services, which rose 3.3%. The labour market is expected to continue to gather momentum although it will be constrained by moderate growth in activity. Towards the end of the forecasting period, employment growth is set to approximate 2.5%, significantly lower than the historic average of 3.4% or the peaks of over 5% achieved during previous cyclical peaks.

In 2010, registered unemployment barely rose at all, stabilising at about 6%, with annual growth of over 2% in domestic employment from the middle of the year on, whereas historically, an average of over 4% employment growth was required to push down unemployment. However, the various macro- economic parameters do not point to any effective drop in the unemployment rate before 2013.

Prices,

Accelerating inflation in consumer prices in recent months was above all due to oil prices. Underlying inflation, which is an (imperfect) measurement of structural inflationary pressures, remained anchored at about 2% at the start of the year. However, although this still stood at 1.4% as an annual average in 2010, it rose to 2.4% in March 2011, mostly due to administered prices such as water and social security. Nevertheless, higher commodity prices seem to be already having an effect on manufactured goods and consumer goods.

Given the economic climate in Luxembourg, which is more sluggish than in the past, the relative slowdown in underlying inflation is also due to slow wage growth, which may be related to high

4 unemployment. STATEC expects the NCPI to rise by 3.5% in 2011, a significant acceleration compared to 2010. Thereafter it is expected to fall back, with annual inflation of less than 2% from 2013 on.

The next indexation adjustment, which would normally have taken place in April/May 2011, will only be paid out in October 2011, in view of the agreement between the government and trade unions in late September 2010. However, because of the recent pick-up in inflation, the next threshold will be exceeded in the first quarter of 2012, which will trigger a 4% rise in the sliding wage scale in 2012 (compared to 1.9% in 2011), assuming that the indexation system remains unchanged.

Over the last twenty years, wage growth has slowed significantly in Luxembourg, and this is all the more apparent when real wages (i.e. offset by consumer prices) rather than nominal wages (i.e. per head) are taken into account. Real wages practically stagnated over the 2006-2010 period. This sluggishness went hand in hand with record unemployment levels and, more generally, with the cyclical downturn in recent years, viz., the slowdown in 2008, the in 2009 and the slack recovery in 2010. It is also true that real wages have effectively fallen in other countries (see Germany).

Over the next few years, both nominal and real wages are set to pick up again. Because of the pace imposed by the thresholds of the sliding wage scale, monthly nominal wage costs are set to exceed 4% in 2012 (twice that in 2010 and 2011), stabilising at almost 3% in 2013-14. The improved macro- economic situation and the stabilisation (followed by a fall) of unemployment, which strengthen union's bargaining power, are the main reasons behind this.

Public finances

The proportion of public receipts in nominal GDP will fall very slightly between 2010 (the last year for which data is available) and 2014, from 39.5% to 39.1%. While this trend could be considered to represent a certain stabilisation, it in fact masks a rise in 2011 followed by a drop in 2012. Over the entire period, growth in public receipts will therefore be slightly below growth in nominal GDP. However, as spending will grow at lower rates, the public deficit is expected to fall between 2010 (-1.7%) and 2014 (-0.8%).

Between 2010 and 2011, the deficit is expected to fall significantly by 0.7 points to -1% of GDP, thanks to a certain amount of (planned) restraint in public spending (intermediate consumption and investment) and a rise in receipts, due in part to a tightening of household taxation. Better results are possible, in view of the exceptionally dynamic monthly receipts observed during the first quarter of 2011. In order to ensure that this upsurge in receipts helps improve the balance, cost controls must proceed as planned. Between 2011 and 2014, the balance is not expected to vary greatly, rising from -1% to -0.8%, which is in line with a rather flat economic profile, i.e. with no additional (and substantial) acceleration in GDP growth and where the underlying policy assumption remains unchanged.

This NDC also includes an evaluation of the economic and budgetary policy measures determined in 2010. In short, those measures that can be simulated will have significant effects (in 2011) on the public balance (up 0.6 points), the average wage bill (down 0.6 points), consumer prices (up 0.3 points), actual available household income (down 1.3 points) and private consumption (down 1.1 points in volume). The impact on GDP in volume is relatively low (-0.2 ppt), while on unemployment (expected to fall) and employment (expected to rise), it is marginal.

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The electronic version of Note de Conjoncture No. 1-2011 is available free of charge on the STATEC website http://www.statistiques.public.lu/fr/publications/conjoncture/noteConjoncture/index.html. The printed version will be available shortly from STATEC, B.P. 304, L-2013 Luxembourg, Tel.: 247-84219 Fax 46 42 89, E-mail: [email protected], for EUR 8.00 (postage not included).

Press office: For further information: Guy ZACHARIAS Unit: Economic situation Tel: 247-84281 Contact: Ferdy ADAM Fax: 26 20 19 02 Tel: 247-84217 E-mail: [email protected] E-mail: [email protected]

Published by 13, rue Érasme, L-1468 Luxembourg, Tel. 247-84219, Fax 26 20 19 02, E-mail [email protected], www.statec.lu

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