Luxembourg’s financial system has weathered the pandemic well, but the Russia-Ukraine conflict poses new risks to Luxembourg’s economy while the surge in housing prices from recent years threatens the attractiveness of the Grand Duchy, the International Monetary Fund (IMF) has concluded after a two-week mission.
Surging housing prices, low profitability in the banking sector, rising inflation, labour shortages and a growing share of long-term unemployment mean that Luxembourg needs to remain alert, the IMF said on Friday when its mission was completed.
“Luxembourg weathered the pandemic well and its economy has recovered rapidly, with real GDP surpassing its pre-crisis trend. Yet, inflation is picking up amid labor shortages, housing prices have been growing at a fast pace, and the share of long-term unemployment is rising,” the IMF statement said.
Urgent action needed
Actions are urgently needed to reduce pressures in the housing market, the IMF said. “In addition to posing medium-term financial stability risks, the rapid pace of housing price growth is affecting affordability, and, if continued, could reduce Luxembourg’s attractiveness for workers.”
“To mitigate imbalances in the housing market, efforts to increase supply should be accelerated,” the IMF said. “Rapidly growing housing prices, for the third consecutive year, raise concerns about affordability, attractiveness for workers, and medium-term financial stability.”
More and more Luxembourgers in recent years have been moving across the border France, Belgium and Germany to avoid eye-watering real estate prices in the Grand Duchy. More than 70,000 people - of a working population of about 460.000 people - already live in neighbouring countries.
Multipronged approach
“Efforts to boost housing supply, including for affordable and social housing, and reduce speculation through higher taxation of unused land and empty dwellings are welcome.”
The IMF noted that such measures will take time to materialise and may face implementation challenges. To alleviate the current housing pressures, a multipronged approach is needed that combines fiscal policy, resource efficiency, better administrative processes and measures that encourage residential mobility.
The fund said it is in favour of phasing out the deductibility of interest payments and improving productivity in the real estate sector.
Addressing Luxembourg’s financial sector, the IMF said that, on aggregate, banks remain well capitalised and liquid, while asset quality improved somewhat as the economy rebounded and the pandemic did not result in higher bankruptcies and unemployment. “That said, the longer-term pandemic effects are still uncertain, and banks’ structurally low profitability—as in other euro area countries—continues to be a source of concern,” it said.
Funds vulnerable to further corrections
Investment funds - Luxembourg is a global Ucits hub - benefited from the global risk appetite in 2021. However, the IMF noted that global stock markets have been declining since early 2022 and the funds remain vulnerable to further corrections or an abrupt increase in risk premia.
Luxembourg’s direct exposures of banks and investment funds to Russia and Ukraine are very limited as a share of assets. “However, the situation is fluid and the impact of the conflict on the financial sector will mainly depend on spillovers to global financial conditions, in a context where rising inflation could complicate the trade-off between price and financial stability,” it said.
Continuing close monitoring of evolving risks (including cyber security), coordination between supervisors, and communication with financial sector participants will be essential to mitigate adverse impacts, the IMF said.
Luxembourg’s Finance Ministry welcomed the IMF’s conclusions and, in a tweet, thanked the IMF’s Deputy Division Chief Emil Stavrev “for the good collaboration over the past two weeks.”
During an Article IV consultation, an IMF team of economists visits a country to assess economic and financial developments and discuss the country’s economic and financial policies with government and central bank officials. IMF staff missions also often meet with parliamentarians and representatives of business, labour unions, and civil society.