Luxembourg: The Tiny Country with a Huge Rating - "AAA"
#Luxembourg is a small country in the heart of Europe, but it has a big reputation for its economic and financial stability. The country has recently received another confirmation of its triple A rating, the highest possible, from DBRS Morningstar, the world's fourth largest credit ratings agency
What is an "AAA" rating and why does it matter?
The AAA rating means that a country has a very strong capacity to repay its debt obligations and is unlikely to default. It also reflects the country's good fiscal position, its independent and transparent institutions, its stable political environment and the strength of its economy.
The AAA rating matters because it signals to investors and creditors that a country is a safe and reliable destination for their money. It also helps a country to borrow money at lower interest rates, which reduces its debt servicing costs and frees up resources for other public spending.
How did Luxembourg achieve and maintain its AAA rating?
Luxembourg has achieved and maintained its AAA rating thanks to its prudent and responsible fiscal policy, its diversified and resilient economy, its strong external position and its solid banking sector.
Despite the shock of the war in Ukraine, Luxembourg's growth and public finances remain strong. The country has a low level of public debt, which is among the lowest in Europe, and a large stock of government assets. The government remains committed to keeping the public debt below 30% of GDP.
Luxembourg's economy is advanced and wealthy, with a high per capita income and a competitive business environment. The country has a diversified economic structure, with a large international financial centre, a dynamic industrial sector and a growing digital economy. The country also benefits from its strategic location in the EU single market and its close ties with its neighbours.
Luxembourg's external position is strong, with a large current account surplus and a high level of international reserves. The country has a positive net international investment position, meaning that it owns more foreign assets than liabilities. The country also has a flexible exchange rate regime, which allows it to adjust to external shocks.
Luxembourg's banking sector is solid and well-regulated, with high capital ratios and liquidity buffers. The sector is supervised by the European Central Bank and the national authorities, which ensure compliance with prudential standards and anti-money laundering rules. The sector is also diversified, with a presence of domestic and foreign banks, as well as specialised financial institutions.
What are the challenges and opportunities for Luxembourg?
Luxembourg faces some challenges that could affect its economic performance and fiscal outlook. These include:
The impact of high energy prices on consumer and business sentiment, inflation and growth. DBRS Morningstar expects the negative impact of inflation to be mitigated from 2023 onwards by the implementation of the support measures agreed in the Tripartite framework.
The vulnerability to external shocks, such as sustained turmoil in financial markets, geopolitical tensions or health crises. These shocks could have a significant impact on Luxembourg's small economy and its large financial centre.
The exposure to potential financial stability risks, such as spillovers from banking crises in other countries or changes in international tax regulations. These risks could affect Luxembourg's attractiveness as a business hub and reduce its fiscal revenues.
The need for structural reforms to enhance productivity growth, innovation and competitiveness. These reforms include investing in human capital, digitalisation, infrastructure and green transition.
Luxembourg also has some opportunities that could boost its economic prospects and social cohesion. These include:
The potential for further diversification of its economic base, especially in emerging sectors such as space technology, biotechnology or cybersecurity. These sectors could create new sources of growth, employment and value added.
The possibility to leverage its role as a regional leader and an active partner in the EU integration process. Luxembourg could contribute to shaping the EU agenda on key issues such as climate change, digital transformation or social inclusion.
The opportunity to strengthen its social model and welfare system, which are based on social dialogue, solidarity and quality of life. Luxembourg could enhance its social protection schemes, improve its health care system and address inequalities.