Report from the Commission - Luxembourg - Report prepared in accordance with Article 126(3) of the Treaty
Date: 2010-05-12
Institutions: European Commission
Subjects: Bulgaria, Economic and Monetary Union, Luxembourg, budget deficit, economic recession, stability pact

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EUROPEAN COMMISSION 

Brussels, 12.5.2010 
SEC(2010) 588 final 

REPORT FROM THE COMMISSION 

Luxembourg 

Report prepared in accordance with Article 126(3) of the Treaty 

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REPORT FROM THE COMMISSION 

Luxembourg 

Report prepared in accordance with Article 126(3) of the Treaty 

1. 

THE APPLICATION OF THE STABILITY AND GROWTH PACT IN THE CURRENT CRISIS 
SITUATION 

Many  EU  countries  are  presently  facing  general  government  deficits  above  the  3%  of  GDP 
reference value set in the Treaty. The often strong deterioration in the deficit as well as the 
debt  positions  must  be  seen  in  the  context  of  the  unprecedented  global  financial  crisis  and 
economic  downturn.  Several  factors  are  at  play.  First,  the  economic  downturn  has  brought 
about  declining  tax  revenue  and  rising  social  benefit  expenditure  (e.g.  unemployment 
benefits).  Second,  recognising  that  budgetary  policies  have  an  important  role  to  play  in  the 
current  extraordinary  economic  situation,  the  Commission  called  for  a  fiscal  stimulus  in  its 
November  2008  European  Economic  Recovery  Plan  (EERP),  endorsed  by  the  European 
Council  in  December.  The  Plan  explicated  that  the  stimulus  should  be  differentiated  across 
Member States to reflect their different positions in terms of public finance sustainability and 
competitiveness and should be reversed when economic conditions improve. Finally, several 
countries have taken measures to stabilise the financial sector, some of which have impacted 
on  the  debt  position  or  constitute  a  risk  of  higher  deficits  and  debt  in  the  future,  although 
some of the costs of the government support could be recouped in the future. 

The Stability and Growth Pact requires the Commission to prepare a report such as the present 
one  whenever  an  actual  or  planned  deficit  of  a  Member  State  exceeds  the  3%  of  GDP 
reference  value.  This  report,  which  represents  the  first  step  in  the  “excessive  deficit 
procedure” (EDP), analyses the reasons for the breach of the reference value with due regard 
to the economic background and all other relevant factors. The amendments to the Stability 
and Growth Pact  in  2005  aimed  specifically at ensuring that in particular the economic and 
budgetary  background  was  fully  taken  into  account  in  all  steps  in  the  EDP.  This  means  for 
instance that, if an “excessive deficit” is deemed to exist, adequate consideration needs to be 
paid to the economic background and outlook when making recommendations on the pace of 
the correction. In this way, the Stability and Growth Pact provides the framework supporting 
government  policies  for  a  prompt  return  to  sound  budgetary  positions taking  account  of  the 
economic situation. 

2. 

LEGAL BACKGROUND 

This  report,  which  assesses  recent  and  current  budgetary  developments  in  Luxembourg  and 
reviews the short and medium-term prospects in the light of overall economic conditions and 
policy action taken by the government, is prepared according to Article 126(3) of the Treaty 
on the Functioning of the European Union (TFEU). 

Article 126 TFEU lays down an excessive deficit procedure (EDP). This procedure is further 
specified  in  Council  Regulation  (EC)  No  1467/97  “on  speeding  up  and  clarifying  the 

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implementation of the excessive deficit procedure”1, which is part of the Stability and Growth 
Pact. According to Article 126(2) of the Treaty, the Commission has to monitor compliance 
with  budgetary  discipline  on  the  basis  of  two  criteria,  namely:  (a)  whether  the  ratio  of  the 
planned or actual government deficit to gross domestic product (GDP) exceeds the reference 
value of 3% (unless either the ratio has declined substantially and continuously and reached a 
level that comes close to the reference value; or, alternatively, the excess over the reference 
value is only exceptional and temporary and the ratio remains close to the reference value); 
and  (b)  whether  the  ratio  of  government  debt  to  GDP  exceeds  the  reference  value  of  60% 
(unless  the  ratio  is  sufficiently  diminishing  and  approaching  the  reference  value  at  a 
satisfactory pace). 

Article 126(3) stipulates that, if a Member State does not fulfil the requirements under one or 
both of these criteria, the Commission has  to prepare a  report. This report also has to “take 
into account whether the government deficit exceeds government investment expenditure and 
take  into  account  all  other  relevant  factors,  including  the  medium-term  economic  and 
budgetary position of the Member State”. 

According to data notified by the authorities in April 20102, validated by Eurostat3 the general 
government deficit in Luxembourg is planned to reach 4.2% of GDP in 2010, thus exceeding 
the  3%  of  GDP  reference  value,  while  general  government  gross  debt  would  be  19.3%  of 
GDP, well below the 60% of GDP reference value even if on a rising trend since 2007. 

The planned figure for the 2010 deficit provides prima facie evidence on the existence of an 
excessive deficit in Luxembourg in the sense of the Treaty and the Stability and Growth Pact. 
The  Commission  has  therefore  decided  to  initiate  the  excessive  deficit  procedure  for 
Luxembourg  with  the  adoption  of  this  report.  Section  3  of  the  report  examines  the  deficit 
criterion. Section 4 deals with public investment and other relevant factors. The report takes 
into  account  the  Commission  services’  spring  2010  forecast,  which  has  been  released  on  5 
May 2010.  

Table 1: General government deficit and debt a 

2005 

2006 

2007 

2008 

2009 

2010 

COM 

Apr 2010 
notif. 

2011 

COM 

General government balance 

General government gross debt 

0.0 

6.1 

1.4 

6.5 

3.6 

6.7 

2.9 

13.7 

-0.7 

14.5 

-3.5 

18.9 

-4.2 

19.3 

-3.9 

23.5 

Note:  
a In percent of GDP ;  
Source: April 2010 EDP notification, Eurostat and Commission services’ spring 2010 forecast (COM). 

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OJ L 209, 2.8.1997, p. 6. The report also takes into account the “Specifications on the implementation 
of the Stability and Growth Pact and guidelines on the format and content of stability and convergence 
programmes”, endorsed by the ECOFIN Council of 10 November 2009, available at 
http://ec.europa.eu/economy_finance/sgp/legal_texts/index_en.htm. 
According to Council Regulation (EC) No 479/2009, Member States have to report to the Commission, 
twice a year, their planned and actual government deficit and debt levels. The most recent notification 
of Luxembourg can be found at: 
http://epp.eurostat.ec.europa.eu/portal/page/portal/government_finance_statistics/excessive_deficit/edp_
notification_tables. 
Eurostat news release No 55/2010 of 22 April 2010. 

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3. 

DEFICIT CRITERION  

In 2010, the general government deficit is planned to reach 4.2% of GDP. 

Well in excess of to the 3% of GDP, the planned deficit is not close to the Treaty reference 
value, but according to the Commission services' spring 2010 forecast the general government 
deficit  would  come  out  at  3.5%  of  GDP,  which  can  still  be  considered  as  close.  This 
divergence  is  mainly  due  to  the  fact  that  the  Commission  services  forecast  a  lower  rise  in 
government expenditure (since they do not fully incorporate the 15% rise in public investment 
planned  by  the  government)  and  expect  that  government  revenues  broadly  stabilise  in  2010 
with respect to 2009, while the notification projects them to decline by 1.4%. 

Table 2: Macroeconomic and budgetary developments a 

2005 

2006 

2007 

2008 

2009 

2010 

2011 

COM 

Feb 
2010 SP 

COM 

Feb 
2010 SP 

Real GDP (% change) 
Potential GDP (% change)  
Output gap (% of potential GDP) 

General government balance 

5.4 
3.9 

5.6 
3.5 

6.5 
3.8 

0.0 
3.5 

+0.5  +2.5  +5.2  +1.7 

-3.4 
2.3 

-3.9 

0.0 

1.4 

3.6 

2.9 

-0.7 

2.0 
2.1 

-4.1 

-3.5 

Primary balance 

0.2 

1.5 

3.9 

3.2 

-0.2 

-3.0 

One-off and other temporary measures 

0.0 

0.0 

0.0 

0.0 

0.0 

0.0 

Government 
formation 

gross 

fixed 

capital 

Cyclically-adjusted balance 

4.5 

3.6 

3.3 

3.2 

3.6 

3.7 

-0.3 
-0.1 
-0.3 
-0.1 

0.1 
0.3 
0.1 
0.3 

1.1 
1.3 
1.1 
1.3 

2.0 
2.3 
2.0 
2.3 

1.2 
1.7 
1.2 
1.7 

Cyclically-adjusted primary balance 
Structural balance bc 
Structural primary balance 
Notes:  
a In percent of GDP unless specified otherwise. 
b Cyclically-adjusted balance excluding one-off and other temporary measures. 
c February 2010 update of the stability programme 
d April 2010 notification 
e February 2010 update of the stability programme : "unchanged policy" scenario 
f February 2010 update of the stability programme : proposed adjustment path. 
Source: Eurostat, Commission services’ spring 2010 forecast and February 2010 update of the stability programme. 

-1.4 
-1.0 
-1.4 
-1.0 

-2.2 
-1.6 
-2.2 
-1.6 

-1.9 
-1.3 
-1.9 
-1.3 

2.5 
2.2 

-3.5 
-3.9 (c) 
-4.2 (d) 
-3.3 (c) 
-3.5 (d) 

0.0 
3.9 (c) 
4.0 (d) 

2.4 
2.5 

-4.1 

-3.9 

-3.3 

0.0 

3.5 

3.0 
2.1 

-3.0 
-5.0 (e) 
-3.0 (f) 
-4.3 (e) 
n.a. (f) 

0.0 
3.9 (e) 
n.a. (f) 

-3.5 
-2.8 
-3.5 
-2.8 

The  planned  excess  over  the  3%  of  GDP  reference  value  is  exceptional.  In  particular,  it 
essentially  results  from  a  severe  economic  downturn  in  the  sense  of  the  Treaty  and  the 
Stability and Growth Pact, namely the recession in the context of the global financial crisis. 
According to the Commission services' Spring 2010 forecast, real GDP dropped by 3.4% in 
2009 and is forecast to recover to 2% in 2010. 

The excess over the 3% of GDP reference value can be regarded as temporary in the sense of 
the Treaty and the Stability and Growth Pact. According to the Commission services' spring 
2010  forecast,  which  was  based  on  the  no  policy  change  assumption  for  2011,  the  general 
government deficit would rise from 3.5% of GDP in 2010 to 3.9% of GDP in 2011 essentially 
because  the  rise  in  revenues,  though  larger  than  in  2010,  is  expected  to  fall  short  of  the 
increase  in  expenditure.  However,  on  5  May  2010,  after  the  cut-off  date  of  the  forecast  the 
Prime  Minister  announced  consolidation  measures  that  would  amount,  according  to 

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information  provided  to  the  Commission  on  7  May,  to  1.6%  of  GDP  in  2011  and  another 
1.7%  of  GDP  in  2012;  they  include  a  series  of  expenditure  cuts  ,  in  particular  in  public 
investment as well as an increase in revenues. Given that the Commission forecast of 3.9% of 
GDP already anticipated a somewhat lower investment growth, the part of this consolidation 
package that can be taken into account for 2011 is estimated at about 1.2% of GDP and would 
reduce next year's deficit to around 2¾%, thus below the 3% of GDP threshold.  

In sum, the planned deficit for 2010 can be regarded as exceptional, close to the 3% of GDP 
reference value and temporary in the sense of the Treaty and the Stability and Growth Pact. 
This analysis suggests that the deficit criterion in the Treaty is fulfilled.  

4. 

RELEVANT FACTORS 

Article 126(3) of the Treaty provides that the Commission report “shall also take into account 
whether  the  government  deficit  exceeds  government  investment  expenditure  and  take  into 
account other relevant factors including the medium-term economic and budgetary position of 
the Member State”. These factors are further clarified in Article 2(3) of Council Regulation 
(EC)  No  1467/97,  which  also  specifies  that  “any  other  factors  which,  in  the  opinion  of  the 
Member State concerned, are relevant in order to comprehensively assess in qualitative terms 
the  excess  over  the  reference  value  and  which  the  Member  State  has  put  forward  to  the 
Commission and to the Council” need to be given due consideration. 

In  view  of  the  above  provisions,  the  following  four  subsections  consider  in  turn  (1)  the 
medium-term  economic  position;  (2)  the  medium-term  budgetary  position  (including  public 
investment);  (3)  other  factors  put  forward  by  the  Member  State  and  (4)  other  factors 
considered relevant by the Commission. 

4.1. 

Medium-term economic position 

Cyclical conditions and potential growth  

After having recorded an average annual growth of 5.5% over the years 2004-2007 (slightly 
above the long-term 5.2% average growth recorded from 1983 to 2007), the Luxembourgish 
economy stagnated in 2008 and contracted by 3.4% in 2009. It is projected to grow by 2.0% 
in 2010 and 2.4% in 2011 in the Commission services' spring 2010 forecast. The output gap, 
which  was  substantially  positive  in  the  years  before  the  crisis,  reaching  a  peak  of  5.2%  in 
2007, became widely negative in 2009 (-3.9%). It is projected to slightly increase to -4.1% in 
2010 and to remain at that level in 2011.  

Recent structural reforms  

The structural reforms launched within the Lisbon process comprise a significant increase in 
public R&D  expenditure, which were/are planned  to  be  brought  from  about  ¼%  of  GDP  in 
2005  to  0.6%  in  2010  and  eventually  to  1%  of  GDP,  in  particular  through  the  creation  and 
development of the University of Luxembourg. At the same time, there have been efforts to 
improve R&D governance, in particular through the entry into force of a law on research and 
innovation (loi du 5 juin 2009 relative à la promotion de la recherche, du développement et 
de  l’innovation).  New  projects  have  been  identified  in  the  field  of  transport  and  telecoms 
infrastructures  that  should  support  the  country's  competitiveness  and  keep  the  investment 
activity at a high level/further increase the country's investment activity.  

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4.2. 

Medium-term budgetary position 

Structural deficit and fiscal consolidation in good times  

The strong growth recorded between 2004 and 2007 was used to convert the deficit of 1.1% 
of GDP observed in 2004 to an average surplus of 2.6% from 2006 to 2008. The fiscal stance, 
which  was  strongly  expansionary  in  2002-2004,  turned  moderately  and  then  more  openly 
restrictive,  with  the  structural  balance  improving  by  about  0.4  percentage  point  of  GDP  in 
2005  and  2006  and  by  about  1  percentage  point  of  GDP  in  2007  and  2008.  It  peaked  at  a 
surplus of 2.0% of GDP in 2008 before decreasing to 1.2% in 2009 against the background of 
the  sharp  economic  decline.  Thanks  to  this  fiscal  policy  stance  as  well  as  surpluses 
accumulated during the 1990s4, the debt stock stood at 13.7% of GDP at the end of 2008. 

Public investment  

At  3.9%  of  GDP  in  2010  according  to  the  February  stability  programme,  public  investment 
would be more or less of the same magnitude as the deficit projected in the programme and 
the April EDP reporting. It amounted to 4.1% of GDP on average from 2001 to 2009, which 
is  one  of  the  highest  figures  among  the  EU15.  The  Luxembourgish  stimulus  programme 
comprised a substantial increase in public investment, which rose from 3.2% of GDP in 2008 
to 3.6% in 2009.  

Quality of public finances  

Despite its sizeable increase resulting from the crisis, general government expenditure (42% 
of GDP in 2009) remains low compared to most other Member States and public investment 
in percent of GDP is amongst the highest among the EU15. The government, especially the 
social  security  system,  holds  sizeable  assets,  which  are  the  result  of  the  recurrent  surpluses 
recorded in the last decades. According to most estimates, these assets amount to more than 
30% of GDP, compared to a debt-to-GDP ratio of just below 20% in 2010. The net financial 
position  of  the  government  is  thus  positive.  The  support  operation  to  the  financial  sector 
launched  at  the  end  of  2008,  which  caused  the  doubling  of  the  gross  debt  in  that  year,  also 
resulted in a corresponding increase in government assets. The increase in the gross debt ratio 
projected  for  2010  and  2011,  triggered  by  the  large  deficits  of  the  central  government,  will 
also go together with a rise in government assets, mainly accumulated from the surpluses of 
the social security system (about 1¾% of GDP in both years).  

Long-term sustainability of public finances  

In its opinion of 26 April 2010 on the most recent stability programme, the Council assessed 
the  long-term  sustainability  of  Luxembourg's  public  finances  as  follows.  The  long-term 
budgetary impact of ageing projected for Luxembourg is significantly above the EU average 
due  in  particular  to  a  very  considerable  projected  increase  in  pension  expenditure.  The 
significant  assets  accumulated  by  the  social  security  system  will  contribute  to  offsetting  the 
projected  long-term  budgetary  impact  of  ageing  but  this  will  not  be  sufficient  to  cover  the 
sizeable  increase  in  age-related  expenditure.  Achieving  high  primary  surpluses  over  the 
medium  term  and  implementing  measures  aimed  at  curbing  the  substantial  increase  in  age-
related  expenditure  would  contribute  to  reducing  the  risk  to  the  sustainability  of  public 
finances,  which  were  assessed  in  the  Commission  2009  Sustainability  Report  as  medium. 

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Against this background, Luxembourg was invited to improve the long-term sustainability of 
public finances by reforming the pension system and to set a MTO that takes sufficiently into 
account the implicit liabilities related to ageing. 

4.3. 

Other factors put forward by the Member State 

In reply to a request addressed by the Commission to the authorities of Luxembourg regarding 
relevant factors in accordance with Article 2(3) of Council Regulation (EC) No 1467/97, they 
confirmed  on  3  May  2010  that  according  to  their  latest  estimations,  Luxembourg's  2010 
public  deficit  is  likely  to  exceed  the  3%  of  GDP  threshold.  As  regards  the  closeness  to  the 
reference value, the authorities acknowledged that their latest estimate of a deficit of 4.2% of 
GDP  in  2010  could  under  no  circumstances  be  qualified  as  "close"  to  the  reference  value, 
while pointing out that it was made before receiving revenue data for the first quarter and an 
upward revision of the GDP growth forecasts for 2010. This better performance had been to 
some extent already anticipated in the Commission services Spring 2010 forecast. Moreover, 
following discussions in Parliament on 6 and 7 May, the authorities provided information to 
the Commission on 7 May regarding the consolidation measures that Prime Minister Juncker 
had announced during his speech to Parliament on 5 May.  

4.4. 

Other factors considered relevant by the Commission  

Apart from the impact of the economic downturn, the excess above the reference value also 
results from the stimulus package decided by the Luxembourgish government as part of the 
European  Economic  Recovery  Plan  (EERP):  as  a  response  to  the  economic  crisis,  the 
Luxembourgish  government  adopted  a  recovery  package,  which  (together  with  other 
measures  which  were  taken  before  the  aggravation  of  the  crisis  but  have  also  the  effect  to 
support the economy) amounted in 2009 to over 3% of GDP. 

To  stabilise  the  financial  system,  the  Luxembourgish  authorities  granted  a  loan  to  the 
Luxembourgish  subsidiaries  of  Fortis  and  Dexia.  These  loans  amounted  together  to  about 
EUR 2.8 billion (7% of GDP). The loan to Fortis, which amounted to EUR 2.4 billion, was 
subsequently converted into capital. The financing of these loans resulted in a doubling of the 
general government gross debt by the end of 2008, from 7.0% of GDP in 2007 to 14.4% of 
GDP  (although  it  also  increased  the  government’s  assets  to  the  same  extent).  The 
Luxembourgish authorities also decided together with the Belgian and French governments to 
guarantee  Dexia's  liabilities  towards  credit  institutions  and  institutional  counterparties  for  a 
total of EUR 150 billion, of which 3% or EUR 4.5 billion for the Luxembourgish government 
(about 12½% of Luxembourg's GDP). This guarantee has not led to any disbursement up to 
now. 

In  its  opinion  of  26  April  2010  on  the  most  recent  update  of  the  stability  programme,  the 
Council considered that, in view of the downturn and the sound budgetary starting position of 
Luxembourg the temporary deterioration in the general government balance in 2009 and 2010 
partly  reflecting  the  adoption  of  stimulus  measures  is  appropriate.  However,  from  2011 
onwards,  the  Council  also  noted  that  the  fiscal  stance  as  shown  in  the  programme's 
"unchanged policy scenario" cannot be considered in line with the requirements of the Pact, as 
the  government  deficit  would  remain  above  3%  of  GDP  until  2014  and  there  would  be  no 
consolidation effort to ensure that the deficit is brought below the threshold. The Council also 
stated  that,  while  the  authorities  indicated  their  intention  to  follow  a  more  ambitious 
consolidation  path  with  a  view  to  bringing  public  finances  back  to  balance  in  2014  and  to 
achieve the medium-term objective in the following years, this adjustment path could not be 

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properly assessed in the absence of any information including the underlying measures. It thus 
indicated that more information on these measures would be welcome.  

The Council, therefore, invited Luxembourg to start fiscal consolidation as from 2011 with a 
view  to  bringing  the  deficit  below  the  3%  of  GDP  threshold  and  thereafter  progressing 
towards the MTO. It also invited Luxembourg to specify the measures that would be needed 
to achieve this consolidation. 

5. 

CONCLUSIONS 

Whereas the general government deficit in Luxembourg is planned to reach 4.2% of GDP in 
2010,  which  is  above  and  not  close  to  the  3%  of  GDP  reference  value  of  the  Treaty,  the 
Commission  services'  2010  spring  forecast  projects  a  deficit  of  3.5%  of  GDP  which  can  be 
considered  as  close.  The  excess  over  the  reference  value  can  be  qualified  as  exceptional 
within the meaning of the Treaty and the Stability and Growth Pact. Taking into account the 
latest consolidation measures announced by the Luxembourg government, this excess can be 
regarded as temporary. This suggests that the deficit criterion in the Treaty is fulfilled.  

The general government gross debt remains well below the 60% of GDP reference value. This 
suggests that the debt criterion in the Treaty is fulfilled. 

In line with the Treaty, this report has also examined “relevant factors”, which, according to 
the  Stability  and  Growth  Pact,  can  only  be  taken  into  account  in  the  steps  leading  to  the 
decision  on  the  existence  of  an  excessive  deficit  if  the  double  condition  -  that  the  deficit 
remains close to the reference value and that its excess over the reference value is temporary - 
is fully met. Considered on their own merit, the relevant factors in the current case on balance 
seem to be favourable. 

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