OREANDA-NEWS. January 26, 2016. Fitch Ratings has affirmed Belgium's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AA' with a Negative Outlook. The issue ratings on Belgium's unsecured foreign and local currency bonds and commercial paper have also been affirmed at 'AA'/'F1+'. The Country Ceiling has been affirmed at 'AAA' and the Short-term foreign currency IDR at 'F1+'.

KEY RATING DRIVERS
Belgium's 'AA' IDRs and Negative Outlook reflect the following key rating drivers:

The ratings balance Belgium's high public debt burden and fiscal slippage in recent years against the economy's strong net external creditor position, high per capita income, track record of macroeconomic stability and relatively good governance.

Belgium's gross general government debt is the highest among 'AA' rated sovereigns at 106.7% of GDP at end-2015, and is estimated to remain flat in 2016 before declining. Debt/GDP benefited at end-2015 from KBC Bank's reimbursement of its remaining state funds, amounting to 0.7pp of GDP. Fitch expects debt/GDP to remain above 100% until 2020 (unchanged from our previous review). Sovereign refinancing risk is low, reflecting a long average debt maturity of 7.9 years and a low average cost of borrowing of 2.8%. Government debt is predominantly euro-denominated.

Fitch estimates a general government deficit of 2.7% of GDP for 2015, in line with our last review and down from 3.1% in 2014. The deficit is forecast to fall to 2.3% of GDP in 2016 (2.2% at the last review), an assumption that incorporates 0.3pp of GDP of consolidation measures that are expected to be identified in early 2016. Fiscal consolidation in 2016 is focussed on curbing expenditure and a shift in tax revenues away from labour.

In its recent assessment of the draft 2016 budget, the European Commission (EC) concluded that Belgium's expected structural improvement in 2015 and 2016 falls short of the requirement under the debt criterion, and risks some deviation from the adjustment path towards its medium-term fiscal objective. The EC is expected to publish its recommendations based on revised forecasts in May 2016.

The government is implementing some structural reforms that will benefit competitiveness, including a temporary freeze to the wage indexation mechanism that will lower wage costs by 2-3% by end-2016, and a cut to employers' social security contributions by 1%. The government also passed pension reforms at end-2015 to strengthen the age and career requirements for pensions, reducing the generosity of public pensions and incentives for early retirement. The Committee on Ageing estimates the measures would result in the fiscal costs of ageing halving to 2.1pp of GDP by 2060.

Belgium's ratings are supported by its diversified and high-value added economy, strong performance on governance indicators relative to the 'AA' medians, and low volatility of growth and inflation. The economy has a strong net external creditor position of 87% of GDP attributable to Belgian households and corporations, which has increased Belgium's primary income and contributed to a growing current account surplus of 0.9% of GDP in 2015.

Real GDP growth is estimated to grow by 1.3% in 2015, slightly faster than our forecast in the previous review (1.1%). We forecast growth to stay at 1.3% in 2016 before picking up to 1.6% in 2017, driven by private consumption and investments, and supported by low interest rates and oil prices.

The health of the Belgian banking sector is improving. Total banking sector assets have been cut significantly since the financial crisis, but grew by 2.2% yoy in November 2015, suggesting that banks are beginning to grow again. Profitability and capitalisation are improving, while non-performing loans are low at 4.0% of gross loans at end-June 2015. Government guarantees to Dexia remain large at EUR31.5bn at end-2015 (7.7% of GDP).

RATING SENSITIVITIES
The Negative Outlook reflects the following risk factors that may, individually or collectively, result in a downgrade:
- Slippage in the budget deficit, reducing confidence that debt/GDP can be put on a downward trajectory.
- Persistently weak growth and inflation.

The Negative Outlook means Fitch's analysis does not currently expect developments with a material likelihood of leading to an upgrade. Nonetheless, future developments that may individually or collectively result in a revision of the Outlook to Stable include:
- Fiscal deficit reduction consistent with the public debt/GDP being placed on a sustained downward trajectory.
- Strengthening growth prospects and competitiveness, particularly through implementation of structural reforms.

KEY ASSUMPTIONS
In its debt sensitivity analysis, Fitch assumes a primary surplus averaging 1.8% over the next 10 years, trend real GDP growth averaging 1.2%, an average effective interest rate of 2.8% and GDP deflator of 1.7%. Based on these assumptions, the debt/GDP ratio would remain flat in 2015-2016 before declining to 104.9% in 2017 and 90% by 2024.

The European Central Bank's asset purchase programme should help underpin inflation expectations, and supports our base case that in the context of an economic recovery, Belgium and the eurozone will avoid prolonged deflation. Nevertheless, deflation risks could re-intensify in case of adverse shocks increasing the real debt burden in the public and private sectors.