Economic studies
Luxembourg

Luxembourg

Population 0.6 million
GDP per capita 116,921 US$ billion
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Synthesis

major macro economic indicators

  2019 2020 2021 (e) 2022 (f)
GDP growth (%) 2.3 -1.8 7.0 2.1
Inflation (yearly average, %) 1.6 0.8 2.3 1.9
Budget balance (% GDP) 2.4 -3.5 -0.7 0.1
Current account balance (% GDP) 4.5 4.3 4.7 4.5
Public debt (% GDP) 22.0 24.8 25.8 26.3

(e): Estimate (f): Forecast

STRENGTHS

  • Fiscal stability
  • Skilled multilingual workforce
  • High-quality infrastructure, business-friendly regulation
  • Major international financial centre
  • High standard of living

WEAKNESSES

  • Heavily dependent on the financial sector
  • Economy vulnerable to Eurozone economic conditions
  • Long-term budgetary impact of population ageing

Risk assessment

Return to pre-crisis growth rate

The economy has been resilient throughout the pandemic, thanks to its specialisation in financial services (27% of GDP), which have proved robust overall. In mid-2021, GDP was 3.5% above its pre-crisis level, while it was still, on average, 3% lower in the Eurozone. In 2022, activity should return to a growth rate similar to that seen in the years preceding the pandemic. As the second-largest fund management centre in the world (EUR 4,700 billion in assets under management), behind the United States, the economy will depend heavily on the health of international financial markets. The financial sector is mainly composed of foreign banks (subsidiaries of European banks) – of the 130 banks registered in 2019, seven were domestically focused commercial banks – and alternative investment funds. Despite an unsupportive ultra-low interest rate environment, the financial sector has continued to report significant profitability, thanks to its diverse range of activities, and has appeared solid due to its strong capitalisation. Meanwhile, the vaccination of a large section of the population (63% fully vaccinated in November 2021) should make it possible to avoid the implementation of new restrictions on economic activity, and thus encourage the consumption of savings built up during the crisis. While demand will remain buoyant, activity will continue to be constrained by companies' production capacity. In continuation from the second half of 2021, transport, commodity and industrial input costs will remain high, pushing up the cost of, and potentially hampering, production in industry and construction. This situation will be compounded since the hiring challenges reported in 2021 – by 45% of companies in construction and 20% in other sectors – are set to persist as the recovery continues in 2022. However, despite becoming a hub for scientific R&D, Luxembourg will be less exposed than the rest of the region to ups and downs in industry, whose weight in GDP has been steadily decreasing (5% of GDP in 2019, with metals accounting for one-third, compared with 13% in 1995), replaced by real estate activities and business services (20% of GDP) and non-market services (19%).

 

Moreover, driven, as in the rest of the Eurozone, by the rise in energy prices and production costs, but also by the triggering in October 2021 of indexation (2.5% increase in wages, salaries and pensions), inflation will remain high throughout the first part of the year, before gradually decreasing.

 

Continued rebalancing of public accounts 

After two years of deficits, due to the fall in activity and support measures (unemployment, direct aid to businesses, deferral of tax and social security payments), the public accounts will continue to rebalance in 2022, and could even return to a surplus, as in the nine years prior to the pandemic. Rebalancing will be achieved mainly through increased tax revenues: on the one hand, VAT (+5% according to the 2022 Finance Bill) will be driven by the continuing recovery in activity, on the other, income tax (+3%) and especially taxation of salaries and wages (+9%) will increase strongly with employment and wages. Concomitantly, despite the wage hike for civil servants (+0.4 of a point of GDP compared with 2021), expenditure will increase less rapidly, due to the phase-out of support measures and slightly weaker public investment (4.4% of GDP, -0.1 of a point compared with 2021). Public debt, which was already the lowest in the euro area before the crisis, will remain modest.

 

The current account will continue to record a large surplus in 2022. The trade balance will again show a substantial surplus (EUR 24 billion in 2020, or 37% of GDP), almost three-quarters of which is attributable to financial services. This offsets the large income deficit, caused in equal parts by cross-border remittances and the repatriation of dividends from massive portfolio investments in the country (16% of GDP each). Holding consistently more assets than liabilities with the rest of the world since 2013, the Grand Duchy continues to have a strong positive net international investment position (47% of GDP at end-June 2021).

 

The coalition emerges stronger from the pandemic one year ahead of parliamentary elections

At the head of the country since 2013. Prime Minister Xavier Bettel of the centre-right Democratic Party (DP) remained in power following the 2018 parliamentary elections by forming a coalition, as in the previous term, with the Socialist Party (LSAP) and Déi Gréng (environmentalist). The Christian Social People's Party (CSV) won 29% of the vote in these elections (compared with 18% for the DP) and is the main opposition party with 21 seats. While the DP was forced to make concessions to its partners, notably the Green Party, the only one of the main parties to make gains in 2018, the coalition looks solid, despite its narrow majority (31 seats out of 60). According to a June 2021 poll, the coalition’s position was actually strengthened by the partners’ handling of the pandemic, with voting intentions up for the DP and LSAP and indicating that if elections were held, each party would win one more seat than in 2018, unlike the environmentalists (-1). While remaining the largest party in the country, the CSV (-4) would surrender some of its position in the opposition to parties from the other end of the political spectrum, namely Piraten (direct democracy, +2) and Déi Lenk (extreme left, +1). To reverse this trend in the run-up to the parliamentary elections in June 2023, the CSV appointed Claude Wiseler, who headed the national list in the 2018 elections, as party leader in April 2021.

 

Last updated: February 2022

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