Belgium: 2015 Article IV Consultation-Staff Report; and Press Release

KEY ISSUESThe economy has shown considerable resilience but the outlook is weighed down byweak demand in Europe. Healthy private balance sheets, integration with Germany, and employment support schemes have helped sustain employment and economic activity. However, output is still well below potential and private sector job creation insufficient. With exports accounting for about one third of domestic value added, the growth outlook(1 percent in 2015) is heavily influenced by conditions in Europe.The critical challenges are preserving competitiveness and addressing the looming fiscal cost of ageing. The wage policies of the previous government reversed in part a loss in cost competitiveness relative to the three main trading partners, but the economy has also been losing ground in terms of innovation and productivity growth. Age-related government spending is projected to increase sizably by 2040 (an added annual cost of 6 percent of GDP). This reflects the combination of demographics and early withdrawals from the labor force owing to generous access to social benefits and inadequate active labor market policies.The new federal government has announced ambitious reforms to address these challenges. Its focus is on improving competitiveness through temporary de-indexation of wages and a modest fiscal devaluation, and activating underused labor resources by tightening eligibility to pension, pre-pension and unemployment benefits. The program should be complemented by reforms to increase productivity growth and employment creation, by opening sheltered sectors to competition, lowering the cost of regulation, increasing labor market flexibility and improving education and professional training.Fiscal adjustment is expected to resume after a pause in 2014. The pace of structural adjustment targeted for 2015–16 (0.7 percent of GDP a year) is appropriate given debt sustainability risks, and is underpinned by pro-growth expenditure measures. Coordination between the levels of government still needs strengthening across a range of issues.Banks are adapting to a challenging operational environment and a more demanding regulatory framework. The banking sector fared relatively well by the ECB's comprehensive assessment, but additional efforts will be needed toward Basel III capital standards. To maintain adequate profitability, business models need to adapt further to the low growthand low interest rate environment.