Luxembourg: 2015 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Luxembourg

EXECUTIVE SUMMARY Luxembourg's main challenge is to strengthen an economic model that has served it well. Growth was close to 3 percent in 2014, and is projected at 2½ percent in 2015, with continued strong job creation. The model emphasizes maintaining fiscal stability and openness, practicing conservative prudential oversight, and responding to investor needs. This combination has been a magnet for international financial business, nowhere more so than in the investment fund industry, where assets under management have more than doubled since 2008, to €3½ trillion. Recent challenges to this model necessitate a proactive approach to adjust to a changing landscape. The authorities' commitment to positive engagement in the international tax transparency agenda supports a proactive approach. Having adjusted fiscal policy for lower revenues from electronic commerce, they should also address the additional base erosion that could now arise, exploring options to make the tax system more robust. At the same time, they should pursue further reforms to make the pension system more resilient to population aging. These policy initiatives, along with the authorities' commitment to a modest budget surplus over the medium term, should fortify Luxembourg's 'AAA' sovereign credit standing. Equally, Luxembourg also plans a series of actions to uphold its reputation as a firm and sophisticated financial regulator. These include faster passage of EU banking laws, where the banking union promises to be especially beneficial for Luxembourg, operationalizing a purposeful systemic risk committee, and being a voice for strong cross border oversight. On the latter, effective EU regulatory arrangements for nonbank companies that control banks should form a particular focus, given the large volume of intragroup activity transiting through Luxembourg. Provided the challenges ahead are well managed, growth in the near term could beat staff's baseline, helped by a firmer euro area recovery. In the medium term, however, the success of the authorities' initiatives to diversify the economy will play out against a backdrop of lower potential growth. It is doubly important, therefore, that efforts are also underway to better equip workers with relevant skills and to lift youth and women's participation in the labor force.