Is Belgium next?

Βy Susanne Mundschenk and Raphael Cottin*
Eurointelligence, 15-10-2010

''For four months Belgium has been without a government, its public debt is approaching 100% of GDP and the spread of Belgian 10-year bonds over the German benchmark is today three times as high as at the beginning of this year. Is Belgium the next country with a sovereign debt crisis?

So far the country has managed to stay off the radar screens of most international investors, who focus on Greece, Ireland, Spain and Portugal. But that may change if the political crisis – which has been going on for more than two years - is not resolved soon.

At the June general elections, the separatist NVA emerged as the strongest party in Flanders, while in French-speaking Wallonia, the Socialists came out first. In the ensuing coalition negotiations, the N-VA has chosen to get a federal reform agreed first before building a government, in a complex bargaining process between the seven parties that currently participate in the negotiation talks. The result is a political stalemate that risks paralysing the political system for months.

It helps to think about Belgium's economic future using four different scenarios. The first scenario, the status quo, is not very likely, perhaps surprisingly. Under that scenario, there would be no further devolution of power from the centre to the regions. So much political capital is tied up in the constitutional reform process that the leading parties in both Flanders and Wallonia could not turn their back on it.

If there were new elections now, the N-VA would receive more votes in Flanders than it did in June, according to latest opinion polls. The same seems to be true for the Socialists in Wallonia. New elections would lead Belgium further down the road of separatism.

Under the second scenario, the parties would agree on a minimal degree of devolution to the regions. Under a previously negotiated conditional deal, a total of €15.8bn in expenditures would be transferred to the regions. The critical part is the regional share in tax revenues. A minimal scenario would be on the line of the Socialists' maximal concession of 10% of tax revenues to be transferred to the regions.

Under scenario three, the expenditure share would be the same, but the scale of the income tax transfer would be significantly larger – more in line with the N-VA demand of a 50% transfer.

What would be the implications for public debt and the overall deficit in both devolution scenarios?

These questions have hardly ever been addressed in these negotiations today. The problem is that both devolution scenarios are essentially unsustainable. Depending on the chosen scenario, either the federal state or the regional administrations will at some point in time be short of resources to cover their expenses.

Under scenario two, the federal state budget might be better off to service the debt and to provide social security, but the regions' revenue share will be too small to cover for the new list of responsibilities.

Under scenario three, the federal state might no longer be able to finance its remaining duties, namely to service Belgian debt and to provide social security for its citizens. The outlook for public debt is not promising either. The public debt-to-GDP ratio might stabilise under scenario two but is likely to rise continuously under scenario three. These deteriorations would be the more pronounced if economic growth is lower, and the real interest rate higher, than forecast.

Scenario four is the breakup of the country. It is hard to see how the parties could agree on the complete breakup as long as all parties still have an interest in keeping the state and public opinion continues to have no appetite for such an extreme scenario. But the political climate is highly sensitive, so that such a scenario, as irrational as it may be, cannot be excluded either.

A breakup can never be the outcome of a friendly agreement between the regions, and is only thinkable with some kind of external mediator. If there were an agreement of a breakup, it would obviously include the delegation of all spending and taxing powers to the regions. Less clear is what will happen to the legacy of outstanding debts, including the hidden debt in social security. Here some key issues will have to be agreed upon on how to share the burden.

Another interesting question is whether Belgium, as we know it, will cease to exist or continue to exist under a different territorial definition. The latter would mean that one or two regions split apart and form a new state instead. The Francophones recently suggested that Wallonia and Brussels should form a new Belgium, leaving the Flemish to decide whether or not they want to split apart. The Flemish, of course, lay claim to Brussels as well.

Whatever the eventual outcome, it will be preceded by political instability. In the meantime, borrowing costs will rise, thus exasperating the negative debt dynamics of high real interest rates and low economic growth.

Whether Belgium is next to succumb to a debt crisis will depend on which scenario the Belgians end up choosing. All of the devolution scenarios come with a large political cost, a large financial cost, or both.''

*Susanne Mundschenk is Executive Director of Eurointelligence ASBL. Raphael Cottin is a research associate of Eurointeligence.