OECD Economic Outlook, Volume 2020 Issue 1

Luxembourg

The COVID-19 pandemic has led to a sharp contraction of the economy. If the virus subsides by the summer (the single-hit scenario), GDP is projected to shrink by 6.5% in 2020, as a consequence of measures put in place to contain the spread of the COVID-19 pandemic, and then recover by 3.9% in 2021. If there is a new virus outbreak later this year (the double-hit scenario), GDP would drop by 7.7% in 2020 and rebound by only 0.2% in 2021. In both scenarios, the recovery will be supported by domestic demand and, to a lesser extent, by exports. The unemployment rate would reach a level close to 8.6% in 2021 in the double-hit scenario and 7.5% in the single-hit scenario.

Policies that protect workers, businesses and households – including grants for small firms, credit guarantees for businesses and the extension of short-time work schemes – should stay in place until domestic demand shows stronger signs of recovery to minimise possible long-run damage to the economy. To reduce the likelihood of renewed outbreaks, businesses should be encouraged to redesign production and service provision processes in order to reduce physical contact among individuals, for instance through financial incentives. The current extensive testing strategy should continue, to promptly detect and monitor possible new virus clusters.

Strict containment measures brought the virus outbreak under control

The first COVID-19 case in the country was reported on 29 February. The pandemic spread quickly in March, reaching a peak in early April. The containment measures adopted succeeded in limiting the outbreak, with new infections, hospitalisations and deaths declining markedly. A widespread COVID‑19 testing strategy supported a relatively accurate and timely tracking of the pandemic.

Luxembourg: Two scenarios of real GDP and two scenarios of unemployment

Source: OECD Economic Outlook 107 database.

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Luxembourg: Demand, output and prices (double-hit scenario)

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On 16 March, the authorities advised against all non‑essential travel to other countries. A number of strict containment measures were adopted after the state of crisis was approved by parliament on 21 March. These included the closure of schools and all non‑essential commercial activities, a suspension of all cultural, social and recreational activities, the cancellation of all gatherings, and the shutdown of all construction sites, except for those related to health and other critical infrastructure. All residents were advised to remain at home and to practice physical distancing. Following a three‑phase lockdown exit plan adopted in mid‑April, commercial activities and schools reopened in May.

The economy has deteriorated fast

Short‑term indicators point to a rapid deterioration in the economic situation in the second quarter of 2020 due to the measures taken to contain the pandemic. The unemployment rate rose considerably in March and April, and May’s business survey reported the lowest confidence level since the Global Financial Crisis. Following 8 weeks of lockdown, private consumption is expected to drop by about 16% in the second quarter of 2020. Over the same period, non‑residential and government fixed investment are set to decline by over 21%. These figures are slightly smaller with respect to other advanced economies due to the relative resilience of the financial sector and its large role in the economy of Luxembourg.

Luxembourg: Demand, output and prices (single-hit scenario)

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The policy response has been prompt and forceful

To reduce the impact of containment measures on the economy and to preserve jobs and viable firms, a number of tax, expenditure and financial measures have been put in place. Tax and social security charge deferrals have been announced, aimed at alleviating the liquidity situation of businesses and self‑employed individuals. The government set up a loan guarantee facility of EUR 2.5 billion for new credit lines until the end of 2020. This adds to the six‑month moratorium on debt repayments voluntarily agreed by Luxembourg banks. Eligible companies can benefit from a repayable advance introduced to support SMEs affected by the economic consequences of the COVID‑19 outbreak. Companies with less than 10 employees can request lump-sum grants. The short-time work scheme (“chômage partiel”) was expanded to all companies affected by the COVID-19 crisis. Overall, the projection envisages a discretionary fiscal stimulus of about 3% of GDP in 2020.

Risks are on the downside

In the single‑hit scenario, GDP is expected to contract by 6.5% in 2020, while it would shrink by 7.7% in the equally likely double-hit scenario. In both scenarios, the fall in domestic demand projected in 2020 is driven by sinking private consumption and business investment. In 2021, in the single-hit scenario, GDP growth is expected to rebound to 3.9%, supported by a bounce‑back in private consumption and investment, and by a more limited quarter-on-quarter recovery in exports. A more modest recovery is envisaged in the double‑hit scenario, with GDP growth in 2021 of only 0.2%. The unemployment rate will increase in both scenarios, reaching 7.5% (single‑hit scenario) and 8.6% (double‑hit scenario) in 2021. Risks to the projections are on the downside and include a persistently high unemployment rate, labour force de‑skilling, and long‑term negative impacts on private investment, causing a decline in output potential. Prolonged weakness in external demand and increased distress in the financial sector are additional risk factors. On the upside, a faster disappearance of the pandemic could lead to a stronger rebound.

Sustained policy support is essential

Policy support should remain in place until the economic pick‑up becomes self‑sustained. A possible time extension of short‑term work schemes should be considered to preserve valuable job matches, especially in event of a second pandemic outbreak. To support a needed recovery in the job market, active labour market policies should be scaled up to cope with the rising number of job seekers. Businesses should be encouraged to adopt production and service provision models that reduce physical contact among individuals, thereby minimising the risk of new outbreaks. To this end, targeted financial support should be considered.