NEW YORK (KWR) November 24, 2010 - There is nothing attractive about a country going down into an economic crisis. It usually includes panicked investors, angry citizens, and, in some cases, riots and demonstrations. In 2010 we have watched Greece tumble into an IMF/European Union bailout and later in the year, Ireland. The second case should be of particular alarm to global policy-makers and investors as the Irish government made a very strong effort to avert a bailout, imposing tough austerity on the country for two years running. Now there is more pain coming in the form of the 2011 budget and an IMF/EU support package, a situation complicated by elections in January 2011. Despite the horror of the situation, Ireland is still going to exist as a country. Yes, its sovereignty is dented, but nobody is questioning its future existence. If that were the case, the financial panic would no doubt be greater. That is why the case of Belgium, one of Europe's largest debtors, remains so intriguing.
Greece, Ireland, Portugal and Spain have all been in investor cross hairs since 2009. The issues of too much debt, the imposition of tough-nosed austerity, and ongoing concerns over access to capital -- the critical lifeblood of national finances -- have rearranged the political and economic landscape in Europe. The EU now has a European Financial Stability Fund (EFSF), Germany is emerging as the regional bloc's heavy with France following behind, and small countries are being warned to get their fiscal houses in order. Yet, Belgium's political drama has largely sailed under investor radar screens. But this fractious country of 10.8 million known for its Flemish painters, waffles, French fries, and, of course, beer, potentially faces a profound political crisis that could see an end to the unified state, something which has substantial implications for the management of its debt. It tends to be forgotten, but Belgium has one of the higher levels of debt to GDP in the EU with French banks having the largest exposure (Exhibit 1).
Belgium was established in 1830, following a revolution that pulled the predominately Catholic Southern Law Lands out of the United Kingdom of the Netherlands. The country was, and continues to be, divided between two major linguistic groups, the Dutch-speakers, mostly Flemish and the French-speakers, overwhelmingly Walloons. Hence, Belgium has two political-cultural poles, Flanders in the north and Wallonia in the South. There is also a small German-speaking minority.
To accommodate this often culturally-at-odds mix, Belgium's constitutional monarchy presides over a complicated political system that has devolved considerable authority into regional governments at the expense of the center. This leaves a state headed by the King and a government led by a prime minister, but with a federal cabinet that seeks to equally balance Dutch and French-speaking ministers as prescribed by the constitution. Adding to the cultural-regional mix, the Parliament's upper house, the Senate, consists of 40 directly elected members and 21 representatives appointed by three community parliaments, 10 co-opted senators and the children of the King (as senators by Right who in practice do not cast their vote). The lower Chamber has 150 representatives who are elected under a proportional voting system from 11 electoral districts.
The Belgian political system worked relatively well from 1958 to 1999, with a chain of largely Christian Democrats running the country. In 1999, a major scandal over contaminated food was the catalyst to an unwinding of the Christian Democrat's hegemony and a shift to more regionally-driven political parties. Although the regional polarization factor loomed large over Belgium's political landscape, the country benefited from the governments of Prime Minister Guy Verhofstadt (1999-2008), during which attention was given to improving the country's fiscal situation, containing the growth of national debt, and making some tax reforms.
With the end of the Verhofstadt government, Belgian politics entered a period of instability from which it has yet to find an exit. The latest failure in forming a government came in October when the winner of the June elections, Bar De Wever, head of the separatist N-VA (Flemish) party, proposed greater fiscal autonomy for the regional governments, i.e. more control over tax revenues in regions at the expense of the federal government, a move which would no doubt favor the more affluent Flemish areas. As one journalist noted: "It would leave Flanders, the country's most popular but also wealthiest region, to grab the lion's share of 45 percent of tax revenue no longer in the hands of the federal government. The French-speaking parties were opposed to De Wever's proposal as it could lead to tax competition (i.e. the Flemish areas could lower taxes to attract business).
The thing that most investors are not focused on is that one exit from the situation of June's inclusive 2010 election in which a government has yet to emerge is the end of Belgium as a unified country. Simply stated, Belgium could fraction into two separate countries, much like Czechoslovakia's "Velvet Divorce" in 1992. While the birth of the Czech and Slovak republics was handled without a major sovereign debt crisis, the current environment in Europe and international capital markets is not as open to the birthing process, especially considering that Belgium's debt burden (in terms of debt to GDP) is the third highest.
Are we overstating our concerns? While we hope our perception of Belgium's sovereign risk is overstated, The Economist Intelligence Unit (EIU) has observed (October 12th, 2010): "Belgium is the least stable country in the EU, in that there is no consensus about what form the state should take or whether it should continue to exist at all. Although the EIU went on to emphasize that its central forecast was Belgium will still exist in 2014, it also stated "there will be no long-term resolution of the divisions between the Flemish and francophones. There is indeed a possibility that majorities on both sides will decide their future is as separate countries." Just to add a little more flavor, the Financial Times' Stanley Pignal (November 15, 2010) stated: "The budget questions Belgium faces are the same ones that many other countries in Europe and beyond are asking themselves. But, at the moment, there is no government in office to provide answers."
As of October 2010, Belgium was presided over by interim Prime Minister Yves Leterme, a Flemish Christian Democrat who led the last official government that folded earlier in 2010. A Flemish separatist party was the winner of the June elections and is trying to form a government with a collection of both federalist and separatist parties, not a very promising landscape. This leaves the door open to new elections, a costly yet potentially inconclusive exercise. It is very likely that a new election will only return the same cast of characters - De Wever was recently given 70% support by potential Flemish voters. This situation has hit Belgian society, leaving the daily De Standard to comment: "There is practically no solution but new elections. Chaos is just around the corner."
Belgium's economy has its own set of problems. Real GDP contracted by 2.7% in 2009, but headed back into positive territory in 2010 (with the IMF forecasting 1.6%). Like so many countries in the Euro Area, Belgium has been forced to adopt austerity with an eye to reducing the budget deficit and public debt to meet targets set with the 2010-2013 Stability and Growth Program agreed upon with the European Commission. This situation is not helped by efforts of the regions to increasingly take a larger share of federal tax authority, especially revenues.
The challenge on the economic side is that Belgium is likely to share in the larger slowdown, which is expected to hit the domestic economy hard as the situation is likely to be complicated by ongoing political uncertainty, leaving the export sector one of the few areas of modest expansion. If growth dips lower than expected, it could add to social discontent, considering that unemployment is set to remain above 8% for the foreseeable future.
Bearing in mind the international environment -- with Ireland having crashed and pressure now on Portugal -- domestic political risk and the less than robust economic landscape, we expect that at some point questions could be raised over Belgium's ability to pay, especially if there is ongoing uncertainty over whether the country remains as a unified entity or splits into two new units. Belgium has remained a unified polity since 1830 and a velvet divorce is most likely not a short-term outcome. The EU, with its headquarters in Brussels, would also have a stake in engineering an optimal outcome if tensions were to increase. However, the political squabbling and entrenchment of regionalism among voters pushes a possible day of separation that much closer. For a country with debt forecast toward 100% of GDP and an uncertain political future, Belgian debt trades too tight for the risk. One also has to question the strength of the country's Aa1/AA+ ratings. At some point, investors are going to recognize the gravity of the situation.
Hopefully we do not have another Greece or Ireland-like situation on our hands.
