Political and social strife are nothing new to Belgium; however, the failure of talks last week to build a new coalition government following political gridlock since elections in June 2009 has severely weighed on the country’s investment risk.
In the chart below we show the Belgian 10 YR bond yield alongside the country’s 5YR CDS spread. Both reflect the rising risk premium to own Belgian debt, a risk that has developed over the last year alongside political instability. And now due to this political gridlocked the country has not addressed any fiscal consolidation measures (austerity) like its neighbors, which has investors concerned given that Belgium has the third highest public debt as a percentage of GDP in the EU at ~96.2% in 2009, behind Greece and Italy.
Reflecting this risk, and the uncertainty of a meeting King Albert II has tomorrow with Johan Vande Lanotte, a Socialist from Flanders and author of last week’s failed constitutional compromise (who also resigned after the failed talks), the Belgian 10YR yield is now at a new high of 4.21% (or a 1.4% premium spread over German paper, the highest since January 2009).
To understand the main political disagreements of the government one must understand the divided make-up of the country as well. These lines include Language and Culture: Dutch is spoken to the north (Flanders) while French is spoken in the south (Wallonia); Economy: more robust and profitable to the north; and Politics: The New Flemish Alliance is the dominate party of Flanders and calls for independence, while the Socialist are the largest party in Wallonia and call for a stronger central government.
In finer terms the disagreements center around political control of the Brussels suburbs, regional control of government services, and the transfers of tax revenue from Flanders to Brussels and Wallonia.
On the hot issue of tax revenue, and given that Flanders is far richer than Wallonia, there’s real divide on just how tax revenue should be allocated. As an example, The New Flemish Alliance wanted more than 40% of it returned to the regions, while the socialists proposed around 25%.
While Belgium is not at the stage of a Greek or Irish Tragedy, there’s room for concern given the sudden swings in investor confidence around Europe’s sovereign debt issues. Belgium has forecast a budget deficit of 4.8% in 2010 (above the EU’s mandated ceiling of 3%) and 4.6% in 2011, yet Belgium needs to save an additional €1.8 billion to meet a EU target of cutting the deficit to 4.1% of GDP in 2011.
Slightly better news could come on Wednesday when Yves Leterme, currently Belgium's caretaker Prime Minister, is expected to publish an annual economic report with a 2010 deficit below 4.8%.
Even so, the quarrels developing within the country present investment risk that should be monitored. In the context of Europe, we add Belgium to the list of PIIGS that present downside investment risk, including to the common currency. We covered our EUR-USD position via the etf FXE on 1/6. We remain long Germany (EWG) and short Italy (EWI) in the Hedgeye Virtual Portfolio.
Matthew Hedrick
Analyst