LUXEMBOURG - The International Monetary Fund (IMF) has warned Luxembourg its continued fiscal stability requires substantial reforms of the pension system.

In preliminary findings from its latest mission to Luxembourg, the IMF noted the country had mitigated the worst of the financial crisis with a "prompt and aggressive policy response". But it warned the country faces three main challenges: strengthening the financial sector; ensuring fiscal sustainability and "withstanding the headwinds on Luxembourg's growth model".

Within the area of maintaining fiscal sustainability, the IMF warned Luxembourg requires "substantive pension reform". This is because increased life expectancy combined with generous benefits will place considerable pressure on the existing pay-as-you-go system.

The IMF suggested reforms should begin gradually by increasing the effective and statutory retirement age, and said this could be achieved by discouraging early retirement and improving the alignment between benefits and contributions.

Figures from the OECD for 2006 revealed the public sector pension expenditure for Luxembourg equated to approximately 4% of GDP, while private sector pensions - those supervised by the Financial Sector Services Committee and Insurance Commissariat - was just 0.1% of GDP in the same year.

In its findings, the IMF also noted any pension reforms would also need to "rein in the rate of increase of existing old-age pensions".

In a statement, the IMF added: "The urgency of putting in place reforms early has been heightened by the global financial crisis with its adverse impact on employment growth prospects and social security contributions from cross-border workers and lasting effect on Luxembourg's growth."

If you have any comments you would like to add to this or any other story, contact Nyree Stewart on + 44 (0)20 7261 4618 or email nyree.stewart@ipe.com

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