Fitch Ratings estimates that the interruption of Russian natural gas flows will cause a recession in the Eurozone
The measures taken by the Greek government but also in general by the European governments of Western Europe to deal with the energy crisis will have a large fiscal cost, preventing the recovery of public finances after the pandemic, reports Fitch Ratings.
The impact on deficits and debt levels, if anything, will correspond to the policies implemented and will vary from country to country.
According to the American house, the complete cessation of natural gas flows from Russia to the Old Continent will trigger a recession in the Eurozone and the UK, resulting in GDP contraction of 0.1% and 0.2% in 2023, respectively.
Since European states will not be able to achieve a seamless transition to alternative energy sources and, as a result, they will even suffer a tenfold increase in electricity prices on household bills, Fitch’s forecasts for both Eurozone and UK inflation incorporate 30%-35% increases on retail gas and electricity prices – beyond the 50%-60% increases from April 2021.
“There are reasons to believe that the pass-through rate has increased to 30%-40% from around 10%, meaning that absorbing the increases for households and businesses will have a large fiscal cost” says Fitch.
The nature and size of policy responses and their funding will reflect the path of wholesale prices, the dependence of each country’s energy mix on natural gas and reliance on Russian imports, and policy choices, including how constrained they feel the policymakers from the current debt.
The UK retail price freeze, which some estimates could cost up to £150 billion (6.8% of GDP) over two years, and Germany’s planned third fiscal support package, amounting to 65 billion euros (1.6% of GDP), underline the possibility of substantial intervention.
In most western European countries, revenues in 2022 exceeded expectations, absorbing energy-related spending without major revisions to 2022 deficit targets.
However, the current ‘hit’ to growth will prevent a repeat of this strong revenue performance in 2023, while the indexation of providers (including pensions) will put pressure on public spending.
High inflation has eliminated the ability to ease monetary policy to offset the impact on households and businesses, unlike when the Covid-19 pandemic broke out.
The ECB will not absorb additional debt issuance, so there will be a fiscal expansion in an environment of much higher marginal cost of financing.
This could limit the scope and strength of fiscal responses, particularly in highly indebted countries such as Greece – although policymakers will weigh social and political pressures against the risks of adverse market reactions.
A European response is needed…
A credible fiscal anchor at the EU level could limit fiscal easing.
The fiscal rules of the Stability and Growth Pact (SGP) have been suspended until 2023, but the European Commission has issued qualitative guidelines to limit the growth of nationally financed spending and is to propose changes to the SGP next month.
Failure to design and implement a credible proposal could increase pressure on Fitch’s ratings, given the high public debt found in the Greek economy.
So far, new joint lending schemes that would offset fiscal costs remain controversial.
The Commission has proposed an extraordinary tax on skyrocketing profits made by energy companies…
As he claims, in this way he could raise more than 140 billion euros.
However, it is not clear whether the specific measure will be accepted by the member states and whether it protects all consumers and businesses.
The impact on public finances will also depend on the duration of the energy crisis.
The house’s macroeconomic forecasts assume that energy production and consumption adjust and new import infrastructure comes into operation by 2024.
This will allow for a reduction in fiscal support.