By Eleftherias Kourtalis
Eurozone governments that cannot implement coherent medium-term fiscal plans will face pressures on their credit rating, Score Ratings warns in a report today, in contrast to countries such as Greece, which have implemented significant reforms.
“We are concerned about highly indebted countries with large primary deficits and governments operating in highly fragmented political environments and struggling to implement reforms,” as Alvise Lennkh-Yunus, head of sovereign assessments at Scope, emphasizes in particular.
Former crisis-hit countries such as Greece, Ireland, Portugal, Spain and Cyprus have implemented significant reforms within the framework of EU financial assistance programs, resulting in more favorable macroeconomic trajectories, the house emphasizes. However, not all euro area countries have used the recent years of loose monetary policy so effectively to address the fiscal challenges they face.
Cloudy macroeconomic landscape
Europe faces a challenging macroeconomic environment in the coming years, with low growth, higher interest payments and significant upward pressure on social, environmental and defense spending. Recognizing these fiscal constraints should lead to significant fiscal compromises, Scope points out. While public debt reduction is possible, even for over-indebted states, based on historical fiscal adjustments, weak governments struggling to implement coherent medium-term fiscal plans are putting pressure on the credit ratings of some euro area states.
While the EU has demonstrated its ability to respond and recover from the pandemic and the energy crisis, moderate economic growth of 1.0% in 2024 and 1.8% in 2025 is expected. The increase in Europe’s long-term growth potential – estimated at 1.4% – remains critical. Speeding up Next Generation EU (NGEU) implementation, both in reforms and investment, would help, Scope notes.
Also, faster progress in the capital markets union, launched in 2015, to facilitate cross-border savings and investment and thus better allocation of resources across Europe would also support growth. Digital transformation and innovations such as artificial intelligence (AI) can also help boost productivity. Europe is leading the way in developing regulatory frameworks for the sector, but risks falling behind other major economies in reaping the benefits of AI-related digital innovations.
In addition, Europe is facing structurally higher levels of public debt following the pandemic and the energy crisis. Public debt, which was high due to overall and fiscal disparities between eurozone states, widened after the crises, as Scope points out. The debt ratio gap between Germany and France rose from 38% in 2019 to almost 50%, in contrast to the almost zero gap between 1992 (when the Maastricht Treaty was signed) and 2012, at the height of the eurozone crisis .
The ability of euro area states to respond to a new shock varies
This matters because different levels of public debt imply different capacities for countries to respond to the next shock. In addition, divergent fiscal positions may also complicate discussions about future solidarity and fiscal risk sharing, especially in the event of shocks to the country rather than the entire region, the house underlines.
Finally, Scope expects interest rates to be permanently higher compared to pre-Covid years, even when central banks ease interest rates later this year. Interest payments will continue to rise as government debt issued at lower interest rates before and during the pandemic matures and is now refinanced at higher interest rates. Italy, Germany, France and Spain will collectively pay almost €170 billion more in interest in 2028 compared to 2020. While net interest payments as a percentage of revenue will remain below their highs, higher payments expected interest rates will tighten fiscal space, forcing governments to cut spending elsewhere, raise taxes or borrow more.
Spending is rising
“The difficult context for euro area governments stems from three challenges: moderate growth, high public debt and rising interest payments, coinciding with pressures for higher spending and investment earmarked mainly for the elderly, the environment and defence,” emphasizes the house.
Together, these trends will strain fiscal budgets by around 3%-4% of GDP on average over the coming years. These include significant investment needs for carbon neutrality by 2050, estimated at around 0.5% to 1.0% of GDP per year for the public sector alone, based on European Commission data.
Europe also faces large investment needs to meet NATO defense goals, in some cases 0.5% to 1.0% of GDP, in addition to financial support for Ukraine. Also, industrial policies to boost domestic production for economic autonomy and national security will also squeeze European government budgets, through lower taxes and/or more generous subsidies.
Overall, Scope points out, Europe’s policy priorities entail higher spending and investment needs of around 3-4% of GDP at a time when growth is moderate, at best.
Unlike countries like Greece, many countries are facing significant risks, the house reports. France and Belgium, for example, which Scope assesses with a negative outlook, are at risk of not fully recognizing their economic constraints. Government plans aimed only at stabilizing public debt at current elevated ratios suggest that debt will continue to rise whenever the next crisis occurs.
The recent upward revision of France’s budget deficit to 5.5% of GDP for 2023 poses significant further obstacles to the government’s consolidation plan, which, according to the Court of Auditors, may now require additional savings of around €50bn or 2% of GDP in the coming years, ahead of the 2027 presidential elections.
Similarly, in the absence of policy changes in Belgium following June’s federal and regional elections, Scope expects the country to record the largest budget deficit in Europe, exceeding 5% of GDP in the coming years. This will lead to a steadily increasing debt trajectory and the third highest level of public debt in Europe by 2028, after Greece and Italy.
