Euro Area Sovereign Credit: Some Ratings Under Pressure as Fiscal Challenges Mount

Scope Ratings is concerned about heavily-indebted countries with large primary deficits, and governments operating in highly fragmented political environments struggling to implement reforms.

Previous crisis-hit countries such as Greece, Ireland, Portugal, Spain and Cyprus have implemented important reforms under EU financial assistance programmes, resulting in more favourable macroeconomic trajectories. However, not all euro area countries have used the past years of loose monetary policy as effectively to address the fiscal challenges they face.

For example, France and Belgium, both of which Scope rates with a Negative Outlook, risk failing to fully acknowledge their financial constraints. Government plans that only aim to stabilise public debt at current elevated ratios imply that debt will continue to rise whenever the next crisis emerges.

Figure 1. Rising expenditure and investment needs in France, Germany, Italy and Spain
% of GDP

France’s Fiscal Revisions Challenges Its Fiscal-consolidation Plan

France’s recent upward revision of its fiscal deficit to 5.5% of GDP for 2023 further challenges the government’s consolidation plan, which may now, according to the Court of Auditors, require additional savings of around EUR 50bn, or 2% of GDP, over coming years ahead of the 2027 presidential elections.

Similarly, in the absence of policy changes in Belgium following federal and regional elections in June, Scope expects Belgium to record the largest fiscal deficit in Europe, exceeding 5% of GDP over the coming years. This would result in a steadily increasing debt trajectory, and the third-highest public debt level in Europe by 2028, after Greece and Italy.

Difficult Context of Moderate Growth, High Public Debt and Rising Interest Payments

The difficult context for euro area governments stems from three challenges – moderate growth, high public debt, and rising interest payments – which coincide with pressures for higher spending and investment principally destined for the elderly, the environment and defence (Figure 1).

Together, these trends will strain fiscal budgets by an average of around 3-4% of GDP in coming years. This includes substantial investment needs to achieve carbon neutrality by 2050, which are estimated at about 0.5% to 1.0% of GDP per year for the public sector alone, based on European Commission data.

Public debt is higher on aggregate and fiscal disparities across euro area sovereigns have also widened since the crises. For example, the general government debt-ratio differential between Germany and France has surged from 38pps in 2019 to nearly 50pps, contrasting sharply with the near zero differential between 1992, when the Maastricht Treaty was signed, and in 2012 at the height of the euro area sovereign crisis.

Different public-debt levels imply varying capacities to respond to the next shock. Such divergent fiscal positions may complicate discussions about future solidarity and fiscal risk sharing, especially in case of country-specific rather than region-wide shocks.

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Alvise Lennkh-Yunus is the Managing Director of Sovereign and Public Sector ratings at Scope Ratings GmbH.