The debt burden is also falling for Italy.
(Photo: imago images/Westend61)
Brussels It wasn’t long ago that economists prophesied about a return of the debt crisis in the euro zone. The mountains of debt had grown significantly during the corona pandemic, especially in the southern European countries: in Greece the debt ratio was at times more than 200 percent of gross domestic product (GDP), in Italy more than 150 percent.
But the situation has eased significantly. Debt ratios have been falling rapidly for two years, and economists expect the trend to continue this year. The additional mountain of debt from the Corona period has already been completely eliminated in some countries, according to an analysis by the consulting firm Oxford Economics, which is to be published on Thursday.
The average debt ratio in the euro zone fell from a peak of 100 percent in early 2021 to 93 percent of GDP at the end of 2022. This is still above the lowest level before the pandemic (84 percent), but some highly indebted countries in particular stand out positively: Greek public finances, for example, are in better shape than before Corona, and Portugal has almost reached this goal.
Italy and Spain are also making big strides in deleveraging, while Germany is sluggish. However, the level of debt is also significantly lower here, and reduction is less urgent.
The economist Daniel Kral from Oxford Economics cites strong economic growth and high inflation as reasons for the positive trend in southern Europe. Both provided governments with more tax revenue than expected last year. The economy grew by more than five percent in Greece, Portugal and Spain because tourism recovered quickly after the pandemic. The German economy, on the other hand, suffered much more from the energy crisis and only grew by 1.8 percent. Expensive energy aid put an additional burden on the budget.
Further falling debt levels expected
The sharp rise in inflation after the Russian invasion of Ukraine also helped the debt ratio fall, says Kral. First, there is the arithmetical effect: if the value of nominal GDP rises in line with inflation, debt automatically accounts for a smaller percentage of that. In addition, the state collects more taxes when the prices of goods and services rise.
Michele Napolitano from the Fitch rating agency expects debt levels in southern Europe to continue to fall this year and next. But the pace will slow down, he says. From now on, inflation will have less of an impact because the amount of many social benefits is linked to the inflation of the previous year. This part of government spending will therefore increase. If you balance the positive and negative effects of inflation on debt, the bottom line is that they are slightly positive, says Napolitano.
Portugal already generated a surplus in the primary budget last year. This is the state budget without interest payments. Greece is to follow this year. Fitch has therefore recently upgraded the creditworthiness of the two former crisis countries. In Italy and Spain, on the other hand, debt reduction is progressing more slowly and it doesn’t take much to reverse the trend, says Napolitano.
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He sees the help from the European Corona reconstruction fund as decisive. The EU funds, which primarily benefit southern Europe, are an economic boost outside of the national budget. “If these are used correctly, they can boost growth without putting a strain on budgets,” says Napolitano.
“We could see a significant boost from 2024.” On top of that, the recovery fund is a strong incentive for southern European governments to continue to exercise budgetary discipline. “If a government does not follow the recommendations of the EU Commission, there is a risk of the funds being lost.”
The economists do not see the rising interest rates of the European Central Bank (ECB) as a danger. Due to the long maturities of European bonds, the higher interest rates would only weigh on national budgets in two or three years, says Napolitano. Until then, the situation is stable. Economist Kral expects that the interest effect will be limited to two years. The markets are already pricing in the end of rate hikes. A new debt crisis is therefore not to be expected.
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